Safe as Houses

Real estate investment can be conservative, says DS-Apex

Lately Victor Shimrich has been hearing it from not a few institutional investors: They wouldn't touch real estate stocks with a barge pole. They shouldn't generalize, says Shimrich, co-CEO of the DS-Apex investment firm. "They should distinguish the experienced and promising companies from the bubble companies."

Indeed, market players seem to lump all the real estate companies into a single amorphous mass without making distinctions. That led share prices of solid companies to plunge by as much as 20 percent, says Shimrich. That in turn has created opportunity to get into these firms even though the Real Estate-15 index can be expected to underperform the Tel Aviv Stock Exchange's other leading indexes this year, and in 2008 as well.

Tel Aviv-based DS-Apex thinks investors should target real estate companies that distribute dividends. Equity analyst Dror Parsa explains that buying shares in companies that pay dividends is like buying an apartment: You're assured some returns in any case and there's the potential for some upside if the share price rises. Dividends help investors weather spasms of negative sentiment in real estate, exactly as has been happening since the subprime meltdown in the United States.

Shimrich and Parsa recommend five particular shares, which can be split into two sets. One represents companies that operate mainly in the local arena, which hasn't been affected by the subprime mortgage crisis and whose future is looking robust as well. The other is Israeli real estate companies with powerful managements in whom the analysts have faith; people who can guide the company through the rough times and make it stronger.

The first group of local players includes Bayside (Gav Yam), Melisron, and REIT-1. The second includes Gazit Globe and Alony Hetz.

Target price: NIS 70, a premium of 17 percent over its share price on the TASE.

Company: Melisron is the yield-generating assets arm of the Ofer Brothers. It operates and manages two shopping centers: Hakiryon, in Kiryat Bialik, and Renanim in Ra'anana. Recently Melisron finished building a Cinema City complex at Kiryon.

The two centers generate most of Melisron's income. The company is mulling various options for diversification and has already taken the first step by establishing a subsidiary, Minron, which will be building housing in Budapest, Hungary.

DS-Apex says that for years Melisron has been steadily increasing its revenues from both centers, thanks to intense demand for space in the malls. The northern center faces little competition and the one in Ra'anana is well situated. Parsa predicts that Melisron's rental income will continue to climb in the long run, but the trend will be slow and modest. Also, the centers boast 99 percent occupancy, and some of the tenants have long-term contracts. Still, Parsa sees potential in expanding Kiryon and building rights in Renanim.

Melisron is reliable, operates at low leverage levels - its bonds bear an AA rating and its equity/balance sheet ratio is a sane 50 percent, one of the best in the industry. Its cash flow has been steady over the years; the two assets generate NIS 240 million a year.

Parsa thinks that one of Melisron's main virtues is dividends. The company has no formal dividend policy, but during the last four years it has given shareholders NIS 250 million, translating into returns of 7 to 8 percent a year beyond the share price's performance.

Target price: NIS 1,000, a premium of 11 percent over its Tel Aviv share price.

Company: Bayside is one of the oldest and biggest real estate companies in Israel. It initiates, plans, develops, constructs (through subcontractors), leases, maintains and manages industrial parks, offices, commercial space and parking lots, as well as storage facilities. Bayside, which belongs to Nochi Dankner's IDB group through subsidiary Property & Building, also builds and sells housing.

Parsa notes that for better or worse, Bayside operates solely in Israel. The company leases its properties to A-list tenants through long-term contracts, so even if Israel's economy suffers setbacks, Bayside should barely feel the effects. Like Melisron, Bayside has no declared dividend policy, but in recent years it has distributed hundreds of millions of shekels to investors and Parsa doesn't see it stopping. Dividend returns have amounted to 5 to 7 percent a year.

Target price: NIS 8.80, a premium of 26 percent over its TASE share price.

