Real Estate 2021

Last Updated April 13, 2021

Israel

Law and Practice

Authors



Yigal Arnon & Co has one of the largest, most professional, experienced and reputable real estate departments in Israel, with 60 lawyers operating in its offices in Tel Aviv and Jerusalem. The firm's real estate practice, in addition to its planning and zoning and urban renewal practices, is recognised by international legal directories. The firm has unique and unparalleled expertise, gained in almost 60 years of involvement in many of Israel's most significant commercial, residential, industrial, infrastructure, office, shopping centre, hotel, resort, residential and mixed-use real estate projects. Clients include major Israeli and international real estate and construction companies, REITs, holding companies, banks, real estate developers, entrepreneurs, and hotels. The firm provides a wide range of services in the field of planning and zoning, assisting its clients in all planning stages, from property re-zoning and conversion to building plan and building permits approvals, and provides litigation, including representation before planning committees and courts.

Most of the provisions contemplating real property rights are included in the following statutes: the Land Law 5729-1969 (the Land Law), the Planning and Building Law 5725-1965, the Contracts Law (General Part) 4733-1973, the Lease and Borrowing Law 5731-1971, the Sale Law 5728-1968, and the Land Tax Law (Betterment and Purchase) 5723-1963.

For the past 12 months, the real estate market has been extremely active, many transactions were negotiated and completed, in all real estate sectors, including the office sector, but mainly in the residential sector.

In addition, investors are exploring the residential lease market, which until recently was relevant almost exclusively to owners of private apartments.

These technologies do not yet have any impact on the real estate market.

At the end of 2019, amendment 33 to the Land Law came into force, and allowed the registration of rights in different layers, and creation of three-dimensional parcels.

Prior to this amendment, the Land Law stipulated that ownership spreads to the entire depth and height below and above the land surface, and it was not possible to transfer and register ownership rights (distinct from leasehold) in separate layers.

Israeli law recognises five types of property rights: ownership, leasehold, mortgage, right of way and easement.

The Land Law stipulates the principles for performing a real estate transaction for different types of real estate. Other statutes govern specific areas and stipulate further provisions, usually binding upon the seller and protecting the buyer; one such example are the sale laws that apply primarily to the sale of residential units.

Article 7(a) of the Land Law prescribes: “A transaction in immovable property requires registration. The transaction is completed upon registration.” In other words, a real estate transaction is only performed by registration in the Land Registry Office, until registration; the transaction is regarded as a contractual obligation. Registration is computerised and accessible via the internet, both for viewing and for registration of sale transactions and other transactions, such as registering a “warning note” regarding a real estate transaction.

Israel does not yet have title insurance, as in the United States and other jurisdictions. Perhaps no such mechanism was developed because there is no need, as registration is conclusive and is relied upon.

One of the elements that impact, and delay, registration is that tax clearances need to be submitted for the transaction. In the last few years, changes have been made in order to facilitate tax payment and obtaining the clearances, mainly through automatic clearance against tax advances' payment.

However, a substantial portion of the land in Israel is owned by the government or by related entities and managed by the Israel Land Authority (ILA), which is a government agency. The process of making such land registrable is very long, and many of these properties have not yet undergone parcel planning. Article 13 of the Land Law stipulates: “a transaction in immovable property extends to the land … and a transaction in respect of a specific part of the property is invalid.” Therefore, title cannot be registered with regard to land that has not yet undergone parcel planning. In multi-ownership buildings, title cannot be registered until the built property has been registered as a “condominium”.

The result is that, in many cases, real estate rights cannot be registered in the Land Registry office and have the status of obligatory rights (only).

Before any transaction in immovable property takes place, a due diligence review is conducted, with the scope varying according to the type, complexity and value of the property, and other parameters. The review may include:

  • checking the registration and any restrictions that may exist with regard to the registered rights, such as mortgage, lien, eminent domain;
  • planning restrictions – what may be built on the property, was a valid permit issued for the property already built, will taxes or levies be imposed in connection with future construction;
  • physical inspection – of the land, of construction on the land, of systems on the property;
  • third-party rights such as those of lessees, or debts to planners or contractors;
  • outstanding taxes and levies on the property, including taxes and levies that will be imposed on the seller and will be required in order to register the transaction.

Depending on the value and complexity of the property, various professionals may be retained for the due diligence process – lawyers, accountants, insurance consultants, tax experts, engineers, assessors, etc.

