The third quarter of 2022 actually started well for the largest yielding real estate companies in the economy. The companies operating in Israel, such as Geb-Yam, Amot, Azrieli and Melisron, continued to show high profits in the third quarter, thanks to an increase in rents and positive valuations of properties, and this despite an increase in expenses The funding is due to the increase in inflation and interest in the economy.
Even when Haim Katzman’s global G City (which is spread over four continents) posted a quarterly loss of NIS 16 million, the investors treated this as a one-off matter. G City (formerly Gazit Globe) is a leveraged company, which suffered in the third quarter from a sharp jump of 27% in financing expenses and the lack of substantial adjustments in operations outside of Israel.
That was until Wednesday of the week, when everything changed. That morning, the real estate investment company Aloni Hatz presented a surprising loss of NIS 102 million in the third quarter, as a result of a huge negative valuation of some of its assets in the US.
The company emphasized that from the beginning of 2022, its yielding assets in the USA suffered a decrease in value of 279 million dollars, which resulted in valuation losses of NIS 417 million. These negative valuations were explained by raising the discount rate of the projected cash flow in some of the assets.
The discount rate is the interest rate, or rate of return, by which a series of future payments are capitalized into a single present value, which is the value of the asset. The higher the discount rate, the lower the present value of the future payments and thus the value of the property.
Aloni Hatz is considered by investors to be one of the high-quality real estate companies on the stock exchange. It operates with relatively low leverage, and controls two Israeli public companies: the firm Amot Investments and the renewable energy company Energix.
A sharp decrease in the volume of commercial real estate transactions
In addition, Eloni Hatz owns a private real estate activity in the USA and the UK. In the USA, it operates mainly in the field of offices in the cities of Washington, Boston and Austin, through investment in the private companies Carr and AH Boston.
These investments absorbed the reductions in value, due to the increase in the capitalization rate of the assets, which is the result of several factors. The two known ones are the increase of the base interest rate by the Federal Central Bank (Fed) from 0%-0.25% at the beginning of the year to the current range of 3.75%-4%, and this is due to the jump in inflation in the US to the current rate of 7.7%.
Along with them, Aloni Hatz emphasized two other factors: the Fed’s appeal to the commercial banks to reduce their exposure to commercial real estate, and the sharp decrease in the volume of commercial real estate transactions along with the increase in the price of debt demanded by other financial lenders as a result. All of these are economy-wide factors that should affect all yielding real estate companies operating in the US, and possibly beyond.
Azrieli Tower Sharona Tel Aviv / Photo: Eyal Yitzhar
The investors in the Tel Aviv Stock Exchange were surprised as mentioned, and responded by selling the shares of the yielding real estate companies. The Tel Aviv Real Estate Index fell by 3.2% on Wednesday, and apart from the Aloni Hatz share, which fell by 7.6%, other stocks with a high exposure to the US, such as properties and construction (down by 7.8%), which holds In the HSBC office tower in Manhattan (which it is working to sell after reducing its value by 16% in the past year, to $720 million). On Thursday, however, the industry’s shares traded in a positive trend.
“The Fed signaled to the banks to stop financing real estate”
The questions that the investors asked themselves that day concerned the scope of the threat to the activities of the Israeli real estate companies. Does this belong only to the companies operating in the USA, or also to those operating in Israel and Europe? And is this a threat that concerns the entire sector, or only certain areas, chief among them the office companies?
The conference call held by the CEO of Aloni Hatz, Natan Hatz, and the VP of Business Development, Moti Barzilai, did not allay the concerns. On the contrary, the two sounded concerned about the situation in the market and especially about what is expected to come in 2023, and the exit from the crisis should, in their view, come only in 2024.
“All in all, so far we have had an excellent year operating in Israel. Emot and Energix are in excellent condition,” CEO Hatz opened the conference call. B, not in England. The volume decreased greatly for two reasons. One reason is that the Fed signaled to the banks to stop financing real estate in terms of risk levels, and you can say that they have completely exited the market. Therefore, if the banks finance anything, it is at very high price levels.
“As soon as they left the market, it pretty much stopped. As a result of the rise in government bond yields, the current interest rate went up, so the appraisers decided to raise the cap rate in the US by 0.25%, and of course that He hit us with Carr’s and AH Boston’s adjustments to a large extent,” explained Hatz. Beyond that, he emphasized, “I don’t think this is the end. I suppose that towards the end of the year there may be some more downgrades. However, the cash flows and the cash flow profitability presented by the private companies in the US and the UK have actually been maintained, or increased, and in the end this What interests us,” said Hatz.
Barzilai added that in the US we are already feeling a decrease in the active demand of high-tech companies, which have been one of the biggest engines of the office market there in recent years. This phenomenon, it should be noted, has not yet been recorded in Israel, and the big question is whether this situation will not change next year. in which a sharp drop in economic growth is expected in the world with the possibility of entering recession in many countries.
Barzilai also pointed out that the REIT funds have stopped the beginnings of construction in the US, and are only busy completing projects whose construction has already begun: “The only buyers who circulate in the market today are equity buyers, that is, those who purchase properties without leverage, and this alone reduces the number of transactions and makes it difficult for appraisers to make appraisals the value of the assets”.
On the other hand, he emphasized, for the moment we do not see REIT funds and strong real estate companies in the US getting into difficulties due to covenant violations as a result of coverage ratios of the increased interest rate. The reasons for this, according to him, are that most of the players have defined the debt as fixed debt, and the banks are not interested in taking over a large amount of assets, as they did in 2008.
The main reason for raising the discount rate, then, is the increase in the risk-free interest rate, which jumped at a sharp rate this year in just six months. Today the yield on the US government’s ten-year bond stands at 3.7%, after at the beginning of the month it stood at an even higher level of 4.2%.
For the time being, trading in futures contracts on the federal interest rate on the Chicago Stock Exchange represents further increases in the interest rate at a total rate of 1.5% until the end of March, which will bring the interest rate in the US to a range of 5%-5.25%.
In Israel, the Bank of Israel interest rate increased this week by 0.5% to 3.25%, and another increase of 0.25% may be the last in the chain, according to a forecast published by the Bank of Israel’s research department in October. The ten-year shekel government bond is currently trading at an annual yield to maturity of 3.2%, that is, 0.5% less than the equivalent US government bond.
Will all this affect the appraisers in Israel?
The big question is, as mentioned, whether this will affect the appraisers in Israel, when they evaluate the value of the local companies’ assets at the end of 2022. According to Barzilai, the work method of the appraisers in the US is different from that in Israel, and so are the results.
He also emphasized that the discount rate in the few transactions that were nevertheless carried out this year in Washington, DC indicated an increase to 5.9% today, compared to 5.1% at the beginning of the year. In Israel, most companies present a weighted discount rate of more than 6%, and many of the transactions in yielding assets that have been made in recent years have not fallen below this level.