The Real Estate Riddle: How Do Such a Huge Number of Low-earners Buy So Many Homes in Israel?

The answer lies in billions of shekels of unreported income that is driving housing prices beyond the reach of ordinary law-abiding citizens.

Someone from the center of Israel recently entered the sales office of a construction company and left owning five new apartments at a cost of NIS 2 million each. A millionaire who decided to snatch up a few properties? Guess again. This buyer was a salaried employee who earns less than NIS 7,000 wage a month. He might have come into a substantial inheritance or gotten lucky in the lottery, but the story might also be something else.

According to the Finance Ministry's State Revenue Administration, almost 20 percent of property investors seem to be out of their league in terms of income - at least based on what's reported to the government.

In Israel there is a serious discrepancy in the international index linking housing prices with income, a key indicator for detecting the formation of market bubbles. The rationale behind the index is that a basic long-term balance between housing prices and average income serves as something of a norm in each relevant market. Deeper investigation is needed if the ratio shifts radically upward and property prices rise much faster than average wages.

The index, however, seems to say little about the situation in Israel: Certain variables strongly prevent arriving at any conclusions. Bank of Israel Governor Stanley Fischer already pointed out one notable flaw in applying the index to Israel, when he commented that he knows of nowhere else in the world where parents provide their children with so much assistance in buying a home.

But this perceptive insight hasn't yet hit home with the system or, amazingly, even at the central bank itself. The moment young couples buy a home through reliance on parents' savings their own income becomes meaningless in the equation. Furthermore, parents and grandparents who have passed away continue helping their children through inheritance, so it isn't unusual to find people without high incomes suddenly coming into considerable capital.

This can go a long way in explaining how housing prices have risen so disproportionately to wages in recent years and the over-reliance on an index unsuitable to housing market conditions in Israel. But the explanation is more complex.

Parental help and inheritance can logically explain why the index isn't an effective measure for first-time home buyers or even for those upgrading their living accommodations. When it comes to buying homes for investment purposes, however, a strong correlation should be found between housing prices and earnings since investors usually rely on their own capital rather than assistance from others. It turns out, however, that this isn't necessarily the case here either.

Huge investments from thin paychecks

The State Revenue Administration looked at homes bought between 2003 and June 2012 by investors who had previously reported joint earnings with their spouses of up to NIS 7,000 per month.

The results were startling: Of the 136,135 investment homes purchased during that period, 19.4% - 26,403 units - were bought by people whose gross income didn't exceed the NIS 7,000 per month threshold. The total amount spent in buying these homes was more than NIS 17.5 billion.

Most of these "poor investors" were people holding down jobs whose average pay was - believe it or not - just NIS 4,093 a month, while the 21,001 investment homes they bought cost an average of NIS 828,295 each - a total of NIS 13.8 billion in all. But that's not all: There were 16,660 such investors, so a fair number bought two or more homes for investment. In fact, 2,724 of these investors working for meager paychecks managed to purchase a total of 7,065 investment properties.

Even worse off than the working stiffs were the "poor self-employed" whose household incomes averaged NIS 3,667 per month but nevertheless succeeded in raising enough capital to buy investment homes. Some 4,344 of these self-employed purchased a total of 5,402 rental units costing a total of over NIS 3.7 billion, with 680 shelling out an average of NIS 1.5 million for two or more properties. Who said buying a home in Israel is prohibitively expensive?

It's likely that some of these cases can be chalked up to special circumstances, but in general it doesn't take a Sherlock Holmes to guess what exactly is going on here.

The existence of Israel's shadow economy isn't shocking news. It's a booming market and the only questions are just how extensive it really is and where all the money ends up. In a recent survey by the research institute Panels - which relied on a Panel4all Internet survey platform - 40% of 305 respondents admitted to having being involved in a transaction that went unreported to the tax authorities. According to a World Bank estimates released last year, some NIS 190 billion flows through Israel's shadow economy, equaling 22% of the annual gross domestic product. Considering this enormous sum, it is only logical that its prevalence in the real estate market is much greater than the NIS 17.5 billion spent in home purchases, according to the transactions reported by the State Revenue Administration.

Given the few reasonable investment alternatives available nowadays, it is also quite likely that real estate offers a relatively good channel for storing wealth. The result is that heavy sums - from the black market too - are being invested in real estate, including starter homes which weren't included in the study due to the previously explained weak correlation between salary levels and housing prices. Investors have no problem buying several apartments and registering each one under the name of a different trusted relative. It is quite conceivable that some of the purchases included in the revenue authority's examination were conducted by straw men used by large-scale tax evaders.

Black market money from foreign investors too

When a big wave of foreign residents was buying up luxury apartments here several years ago, there was much talk about this largely being in response to the rising tide of anti-Semitism in their home countries. In retrospect, however, many now think they used this as a cover story for funneling illicit funds into Israel.

Another factor that distorts the picture is the dubious documentation of business transaction in certain ultra-Orthodox and Arab communities, which suffer from rampant unemployment and derive much of their income from social security allowances and handouts. The exam conducted by the State Revenue Administration only included individuals with reported earnings, and many in these two sectors have no record of any income whatsoever. Tales of cash transactions and money-filled briefcases are plentiful.

For instance, Avraham (not his real name ) from Haifa's Hadar Hacarmel neighborhood relates that one fine day someone showed up at his doorstep with a valise full of cash and offered to buy his apartment. "Where did all that money come from?" Avraham wondered. "The Haredim are buying up dozens of apartments in the vicinity. While it's true these are just cheap apartments - some costing under NIS 500,000 - that's still a lot of dough, and we're talking about a community reputed to be needy," continued Avraham. "How do they pull it off?"

The common response to this question is the modest and frugal lifestyle of the Haredi community, their plain abodes, charity, handouts, mutual support, and massive assistance from parents. But does this tell the full story? There is no way of knowing as long as no clear records are kept of the money trail.

Money originating from criminal activity is making it way into the real estate market. As families allegedly associated with the underworld have begun buying moshav properties in recent years, particularly in the central region of the country, governing councils of the rural communities have been grappling with ways to keep undesirable elements out. There are also rumors that illicit underworld funds are flowing into nascent real estate developments.

Black market funds are a bane to the public not just because they go unreported and untaxed, but also because they warp demand, thereby rendering explanatory models of market behavior useless. Worst of all, distorted demand patterns drive prices up and drive out of the market many law-abiding citizens wanting to acquire housing of their own.

All this raises the question of whether the tax authority, whose role it is to investigate suspicious transactions, is indeed focused on the task. The spokeswoman for the Israel Tax Authority responded: "In an effort to trace the sources of unreported income, several months ago the authority's director general, Doron Arbely, appointed a committee to recommend ways to improve the data flowing between land taxation and income tax as part of an overall ITA review of its work processes. As part of its work, the committee decided on developing computerized tools to help identify cases requiring deeper investigation of funding sources for real estate transactions, including those involving investment properties.

"It should be emphasized that funding sources for luxury home transactions are generally subject to special examination. It should also be noted that there are likely additional reasons for lack of correlation with State Revenue Administration data, including cases where the purchased home considered 'investment property' is actually an addition or part of a home received through inheritance. There are also cases of individuals whose income isn't derived from a business or employment - such as income from capital markets - that wasn't taken into account in the figures, or cases of leveraging to some degree when financing of the purchase comes from loans."