The 7-year Glitch: Will Israeli Housing Prices Ever Stop Rising?

Finance Minister Yair Lapid cautions against buying right now due to government moves to lower home prices. Buyers meanwhile seem convinced that what goes up must keep going up.

Daniel Bar-on

Seven consecutive years of rising prices – sometimes steeply – in Israeli real estate have spawned two commonly held views about the marketplace. One view, widely held by both frustrated young couples and exuberant investors, is that home prices in Israel never decline. The other view, in complete contrast, holds that because nominal home prices have soared 80% on average over the past seven years, a dangerous real estate bubble has formed. This alleged bubble is said to be based on enormous amounts of credit and loans, and that the day the market collapses and prices start plummeting – taking down a multitude of households and a number of banks – is closer than ever.

It would seem that both views are flawed. The first ignores the lengthy period – nearly 10 years, ending in 2007 – when the housing market was in a slump, with prices declining moderately. The second view, while backed by recent warnings by the Bank of Israel and the International Monetary Fund, has been roundly rejected by most Israeli mortgage-issuing institutions, which are considered much more conservative than their U.S. counterparts.

However, both viewpoints reflect various truths about the housing market. Indeed, even if Israel isn’t experiencing a housing bubble, the trend over the past few years has been far from normal. Consequently, homes in Israel may not be quite as good an investment as they were in the past.

For instance, at one point buying a 3-room apartment in the center of Tel Aviv and renting it out would have provided a steady 5% return. Now that apartment could be expected to generate just 2% or 3% at most. This is because the average rent increase in Israel – about 50% since 2007 – hasn’t caught up with the increase in home prices over the same period, especially in “hot” markets like central Tel Aviv or Jerusalem.

8% yield on rental properties

This doesn’t necessarily mean that buying a home in Israel isn’t a good investment. Even if the relative return from rent has declined, the increase in purchase prices – which shows no sign of abating so far – means that homes are continuing to appreciate in value. Data released recently by the Yad2 classified ads website – which also produces a price list for homes – showed that the average annual return on rental homes from 2011 to 2013 was 8%: 3.5% from rental income, plus an additional 4.5% due to increased property value.

Finance Ministry figures indicate that toward the end of 2013, there was a sharp increase in the number of investors putting their homes up for sale, apparently due to changes in taxation, including a hike in betterment taxes for investment properties.

Even so, owners of rental homes in Israel still enjoy very low tax rates on rental income. The first 5,000 shekels ($1,444) a month is entirely tax exempt, whereas other investment vehicles such as the stock market are fully taxed. In this regard, it is tough to argue that government policy discourages owning investment properties.

Cost-of-living protests

The main jump in prices in Israel’s housing market began at the end of 2008 – when the average home cost slightly over 800,000 shekels – and lasted until the middle of 2011, when home prices averaged 1.15 million shekels. That’s a 40% increase over two and a half years. This may have been good news for those who already owned a home, but it was a hammer blow to the general Israeli public, especially young couples, and one of the main reasons for the outbreak of the massive cost-of-living protest that summer.

The 2011 protest led to a severe slowdown in the industry, and even halted price increases entirely until April 2012. But once the Israeli public – which was awaiting government measures to bring prices down – realized that not enough was being done, it started buying once more.

Prices again began to rise, albeit not at the same frenzied rate as seen in 2009 and 2010. Prices climbed 8% in 2013, and the average price reached 1.26 million shekels toward the end of the year, with newly built homes averaging more than 1.5 million shekels.

Salaries did not keep pace with these frenzied price increases: It cost the equivalent of a record of 147 average salaries to buy the average-priced home as of the end of 2013, according to the Housing and Construction Ministry. That figure was 96 average salaries in 2008, only five years earlier.

The average cost of a home in 2012 was 2.06 million shekels in Tel Aviv; 1.65 million shekels in Jerusalem; 1.9 million shekels in suburban Ra’anana; and 1.29 million shekels in seafront Netanya – though the price of a new apartment near the city’s shoreline could range from 2.5 million to 3 million shekels.

Anyone looking to maximize their return on investment, however, might want to venture away from familiar places and head toward outlying cities, which experienced the largest price gains in 2013. Prices there are still cheaper and the yields on rental housing – particularly in student enclaves – are also likely to be higher.