Company: REIT-1 belongs to the Excellence-Nessuah group. It's Israel's first and so far only real estate investment trust. Any investor can get in and thus become a property owner, a bit of one, without the headaches (collecting rent from tenants, maintaining the property, taxes, repairs and so on). The assets are diversified and the risk is limited to the scale of your investment. There are also certain tax benefits to investing via a REIT and it's a relatively conservative investment because the fund has undertaken not to exceed a certain level of leverage, namely 60 percent.

Since its establishment REIT-1 has acquired eight assets for NIS 800 million. It expects to net NIS 65 million a year, representing average returns of 8 percent.

As a REIT, the company is committed to distributing at least 90 percent of its net profit. When it does, its dividend yield should reach 7 percent. If it distributes more, its yield could reach 10 percent.

The common factor to Melisron, Bayside and REIT-1 is that their dividend yield is higher than the yield on their bonds. Melisron shareholders get around 7 percent compared with 4.5 percent on the company's bonds. Bayside backers get 6 percent versus 5.2 percent on the bonds and REIT-1 stockholders get 7 percent while the bonds trade at a yield of 5.5 percent. Note that the dividend yields comes on top of the return on the share.

In short, Parsa sees no reason to invest in the companies' bonds: The share served as a conservative investment, with assured returns and a potential upside, in his view. But never forget, he cautions investors, that conservative doesn't mean risk-free, and the rights of the companies' bondholders prevail over the rights of shareholders as creditors.

Target price: NIS 58, a premium of 14 percent over TASE share price.

Company: Gazit Globe, which belongs to the TA-25 index, is Israel's biggest company in yield-generating property. It owns 454 commercial assets (413 active malls, 27 under construction, and protected-tenancy housing with about 1,000 apartments). The company operates in the southern U.S. through Equity One, which is a REIT traded on Wall Street; in Canada via First Capital Realty, listed in Toronto; in Europe through Helsinki-listed Citycon, and in Israel and Europe through other subsidiaries. It has also started operating in India.

Parsa sees Gazit Globe as a strong company with strict financial discipline. The fingerprints of management are clear in its policy of choosing investments: The company has been growing fast and consistently, but cleverly, says the analyst. Its credit rating is good and its leverage is reasonable, giving it good access to the financial markets.

Buying shares in geothermal-energy company Ormat Industries and entering into India attest to major changes in policy, Parsa explains. Typically, Gazit Globe is diversifying into less conservative areas such as alternative energy, gradually and carefully, learning the subject in depth as it goes, he says.

Parsa also sees great potential in the new growth drivers and believes that Gazit Globe's experience will keep its risk level low in the years to come. Moreover, the company was largely spared the effects of the subprime meltdown; if anything, it has continued to grow. Gazit Globe won't be immune if the crisis continues to build up momentum, Parsa warns, but he believes in its management and in the company's strength in taking advantage of opportunities.

Gazit Globe does have a declared dividend policy which generated dividend yields of 2.2 percent in the last year. Not much, but DS-Apex also has faith in the potential upside of the share.

Target price: NIS 20 (not including potential in India), a premium of 5 percent over TASE share price.

Company: Alony Hetz makes long-term investments in yield-generating assets here and abroad. It leases out its properties through long-term contracts. It owns 80 percent of Amot Investments, which owns 90 properties in Israel and two overseas; 7 percent of Equity One (see Gazit Globe); 15 percent of FCR (see Gazit Globe); and 14 percent of PSP, a Swiss company.

DS-Apex lauds Alony Hetz's management for its record and proven growth strategy, which has resulted in consistent growth over years.

Parsa believes that Alony Hetz's entry into India, Switzerland and other markets, most recently Sweden, will reduce risk through geographic diversification.

Alony Hetz trades at a discount to its net asset value, says Parsa, and there's all that growth potential not factored into the share price.

Regarding dividends, from 2004 Alony Hetz distributed more than NIS 400 million, resulting in a minimal dividend yield of 3 percent. It also handed out dividends on special events such as its massive divestiture of assets in England, or the flotation of Amot. Those kicked up the dividend yield to 8 percent in those years.