Soaring Home Prices? Look to Black Capital for an Answer

A global crackdown on tax evasion has driven a lot of money into Israel real estate, which has become a giant laundromat for dubious capital.

Dreamstime

Between 2010 and 2013, the number of construction workers in Israel plummeted, but for some reason the pace of construction stayed the same. Was there suddenly some big labor-saving technology advance in building?

No. It turns out that the workers that had been laid off were replaced by others who were being paid off the books.

The return on homes bought for investment in Tel Aviv has fallen to ridicuously low levels. So why are people still investing in residential real estate? It seems landlords are reporting to the tax authorities lower rental income than what they actually collect, in order to avoid taxes. Another interesting fact: In 2008, 2010 and 2011 foreigners bought real estate worth 6 billion shekels ($1.5 billion), with money that it seems was never reported to tax authorities overseas.

These are just three of the findings concerning the black market in Israeli real estate that will be presented next week at a special panel dealing with the issue, as part of the Sderot Conference for Society, which will be held next week at Sapir College in the southern city.

All told, the amount of black market money pumping through the Israeli real estate sector is estimated at 15.3 billion shekels annually and is one of the factors that have led to the steep rise in housing prices, according a study by Avichai Snir, a lecturer at the Netanya Academic College. He estimates the total Israeli black market at 355 billion shekels a year.

“Black market [money] in Israel grew 4%, from 22% to 26% of gross domestic product, at the same time as the large rise in housing prices — and that says quite a lot,” says Snir, who is also the chief economist at Infinity investment house. “This is huge growth, which came at the same time as the big increases in the real estate market.”

Snir thinks that in comparison to most sectors of the economy, real estate is especially prone to off-the-books transactions because it is labor intensive. In addition, people buying homes do not have to account for where the money came from — in contrast to people depositing large sums in a bank or opening an account at a financial service company. With its multi-million-dollar homes and light financial regulation, the real estate sector is a giant laundromat for dubious capital, he says.

Ignoring black money

And as the property sector grows, it attracts more and more illegal money. Everyone asks how can it be that the price of an apartment is the equivalent of a steep 140 monthly salaries, says Snir. Illogical? Only if you ignore the involvement of black money — although that is exactly what experts and policymakers typically do.

“No one likes talking about something they don’t know, and since they don’t know what’s happening in the black market, they prefer to talk about something they see,” asserts Snir. If the government were to admit black money is behind skyrocketing housing prices, it would be open to charges of failing to act, he says.

So how do we verify the existence of the black market if we don’t have data on it? Snir says one way is to look for seemingly illogical behavior, explain it and estimate the value.

Take construction workers. Snir looked at those engaged in what is known as “wet work” like plastering, tiling and surfacing. The work is labor intensive and its pace generally dictates the time it takes to build a home because most other work cannot be started until “wet work” is completed. Moreover, over 40% of those in these trades are foreigners and a lot of them work off the books.

Snir found that between 2010 and 2013 the reported number of workers employed per housing unit dropped by a third even though there was almost no change in the time it took to build a house. How could this be? Snir is of the opinion that a lot more people were working in wet construction than contractors were reporting to the tax authorities.

“Since there were no significant advances in building technology nor in the types of homes being built during that period, the figure can only be explained if we assume that the number of workers in practice was not reduced to the same extent as the reported figures. Otherwise, a 33% drop in the number of wet workers per unit would have resulted in a big increase in the time of construction,” he says.

Snir next tried to estimate the total value of all this black market labor. His conclusion: In 2013, at least 25,000 workers were employed off the books in “wet work” and the value of their labor reached 1.5 billion to 2 billion shekels a year.

Foreign capital

Foreigners buy homes in Israel for all sorts of reasons, one of which is to hide the source of money from the authorities in their home countries. Between 2008 and 2010, citizens of France, the United States and other nations had reason in particular to invest and launder money via real estate, says Snir. The lists of secret bank accounts in Switzerland had been obtained by U.S. tax authorities, enabling them to locate the source of the funds much more effectively. Many took it out of the banks and put it into real estate.

Interestingly enough, foreign residents in Israel generally have incomes that exceed their local expenses — except for the years 2008, 2010 and 2011, according to the Bank of Israel. It seems that much of that money went to buy real estate, a figure Snir estimates amounted to over 2 billion shekels in the three years, enough to buy about 2,000 homes every year. That is equal to some 2% of annual sales, which is a large enough chunk to influence prices, especially in areas where foreigners tend to buy. In practice, the figures are probably larger, because many foreigners pay for homes in cash, and these transactions don’t appear in the Bank of Israel’s figures.

However, it isn’t just foreigners who are hiding illegal money in Israeli housing, Snir says. In some cases the money is used for buying homes, and in other cases by evading taxes on rental income. Of the 50,000 homes bought by investors between mid-2012 and the end of 2014, 18% were bought by people with reported incomes of under 7,000 shekels a month, an amount that puts them under the poverty line, even though the average price they paid per home was 995,000 shekels. Another 9% of houses bought for investment were purchased by people claiming they earned less than 10,000 shekels a month. It is unlikely the banks aided them in taking out mortgages so they would have needed to put up large down payments. The money must have come from somewhere, possibly from others or from unreported income.

All told, Snir estimates home purchases used to launder money not reported to the tax authorities totaled at least 9 billion shekels annually in 2012 and 2013, which like foreign buying had the effect of boosting home prices, he says.

There are also illegal funds in the rental sector, such as when the landlord does not report his rental income to the tax authorities. The reason is that rental income of up to 4,980 shekels a month (as of 2013) is tax exempt, and does not even have to be reported in many cases. Over this amount the owners must declare the income and pay taxes on it.

In many cases landlords reach an agreement with the tenants on a rent higher than the tax-exempt maximum, but only write the exempt amount in the contract. The tenants pay the difference in cash, often in return for a discount on the rent. Snir’s research examined only Tel Aviv. But since many landlords don’t regard evading such taxes as immoral, it can be assumed that concealing part of the rental income takes place in many other places across the country, he says.