The coronavirus pandemic forced buyers to examine carefully the tenants in the potential property, and their financial strength, and also assess how complex it would be to lease the potential property.

The seller of real estate must make a representation about the property and about any restriction imposed on his or her rights to the property and their sale and transfer, and must disclose to the buyer anything he or she knows about the property, including defects. This does not limit the buyer’s duty to perform a due diligence review himself or herself.

A seller who fails to satisfy this disclosure obligation can be sued for damages suffered by the buyer as a result of entering into the agreement, and in some cases the contract may even be terminated.

There are specific obligations upon a developer that builds and sells real property, which pertain primarily to the sale of residential units. That developer is subject to enhanced duties, both with regard to the presentation of the property and with regard to details and provisions that must be included in the sale agreement, such as a duty to register the property and to guarantee the buyer’s consideration payment until construction has been completed and a collateral has been provided to secure the buyer’s right to be registered as the owner of rights in the property.

If, following the execution of a sale agreement, the buyer discovers information that the seller knew or should have known and which, had the buyer known it prior to signing, it would not have entered into the agreement (except for a mistake about the cost-effectiveness of the deal), the buyer may have the right to void the agreement.

In addition to the items detailed in 2.5 Typical Representations and Warranties, before entering a transaction for immovable property, the buyer should consider the status of the legal rights to the property, the planning and permit status of the property and its surroundings, existing and future tax exposures and the legal condition – any obligations in connection with the property towards third parties which might affect their ability to use or develop the property. If the property is part of a condominium, the buyer should inspect the condominium's documents, if the property is subject to a long-term lease, it should review the terms and restrictions of the lease, etc.

The 2011 Bill for Prevention of Soil Contamination and Rehabilitation of Contaminated Land is still pending. Among its other provisions, the Bill proposes to prohibit soil contamination and imposes liability on the contaminator. The Bill further imposes a duty on the landowner to inform any prospective buyer of any contamination on his or her land.

Yet, there are various laws that deal with the responsibility of a landowner to the land pollution in his or her property, and grant the authorities enforcement power in this respect. For example, the Water Law-1995 allows the Ministry of Environmental Protection to act against those who cause land pollution. According to the Business Licensing Law (1968), treatment of soil contamination could be a condition to obtaining a business licence, and, according to the Planning and Building Law 5725-1965, obtaining a building permit could be conditioned by aspects related to the investigation and rehabilitation of contaminated land.

Unofficial information about the possibility and building rights with respect to certain immovable property, including zoning, can be extracted from the websites of the different planning authorities. Binding, accurate information can be obtained by filing an application and paying an application fee (a negligible amount). If necessary, the applicant should also submit a survey of the property.

A landowner seeking to change the defined use of his or her property, or to change the building rights, can initiate a planning process for his or her property, provided that the proposed plan is consistent with binding plans that are higher up in the planning hierarchy, and subject, of course, to the planning policy of the applicable authorities. In the last few years, city plans have been approved for many of the larger cities in Israel, stipulating planning principles, such as permitted uses, building height limits and density, location of public buildings, road systems, etc, with which specific plans must comply. There is no planning certainty, except regarding approved city plans.

Various laws allow property to be taken by eminent domain for public use, such as roads, parks, recreation areas, nature reserves, parking areas, etc.

Before any such taking, the local government must post a notice of this intended move in the vicinity of the property, and deliver this notice to the owner in person, to allow them to argue against it. Compensation will be paid if more than 40% of the property (on aggregate, over the years) has been taken.

If the land is taken by eminent domain but not used for the purpose for which it was taken, or if the need for that declared use has ended, the original owner can claim his or her land back. 

Built property cannot be taken by eminent domain; this tool is only available to the government with regard to undeveloped land.

Pursuant to the Land Tax Law (Betterment and Purchase) 5723-1963 (the Land Tax Law), upon any real estate transaction, the buyer must pay purchase tax and the seller must pay land-betterment tax (capital gains tax).

Generally, the purchase tax rate is 6%; for residential properties, there are progressive rates that may exceed this figure. As a rule, betterment tax for an individual is equal to 25% of the seller’s capital gain on the transacted property. However, if the seller’s business is the development and selling of real property, they shall not pay betterment tax but rather income tax. Individuals are also liable to surtax at the rate of 3% with regard to an amount exceeding a certain threshold. 

