Emerging markets in South Africa, Dubai and Israel generate
investment interest

By Pauline Larsen

Yield-hungry investors roaming the globe for new income opportunities are finding listed real estate companies in unexpected places.

In Israel, the country’s first REIT, REIT 1 Limited (TASE: RIT1), has high growth in a booming market. In the United Arab Emirates (UAE), the acceptance in Dubai of property ownership by foreigners is lifting the veil on a notoriously closed marketplace. Additionally, in South Africa a lesser-known but well-established listed real estate market is beginning to open doors for international investors.

Of course, investors interested in these emerging markets need a strong tolerance for different types of risk. Limited property rights are a concern for investors in Dubai, unfamiliar listed real estate structures in South Africa defy global norms and Israeli tax treatment of REITs remains burdensome.

However, while harmonization with international best practices is often what prods new listed real estate markets into the spotlight, many investors aren’t waiting around before moving to capitalize on these emerging markets.

Investor Interest

Listed real estate securities have taken hold in Australia, Asia, Europe and North America, and now there is a new wave. Israel, UAE and South Africa are part of the growing worldwide listed real estate phenomenon that has already spread to more than 22 countries, according to Credit Suisse Real Estate Securities Fund.

“Investor enthusiasm will develop in most major European countries and will gain momentum in many Eastern European and Latin American countries as well,” says Lawrence Raiman, managing director and portfolio manager for Credit Suisse. “In fact, the global REIT marketplace is now worth more than $1 trillion.” Raiman says that the global market capitalization of REITs could double in the next few years on the back of capital growth and new issuances.

Since competition for real estate assets in developed economies is intense, investors are seeking emerging markets that offer more tempting growth prospects. “Increasingly, investors are looking for relative value and less competition in previously uncharted geographies,” says Padraig Brown, global strategist at Jones Lang Lasalle.

Rapid growth and tempting yields are a more than acceptable trade-off for the early wave of investors entering emerging listed real estate markets, says Christian Serao of Ernst & Young’s international real estate tax division. “Pioneers go to a new market because of the potential for extremely high growth and the draw of returns. These investors dive into new markets and then others will follow,” he says.

South Africa
Well-Established Market

South Africa has a competitive advantage over other emerging listed real estate markets because it offers interested investors a well-established market.

In 2006, Ernst & Young concluded that South Africa has been a top-performer in terms of total return during the past three years. Impressively, the country achieved this with the lowest level of leverage of all surveyed markets, offering high returns with lower risk. South Africa is included in an increasing number of global REIT surveys, including both the Ernst & Young Global REIT Report 2006 and Jones Lang Lasalle’s bi-annual Real Estate Transparency Index, giving investors the opportunity to assess its comparative performance.

The local market still needs to harmonize its existing listed real estate vehicles with international structures. South Africa’s current structures include a property unit trust (PUT) and a property loanstock (PLS). They are both income funds that derive their income from real estate investments and generally distribute all their profits, but PUTs are highly regulated and limited to borrowing 30 percent of their portfolio value, plus they do not pay capital gains tax. PLS is an equity unit that can borrow without restriction and can invest in other property companies.

However, both of these structures lack REIT elements, says Brian Azizollahoff, CEO of Redefine Income Fund, a hybrid real estate vehicle listed on the JSE Securities Exchange South Africa. Global research generally focuses strictly on PUTs, a focus that Azizollahoff says is limiting, since PUTs represent only 15 percent of the industry’s total market cap.

South Africa is pushing for a REIT structure to attract international investors. Concerns with new REIT markets are often related to untried institutional frameworks or unfamiliar business conditions, according to Chris Conway, director, government relations for Real Property Association of Canada (REALpac). He says that a main concern for investors is the general business environment.

Israel
Growing Capital Market

Conditions are ripe for Israeli REITs. Local experts, such as Amir Biram, partner for British Israel Investments, a real estate investment company, say that the capital market is booming. REITs could raise equity and debt with ease and the economy is seeing growth of approximately 5 percent a year. From a REIT perspective, there’s little development, which means rental growth is looking strong.

“Yields on direct commercial properties are now compressing and are currently at or under 7.5 percent for good properties, as compared to 9.5 percent about three years ago,” Biram says.

However, in Israel’s nascent REIT sector–with just a single REIT vehicle listed on the Tel Aviv Stock Exchange–the tax system is hampering the market. “The tax benefits aren’t there yet,” Biram says. “The setup of a REIT is problematic, because the transfer of properties from a holding company to a REIT is taxable. It’s considered a sale.”

Right now, Tel Aviv-based REIT 1 Limited is the only fully fledged REIT in Israel, although there are approximately four companies poised to grow into REITs in time. Locally, REITs are known as real estate investment funds (REIF), according to Ariel Aven, chairman of REIT 1 Limited.

REIT 1 is just over a year old and already owns NIS 675 million ($16 million) of real estate with an average yield of around 8 percent. The REIT has NIS 311 million ($73 million) in capital and invests in all sectors of the Israeli real estate market.

“We raised our first round of equity in April 2006 and we aim high,” Aven says. “We expect to be able to grow into a multi-billion NIS company in just a few years.”

However, Aven agrees with Biram that the tax treatment of Israeli REITs needs to change before this fledgling market can take off. “The establishment of a REIT and the purchase of real estate is a lengthy process. Real estate companies choose not to sell their properties to a REIT because they prefer to avoid the taxes associated with the sale.”

UAE
A Source of Diversification?

Dubai is an interesting real estate market, precisely because it doesn’t offer a traditional REIT structure, and foreign property ownership is strictly controlled. However, the city is enjoying a development boom, with approximately one-third of its economic growth tied to real estate and construction projects, says Ashley Painter, a partner in the Dubai law firm Clyde & Co.

With capital values in recent years climbing by 30 percent annually and yields starting at approximately 15 percent, Painter notes that European and U.S. investors are beginning to move into Dubai. The appeal is being sweetened by a tightening supply of rental space, which is putting upward pressure on rents. “The shortage of available commercial and retail property for rent is generating very attractive property returns, substantially in excess of the financing costs,” Painter says.

Although foreigners currently make money in Dubai real estate, concerns about property rights remain a consideration. “Foreigners have been permitted to purchase Dubai real estate for only the past three years, but only in designated areas, such as free zones,” Painter says.

However, the majority of land in Dubai is still reserved for locals and Gulf Cooperation Council (GCC) residents. Additionally, international real estate buyers need to consider the lack of a functioning resale market and high mortgage financing costs.

“There’s no real tax advantage to holding property in corporate vehicles, and there’s no REIT vehicle in the North American or European sense,” Painter says.

Overall, how can emerging REIT markets attract more foreign interest? The trick, Conway says, is to sell the local business environment. A modern tax system that is understood by foreign investors, REIT structures that are familiar to investors and sufficient information are all good selling points.

Pauline Larsen is a freelance writer based in Toronto.