By Jada A. Graves

Just two years ago a group of real estate investment professionals, leading Israeli lawyers and a forum of approximately 25 real estate investment companies in Israel provided their respective opinions to the Israeli Ministry of Finance on a proposed structure for REIT companies and legislation in the country. Now, the new year will bring the commencement of "Keren," or simply put, Israeli REITs, as on July 25, 2005 the Israeli parliament approved legislation for their creation. REITs will become effective Jan. 1, 2006.

The structure approved by the parliament, which is called the Knesset, is formatted differently from earlier drafts the Ministry of Finance proposed. "At the beginning, [the Ministry of Finance] tried to do something very different, but due to many comments from Israeli real estate professionals and others, they eventually changed the legislation to be as it is," says Ariel Aven, executive vice president of Gazit-Globe, Ltd, the leading real estate investment holding company in Israel.

Aven is the head of the forum of real estate companies that met with the Ministry of Finance. The forum, loosely translated from Hebrew to mean, "The Public Real Estate Investment Companies Forum," has voluntary participation, and meets occasionally to discuss the real estate market, as well as to assist in providing insight into REIT legislation.

In 2003, the Israeli Ministry of Finance also asked Chaim Katzman to suggest means of regulating the country’s real estate industry. Katzman is the chairman and CEO of U.S.-based Equity One, Inc. (NYSE: EQY), as well as the principal shareholder and chairman of the board for Gazit-Globe. At first, Katzman studied European property company models, but says that his experience with U.S. REITs influenced him to advise the Ministry to adopt a similar format.

According to Aven, the biggest difference from the original draft legislation is taxation. Aven says companies structured as REITs would have had to pay company taxes, with each shareholder then entitled to compensation. "We tried to explain to them that it would be very complicated to operate like that and very difficult to get that kind of REIT to work, and eventually they were convinced that it had to be done differently," he says.

The approved REIT must be a public company no more than a year old, with capital gains tax of 25 percent to 34 percent applied to the transfer of appreciated property, as well as a purchase tax of 0.5 percent. There are two significant differences from U.S. REITs—first, there is a statutory limit of 60 percent on the amount of leverage Israeli REITs can assume, and second, Israeli REITs must have at least 75 percent of their portfolio invested in domestic real estate assets. Other provisions include a mandatory listing on the Tel Aviv Stock Exchange (TASE), at least 100 shareholders in the company upon registration, and no more than five of the investors can directly or indirectly own more than half of the REIT shares.

What remains to be determined is the impact Israeli REITs will have on existing public real estate companies that cannot re-establish themselves as REITs. Aven says there are currently at least 20 real estate companies in Israel, including Gazit-Globe, and 10 to 15 of these companies have mostly domestic investments. None of these companies are less than a year old and are therefore not permissible to adopt a REIT structure.

Katzman estimates that local real estate investment firms currently own about 25 percent of the country’s commercial real estate. The largest corporate owner of retail real estate in Israel is the Azrieli Group, with seven enclosed malls. Located in the Tel Aviv area, this private company is one of the strongest commercial groups in Israel, with investment interests in the U.S. and Canada as well. Katzman started Gazit-Globe in 1991, later expanding its reach to North America through the formation of Equity One. In 1997, Katzman expanded again to create the Canadian arm of the corporation, First Capital Realty, Inc. (TSX: FCR). Last year, Gazit-Globe acquired a 40 percent stake in Citycon, a Finnish company listed on the Helsinki stock exchange.

"Gazit-Globe is constantly exploring opportunities to acquire more holdings in real estate companies in other countries without competing with its own," Katzman says.

Those Israeli real estate companies with primarily domestic investments could face competition for property once the REIT is off and running, Aven says.

"Existing companies have two options. They can either stay as they are and have some kind of disadvantage, or sell all their portfolios to a REIT and take the entire tax consequences of such a sell. Therefore, most of the existing public real estate companies see the legislation as something that hurts them,"he says.

However, this predicted effect will not happen in the immediate future. "New companies established as REITs can start buying real estate from scratch. It might take years for those companies to become large enough to attract large retail ownership," Aven says.