Bumpy Israeli Bond Deals a Warning to US Developers

Law360, New York (September 24, 2015, 12:17 PM ET) — The hiccups that U.S. real estate developers have recently faced in Israel’s bond markets show the importance of being able to quell local concerns about unique assets or structures underwriting a deal, as well as other key lessons for maneuvering in the ever-popular capital market, experts say.

Over the last few months, the Israeli bond market has proven appetizing for top real estate companies, such as the Extell Development Co. and The Moinan Group, which landed a $361 million issuance earlier this summer — the largest yet for a U.S. property firm in Israel. Having seen the success of these early trailblazers, others have hurried to follow suit.

But some in the latest wave have hit speed bumps as the deals get bigger and more complicated, prompting underwriters and investors to hit the brakes. Last week, Jeff Sutton’s Wharton Properties (BVI) Ltd. had to to delay its plans for a record $500 million bond issuance — what aims to be the largest ever one-time debt issuance by a U.S. developer on the Tel Aviv Stock Exchange — and David Marx’s MDG Real Estate Global Ltd. was buzzed to have missed its $40 million issuance target in early September by nearly half.

“I think that the market is as active as it has ever been,” said Yariv C. Ben-Ari, a partner with Akerman LLP’s real estate group, noting that he is aware of four or five prospectuses in draft form for future issuance deals. “The appetite is still there for the Israeli market. I think the quality of the issuers and size of issuances have improved tremendously, so they are getting much more attention and review.”

Experts say developers’ recent troubles with TASE bond deals has less to do with waning investor appetite for deals and more to do with the investor pool’s risk-averse nature butting up against more complicated deals. Instead of being scared off, experts say developers watching the market should heed the lessons of these bumpy issuances, namely that it’s important to invest in advisers that can best communicate portfolio issues and to be careful about timing the market.

“A developer wanting to go through this process now, particularly with development deals [in the portfolio being underwritten, should] take on advisers that have gone through the process,” Ben-Ari said. “Such consultants, who have the boots on the ground and really know the market, are able to streamline the financial information.”

And experts warn that while the investor pool is flush with cash, investors and underwriters are not loosening their standards as they compete for deals and companies with riskier assets should be prepared for lukewarm welcomes.

“Not every cluster of assets will be perceived in a positive light that will yield interest rates similar to the ones we saw with Joe Moinan and others,” noted Joe Berko, the founder and president of brokerage firm Berko & Associates.

Those that are unlikely to do as well in Israel are “assets that are incomplete, have no cash flow or simply have elements of risk that the Israeli market is unwilling to bear,” said Berko.

While Moinan’s portfolio secured an Aa3 stable rating by Midroog Ltd., a Moody’s subsidiary in Israel, and Extell Limited scored an A2 stable rating, MDG Real Estate earned a lower Baa1 stable rating, in part due to the presence of development projects and a hotel, which were all deemed inherently risky.

Such assets can still be hard for some Israeli investors to wrap their arms around, considering the relatively straightforward, stable income-producing assets that populated the first wave of deals to hit TASE, according to experts.

“[The deals] have gone from a much more simplified bond offering to a more complex structure and assets, and its part of a learning curve,” said Ben Ari.

Even when the assets being underwritten are considered solid, a unique detail or miscommunication can sideline a deal. That is essentially what happened with Wharton Properties.

The company had been working on putting together its deal for nine months and had been well received by the investor community and Midroog, which gave its initial bond plans an Aa2 stable rating. But at the eleventh hour, a local financial writer cast concerns about Wharton’s plans to use the proceeds to purchase and create mezzanine loans, which — coupled with the offering’s planned launch amidst the Jewish holidays — chilled investor interest, according to a source familiar with the situation.

Concerns were also raised about the offering’s complicated structure and numerous prospectus amendments, which raised flags in the risk-averse Israeli markets, according to local reports.

But while mezzanine loans got a bad reputation in the latest downturn, Wharton Properties is planning to take positions in properties with strong loan-to-value ratios and the company believes the mezzanine positions are safer than taking equity positions because Wharton Properties won’t have to worry about losing stake value in a downturn, according to the source.

Due to the potential investors getting rattled, executives at Wharton Properties decided to delay its offering until after the Jewish holidays. And before relaunching the offering, the company plans to meet with underwriters and the top investors to explain Wharton Properties’ position and to make their case for why the offering is a good investment, the source said.

The Wharton Properties portfolio that will underwrite the bond consists of a number of high-profile Manhattan retail properties that have lease deals that guarantee income for the next seven years.

Berko noted that he believed the Wharton portfolio was strong and that once the developer handles the “bureaucracy” issues, it will likely score a groundbreaking interest rate on its bonds.

And in general, none of the experts predict a slowdown in U.S. developers turning to the Israeli market for capital. Indeed, Israeli investors’ appetite for developer-backed bonds is leading to larger-scaled issuances of $100 million or more, said Ben Ari.

“The Israeli bond market is ripe. It is flush with cash and it is very liquid,” Berko said.