Betterment tax for a corporation is paid at the corporate tax rate, which is currently 23%.

There are specific exemptions from betterment tax on residential apartments relevant to individuals. The most common exemption from betterment tax applies to the sale of an apartment at a price of up to ILS4.5 million. This exemption will apply only in the case where the apartment sold is the seller's only residential apartment. It should be noted that this exemption from betterment tax on real property are available only to Israeli residents, or foreign residents who can prove that they do not own residential property in their resident country.

In the sale of a residential apartment that was purchased before 1 January 2014, when the seller owns more than one apartment, the seller will be entitled to a "Linear Exemption". According to the "Linear Exemption", the betterment on the apartment sold is attributed to two periods; betterment accrued up to 1 January 2014 will be exempt from betterment tax, and with regard to betterment accrued from 1 January 2014 onwards, the seller will pay betterment tax in the rate of 25%.

In addition, if the seller makes a profit on the sale that results from a change in the city plan that governs their property, and the change occurred while they owned the property, the seller would have to pay (in addition) an improvement levy to the local authority within whose jurisdiction the property is located. This levy equals 50% of the improvement of the property as a result of the approval of the city plan.

Under certain conditions, a gift between immediate relatives is exempt from betterment tax, and is entitled to reduced purchase tax rates.

Note that (currently) there is no inheritance or estate tax in Israel, so the transfer of real property by will or succession is not taxable. 

Betterment and purchase tax pursuant to the Land Tax Law also apply in the event of transfer of shares in a property association of which the assets are mostly immovable property and is defined under Israeli Law as "a real estate entity".       

There is no restriction on transfer of privately owned immovable property to foreigners. Land administered by the ILA (see 2.3 Effecting Lawful and Proper Transfer of Title) can only be transferred to foreigners subject to certain limitations and ILA conditions and approval.

In most case, transactions in commercial real estate are financed by Israeli banks or insurance companies. Parties that cannot obtain such financing approach private financers, such as financing funds; the terms of non-bank loans will usually be less convenient for the borrower.

Larger parties can raise money by issuing debentures or shares.

The collateral available to the financing entity is first and foremost the property itself. Sometimes, the borrower is required to provide additional collaterals. In the last few years, there have hardly been any non-recourse loans; in other words, the lender has recourse against the borrower, including with regard to other assets that are not a collateral to the loan.

The property is pledged through registration of a mortgage at the Land Registry, and if the property is administered by the ILA and has not yet been registered in the Land Registry in the name of the borrower, the collateral is a letter of undertaking from the ILA, to register a mortgage in the future.     

All income accruing on the property is also pledged as collateral, including by way of irrevocable instructions to all tenants to pay their rent to a designated bank account that is pledged to the lender. Any insurance payments to which the borrower may be entitled are also pledged as collateral.

There is no legal restriction on lending money to foreign residents for the purpose of buying real property in Israel, but naturally, lenders will stipulate stricter terms with regard to foreigners, because they are less familiar with the borrower and their business, and because in such loans it may be more difficult to foreclose on the borrower’s collateral in the case of default.   

Beneficial financing terms granted by Israeli banks to Israeli residents who purchase their first residential apartment are not available to foreign residents.

Registration of pledges is subject to payment of a small fee to the Land Registry. The fee is fixed and is not calculated according to the value of the property, and is therefore negligible.

The cost of notarising a document is also fixed and negligible.

Lenders charge reimbursement for preparation of their documents, and for costs of their consultants. These amounts could be significant.

Financing agreements always stipulate that the cost of foreclosing on the collateral, in a case of default, will be borne and paid by the borrower. Such costs may be significant, especially due to the fee to the consultants engaged for the purpose of liquidating the property.

Upon foreclosure, property is liquidated by selling it and collecting the debt from the proceeds. On the sale of a property in such a case, the borrower shall have to pay land betterment tax, pursuant to the provisions of the Land Law, as previously described.     

When resolving to pledge the company’s property, directors must weigh the best interests of the company and its shareholders, and verify that the pledge and financing transaction does not cause a capital reduction.

