Almost anyone with a few hundred thousand shekels stashed away invariably faces the question of where to put it: in stocks and bonds, or as Israelis love to do, in a nice little apartment that will generate rental fees.
The dilemma takes on an added dimension with today’s low interest rates coupled with the sharp increase in housing prices over the past five years. Both the Bank of Israel’s low interest rate (currently 1.75%) and the yields on government bonds make property seem like a better investment.
Low interest rates make mortgages cheaper − giving investors more leverage − thereby boosting the return on equity. Individuals don’t generally use leverage − a.k.a. borrowed money − when investing in stocks and bonds, so this factor is relevant mainly in the housing market.
Real estate investments have returned about 88% over the past five years, much more than the leading capital market indices returned. This figure includes both property price increases as well as rental income. This was certainly a very rewarding period for property investors, but the sharp gain raises the question of how much housing prices could still increase in the future. Israel’s housing prices are now among the highest in the world relative to local salaries, and few experts are willing to bet that they’ll rise too much more.
In addition, the new government is likely to set itself the goal of lowering housing costs. It has the means to do so, namely by increasing supply. The Bank of Israel, also worried about high housing prices, has also taken steps to reduce mortgage lending by toughening regulation on banks.
But most Israeli investors still prefer to put their money into property, and the majority still consider this a better investment than the Tel Aviv Stock Exchange. The opportunity for leverage and for steady rental income to pay back that loan also entices many Israelis.
The research department at Migdal Capital Markets compared the performance of both investment channels − housing and securities − over the past 14 years. The results show that contrary to popular belief, Tel Aviv’s stock and bond markets provided better returns than housing over this period.
Housing prices' five good years
Investing in real estate was the way to go for the last five years, from 2008 to 2012. This period started with the global economic crisis and market collapse at the end of 2008. Over this period, the average home returned 88% in nominal terms, while a portfolio of stock and bonds traded on the TASE squeezed out a miserly 17%.
But over a 10-year period − from 2003 to 2012 − the results were reversed. Stocks and bonds generated an average nominal return of 155%, while the average home returned about 100%. The gap was even wider for the 14-year stretch from 1998 to 2012: 200% to 115% in favor of the stock and bond portfolio, nearly double the return on the average home.
The analysts reached this figure by calculating that home prices increased 64% in the past five years, while rental income generated returns totaling another 23% − about 4.2% a year. This works out to an 88% average return on real estate investments. The capital market, on the other hand, underwent one major crash in 2008 and a somewhat more moderate tumble from the middle of 2011 to September 2012. The general bond index returned 35% over this five-year period, with the index of corporate bonds returning 32%. But the leading stock indices fell flat: The benchmark Tel Aviv-25 Index of blue-chip shares crept up 4%, while the broader Tel Aviv-100 Index actually shed 5% in value.
Analysts at Migdal point out that construction companies traded on the TASE failed to capitalize on the housing market boom: The major publicly traded residential real estate firms actually lost 64% of their aggregate value during the 5-year period.
Adar Etzioni, head of Migdal’s research department, says the past five years were an aberration. This is what explains the huge imbalance between investments in housing and the capital market, he says.
“The beginning of the period under discussion − the end of September 2007 − was close to when the financial markets peaked, before collapsing when the sub-prime mortgage bubble burst in the United States,” he says. “These years don’t represent the normal capital market dynamics.”
2003 to 2012: Stocks win
In the longer run, though, real estate hasn’t done nearly as well. Residential properties yielded 47% in rental returns since 2003, while rising property values added another 54%. This is less than the 64% gain in values posted since 2008, meaning that prices actually declined between 2003 and 2007. In total, real estate yielded returns averaging 100% over this period.
Over the same 10-year stretch, the TA-25 index jumped 245%, and the TA-100 rose 213% for a handsome average annual return of 12.4%. The general bond index climbed 89% and the general corporate bond index gained 78% − an average of 6.3% per year.
The portfolio of residential real estate stocks dipped 1% over the entire 10-year period but varied wildly, says Etzioni. “Shikun & Binui shares actually produced a nice return of about 150% in this period, but shares in companies like Africa-Israel (which fell 78%) and Azorim (down by 75%) depressed the sector’s overall returns.
