This morning, just before the beginning of trading on the Tel Aviv Stock Exchange (TASE), the screens showed an impressive statistic: the Tel Aviv 100 Index had risen 13% since the beginning of the year. A look at the graph of the index shows that this entire rise took place during the past two months, making the rally even stronger.
While the TA-Insurance Index has a return roughly equal to that of the market as a whole, and the TA-Banks Index has risen only 8% since the beginning of 2015, as of now, one sector is standing out and powering the market: the real estate sector. As of this morning, the TA Real Estate-15 Index is up 27% this year, and the mutual funds investing in this sector are the big stars of the investment portfolios to date, if the results of the leveraged funds (high-risk funds that increase their exposure to their assets by using derivatives) are excluded.
Data from the Funder website, which monitors mutual funds and exchange traded funds (ETFs), before the start of today's trading show that the three older funds in the sector - Migdal Nadlan, Analyst Nadlan, and Altshuler Nadlan - have returns of 24-26% this year. These active investment funds charge managing fees ranging from 1.24% at Altshuler Nadlan to 2.5% at Migdal Nadlan.
It is a new fund, however, IBI (4A) SAL Israel Commercial Real Estate, launched only last December, which already manages NIS 155 million, that has posted the best performance this year - a 35% return. The substantial difference between it and its competitors during this period lies of course in the assets in which the IBI fund is investing.
While the funds actively managed by Migdal Insurance and Financial Holdings Ltd. (TASE: MGDL), Analyst IMS Investment Management Services Ltd., and Altshuler Shaham Ltd. hold shares in the commercial real estate sector in Israel and overseas, rental apartments, residential construction, and even building and infrastructure contractors, IBI has chosen to launch a passive fund following the commercial real estate index in Israel: Solactive B-BRE, developed by Nirit Bregman, CPA (Israe), and Dr. Daniel Baraz. The index includes 15 shares, just like the TA Real Estate-15 Index, but most of it is currently concentrated on only seven shares.
Companies that benefit from the interest rate cut
A glance at the holdings of the fund, which charges 0.8% management fees, as reported on the Funder website, shows that as of the end of January, 66% of the fund's assets were held in only three shares: REIT 1 Ltd. (TASE:RIT1), Melisron Ltd. (TASE: MLSR), and Nitsba Holdings Ltd. (TASE: NTBA), with 24% more held in three more shares: Airport City Ltd. (TASE:ARPT), Amot Investments Ltd. (TASE:AMOT), and Bayside Land Corp. Ltd.(Gav Yam) (TASE: BYSD1). Since the beginning of the year, Melisron has risen 50%, while Nitsba, Azrieli Group Ltd. (TASE: AZRG), and Bayside have each risen by 30%, and Amot has gained a "mere" 20%. Gazit-Globe Ltd. (NYSE: GZT; TASE: GZT; TSX: GZT), most of whose business is overseas, and which accounts for a substantial part of the TA Real Estate-15 Index, has gone up only 7% this year, thereby widening the gap between the index for the entire sector and the commercial index for Israel.
Note that the high exposure to a limited number of shares, as indicated by the IBI fund's holdings, increases the risk of investing in this fund, but also bolsters its chances when the real estate sector is strong, with an emphasis on income producing real estate companies having most of the their business in Israel.
Actually, this is just what has been happening in recent months. The main reason for the rally in the sector's companies is the Bank of Israel's interest rate cuts, which have enabled income producing real estate companies to exchange their old debt for new debt at a much lower interest rate, thereby guaranteeing themselves lower financing expenses in the coming years. Even if the income of the companies operating in the sector drops in the coming years as a result of massive building of office towers and shopping centers, the expected drop in financing costs will leave them with the possibility of increasing their profits, even in this situation.
Raising debt at low interest
A look at the dry figures shows that in the first quarter of 2015 alone, the real estate companies raised NIS 5 billion in bonds on the capital market, after raising NIS 15 billion through bond issues in all of 2014. Note that the Bank of Israel interest rate dropped from 1% in January 2014 to 0.1% in March 2015, and the yield to maturity on the corporate bonds of the leading companies in the field fell accordingly.
For example, the Melisron shopping malls company last week completed a giant NIS 930 million bond issue, with the longest bonds issued having an average duration of more than eight years at an index-linked interest rate of only 1.7%-2.3% (depending on the character of the securities for each series). For the sake of comparison, Melisron issued long-term bonds in 2005 at 4.85% index-linked interest, while three years later, the company had to pay 4.7% interest for the debt it issued. Its interest payments are therefore slated to drop by more than half.
Azrieli Group, Israel's largest income producing real estate company, which operates in the shopping malls and office rental sectors, also took advantage this year of the low market returns to raise NIS 623 million in bonds with an average duration of 5.4 years at an index-linked interest rate of only 0.65%. For the sake of comparison, exactly 10 years ago, when Azrieli was still a private company, it issued (through its Kanit Hashalom subsidiary) index-linked bonds for investment institutions at 4.95% interest. These bonds will finally be repaid at the end of the current year.
The interest rate cut helps income producing real estate companies another way by lowering the capitalization rate on future cash flow, thereby increasing the value of the income producing properties that they own. It is also important to stress that in Israel, the companies charging rent link it to the Consumer Price Index, and a rise in this index therefore increases financing expenses, but at the same time also their revenue. With good management, the damage to their bottom line should therefore be minor.
Published by Globes [online], Israel business news - www.globes-online.com - on April 8, 2015
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