A borrower seeking to foreclose on a mortgage or pledge created over a residential apartment must comply with Article 81B1 of the Execution Law 5721-1967, which stipulates that, in the case of a loan that is repaid in instalments, where the borrower defaults on at least one instalment, the lender may file a petition to foreclose only seven months after the date of default, and only with regard to the amount in arrears, and not with respect to the entire loan amount. If it was not stipulated that the loan would be repaid in instalments, the lender may, upon default, file a petition for full recovery of the loan as of the actual date of default.

The lender will rank higher than other creditors only if it procured the appropriate registration for their rights. The best protection is granted by registering a mortgage in the Land Registry, and, if the borrower’s rights are not yet registered, a pledge with the Registrar of Companies with regard to a company and in the Registry of Pledges with regard to an individual.

If the borrower is an entity, then, in addition to recording the mortgage with the Land Registry, a pledge should be recorded with the Registrar of Companies and Partnerships.   

In the case of two or more pledges ranking the same, the one that was registered first will prevail. A fixed charge will prevail over a floating charge. Obviously, by agreement between the owner and all charges, the ranking can be changed.

The lender does not hold possession or rights in the property. Foreclosure is usually effected by selling the property (to a third party), and not by the transfer of the ownership rights to the lender. The lender is not deemed possessor and therefore is not liable to comply with environmental laws with respect to the property.

In the event that the lender is declared insolvent, the rights pursuant to registered securities shall not be effected, and will be handled by the lender’s receiver, trustee or special manager.

Unregistered securities will not, of course, be secured in such a case.

The banks in Israel continue to give loans with LIBOR-indexed interest, but inform the borrowers that, upon termination of the LIBOR (London Inter-Bank Offered Rate) index, the loan interest rate will be adjusted in accordance with a pre-agreed formula.

The Planning and Building Law 5725-1965 (and the regulations promulgated thereunder) defines the planning authorities – Regional Committees, Local Committees and National authorities such as the National Planning and Building Council, the Committee for Protection of the Coastline Environment, and others, and the hierarchy among them and among the plans that each is authorised to approve. Each of the planning and building committees is subject to the one next higher up in the hierarchy, although they also have independent discretion with respect to certain matters. Building plans must always comply with those of the higher hierarchy, including regional and national outline plans. Certain subjects, such as gas stations and railways, are regulated at the national level.

Local committees may stipulate instructions for their jurisdiction, relating, for example, to the aesthetic design of the building, its entrance elevations and its integration into the environment. In some cities, such as Tel Aviv, specific plans are adopted for restoration of heritage buildings. Each such plan defines which buildings must be restored and categorises them according to the level of restoration required. The most protected level requires the restoration of all design elements and prohibits the addition of any new element.

There are three planning levels – the National Council, which is charged with planning and stipulating state-wide instructions and policy, the National Committees, which are charged with promoting and implementing the instructions of the National Council in their respective regions, and the Local Committees, which promote and approve plans at the local level, designate uses, define the land-to-building ratio, stipulate building restrictions, etc.

As previously mentioned, there are also state-wide terms and conditions, such as building and uses on the coastline, or near gas stations, and others.

A planning subject that has been on the planning agenda in the last few years is the building of intracity and intercity public transport facilities. This also affects construction in the city centres and the regulations for construction of parking spaces in private and public buildings, and the effort to reduce the parking allocations and stipulating maximum parking allocations, to make it more difficult to use private cars and spur their owners to use public transport.

All “construction work”, which, under Israeli law, has a very broad definition, requires a building permit by the applicable Local Planning and Building Committee. A building permit must comply with all plans that govern the land lot in terms of the land-to-building ratio, location within the lot boundaries, height, intended use, etc. An owner of real property, who wants to build a building that does not comply with the plans, can apply for an ad hoc city plan for its property. If any such ad hoc plan conflicts with other plans of a higher hierarchy, it may also have to be approved by the Regional Planning and Building Committee if it conflicts with Regional plans, or the National Planning and Building Council, if it conflicts with nationwide plans, etc.

Any person (or entity) who may be adversely affected, if a plan is approved, may file an objection to the plan. The planning authorities will examine the plan and the objections, and may also consider planning policy. It is not permitted to object to an application for a building permit that is compliant with the governing building plans, unless the application includes some concession or special use.

Decisions of the Planning Committees, to approve or reject a plan or an application for a concession or special use, can be appealed to the Appellate Boards or to the Administrative Courts.

Decisions of the Administrative Courts can be appealed to the High Court of Justice, if the Court grants leave to appeal.

