The average closing price for home sales in Tel Aviv dropped 13% from the third quarter of 2010 to the third quarter of 2011, according to MNA Real Estate Research. This wasn't just due to falling demand, it also reflected a shift of activity toward cheaper neighborhoods in the more rugged south.

MNA's survey reveals that homebuyers in the city have recently been enjoying a better bargaining position, with sellers having to compromise. The decline in prices intensified toward the end of the year.

According to the study, based on data provided by the Israel Tax Authority, home sales in Tel Aviv fell by half between the first and third quarters of the year, from 773 to 366. The market chill was particularly acute in expensive neighborhoods.

In the priciest area, the city center, the number of transactions plunged from 201 to 51, in the "Big Block" next to Sde Dov Airport, it dropped from 26 to just two, and in Azorei Chen it fell from 18 to five. A similar pattern was seen in the city's other upscale areas.

In contrast, cheap neighborhoods grabbed a larger slice of the market: Almost 15% of the city's transactions in the third quarter were in Neveh Sharett, up from less than 10% in the first quarter. In Florentin the percentage rose from less than 5% to about 8%, and in Yad Eliahu it surged from 1.4% to 6.3%.

Except for two-room and 2.5-room apartments, where the average sale price in Tel Aviv rose 12% from the first quarter to the third quarter of 2011, average prices in all size categories during the period declined.

Prices for one-room and 1.5-room units dropped about 15% to NIS 765,000 on average, three-room and 3.5-room units went down by around 10% to NIS 1.66 million, four-room and 4.5 room homes tumbled 24% to NIS 2.13 million, five-room and 5.5 room residences slipped 3% to NIS 4.2 million, and homes with six rooms or more dropped 13% to 6.43 million.

Tel Aviv's priciest sales for three-to-five-room units took place mainly in the city center thanks largely to new deluxe projects, but the northern neighborhoods weren't far behind. Park Tzameret, with its Yoo Towers, and Azorei Chen were slightly costlier than Bavli, Kochav Hatzafon, Ramat Aviv and the Big Block. The lowest-priced deals were concentrated in Yad Eliahu, Neveh Sharett, and Jaffa's central and southern neighborhoods.

Five-year investment in Tel Aviv property yielded 350%

The rental market in Tel Aviv-Jaffa shows an average gap of NIS 1,000 between monthly rent charged on three-room and four-room apartments, while five-room units cost almost NIS 2,000 more than four-room units.

"Income apartments in Tel Aviv have among the lowest yields we've measured, compared to the entire central region too, due to the significant rise in property prices and despite the higher rents charged," MNA said.

"In the past year investors earned on average a nominal 2.6% annual return for an average apartment. The Bank of Israel rate, by comparison, averaged 2.75% over the year, while the Tel Aviv Stock Exchange benchmark TA-25 index provided investors with a nominal 17% return. It should be noted that the rate of return in Tel Aviv is affected by the fact that many apartments have been subdivided by investors into a number of separate units."

But despite the low returns from rentals, Tel Aviv homebuyers have chalked up handsome profits from rising values since the end of 2006. Over those five years, the value of a 100-square-meter four-room unit has gained, on average, more than the return on the TA-25 index.

"We examined a NIS 300,000 investment in a four-room property averaging 100 square meters, with the balance financed by a mortgage at interest linked to the prime rate, and mortgage payments deducted from the property price at each interval calculated from the rate set by the central bank," MNA said.

"These figures show that investing in real estate in Tel Aviv-Jaffa yielded a much higher return than an investment in the TA-25 index. The return on equity invested in a four-room apartment in Tel Aviv since December 2006 stands at 350% as of October 2011, against a return of about 43% from the TA-25 index."

Housing overpriced by 50% - until protests

To measure the relation between average market prices for homes in Tel Aviv and their real value, the latter was calculated from rents and the return they offered on investment. The real value of an asset is known as its "fundamental value" and is basically defined as the expected aggregate discounted cash flow provided by the asset.

The real value was found by dividing rental income by the average annual return on two-room and three-room apartments from 2003 to the third quarter of 2011. This was compared to market prices on the assumption that any difference between the two has no objective economic basis other than reasons generally unrelated to buying property as an investment: view, direction of view, proximity to schools and public transportation.

One possible reason is an expectation that prices will continue rising; such reasoning plays an important part in creating a bubble effect.

In the second half of 2008 and throughout 2009, the prices of two-room apartments in Tel Aviv reflected their real values, and their rates of return were close to their multiyear averages. The gap between real value and average actual prices ranged from -5% to 5%, indicating an efficient market.

The big change began in 2010 and reached its peak in the second quarter of 2011. The difference between real value and average actual prices reached as high as 50% - meaning properties were being sold at 1.5 times their real value.

Average prices for three-room units, however, exceed their real value by just 15%, and are back at the same level as in the second quarter of 2008. This can be explained by their drop in price, along with a rise in rent being charged.

A seller's market no longer

The sale-to-list ratio measuring the balance of power between homebuyers and sellers compares average closing prices reported to the tax authorities with average prices listed in classified ads on the Internet.

Except for July and August, the ratio was higher than 1 throughout last year: Closing prices were even higher than the advertised prices, clearly indicating a seller's market. Prices during the summer dropped significantly, however, before stabilizing in September.

The last three months of 2011 saw the ratio decline from 1.14 to 0.97, evening out the balance between buyers and sellers in Tel Aviv, with buyers having a slight advantage at the end of the year.