Will the Government Bring Down Home Prices? The People Have Little Faith

Some claim the dynamics in Israel's housing market echo those in the United States and Europe before the subprime crisis. The truth is more complex.

Eyal Toueg

Israel’s short history is littered with incidents of falling home prices, all without exception under the shadow of a crisis. In the early 1960s, housing prices dropped during a deep recession; in the 1970s it was the Yom Kippur War that brought prices down; in the 1980s they fell again under the onslaught of hyperinflation, the collapse of the banking system and in the wake of the first Lebanon war. Recessions also stymied the local real estate market at the end of the 1990s and in the early 2000s. The question is, what will rein in the market now?

Some people in Israel believe the government can lower house prices in a controlled manner. Prime Minister Benjamin Netanyahu and members of his cabinet keep saying they’ll bring down prices by 20%. It’s highly unlikely they can do so, but it’s hard to put their assertions to the test, since the government has so far thrown out numerous declarations and promises while doing very little.

Israel’s party politics also brought about unconventional proposals, such as the plan to exempt some families buying their first home from the 18% VAT on apartments. Criticism of that plan, particularly by economists, has been very harsh, and the chief economist in the Finance Ministry resigned to protest his lack of faith in the program.

Will that proposal actually go through? It’s still uncertain. It’s surrounded by legal controversy, and is expected to cost the state some 3 billion to 4 billion shekels in tax revenue. It’s still not clear how the state would finance that. Furthermore, many people fear the plan would actually increase prices.

Therefore, it seems likelier that the next drop in housing prices will come not thanks to the government, but due to a crisis, just as it has in the past in Israel, and just like it happened during the past decade in Western Europe and the United States.

Indeed, many believe the current dynamics in Israel’s housing market are on par with the recent real estate bubbles in the West. They warn that Israel can expect exactly what happened in Western countries six years ago, with prices falling tens of percent.

This might be true, but it’s not an easy comparison. In some areas of the United States and Britain, housing prices tripled – meaning they went up more than 200% – between the end of the 1990s and the middle of the subsequent decade, whereas in Israel, prices have less than doubled on average. But even more important are the circumstances. In the United States, for example, subprime lending and speculative investing took off, while in Israel the number of homes bought for investment has never exceeded 25% of all home purchases, except for limited periods in 2009 and 2010. The vast majority of homes are bought by people who intend to live in them.

The ‘foreign buyers’ myth

At times, it has been claimed that foreign residents purchasing homes in Israel at inflated prices were causing bubble-like pressure in the market, but these were myths created amid the search for scapegoats to explain rising prices. Foreign residents actually account for just a tiny percentage of Israel’s real estate market. During their peak activity, they bought 5,000 homes a year and constituted about 6% of the overall market – and that was in 2005 and 2006. In recent years, they’ve drastically cut back purchases to around 4,000 a year, making up 4% of the total market.

With little evidence of subprime lending or massive speculative investment in Israel, there isn’t much room to claim that the circumstances here are equivalent to those in the United States and Europe. Furthermore, you can’t blame excess construction in Israel, as it was abroad. But most economists here still believe the root of the problem is the same as it was in the European and U.S. markets: low interest rates, which make borrowing cheaper and impel the banks to provide large amounts of loans, pushing housing prices upward.

So until Israel’s wave of price increases comes to an end, this hypothesis can’t really be tested. The most notable phenomenon in Israel is the public’s disbelief that the government can lower housing prices. Some people even say it’s in the government’s interest to keep prices rising, since this boosts revenues from taxes and public land sales.

This lack of trust in the government made 2013 a record year for home sales, with more homes sold last year than in any year this century – 111,000 – despite the skyrocketing prices. This isn’t characteristic of a population that believes the government will bring down prices, or even one that fears home prices have reached bubble proportions.

Petah Tikva skyline
Daniel Bar-On