It may be an odd quirk of the global capital markets, but Israel has become a major centre for US investors and developers to raise cheap finance. As a result, with the substantial savings they are making, UK and European borrowers are also now eyeing the opportunities presented by the Tel Aviv Stock Exchange.
Bank of Israel research shows $8.3bn of real estate backed bonds were raised in Tel Aviv between 2014 and 2016 and in the first quarter of 2017 a further $500m.
Instead of taking out mezzanine financing that sits at a loan-to-value position of 65%-70% with a detachment point of 40%-50% and typically paying 12%-15%, borrowers are issuing bonds in Tel Aviv priced at around 3%-7% (plus one percentage point for hedging) that serve the same purpose. It allows medium-sized companies the opportunity to borrow in chunks typically of $50m-$250m at rates often reserved for only the very largest players.
Tel Aviv-issued bonds present a potentially attractive alternative for asset rich, cash poor developers looking to bring in a joint venture partner and sacrificing substantial returns on investment when looking to expand their portfolios. The cash can also be used to refinance existing, expensive mezzanine debt if it is in place.
Israel’s major institutional investors are short of sufficient domestic opportunities to deploy the ever-larger pots of cash they have, with savers being forced by government to put more into their pension pots as time goes on. As a result the bonds provide a rare opportunity for them to gain exposure outside of Israel through their own bourse.
The first such issuance was undertaken by New York developer The Leser Group in 2008 and awareness and credibility grew in 2012 after Joel Wiener’s residential business Pinnacle Group started using TASE, since raising more than $500m.
We have built something everyone knows in the US, it is very much connected and there are big Israeli companies issuing bonds against real estate in Germany. The next step is for European companies to do it.”
The trend has accelerated since 2014 and following in their footsteps have been renowned developers including Related, which financed part of its Hudson Yards development in New York with TASE bonds, KBS Strategic Opportunity REIT, Extell Development, Wharton Properties and Moinian Group.
Israeli companies with subsidiaries and interests in Europe such as ADO Group, Brack Capital Group and Summit Real Estate have also bought property in Europe using TASE bonds.
“We have built something everyone knows in the US, it is very much connected and there are big Israeli companies issuing bonds against real estate in Germany. The next step is for European companies to do it. We are talking to two UK owners now and we are also exploring Australia,” says Gal Amit, co-founder of Victory Consulting Group, who initiated and structured the Leser Group’s pioneering issuance.
The buyers of bonds are already comfortable with issuing debt held against assets outside of the US owned by Israeli companies and they are eager to buy into similar issuances.
“It is very important for the risk profile of our funds and the ratings they are given by banks to have exposure to different geographical areas – it is a major factor,” says Gil Musabi, chief of research and strategy at investment house and bond buyer, Excellence. “More European property exposure is something we and all institutions are looking for and having more companies issuing bonds would help us do this.”
How to issue a bond on the Tel Aviv Stock Exchange
Most commonly a new tax-efficient BVI company is formed into which assets are placed. Each property will likely already have asset-specific senior financing secured against it and rank above any bonds issued. The bonds are secured against the new company on a corporate level, against the entire portfolio it holds, in order to diversify risk.
“With normal mezz a borrower is paying double digits and it is only against one asset. The magic here is you have at least five or six assets in the company and diversified risk for the lenders,” says Tzahi Sultan, chairman of Discount Capital, the underwriter which managed the distribution process of 45% of Israeli offerings last year.
An appropriate portfolio is identified typically in conjunction with a local specialist consultant or boutique investment bank and the envisaged structure of the bond will be thrashed out.
An auditor must also be engaged as well as a local law firm that will work in conjunction with a law firm and valuer based in the location of the assets. A prospectus is then created and underwriters, which do not actually guarantee the bond themselves, are then taken on that make indicative agreements with bond buyers. These conversations shape the ultimate pricing and rating that the bond will be issued at in order to be successful. The process usually takes four months.
The classic client will be someone with income-producing assets that has deployed capital three or four years ago, seen growth, but its capital is now locked up.
Once the issuance has taken place the borrower receives the cash and must provide quarterly reports on the underlying property. The bond, as well as having a coupon, is tradeable should investors wish to get out, although many are long-term investors looking for yield that tend to retain them. Pricing of the bond will go up and down dependent upon any perceived change in the likelihood of the borrower being able to pay back the loan, the performance of the assets and the overall market desire to invest in such real estate debt products compared to other opportunities.