In some cases, in order for a permit to be granted, certain development work in the vicinity is necessary, eg, traffic, utilities, etc, to make sure that the new construction is adequately connected to the traffic and utility grids and that their capacity is sufficient to handle the load added by the new construction. For this purpose, the Local Authority may charge a development levy from the applicant, calculated according to the size of the lot and intended scope of construction. The Local Authority sometimes requires the developer, as a condition for a building and occupancy permit, to perform such works himself or herself, or to engage with contractors appointed by the Local Authority for this purpose.

The Planning and Building Law is a penal code, and is enforced by the law enforcement authorities. A person who violates the Planning and Building Law, builds without a permit or in violation of a permit, or uses any property in violation of a permit, will be indicted and enforcement actions will be taken. As part of the effort to enforce planning and building laws, an independent unit was set up for this purpose approximately 20 years ago: the National Unit for Enforcement of Planning and Building Laws.

Investors can hold real property in any way they choose, either in their capacity as individuals or through corporate entities – companies or partnerships. Most commercial properties are held by companies, because of tax reasons and in order to limit the liability.

A company has a separate legal entity from that of its shareholder. A limited company protects its shareholders, such that, subject to special circumstances, a shareholder of a limited company has no exposure in the event that some lawful activity of the company has failed.

A limited partnership also has a separate legal entity from that of its limited partners, and, for limited partners that are not involved in the management of the partnership, affords similar protection to that of shareholders of a limited company.

In real estate deals that are performed by several separate legal entities acting together without incorporation, there are issues of the breakdown of liability and exposure – joint, several, or otherwise.

The Israeli law does not require any minimum equity to form a company or a partnership investing in real estate or initiating real estate projects.

The legal requirements for purchase or investment in real estate companies are the same. The distinction does not depend on the purpose of the purchase. The difference is in the tax regime and scope of liability. In this respect, there is no difference whether the entity’s business is real estate, hi-tech or traditional industries.

A transaction in shares in an entity that owns mostly immovable property (a real estate entity) is viewed for tax purposes as a real estate transaction. 

Companies and partnerships must file annual statements with the Companies Registrar and tax authorities, and pay a fixed annual fee to the Companies Registrar, and also report annually to the tax authorities. The annual fee to the Companies Registrar is approximately USD400, not including the accountant's fee. 

The Leasehold and Borrowing Law 5731 -1971 (the Leasehold Law) stipulates the following definition: “A leasehold is a right granted, against a consideration,… to hold possession and use property for a limited time.” The Land Law, which lists leasehold rights as one of the five rights in real property, offers a similar definition. Making real property available to another for exclusive use, for a limited time, against a consideration, can only be done through a leasehold. People sometimes use other terms such as “use” or “permission” which are not defined by Israeli Law and that are substantially leaseholds.

The duty to report the transaction to the tax authorities and register it in the Land Registry depends on the term of the leasehold. A long-term lease of more than five years is called in Hebrew “hahira”. If the term exceeds 25 years, it is called “hahira-ledorot” (literally: long-term lease for generations).

A status of protected tenancy exists in Israel, protecting individuals who were lessees when the Leasehold Law entered into effect and also anyone who rents real property and pays a substantial amount upfront in order to obtain this status. However, no new protected-lease agreements are entered into anymore. Protected leaseholds no longer exist for commercial property. 

There are various mechanisms to effect commercial lease agreements: prepayment, monthly payment, percentage rent, etc, but this does not affect the substantive nature of the engagement as a leasehold.

The Leasehold Law was amended in 2017, and “fair rental” provisions were added, protecting residential tenancies (only) excluding luxury apartments. The law does not limit the amount of the monthly rent, but defines obligations governing lessors of residential properties, including mandatory contractual disclosures, and stipulates the kinds of payments that the landlord should pay and may not pass on to the tenant.

As previously mentioned, there are still some rare protected tenancies that have survived since the inception of the Leasehold Law, the rent for these leaseholds is limited, but they are gradually disappearing.

No specific legislation was passed to rule leases affected by the coronavirus pandemic.

In a number of cases, lessees (and lessors) asked the courts to rule with regard to obligations or with regard to relief from obligations; however, there is no specific rule in this respect. The courts analyse each case in light of its specific circumstances.

The standard terms in commercial lease agreements are as follows.

