Real estate investment in Lebanon

By Gareth Smyth BEIRUT

Business news in Lebanon this summer was made by record post-war numbers of Gulf tourists and the opening of new hotels, including a Movenpick resort and a 200-room Crowne Plaza. But more significant for the long term may be two quiet attempts to foster secondary markets.

The success of tourism cannot mask continuing problems in the Lebanese economy. Public debt has risen to $28 billion, over 175 percent of GDP and one of the world's highest levels, and the government's borrowing demands have driven up interest rates to double digits, reinforcing the banks' conservative lending policies and crippling businesses.

Despite the moribund state of the Beirut bourse, where trading barely touches $50,000 on most days, some Lebanese are looking to foster vibrant secondary markets, which are seen in developed economies as crucial to the success of primary markets. Alone, secondary markets cannot turn around the Lebanese economy, but they could help kickstart new investment.

Two important recent initiatives involve real estate, traditionally Lebanon's most successful sector after banking and tourism, but one where practices remain very old-fashioned. July saw the Saradar Investment House launch Eagle One, the country's first real estate investment company (REIC). Eagle One aims to purchase properties of around $15 million and list on the Beirut Bourse in around 18 months.

BEMO Securitisation, which was created eight years ago by BEMO bank, structured investment to corporate clients. In April, BEMO Securitisation launched the first securitization transaction in the Middle East and North Africa region: Indigo I issued $6 million asset-backed notes for Solidere, the listed real estate company responsible for rebuilding Beirut central district from wartime devastation. The tradable notes mature in three years, and they offer a fixed yearly return of 5.75 percent - plus the possibility of a higher return if Solidere stocks rise.

Both initiatives are intended to offer the investor good returns plus liquidity. With Eagle One, investors will buy shares in the company, which will own real estate, and receive dividends and, if the market rises, enjoy capital accumulation when Eagle One winds up in 10 years.

"By then all properties would have been sold and disposition sums distributed to investors," said Karim Salameh, the managing director of the Property House, a sister company of Saradar Investment House. "The orderly disposition of properties calls for a gradual sale when real estate prices become attractive again." Eagle One expects the combination of dividend and capital gain to amount to around 15 percent per annum.

In the case of securitization, the investor buys a security, issued by a "special purpose vehicle" (SPV), that entitles the investor either to a fixed return or to a (lower) fixed return bundled with a variable (usually profits).

The SPV is a distinct legal entity from the "parent" company, or "originator." "Securitization is the process by which non-tradable assets are converted into tradable securities," said Iyad Boustany, vice-president of BEMO Securitisation. "Illiquid assets like mortgage loans, auto loan receivables, or cash credit receivables are packaged, underwritten and sold in the form of securities to investors."

Collateral. Although the underlying collateral for Indigo I's notes is Soldiere shares, Indigo I does not own real estate. The whole scheme depends on the quality of Solidere's assets, although it is incidental that these happen to be primarily real estate, essentially its land bank.

"Lebanese law allows the establishment of SPVs in that it allows one entity to have several estates," said Iyad Boustany, vice president of BEMO Securitisation. "The SPV, when set up by a bank, has its own estate and assets, but it is bankruptcy-remote from the bank itself."

The potential of new financial vehicles, whether through securitization or REICs, for Lebanon lies in tempting outside investors with an attractive, assessable ratio between risk and return. With real estate, both securitization and the REIC avoid the hassles - and, for foreigners, legal restrictions - of direct ownership of property. The European experience, where investment in property funds increased from $5.8 billion to $27.2 billion in the three years to December 2001, illustrates the potential.

"The obvious candidates," said an analyst, "are where the investor can invest in an entity - whether it's a company or an SPV - that has a good future income stream from stable, reliable sources."

Solidere has been for some time looking at schemes to securitize the Souks, its long-delayed 120,000 square meter retail-leisure development. The company's cash flow is depleted after profits of just $1.9 million in 2001 and $31.7 million losses in 2000, and its ability to borrow from the banks is restricted by its covenants.

Hence securitization offers the chance to raise the capital necessary to build the above-ground stage of the Souks, which could cost well over $100 million, by issuing securities that entitle their holders to a share of the future rental income. Unlike a loan, the securities would not appear as a liability on Solidere's balance sheets and so would not breach its covenants.
For Lebanon, the mentality is new.