The bonds, which typically have terms of five to seven years, carry amortisation conditions and usually after the second year borrowers must pay back around 25% of the loan. In order to meet these conditions it is important to have an appropriate portfolio, (see below).
What portfolio is best to raise a bond on TASE against?
Typically a portfolio should have a large enough number of assets to diversify risk, usually a minimum of five or so. It will have a total value of at least $300m, otherwise the circa 20% of the total value being borrowed does not justify the cost and effort of the process, nor will it be substantial enough to attract investment. If new prospective purchases have been identified that will be bought using the cash raised, these can also form part of the underlying collateral.
“The classic client will be someone with income-producing assets that has deployed capital three or four years ago, seen growth, but its capital is now locked up. They have identified new opportunities, have the capital on paper but not the cash to purchase and progress their next projects,” says Eyal Jedwab, joint chief executive of Israeli investment bank, Radhan.
The portfolio should not have existing leverage of more than around 50%, otherwise adding another 20 or more percentage points will mean the borrower may be perceived as taking on too much debt by the bond buyers.
In order to service the debt and start amortising after the second or third year, the ideal portfolio will have both a combination of steady income and value-add opportunities that have upside potential.
In order to amortise the loan the borrower can use any combination of:
■ Excess income over and above that used to service the loan
■ Cash released through the refinancing of an individual value-add element of the portfolio that has progressed successfully through a business plan
■ A complete refinancing of the portfolio either through a new bond issuance or traditional lenders.
Dependent on market conditions, later bond issuances by the same company will generally be priced lower than initial issuances, as the market becomes more familiar and trusting in the borrower.
Relative ratings – the pricing “loophole”
Israeli bonds usually achieve lower pricing than they would if it was possible in the US or European countries. As well as the weight of domestic buyers with limited home-grown opportunities driving rates down, Israel’s lower sovereign credit rating is also a major factor.
US government bonds are rated by Moody’s at the best rating possible – Aaa – while Israel’s have the third-best rating at A1, (with the UK in between at Aa1). However, Israel has its own domestic ratings system, that includes an “IL” label, which effectively rates its own government bonds Aaa as they are the safest available on TASE and rates other bonds relative to them. As a result, a company that listed a bond in the US with an A2 rating would probably achieve an Aaa IL rating on TASE and most likely achieve a saving of several percentage points on its debt.
Why are US investors so attracted to TASE?
The all-in cost of TASE bonds compared to mezzanine financing makes them a tempting proposition for investors all over the world. However, as well as cultural familiarity and migration between the two nations, certain practical financial factors make it particularly attractive for borrowers in the US.
■ In the US the corporate bonds market is dominated by huge conglomerates and tech giants. Medium-sized firms raising $50m or $100m, as is possible on TASE, is unthinkable.
■ The US GAAP accounting method means that property values are fixed against initial purchase prices when undertaking borrowing, even if substantial value has clearly been added. This means leverage levels can be substantially restricted.
For example, a property may be bought for $100m with $50m leverage – a 50% LTV ratio. If market conditions and asset management take the property’s value to $200m in the open market, the owner cannot refinance in the US with a $100m loan, maintaining 50% gearing based on open market value, as it will be perceived to be at 100% LTV based upon the initial purchase price and book value. When issuing bonds in Israel, the portfolio is valued using the IFRS method commonly used in the UK and Europe and the higher open market value meaning restrictions on leverage is lessened.
■ Borrowing rates are higher in the US than in parts of Europe so the differential with rates achievable on TASE makes bond issuances even more attractive.
Urbancorp – a harsh lesson learned
The reputation of the Israeli bond market took a substantial hit in April 2016 when Canadian developer Urbancorp filed for bankruptcy having successfully issued a $47.6m bond only five months earlier. The price of the bond subsequently collapsed, trading was ceased and a restructure undertaken. Bondholders accused Urbancorp of breaching disclosure obligations surrounding disclosure of its existing debt but the incident was an embarrassment for TASE and the institutions that bought bonds, highlighting the need for comprehensive due diligence. The market gained the confidence to start issuing bonds to overseas developers again after a three month hiatus, but Urbancorp has shaped a more cautious and mature attitude towards issuances than existed previously.
EG is media partner for UK Israel Business’s proptech delegation to Tel Aviv in January 2018. For more information and details on how to attend, visit www.israelproptech.co.uk
To send feedback, e-mail david.hatcher@egi.co.uk or tweet @hatcherdavid or @estatesgazette