1998 to 2012: Stocks prevail hands down
Stock indices beat out the other investment channels over the 14 years from the end of 1998 to the end of 2012, averaging annual returns of 8.2% compared to 5.6% on investment homes.
“History shows that stocks win out over time and that patience when investing in stocks − volatile as they are − pays off,” says Etzioni. Since December 1998 the local stock indices have outpaced other investment channels by a wide margin: The TA-25 index quadrupled in value, averaging a 10.4% annual gain, while the TA-100 mustered a 265% gain for an average increase of 9.7% a year.
The general bond index registered a nominal 130% return, which works out to 6.1% per year on average. “This is about half the return provided by stocks, but it’s a solid investment vehicle with much less volatility,” says Etzioni. “This shows that risk-averse investors are also better off investing in the capital markets.”
The index of corporate bonds − which, despite being inherently riskier, rose 110% over the 14-year span − was outperformed by the general bond index, which also contains less risky government bonds. “The corporate bond market has experienced upheaval since 2008,” explains Etzioni. “Many companies ran into difficulty and restructured their debt, and the turmoil has weighed heavily on the index’s performance.”
Residential properties provided a 115% return on investment over this period. Rising housing values were responsible for 48% of the gain − an average of 2.8% a year − while the remaining 67% came from rental income, averaging 3.7% a year.
Residential property values have not significantly outpaced inflation, which averaged 2% over this 14-year period. Despite the jump in housing prices in recent years, over longer periods the figures show increases have been much milder.
Pluses and minuses
Despite the clear long-term advantage of investing in the capital market, it still has a number of drawbacks. First off, securities are much more volatile than home prices and are therefore less suited to risk-averse investors. Housing prices may also move abruptly in either direction, but not for very long.
Leverage can be another point against investing in the capital market. Property investors often use financial leveraging − they get credit from the bank. People buying a second home can get a loan worth 70% of the home’s value, under current Bank of Israel regulations, while people buying a third home can receive credit of up to 50%. Investors can also receive loans to buy securities, but this is dependent on the quality of the asset and the investor’s financial stability.
But the capital market has key advantages too, starting with liquidity. Tradable securities can be cashed in much more quickly than investment homes. Buying and selling mutual funds and exchange-traded notes (ETNs) on the TASE is simple and easy, doesn’t cause headaches, and doesn’t entail myriad expenses. In contrast, buying and selling an investment home is a relatively complex affair requiring time, expertise and professionals such as realtors and lawyers.
The costs associated with maintaining a market portfolio are much easier on the wallet than those involved in buying and maintaining a residential unit. The cost of investing in the capital market is generally determined based on the amount invested, who is doing the investing, and the investor’s negotiating ability. Charges mainly include commissions for buying and selling along with management and maintenance fees, but when the investment is a large one, these fees generally work out to be a relatively small percentage.
In buying and selling homes, however, most costs are fixed and are calculated as a percent of the transaction. Purchase tax can be as much as 7%, the lawyers’ cut is 1% to 2%, and realtors take up to 2%. Betterment tax could be another expense. Then there’s the cost of maintaining and insuring the home. All in all, buying and maintaining a home generally costs much more than managing a securities portfolio of similar value.
And the conclusion is ...
The study by Migdal Capital Markets is based on past figures, but Etzioni draws conclusions for future investments. “After experiencing a sharp rise in housing prices in Israel, our chances of seeing continued significant returns from this investment channel are relatively low,” he says. Thus, right now it is better to invest in the capital market, no matter what the time frame − long, medium or short term.
Etzioni feels this way even though lending rates are currently quite low. “If interest rates increase, the argument in favor of the capital market will become even stronger,” he explains. “Leveraging costs will go up, reducing the demand for housing units and pushing prices down.”
The report’s conclusion offers encouragement to anyone considering an investment in the capital market in general, and stocks in particular. But it’s important to note that its future predictions relate to general probabilities regarding the market as a whole, and not any specific property or stock.
It’s likely that even today, there are investment homes on the market that could generate a higher return than the leading stock and bond indices. Statistical data is helpful in making general decisions but investors always need to conduct a thorough, independent examination of the assets that interest them.