With the Israeli economy almost at a halt because of the measures taken to combat the coronavirus outbreak, stock indices on the Tel Aviv Stock Exchange have plummeted in the past few weeks, among them the indices of real estate stocks. The declines presumably create long-term investment opportunities.
Value Base senior research analyst Shay Lipman has published a survey of the Israeli real estate market, covering separately commercial real estate, offices, logistics, and residential real estate.
Lipman writes that shopping malls look like the main casualties of the coronavirus crisis as far as real estate is concerned. Their closure means loss of revenue from rents. Most mall owners expressed readiness to switch to a revenue model of a percentage of store turnover for the foreseeable future, but with the malls shut, turnover is zero. An indirect but possibly even more damaging effect of the crisis is that tenants will go out of business. "In our view, several fashion chains will not be able to withstand the damage in this period without substantial indemnity from the state, and will cease to operate, which will lead to a decline in occupation rates.
"Leisure, which has become an important part of the mix at shopping malls lately, will cause a severe hit, especially since many tenants in this field are new to the malls and had to make large investments in fitting out the leased units, investments that have still not paid themselves back.
"Above all, of course, is the fact that high unemployment will mean that the public has less disposable income, leading to a decline in turnover and making life even harder for the tenants, who more and more will demand a switch to a percentage of turnover rent model. Open shopping centers will be less affected in our view, because the burden on tenants is lower, as is the rent per meter in absolute terms.
"Conservative exposure to commercial real estate should focus in our view on open shopping centers or commerce in main streets." Recommended stocks are Big, Rani Zim, and Lahav.
The risk in the office sector will come from an economic slowdown. "Periods of recession are characterized by maintenance of what there is and cutbacks rather than moves to new offices," Lipman writes. "The office sector enters the crisis with high occupancy (over 95%) and leases averaging five years, so that every year 20% of the leases are up for renewal. In the short-term, there will be downward pressure on rents when leases are renewed.
"The office space market in Tel Aviv has enjoyed high demand from technology companies in the past few years. We see this demand moderating. In addition, the market is saturated with new construction due for occupation in 2020-2021. When tenants shift to their new premises, it will become difficult for the properties that they leave to maintain high occupancy, and this too could put downward pressure on prices. We think that new developments that have not yet made many lease contracts and that are at the excavation stage or car park construction only, will be frozen for the time being."
As far as shared workspaces are concerned, Lipman says that the damage will depend on the duration of the crisis, but changes in density levels and regulations in this area that might be introduced after the crisis is over could have a decisive effect.
Bottom line: Conservative exposure to office real estate should be via the real estate investment trusts, Reit1 and Sela Real Estate (low exposure to development, reasonable leverage, and unencumbered assets), and through investment in Adgar and Dorsel, which are traded at low p/e ratios of about 0.5 and 0.7 respectively.
According to Lipman, logistics is the sub-sector that will be least affected by the situation, and it may even strengthen. The sub-sector's strengths remain, and are even growing: low rents per square meter, adaptation of logistics centers to customers, massive investment by customers in the properties (fit out usually costs more than construction). "Above all, changes in consumption habits leading to more online purchasing could boost demand for new logistics centers. Most contracts in this area are long-term," Lipman writes.
Bottom line: Conservative exposure should be through investment in Villar and Mega Or. Allied exposure could be through investment in IES Holdings, whose market cap reflects a price of less than NIS 1.5 million per dunam (quarter acre) at Palmachim Industrial Park.
On residential real estate, Lipman writes: "The good news is that this sub-sector is still defined as vital to the economy, and work is permitted, and continues at most construction sites. Since 8% of Israel's product arises from this sector and supporting industries, residential real estate represents a significant element in GDP.
"Nevertheless, the sector is characterized by a great deal of regulation and government intervention, and faces a challenging period. The substantial rise in unemployment will lead to a fall in demand for homes, and to the freezing of plans for moving up-market, which are the industry's main growth engine. The paralysis at local authorities will mean delays in obtaining permits, and the fate of the Buyer's Price program seems to have been sealed because of its high cost, which the state is unlikely to be able to continue financing.
"Home prices will probably not fall significantly in the short term, because the decline in demand will meet a decline in supply in the shape of a reduction in construction starts."
Bottom line: Conservative exposure to this sector should be through financially sound residential real estate companies with high capitalization, reserves of land, and a rate of sales higher than units under construction. Companies answering these criteria are Dimri, Prashkovsky, and Dunitz.
This article should not be regarded as containing sufficient information for the purposes of buying the securities and/or other assets mentioned in it, and therefore no investment decision of any kind should be made on the basis of this article alone. This article does not in any way represent advice on buying, holding or selling securities, and certainly does not take into account the position and particular needs of each person. Therefore, readers of this article cannot assume that making an investment while paying regard to what is stated in it will yield profits of any kind.
Published by Globes, Israel business news - en.globes.co.il - on March 30, 2020
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