Real Estate Investment Funds in Israel 2015

Real Estate Investment Trusts in Israel 2015

Real Estate Investment Trusts (Short – REIT) deal mainly with Income Producing Real Estate. A REIT is a corporation that holds and manages Income producing real estate, such as office buildings, shopping centers, hotels, warehouses, rental apartments etc. A public recognition by the authorities regarding REITs grants them an exemption from corporate tax for any sum that was distributed as dividend to investors.

In practice, the special treatment given to REITs comes with some conditions regarding the holding of real estate properties and distribution of profit as dividends. There are two main types of REITs: The first deals with financial funding in real estate, meaning purchasing loans (mostly mortgage portfolios) from banks or insurance companies, while the collateral for the loan is the real estate property. The second type is stock traded funds that allow the public to invest in large projects of real estate, while avoiding large costs and distributing the risk in their investment portfolio.

Basically, a REIT is a tool that allows relatively small investors to participate in large projects in the field of income producing real estate such as shopping centers, office buildings and others. The main purpose of these funds is to provide a financial instrument with large resources that enable it to invest in large projects and to manage investments, but also has the features of a direct investment in property by private investors. This fact enables a small investor to participate in large projects, and simultaneously protects him by diminishing the risk factors by distributing the investment in many projects at once.

The idea of REITs was created by The U.S Congress in 1960, and since its inception spawned many REITs in The U.S and worldwide. Today there are 204 REITs registered in the Security and Exchange Commission (the SEC), most of them trade on the New York Stock Exchange. They have a combined equity market capitalization of 719 billion dollars. In Israel, since amendment 147 in tax law in 2005, there were founded only two REITs – “REIT 1” in 2006, and “Sela Capital” in 2008, and their estimated asset worth is 4 billion NIS. The main shareholders in the Israeli funds are insurance companies and institutional entities (for example – pension funds).

The Existing law in Israeli legislation:

On August 10^th, 2005 a validation for the existing tax law was decreed, that regarded REITs (Amendment number 147). This amendment defined the criteria for REITs and the terms in which they can operate.

This amendment was a result of the success REITs experienced in The U.S over the years. Similar legislation was made many countries, such asn Japan, South-Korea, Mexico, Germany, France, Australia, Singapore, The Emirates, Belgium, Great Britain, Canada, and recently in Brazil.

The benefits of investment via REITs:

1. REITs give investors, and mainly small investors, a chance to vary their investment portfolio, to disperse the risk while diminishing the business risk and to participate in large projects of income producing real estate, and to diminish the deal costs while doing so.
2. REITs allow small investors to put their money in real estate through a fund, but to be charged with tax as though they invested directly in real estate.
3. Diversity of funding origins with direct funding to the real estate market, as opposed to bank based funding, and reduction of credit in this market.
4. The potential of profits that reach directly into investors’ pockets is large in comparison to other fields, since the law decrees that 90% of all earnings be REITs must be distributed as dividends, unlike regular investments in stock, where in most companies there is no regular dividend distribution and the percentages of dividends are much lower.

Tax Formation:

The main advantage in REITs investment lies in tax. A person that invests in real estate through a company is bound to pay a much larger tax than someone who invests directly in real estate himself. A corporation that invests in real estate must pay corporate taxes (for the income and for capital gains). In addition to that, when the company distributes dividends to shareholders, a tax must be paid for that too. If shareholders want to sell their stocks, they must pay a tax for that as well. REITs enjoy a special status that exempts them from corporate tax, and therefore the investors must pay a tax only when they receive dividends, according to each investor’s financial state. That way the tax is paid by each investor in resemblance to a situation in which they invested in the property directly.

Conditions for REITs according to Amendment 147:

The amendment dictates several conditions in order to recognize a REIT. Section 64A3(1) (headlined: Real Estate Fund) asserts that a REIT must be a company that was incorporated in Israel, and the management and control of its business is located in Israel. Another condition is that the company’s stocks will be issued in the stock exchange no more than 12 months since the company’s incorporation. Listed below are the conditions for REITs as they are written in the Israeli Tax Law:

1. The REIT must meet the demands of this section on two dates of each tax year – June 30^th and December 31^st.
2. The capital worth of real estate assets held by the fund must be at least 75% of all its assets.
3. The capital worth of real estate assets held by the fund must be at least 200 million NIS.
4. The capital worth of real estate assets held by the fund in Israel must be at least 75% of the worth of all its real estate assets (this clause implies real estate assets abroad).
5. The maximum leverage according to which the fund receives loans, including debentures and bonds will be no more than 60% of the worth of real estate assets, in addition to 20% of other assets.
6. At least 90% of the profits accumulated by the fund must be distributed as dividends for shareholders.
7. 50% or more of the control of the fund must be distributed between more than five different investors.
8. Failure to comply with any of the rules set in this clause will result in an enlarged tax rate of 60%.

New Amendment Proposition:

As mentioned before, since amendment 147 was decreed in 2005, there have been only two REITs founded in Israel – “REIT 1” in 2006, and “Sela Capital” in 2008. The main reason for that is the strict legislation and conditions listed in amendment 147 that caused investors to hesitate and eventually leave the REIT field. Thus, the amendment hasn’t lived up to its original purpose, the refusal of private investors and households to invest in real estate indirectly and entrepreneurs that have taken the idea and issued it to the public.

Today there is a new amendment proposition that means to make the REITs more accessible and to encourage entrepreneurs and investors to get into this field. Here are a few of the new propositions regarding REITs:

• The owner of the trust fund will be able to transfer assets to the fund without needing to pay land appreciation tax until he sells his stocks or the assets themselves. This proposition will remove the tax barrier that prevented many entrepreneurs and contractors from transferring assets into the REITs.
• Another interesting proposition states that not only income producing real estate will be allowed in a REIT, but also rental apartments, not only that, but an idea is being considered to start a new kind of Trusts specifically for rental apartments. This change is significant not only for the REITs (Right now The Funds can only invest in income producing real estate), but also for the Israeli rental market that is desperate for new housing solutions, which can be provided by the REITs. This initiative is approved and supported by many authorities in Israel, such as the Tax Authority, the National Economy Board, the Ministry Of Finance, the Ministry Of Law, Israeli Securities Authority, and others. For REITs that specialize in rental apartments, there is a consideration to broaden the time period between their foundation and issuing them to the public in the stock exchange to 36 months, due to the complications that are involved in that kind of funds.
• Taxation – the new law proposition states that in order to encourage investors to put their money in REITs that invest in rental apartments, stock owners in those companies will be taxed by only 20% on profits made from the REITs.

Once those changes officially take place, the door will be opened for REITs investment in Israel, and in our opinion, the most profitable of all will be REITs that specialize in rental apartments, since they are encouraged by the government.