Are Home Prices About to Explode Higher?

Demand remains brisk, thanks to the Bank of Israel, and supply is getting tighter, thanks in part to the Finance Ministry – and the result could be something that no one wants

Moshe Kahlon, the Israeli finance minister, speaks during a conference in Tel Aviv.
REUTERS/Baz Ratner

Are the Bank of Israel and the Finance Ministry – each for reasons of its own – rekindling the housing price flame?

The 0.9% increase in the housing price index for May-June after eight months of small declines or no change came at an uncomfortable time for the treasury and its boss, Finance Minister Moshe Kahlon. Kahlon had been marketing himself as the finance minister who had brought down home prices, but now his unofficial election campaign is under threat.

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A lot of factors go into housing prices, like supply and demand, taxes, cost of construction and, of course, interest rates. To that, Kahlon chose to step up government intervention in the market to levels not seen in years, mainly by subsidizing prices through the Machir L’Mishtaken program and crowding out the private market.

But he has also undertaken measures that undermined his goals. He forced property investors out of the market by imposing heavier taxes on them and boosted demand with Machir L’Mishtaken. Meanwhile, housing starts dropped 22% in the year through March to just 43,349.

Bank of Israel Governor Karnit Flug and her banks supervisor, Hedva Ber, are also doing Kahlon few favors by keeping interest rates so low for so long. This week the central bank released figures showing that new mortgages in July had reached a three-year high of 5.8 billion shekels ($1.6 billion).

The finance minister has actually been supportive of low mortgage rates to ensure that every first-time buyer could afford a home of his or her own, but the result is a dangerous brew of strong demand and shrinking supply – just the kind of situation that set off skyrocketing home prices to begin with.

The summer is usually the peak season for home loans as families move homes between school years. In that context, July 2018 figures weren’t unusually high but what was worrying is that mortgage rates have remained unchanged since the end of 2017 at a relatively low 1.6%. 

Eighteen months ago, it was 2.1% because of restrictions placed on the banks by Ber, especially on capital set-asides. It was an interesting maneuver by a central bank – to raise rates only on home loans without affecting borrowing costs in other sectors, The bank succeeded, too, even if that wasn’t its original goal. The banks did as they were instructed and increased capital set-asides. 

But then Ber changed course several months ago and went so far as to ease the requirements on mortgage lending. That move explains a good part of the renewed demand for mortgages and for housing.

Over the last few years, the central bank has taken its fair share of blame for fanning demand for housing. It’s not just that mortgage rates are cheap, but there is an absence of investment alternatives, thus Ber’s latest move could revive the price rise that seemed so close to ending.

It’s reasonable to assume that the Bank of Israel doesn’t want that, certainly not at the breakneck pace of the last few years. On the other hand, it doesn’t want prices to fall sharply either, which could saddle Israel’s banks with a lot of bad mortgage debt. 

There are a few good reasons to suspect that mortgages rates won’t stay low. The Bank of Israel doesn’t set them – it can only influence them by raising or lowering capital requirements. Rates are also determined by the banks’ cost of capital when they raise money in the bond market, and there is good reason to think those costs are going to rise.

For one, the U.S. and Britain are raising their rates and its inevitable that Israel will follow suit. Another is Kahlon and the Netanyahu government, which have become big spenders – Netanyahu with plans for a growing defense budget and Kahlon with the cost of Machir L’Mishtaken subsidies.

If elections are called in the next few months, spending will inevitably rise more. That spells more government borrowing on the bond market and rising interest costs that will reverberate on mortgage rates.

One month worth of housing prices doesn’t add up to a trend and contradictory forces are at work. But for Kahlon and his reputation as the friend of the Israeli consumer, these can only be trying times, all the more so if he has to face the voters early next year.