  • Lease term – the term is usually broken up into an initial period of about three years, plus one or more extension options that the lessee may exercise. Option periods will not usually exceed ten years in total.
  • Maintenance and repairs – standard practice is that the lessee is responsible for ongoing maintenance, and to repair any damage except for reasonable wear and tear. Commercial properties are often let in “shell state" condition, and the lessee completes the necessary finishing at his or her own cost and expense. In such cases, the lessee is liable to make any necessary repairs to the works he has performed. Triple net lease is not commonly practised in Israel.
  • Rent payment schedule – rent is usually paid every quarter, in advance.
  • Coronavirus pandemic – clauses regarding possible delay in the execution of the obligations due to the impact of the pandemic were added to lease (and sale) agreements. The parties agreed that such delays would not be considered as a breach of agreement.

In most cases, rent is linked to the consumer price index.

In each option period, rent usually goes up by 3–5%.

VAT is due for rent on commercial properties, not on residential.

Lessees of commercial properties are required, in addition to the payment of rent, management fees and other current payments throughout the term of the lease, to submit sureties to the lessor ahead of the lease term, to purchase insurance, and in some cases also to participate in the lessor’s legal fees in connection with the lease agreement.

Common areas in commercial properties, such as lobbies and parking areas, are usually managed by the lessor directly or through a third-party management company. The cost is usually broken down among all lessees, according to a predefined formula: per square metre or against a fixed fee.

The same principle applies to utilities and telecommunication infrastructure that serve several tenants; the costs can be divided among the users, per square metre or against a fixed fee.

In commercial properties with many tenants, the lessor insures the building and includes the tenant as another insured entity. In some cases, the tenant is billed separately for this cost. In properties that are let to a single tenant, responsibility for building insurance can be passed on to the tenant. Coverage is standard; disputes sometimes arise in connection with the duty to insure against earthquakes or other natural disasters. The Israeli government provides mandatory insurance against war and terrorism.

Lessors may stipulate in the lease agreement various provisions regarding the intended use, such as the purpose (subject, however, to antitrust law in the case of shopping malls and similar properties), operating hours, maintenance, etc. Tenants’ use of the property is also subject to regulatory provisions, such as the Business Permits Law, which regulates operating hours, the duty to obtain a business permit, compliance with permitted use in accordance with the city plan and building permit, etc.

In commercial properties, standard practice is that the lessor prohibits the lessee from performing any works or changes to the property, and that if any such works or changes are performed, the lessor can choose, at the end of the term, whether to keep the changes or whether the lessee shall remove them, free of charge to the lessor.

As previously mentioned, in 2017, the Leasehold Law was amended and “fair rental” provisions were added, which apply to residential leases only. The purpose of this amendment is to protect residential tenants, primarily through imposing certain disclosure duties and liabilities on the lessor. However, rent is not limited in any way.

Commercial lease agreements sometimes stipulate that, if the tenant enters into bankruptcy or is pronounced insolvent, the lessor shall be entitled to terminate the agreement and evict the tenant. Courts do not enforce this provision as long as the tenant complies with the agreement. The courts sometimes allow a tenant that has become insolvent to transfer the lease to a third party who has acquired the tenant’s business operation.

The best security for lessors is, of course, a bank guarantee. Industry standard is a bank guarantee equal to three to six months’ worth of rent plus management fees. Other securities include money deposits, promissory notes or personal guarantees.

The tenant has no right to stay in the property after the end of the lease. However, if they do so, the lessor is not allowed to take any action himself or herself; they must petition the court, seeking an eviction order. This is one of the reasons why property owners insist on substantial sureties, as previously described. Another effective measure is to stipulate liquidated damages.

According to the provisions of the Lease and Borrowing Law, 1971, a lessee may transfer his or her rights in the property, or rent part of the property to another lessee (sub-lease), subject to obtaining the lessor's consent. The lessor can refuse the lessee's request on reasonable grounds only.

In large commercial leases, lessors sometimes require that the alternative lessee have similar financial stability, that would enable them to take on all the responsibilities and commitments of the current lessee. 

Lease agreements usually include the terms upon which the lessor may terminate the lease, primarily defaulting on the rent or violating the purpose of the lease. The Leasehold Law protects the tenant where the property cannot be used for the purpose of the lease, allowing them not to pay rent for the period during which use of the property was precluded. However, if the lessee exercises this right, the lessor may, after a reasonable period, terminate the lease.

