The Pendulum of the Real Estate Market

Are prices really going to fall? By how much?

Property prices rise over time, even if there are bumps in the road. That's what they say, or some say at least, including the agent attending a recent conference.

There's truth in that adage, but not much of it. Even if prices do rise in the long run, the real estate market can also go through protracted slumps. Buying a costly property using an expensive mortgage just as the market is turning down feels awful.

Marina Zlochin - 16012012
Illustration: Marina Zlochin

Usually, the factor driving home prices up are low interest rates, which send investors hunting for alternative investments. But there can be other reasons too. Israel's victory in the Six-Day War in 1967 boosted morale and shored up confidence, lifting home sales - and prices. But the trend turned after the Yom Kippur War in 1973: Within three years, housing prices had fallen 33%.

Come 1984, the Israeli real estate market entered what would prove to be a seven-year recession. The stock market crisis at the time devastated the public's savings, and contractors were left with apartments they couldn't sell. Over two or three years, prices fell by 25%.

The housing market began to pick up again in the 1990s, with the arrival of the vast wave of Russian immigrants. But when the wave ebbed, in the mid-1990s, prices stopped rising, and then tumbled 25% (again) from 2007 onward - before suddenly beginning to skyrocket in the last few years.

A cycle in two stages

The history of the local real estate market teaches that after a sharp increase in prices, usually comes a drop of 25% or so. Elsewhere, recent years have brought even steeper retreats - about 33% in the United States from the record levels of 2007, and even worse in Spain and Ireland.

The slope of increase in Israeli home prices began to moderate in the last few months, but the decrease is a mere few percent. Will that be it? Will prices drop much harder, as history might indicate?

The real estate market is a cyclical one, says Tamir Agmon of the Knesset's research department. Prices can't keep rising forever. A year ago, he delivered a paper to the Knesset Economics Committee, analyzing the increase in housing prices. He divides Israel's property market cycle into two phases.

Phase One involves a rapid increase in demand, whether due to an influx of immigrants, a taste for investing in property because interest rates are low. The rapid increase in demand lifts prices because it takes a long time to build, hence the demand can't be met overnight. The rise in prices and drop in inventory induce builders to increase the supply of housing.

Phase Two kicks in when the element spurring demand weakens. A glut is created and housing prices start to drop, until the next wave of demand.

Agmon ascribes the last wave of demand to the low level of interest rates, coupled with low supply. There has also been positive migration toward the center, accelerating the rise in prices there.

No pending drama

Danny Ben-Shahar of the Architecture and Town Planning Department at Haifa's Technion - Israel Institute of Technology doesn't see a steep drop in housing prices coming. Prices rise and prices fall in the normal business cycle, he says.

He points to studies describing "the anchor effect," which influences supply - meaning, people figure they know what their home is worth and can't bring themselves to sell for less. That in itself is enough to cushion the drop. "What we're seeing today is that the drop in prices is dwarfed by the drop in the number of deals," says Ben-Shahar.

He acknowledges, however, that the anchor effect can't last forever. Prices in the market could yet drop as sellers give up on getting the price they want.

Bureaucracy and regulation can also stop the drop. They combine to slow construction processes and prevent a glut from forming. This isn't unique to Israel, points out economist Avichai Snir from Bar-Ilan University. It also takes forever to growth estimate a building permit in England - which helped prevent prices from tanking.

Even though Prime Minister Benjamin Netanyahu keeps talking about reducing regulation, and even if he does, it won't create a significant surplus of housing overnight, Snir adds. The bottom line is he doesn't foresee a steep drop in home prices any time soon. Construction has been slowing, also because banks have been cutting off loans to contractors. Former steep drops in prices had been accompanied by a glut in supply, which isn't the case now, Snir sums up.

But there are other opinions, including that of Tal Shavit, an expert on financing and psychology of investors at the College of Management's Business School. He feels property prices in Israel have lost all sight of reality and are fated to fall. People aren't storming for property like potatoes at the grocery store any more, he says. How much will prices retreat? That's anyone's guess.