Two recent announcements by the Bank of Israel reveal the serious Catch-22 the real estate market has found itself in. The central bank itself has played a large part is creating these circumstances. On the one hand, the Bank of Israel announced that the prime interest rate will be remaining at 0.1%, as it’s been for an unprecedented amount of time now. On the other hand, it has warned commercial banks about the great risk they are taking by giving credit to real estate ventures.
There is a tight association between the two. The interest rate set by the Bank of Israel has been very low ever since the global financial crisis in 2008, as has been the case for most central banks around the world. The goal is to support economic growth while providing businesses and individuals with cheap credit so they can invest, consume and drive the wheels of the economy.
If anyone had the intention of slightly increasing interest rates to return them to normal levels, the arrival of the coronavirus shook up the global economy to the point of paralyzing some parts of it for months, obliging governments and central banks to continue with their expansionary monetary policies. This has left interest rates as they were.
But an economy is not composed solely of small businesses (that were hurt) and of airlines and tourism (which suffered critical blows), but also of many businesses that weren’t hurt, and of many working people who continue to consume and invest. When interest rates are low and inflation starts to rear its head, investors and consumers look for better uses for their money, such as in capital markets or real estate.
This quest encounters a problematic reality in Israel’s apartment market: supply that is too low relative to the large demand. The demand side also includes affluent people with financial security. The result has been a 7.6% spike in the price of apartments over the last year.
As soon as the previous government cut the taxes paid by real estate investors, thus announcing that it has no interest in blocking the rise in housing prices, and with the Bank of Israel making it easier to take out larger morgages based on the prime interest rate, the market has been roiling. Banks are interpreting the decisions of the government and the central bank as a lack of concern over the state of the real estate market, and acting accordingly. They loosen their belts a notch and reduce the capital demands they make of contractors – namely how much capital they can borrow relative to the value of a property, and how much financing they can receive for a project relative to the rate of sales.
The Bank of Israel’s governor, Prof. Amir Yaron, is responsible for the low interest rates, but the conduct of banks given the interest rate is under the purview of the supervisor of banks, Yair Avidan, who has identified the shifting trend. He sent a letter a few weeks ago noting that in the first half of 2021, the risky corporate credit held by the five largest banking groups had grown by 66 billion shekels ($20.6 billion), 54% of that being credit to real estate ventures. Banks give contractors generous credit so they can contend for bids and build projects, and are doing so with less caution than in previous years.
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Avidan’s letter detailed the rising risks. It demanded that banks monitor this credit and provide him with the minutes of discussions regarding their credit risk. The supervisor’s message: cool things down.
The Bank of Israel has a dual and contradictory role. On one hand it’s pouring oil on the real estate fire, while with the other hand it’s pulling out a fire extinguisher. However, it’s far from clear that one extinguisher will suffice given the market situation and the immense power of low interest rates. It seems that in order to chill the market, the central bank will need to pour less oil on it.