The Land law distinguishes between three types of lease agreements:

  • short-term lease agreements for a period of up to five years – there is no obligation to draft such an agreement in writing nor to register the agreement with the Land Registry;
  • a lease for a period of up to ten years (or with the option to extend for a period of up to ten years) – in this case, there is an obligation to draft the agreement in writing but there is no obligation to register the agreement with the Land Registry;
  • a lease for a period exceeding ten years – in this case, in addition to the obligation to have a written agreement, there is a requirement to register the agreement with the Land Registry.

Lease agreements are almost always drafted and signed, even for short-term lessees; however, the requirement for registration is rarely implemented. Moreover, in commercial lease agreements for more than ten years, it is customary to stipulate specifically that the lessee will not register their rights.

A lease agreement for a period exceeding 25 years constitutes a property right, and requires the reporting and payment of taxes, similar to a sales transaction. Therefore, lease agreements that exceed 25 years are very rare.

In the event that the lessor terminates the agreement due to a breach by the tenant, the lessor may require the tenant to vacate the property, and if they do not, the lessor may petition the court for an eviction order. This can take many months, and if the tenant offers a substantial defence and refutes the alleged breach, even more.

Courts have stated that there is no justification for the damages of the coronavirus pandemic to be imposed in their entirety on lessors simply because they are perceived as having a "deeper pocket" than the lessee. Nevertheless, in some cases the courts have ruled that the lessors should show "understanding" in the current unusual period.

As described in 6.3 Regulation of Rents or Lease Terms, the courts avoid a broad determination in this matter, and rule each case on its own merits and circumstances.

Termination of a lease by a third party is very rare. This can happen by a court decision, or if a building is declared dangerous, or if the property or any part of it is expropriated for public use; for example, to enable the construction of the light rail route.

  • Termination of a contract by a court decision – when a lessee refuses to evacuate the property at the end of the contract or when the lessee has breached the contract, the lessor could file a claim for eviction;
  • Expropriated property – before any such process, the local government must post notice of this intended move in the vicinity of the property, and deliver this notice to the owner in person, to allow them to argue against the potential expropriation.

In the event of expropriation, compensation will be paid if more than 40% of the property (on aggregate, over the years) has been taken.

The consideration in construction contracts is usually one of the following alternatives: (i) a pre-agreed fixed amount, allocating the risk to the contractor, or (ii) calculated by measuring the quantities of work actually performed, which means that the client cannot know in advance the exact cost of the project.

The client can also decide whether to use a single contractor or to engage several different contractors, structural frame, systems, fit-out work, etc.

Clients usually commission planning and design separately from construction. The client engages planners and consultants, up to 15 to 20 in a complex project, and a project manager who handles supervision and the management; later on, the client will also engage one or more contractors.

These alternatives vary in the certainty of the cost of construction, planning flexibility and the ability for planning to continue after the process has been launched, and in the legal and contractual liability. A client that does not work with a "turnkey" contractor and that uses several different contractors will, even if they retain a project manager and inspector, be liable for the process, including with regard to building safety.

An owner can stipulate that the contractor will bear the entire liability – for construction dates and costs, third-party liability, etc. However, criminal liability for which the owner is liable by law cannot be transferred to the contractor. The courts have drawn a distinction for this matter between turnkey contractors, who are considered liable for everything that happens on the site and on the project, and an owner who builds using several contractors; the latter cannot disclaim criminal liability.

A developer cannot disclaim liability toward purchasers of any part or all of the project. The developer will be directly liable toward purchasers, regardless of whether they have back-to-back liability against the contractor.

Construction contracts usually impose broad liability on the contractor; the contractor assumes contractual liability, and warrants to purchase insurance and to indemnify the client.

A contractor may be held liable for the project’s timetables; this is common practice. Liquidated damages for delays are also common practice.

Contractors usually submit bank guarantees; first, a performance guarantee, the main purpose of which is to guarantee the contractual timetable, and later on also a warranty and overhaul guarantee for the quality of construction. The performance bond is usually equal to 5% of the contractual fee, and the overhaul guarantee is usually half of the performance guarantee, and sometimes reduces after the first year.

In most cases, contracts prohibit the designer and contractor from hypothecating their contractual rights toward the owner. Subject to the owner’s consent, contractors sometimes hypothecate their contractual right to receive their fees.

