A resident of France was interested in purchasing a Netanya apartment overlooking the sea. The owner was asking $600,000. An assessor came to verify the property value on behalf of the Bank of Jerusalem, in order to approve a mortgage, and determined the apartment was worth only $500,000. When a bank representative informed the buyer, he was unfazed.

"I know," he replied, "but a completely outfitted apartment where I don't have to alter a thing is convenient for my trips to Israel."

This is how a real estate bubble develops. Will it continue to grow, or will it implode? That is the main question facing the Israeli real estate market in 2007. The rest of the market is expected to remain constant, and all the underlying problems diagnosed over the past few years are expected to continue.

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Most market players, particularly the contractors, say the recession in their industry is not over. Even so, last week Hefziba Building reported record sales of 1,150 housing units in 2006. The financial results for Y.H. Damari Construction are also better than in 2005. These companies, however, operate mainly in the middle-income residential sector, and do not reflect the burgeoning luxury housing market.

Residential real estate is flourishing in the center of the country, thanks both to luxury projects and to high demand for apartments in the Sharon, Ashdod, Netanya and Jerusalem regions. Reports of apartments that have appreciated by 20 percent over the past two to three years are not unusual.

On the other hand, a general overview reveals a less than rosy picture, because Israel is not comprised of only the central region. This year, fewer than 30,000 new apartments will be sold, and large swaths of the country, including the Haifa region, the Galilee and the Negev, are not recovering. Nationally, the real estate industry is still waiting for real forward momentum.

At the beginning of 2006, the outlook was more positive.

"The year began very well," recalls Benny Keret, CEO of Azimut Advertising and Marketing Research, "and we thought that the hoped-for breakthrough was on its way. The euphoria prompted by the [luxury residential] towers in Tel Aviv and some other high-priced property deals masked a poor year in the new apartments sector."

This euphoria found expression in several million-dollar deals in central Jerusalem and in the luxury towers along Tel Aviv's Hayarkon Street. Some apartments fetched as much as $15,000-$18,000 per square meter, and most of the buyers were foreign residents.

Other sources of optimism were the beachfront apartments in Eilat, Ashdod and Netanya, which really took off; the villas in Herzliya Pituah continue to amaze real estate page readers; apartment buyers in Ra'anana are willing to pay ever higher prices; and the rising land prices in Tel Aviv's new northern neighborhoods are more reminiscent of share prices than real estate. Plots for homes in these areas are now topping $220,000.

At a certain point, however, apprehension replaced the wonder at what was happening in the luxury and mega-luxury markets.

"Economic theories cannot explain uneconomic behavior, such as the French buyer in Netanya, and cannot forecast where the market will go. These prices, of $15,000 per square meter, are beyond the peak real prices and reflect the beginnings of a bubble," says Yaacov Siso, deputy CEO at the Bank of Jerusalem.

Others claim that the prices of the most expensive luxury properties in Israel are not yet on par with those in Manhattan, so there is still something to look forward to - although Tel Aviv cannot be compared to Manhattan, so perhaps this year's records will remain stable in 2007.

The debate over land prices in Tel Aviv's new northern neighborhoods, however, will continue. Attorney Yizhak Hajaj, who represents groups of buyers in those neighborhoods, rejects claims of a bubble. He says his experience shows there is a large group of buyers that can pay these prices and is not deterred by them.

"Land prices in these areas will reach $290,000, even $300,000," says Hajaj.

Just beyond the "euphoria" areas, however, are two niches that account for more than 90 percent of apartment sales (in number of units, not shekels). The residential housing market for middle-income families in the central region is on the upswing, but is following the rules of supply and demand: mortgage rates are down to 5 percent, from about 7 percent in 2001; continuing economic growth has resulted in increased incomes; VAT, income tax and purchase tax are lower; and the capital market is flourishing.

"Still," says Siso, "this applies only to the Netanya-Ashdod-Jerusalem triangle."

Most real estate industry sources believe prices will continue to increase in 2007, as demand outpaces supply. The rezoning of agricultural land for residential construction is progressing slowly, and the inventory of new apartments is waning.

The apartment market in outlying communities offers contractors no reason to smile. The Housing Ministry last week reported a 20-percent decline in new apartment sales in public projects in the periphery, which has been suffering from steady declines for six years.

"The war [in Lebanon] is partly to blame for this," says Keret, "but it did not cause the drop in new apartment purchases in the periphery. In fact, nine apartments were purchased in Carmiel in July and August, when the Katyushas were falling.

"Prices also decreased in private developers' projects, due to the problems troubling the entire market, which is not pulling out of the recession. As a result, various companies also trimmed their advertising budgets by 19 percent."

No change is anticipated in the periphery in the coming year. The housing market recession will continue, as economic growth fails to reach those areas; there is a surplus supply of apartments and land, and the population is economically weak.

"As long as the state does not offer substantial aid to the periphery, in the form of home-purchasing assistance combined with other solutions, it is hard to see how things will change on their own," continues Keret. "The fruits of economic growth will continue to be harvested in the center of the country, blinding the analysts, and at the end of each year people will still not understand why, despite this prosperity, the real estate and construction industries are not flourishing accordingly."