Globes, Raz Dumb, 25.02.2020
In recent years, there has been a significant gap between the pricing of capital-yielding real estate companies and their equity. This is mainly due to the stability in discount rates used by valuers, despite the significant change in the macro environment and interest rates.
In my estimation, given the expectation of a continued low interest rate environment, valuers are expected to slightly reduce the discount rates they use, with Amot Investment Company's report last month being the first swallow - and many companies will make significant valuations in the coming quarter. Amot's initial report on revaluation earnings reflects, in my estimation, a 0.3% -0.4% decrease in the company's average discount rate. The real discrepancy between the average discount rates in the financial statements of real estate companies and the discount rates embodied in their pricing in the capital market is 1.5% -2%.
Therefore, despite the expected change in the forthcoming reports, I believe that even after the upcoming revaluations, the reports are still far from showing the true fair value of real estate companies' assets.
A few weeks ago, Amot Investments reported that, according to preliminary indications, it is expected to record revaluation gains in excess of NIS 500 million in the fourth quarter of 2019, mainly as a result of a decline in discount rates for the company's assets. According to Leader Preliminary Capital Markets, these revaluation gains reflect an absolute 0.3% to 0.4% drop in the company's average discount rate, which stands at about 7.01% as of the third quarter of 2019.
Belider estimates that a similar trend will characterize the reports of the other sector companies, and that in the next quarter, the companies will show revaluation gains of hundreds of millions of shekels. The chart presented with this column shows the expected revaluation volumes in the reports of some sector companies, assuming that their discount rates fall to a similar level of about 0.3% (gross, excluding taxable reserves).
The market is not waiting for the valuers
Since the great global crisis about a decade ago, the global macro environment has changed and bond yields in most countries have dropped significantly. In recent years, 10-year bond yields in prominent Western economies are at 0% to 2% levels - and in some countries, including Germany and Switzerland, the yield is negative. The trend in Israel is similar, and the 10-year bond is trading at about 0.8 %. Yield declines also continue in 2020, with the outbreak of the Corona virus also helping the trend.
Global valuators lowered discount rates based on the macro environment. In many countries of the world, asset discount rates have changed according to global changes in the interest rate environment.According to Bloomberg data, discount rates for office properties in Paris, London and Berlin have dropped 2.5% to 3.0% over the past decade. In contrast, in Israel, there was some stability in discount rates - which led to an increase in the spread between them and the 10-year bond yield.
The capital market reflects the economic reality better than the financial statements of the real estate companies. In recent years, the gap between the value presented in the financial statements of the companies and the real value of their assets is increasing. As a result, the financial statements of the companies have long been inappropriate reflect the true value Of their real estate. Evidence shows that over the past year, a number of deals have been reflected reflecting discount rates of 5% -6%, while the average discount rate in the leading companies in the sector is 7.4%.
Equity multipliers are historically high
The capital market prices companies 'assets in accordance with their true economic value and average discount rates of 5.5%, while the discount rates in the companies' financial statements are on average 7.4%. This distortion leads the sector companies to trade at high equity multiples at a historical level.
The coming revaluations are still not enough to improve the reliability of the financial statements of the real estate companies.
Despite the significant revisions, I believe that this is the tip of the iceberg, and that a 0.3% absolute decrease in discount rates does not solve the distortion that currently exists in the financial statements of companies, as the gaps between economic reality and much larger reports. In my estimation, and in line with market pricing, a much more significant reduction in discount rates is required, which will result in far more significant revaluations (about NIS 6 billion in Azrieli, about NIS 4 billion in Melisron).
The question arises as to whether this is a first step of valuers towards a significant reduction in discount rates in the future as well Or is it a one-off movement that is not expected to change the distortion in the market.