Once construction is completed, the holder of the building permit must obtain a completion certificate from the local planning authority before any use of the building. Several certificates should be obtained as a prerequisite: a certificate confirming that construction is compliant with the building permit, the inspector’s confirmation that the construction product is not faulty, a certificate confirming that the building complies with the access for persons with disabilities rules, etc. Use of a building without a completion certificate is a violation of the criminal code, both by the owner and by the user.

VAT is payable on any transaction in which the seller or purchaser is registered with the VAT Authority as a "Dealer" (an official business entity). Residential properties that are rented to individuals are not liable to VAT.

A business company is usually a "Dealer", and will pay VAT on any purchase of real property. If the seller is a "Dealer", they are liable for remitting VAT, and the purchaser will receive an invoice and can set off input tax against VAT in other transactions, such as payments they make to suppliers. If the seller is an individual who is not a "Dealer", the purchaser shall pay VAT through a self-billing invoice, which they can also set off. The current VAT rate in Israel is 17%.

Purchasers have tried to allocate some of the consideration in real estate deals to assets other than the real property, such as equipment, leasehold rights, etc, in order to reduce their purchase tax obligation. The Supreme Court ruled against this. It is possible to claim that equipment that can be separated from the property, is not part of the real property. It is also possible to argue that some of the consideration of the amount is for goodwill, if one can prove that the goodwill is independent from the real property, and can establish its value.

Two other ways to acquire a real-estate portfolio with a minimum exposure to purchase tax is to invest in a publicly traded real-estate company (traded in Israel) or in a REIT company in which shares are not yet traded, provided that REIT company will meet the future conditions for any such exemption.

City tax is fixed by the local municipality, by a “city tax order”, which is updated from time to time, subject to a cap stipulated by the government. The amount varies, depending on the use category and sub-category, such as office, banking, movie theatres, stores, etc. Exemptions from city tax on usable (as compared to unusable) property are rare, and depend primarily on the user; for example, disabled persons are eligible for discounts on business uses, and senior citizens are also eligible for discounts on residential use.

Payments to foreigners are usually subject to tax withholding, 25% for individuals, and the applicable corporate rate for corporations (currently 23%). All are subject to any applicable tax treaty with the investor’s country of residence, and on the classification of the income in his or her hands. 

Rent is taxable according to the classification of the proceeds: corporations will pay corporate income tax, individuals will pay according to their income tax bracket (which could reach 47%, plus 3% surtax). Tax on rent is paid by the lessor, or by the lessee through tax withholding, depending on whether the lessor has an exemption and whether the lessee is subject to tax withholding duty.

Tax breaks exist only for income on residential rent. Foreign residents can use them in a similar way to Israeli residents.

Taxable profit can be reduced by offsetting expenses against the income; in addition to the cost of purchase, the seller can deduct improvements such as renovations, improvement levy, real interest on loans taken to finance the original purchase, and ancillary expenses to the purchase and sale of the property, such as realtor and attorney fees. 

Companies and “Dealer” entities that generate business income on real property can make ongoing deductions with respect to their expenses on the property, may deduct depreciation on the cost of purchase and improvements invested. Any deductions made on a current basis will not be recognised as an expense upon sale of the property.

Yigal Arnon & Co

1 Azrieli Center
Tel Aviv 6702101
Israel

+3 608 7821

+3 608 7727

hagit@arnon.co.il www.arnon.co.il/content/bavly
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Law and Practice

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Yigal Arnon & Co has one of the largest, most professional, experienced and reputable real estate departments in Israel, with 60 lawyers operating in its offices in Tel Aviv and Jerusalem. The firm's real estate practice, in addition to its planning and zoning and urban renewal practices, is recognised by international legal directories. The firm has unique and unparalleled expertise, gained in almost 60 years of involvement in many of Israel's most significant commercial, residential, industrial, infrastructure, office, shopping centre, hotel, resort, residential and mixed-use real estate projects. Clients include major Israeli and international real estate and construction companies, REITs, holding companies, banks, real estate developers, entrepreneurs, and hotels. The firm provides a wide range of services in the field of planning and zoning, assisting its clients in all planning stages, from property re-zoning and conversion to building plan and building permits approvals, and provides litigation, including representation before planning committees and courts.

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