In the past few years, following global financial trends in addition to local trends in real estate markets, the number of Israeli investors making direct investments in overseas real estate increased.
In this article we have chosen to focus on the field of investments in income yielding properties, as opposed to investment in entrepreneurial real estate projects that have different characteristics.
The article examines briefly a number of main issues according to which one should consider the structure of the transaction and its profitability, and in light of which one should manage the investment until it’s realized.
Backgroung
In the past few years, following global financial trends, including low interest rates, alongside local trends in the local real estate markets that are already saturated, the number of Israeli investors making direct investments in income yielding real estate properties overseas has increased.
Income yielding properties can differ in aspects such as tenants profile, different lease agreements (for example NNN transactions), the duration of the lease, location of property etc. It is important to note that investors and their preferences also vary: starting from institutional investors, followed by “family offices” that manage considerable capital, through private investors interested in diversifying their investment portfolios. Despite the differences between various types of investors, inter alia, their investment portfolios and different regulatory requirements, there are many aspects that are common to all investors.
In this article we will try to provide a brief summary of the characteristics that are common to all investors in income yielding real estate properties managed overseas, describe the legal framework required for the purpose of making the investment, and discuss a few main issues that are related to this type of investments.
Common structures used in investments in income yielding real estate properties
Similar to any other investment in real estate, an investment in income yielding real estate properties located overseas can be executed through three major structures: direct acquisition of the property, acquisition through a special purpose corporation (SPC), or indirect acquisition through an investments entity that invests a given sum of capital in a number of properties (e.g. fund, management vehicle etc).
In terms of the complexity of the transaction, a direct acquisition of the property is the easiest transaction, yet in this framework the buyer loses significant legal protection provided by a company, and therefore may also meet difficulties when approaching a bank seeking to receive finance.
Investing through an SPC involves corporate legal aspects, along with real estate legal aspects. In most cases, the buyer is a special corporation established especially for the purpose of acquiring the property. In such event there is a dual need to decide upon the type of corporation, and drafting the formation documents according to which the corporation will be managed. In the event in which a single shareholder holds the SPC, preparation of formation documents is rather simple, yet in the event that a number of partners are involved, this becomes more complex for obvious reasons (as specified hereunder).
An investment through an investment fund consists of additional aspects to the ones specified above. Aside from the considerations that were specified above, an examination should be conducted about the fund incorporation documents, and the relations between the fund managers and investors, including: compensation to the fund managers, the relations among investors themselves, the manner of acquisition of properties by the fund and more. There are many issues that emerge along the process and in short it should be noted that in most cases investment funds are incorporated as partnerships, with emphasis on limited partnerships that are managed for a limited amount of time, offer a more efficient risk spread in the framework of which fund managers manage the fund assets professionally on a routine basis.
We shall further note that each of the structures specified hereinabove is subject to different taxation policies both in the state of origin and the State of Israel, policies that naturally constitute a main consideration in determining the appropriate structure of the transaction.
Joint investment
Another main issue is whether to conduct the acquisition independently or with partners. Due to the complexity of this subject we will not describe all the considerations involved yet we shall briefly note that when a given amount of investment is concerned, joint investment with partners makes sense due to spread of the investment among a number of assets. Furthermore, joining partners in investments and increasing the overall amount of investment almost always improves the investment and reduces the acquisition price per given sqm.
On the other hand, making an investment with partners requires the creation of mechanisms for making joint decisions as to the joint management of the corporation that holds the property as well as when discontinuation of investment is required. In this context it is important to agree upon a number of issues in advance, for example: the majority required for the purpose of making routine and special decisions and alternatively the appointment of professional managers to run the corporation, setting the corporation’s budget, right of first refusal among the partners, bring along and tag along rights granted to the partners among themselves, pricing mechanism (buy me buy you – BMBY) and so on.
Another issue one should pay attention to concerns the manner of registering investors’ equity in the joint corporation. In most cases capital will be provided as a shareholders’ loan to the corporation, a loan that will be in a lower class than local banking capital in respect of which senior lien/mortgage will be imposed on corporation’s assets. In most cases it is recommended to set up a joint corporation in which there is only one class of shares and single bank debt, a fact that simplifies setting up and managing the corporation.
Other issues
Despite the numerous issues involved, we shall mention a few additional issues:
Real estate and property law – similar to any other real estate acquisition, one should examine some basic issues such as accurate identification of the property, accurate identification of the seller, securities provided until title is transferred, tax payments, power of attorney provided by the seller, local trust mechanisms and more.
Financing – this aspect cannot not be underestimated when an income yielding property is concerned. In most cases financing conditions will decide whether or not the transaction will be executed, and to wit, the income yielding real estate markets prospers only in countries with a stable, conservative banking system that survives the crisis and recession of the past few years. Bank financing raises a number of significant issues such as the nature of securities (whether the transaction is non-recourse), duration of repayment period (loan amortization), exit points and more.
Tax considerations – similar to financing, this issue has significant weight concerning the feasibility of the transaction. In complex transactions that combine local and foreign laws, it is very important to consult with an accountant specializing in taxation, including local accountants in the country of origin. In countries with which Israel signed a tax convention, tax considerations should be straightforward, yet there are still many questions concerning the manner of classification of the property, and payment of current taxes in respect of periodic payments along capital tax payments during sale of the property.
Summary and conclusions
When making an investment, two main considerations operate in opposite directions: maximizing yield and risks reduction.
Real estate in general and income yielding properties in particular are complex fields of practice that combine a number of diverse disciplines: legal, financing, and the commercial discipline.
Similar to any other type of investment, making investments in real estate involves judicious decisions and comprehensive familiarization with the subject matter of investment. Legally, we should make a distinction between two types of disciplines: corporate, that concerns outlining the structure of the transaction, and the relationships among the different partners, and real estate and property law, when we should pay special attention that we are dealing with local laws that sometimes differ from one country to the other, and sometimes even differ between different counties in the same state.
It is very important to distinguish between all the issues that are involved and receive assistance from well experienced professionals in order to deal with every problem that is concerned.