The fact that prices have risen so sharply for several years has made the purchase of a home a “mission impossible” for many Israelis, creating an inelastic demand for rental housing. But the rental market is also far from ideal, with rent in Israel having risen by 49% since 2007 – and by 67% in Tel Aviv, where demand for rentals is considered particularly high.

The market is almost solely based on privately owned homes and 1-year leases, and is completely unregulated. This makes it a very inconvenient solution for families who want to raise their children in the same environment for any extended period of time without facing the constant threat of being forced to move or sudden rent hikes.

The fight to introduce regulation into this field is being led by one of the leaders of the 2011 protests, MK Stav Shaffir (Labor). “The aim of legislation is to regulate relations between tenants and landlords in a way that will provide both sides with security, and allow tenants to live in their homes for an extended period of time so that they can call it a home,” she says.

A draft bill proposes several restrictions on landlords in the private market, such as limiting the maximum annual rent increase. The legislation is still in the initial stages, so it can’t yet be determined to what degree it will succeed.

Shortage of supply

According to decision makers, the main reason behind the sorry state of the market is the growing shortage of supply in the face of very inelastic demand. This inelastic demand is primarily due to the public’s very basic need for housing, but is also due to the vast amount of investment money pouring into the real estate market since the subprime crisis broke out in 2008, driving investors to look for more lucrative investments than the stock market, say these decision makers.

The government is taking several measures in order to increase supply, primarily by trying to increase the amount of land earmarked for new private construction.

The prevalent view held by decision makers, particularly those in the Finance Ministry, is that most of the blame for the inadequate pace of construction rests with the cumbersome and exceedingly bureaucratic planning system. To this end, the ministry is promoting the establishment of a new planning agency that would bypass the existing system and be able to approve construction plans for thousands of housing units in the space of several months.

Another notable step taken by the government is a move to carry out Finance Minister Yair Lapid’s ambitious plan to build tens of thousands of long-term rental apartments in huge compounds, within Israel’s largest cities. A new government corporation, meant to be based mainly on funding from institutional investors, is now being set up to carry out the project. The effects of this move, however, won’t be seen – if at all – for another four or five years, when construction of the first projects is set for completion. A more substantial impact on the housing market won’t be felt for another decade.

Housing starts 
in outlying areas

Another key factor pushing up housing prices is the interest rate. As everyone knows, the Bank of Israel has kept interest rates down for a number of years, and last month its representative rate reached a new low of 0.75%. This incredibly low rate has fueled price increases by boosting the demand for housing – especially demand for investment properties – by making borrowing cheaper. It has also encouraged savers to choose not to have their money in bank deposits or even pension funds, where returns have become negligible, and to seek out more lucrative investment channels – like the housing market.

Meanwhile, despite the constant rise in prices, the Housing Ministry can glean satisfaction from the recently published figures on housing starts. Construction began on 47,000 housing units in 2013 – the largest number of annual starts since the 1990s, when the wave of immigration from the former Soviet Union was in full swing. Housing completions also reached 42,000 units in 2013, up 11.8% from 2012.

But despite the overall increase in housing starts, construction in high-demand areas remained constant or even declined. This was most pronounced in Tel Aviv, where housing starts fell by more than half in 2013. Most of the increase in housing starts was thereby attributable to construction in outlying areas.

One region that generated plenty of attention in this regard was the West Bank, where the pace of settlement construction more than doubled between 2012 and 2013. Credit for this can naturally be given to Housing and Construction Minister Uri Ariel; the Habayit Hayehudi MK is known as an enthusiastic supporter of settlements.

Can all the measures listed here really stop prices from going up, or even bring them down? According to senior government officials, at least, the answer is yes. Ariel has declared that 2014 will be the year when the price increases halt, and 2015 will be the first year when prices decline. Lapid, meanwhile, recently said he doesn’t recommend buying a home now, since prices are about to drop. But aside from these two, it seems almost nobody – developers, sales agents and, especially, buyers – really believes that. Which is understandable, after seven years of prices climbing nonstop and a massive protest to no effect.