"Traditionally, the Lebanese looked at real estate only in terms of the increasing value of the underlying asset," said Boustany. "Because people made so much money in the 1950s, 1960s and early 1970s, the mentality is always bullish. You sit back and wait for the value of your land to go up." But prices fell from around 1995, and are not yet rising again. The state has absorbed more of the GDP and, with the public debt swollen to $28 billion, interest rates have shot up.

Lebanon's poor sovereign rating makes it hard to attract foreign investment as it implies a high level of risk. "Securitization can be a solution," said Boustany. "It is a structured finance technique that enables an investment bank to buck the sovereign ceiling. The company transfers its future income to a legally distinct SPV that issues notes giving investors a right to a share of future income. Where the future income comes from A-rated international companies, or other secure sources, the investment is more attractive.

"Usually we target Gulf or European buyers, and we must breach the country ceiling. This is where the critical issue lies, and this is where structuring plays a key role. You cannot offer to investors an unappealing risk-return ratio. The critical issue is to get three or four or five notches above the sovereign ceiling. Lebanon's sovereign ceiling is low, and securitization is a way for companies to attract finance based on their own credibility - or on their assets' credibility."

Hence the possibilities for the Souks, where Solidere is confident it can attract Galeries Lafayette, the French department store, as one international anchor tenant in what analysts believe should be Lebanon's leading retail destination. Hence Solidere has been exploring securitization, although progress depends on the outcome of its application for a permit for above-ground construction, currently lodged at Beirut municipality.

"Solidere will divide the scheme into two," said one financier. "The northern Souks - including a department store, cinemas and a multi-use building - would be a second step, and would depend on how large a department store Solidere can secure and at what price.

"With the securitization of the southern Souks, the present value depends on how many years of future cash flows are included in the securitization vehicle and the discount rate, which needs to be over 10 percent. But, in my view, Solidere should easily be able to generate today the $60 million it needs to completely develop the southern Souks by securitizing receivables for the next five years, including the receivables from sales of the gold souks."

Dividends. More modest sums are involved in Lebanon's first REIC, Eagle One, although its originators believe later REICs will go beyond its $15 million market capitalization. Like securitization, the REIC allows the investor to participate in the property market without direct ownership and to enjoy a good return with minimal risk. The investor buys shares in a holding company that buys property with a high yield. The shares offer both a dividend and the prospect of capital gain when the company is liquidated, and foreigners would not be restricted in ownership.

The REIC would function like the US real estate investment trusts, which have built up a market capitalization of $130 billion and have generally appreciated along with, or ahead of, GDP growth. But Lebanon has limited legislation on trusts, so Eagle One's legal status is a joint stock holding company.

The identified properties are those let at the height of the market around the mid-1990s when the tenant - often a blue-chip company or foreign embassy - agreed to a rental of 10 percent of sale value. If Eagle One can buy today from capital-hungry owners at, for example, 75 percent of the 1996 price, the yield is instantly converted to 13.4 percent. Eagle One has been actively seeking investors in the Gulf.

The pioneers of these new financial instruments believe that further legal change is needed if secondary markets are to begin fulfilling their true potential in stimulating investment and liquidity.

Karim Salameh advocates a "whole range" of changes. "These include better transparency in corporate accounts, tougher regulation of auditors, wider same-day permissible fluctuations in share prices, and the listing of more companies on the bourse," he said. "But we also need a wider range of financial instruments - options, futures, short sales - to drive the market."

For Iyad Boustany, it is important that an SPV be allowed to own real estate. "Under current law, this is not possible," he said. "But it would be allowed under the securitization law being discussed but not as yet passed by parliament. This could help in cases of default - the more control the SPV has over the securities, the better for investors."

Politically, this is likely to raise the objection that parliament is encouraging foreign ownership of Lebanese real estate, which has been a touchy subject in the past. Boustany believes that the benefits to the country of stimulating secondary markets and attracting overseas capital would outweigh notions of ownership that are becoming outdated.

"In any case the SPV is Lebanese, so the owner is still Lebanese," he said. "The titles can be owned by any person, Lebanese or not, but the owner registered in the real estate register will be a Lebanese SPV."