Why Harel's Clients Got an Imaginary Mall

On Wednesday the dollar sank to a new low and share prices rose to new heights in Tel Aviv. People strain to remember the last time yields on Israeli government bonds sank so low. Anybody buying a long-term fixed-income bond today is locking in future returns at 5.1% a year for ten years. Back in 2002, the equivalent yield was 12% but nobody was buying.

The macroeconomic stats coming to light explain why the shekel and stocks are so strong. Simply, Israel's economy is growing at a healthy pace. In March the government ran a surplus, and posted an 11% increase in tax revenue. The government's income is higher than its expenditure.

Yet some feel that it's just the beginning. Almost unnoticed, on Saturday night before the Seder, Harel Insurance Investments (TASE: HARL)  announced a new real estate deal carried out on behalf of its profit-sharing policies (bituach minahalim).

What was the deal? Harel bought the Givat Shmuel mall from the construction company Gindi for NIS 120 million.

Thing is, at present, Givat Shmuel has no mall. Did Harel buy, on behalf of its customers, something that doesn't actually exist? Yes, it did. The mall is under construction and should be finished sometime in 2008.

It is not that somebody at Harel went mad. The acquisition agreement is contingent on Gindi completing construction and presenting lease agreements. Assuming all that happens, the deal reflects a rate of return of 8.4% on the investment (12 times annual lease income).

What Harel did is carry out a financial deal (for returns), not an entrepreneurial deal. From its perspective, the transaction locks in a rate of a return, starting from a year's time, when the thing is built.

We may conclude that the Harel people believe they'll have difficulty finding a similar 8.4% rate of return in a year's time. They believe that asset prices will keep climbing and returns will keep falling.

Gindi can also be pleased. It has leased 80% of the space in the mall to banks, fashion chains, cafes, a supermarket and a drugstore, and now it's sold the whole thing lock, stock and barrel, and made its profit. Even before receiving a single shekel from Harel, it can go to the bank and borrow money for its next project.