The issue of housing never out of the headlines, and justifiably so. When people in the late 20s and early 30s have to live with their parents, there is a problem. But there is a problem with the problem: identifying where the initial problem is. This article will deal with both problems, and will also say something about each problem's connection with the Bank of Israel.
What is a bubble
Identifying the initial problem boils down to whether there is genuine surplus housing demand or a real estate bubble. What is a bubble? A bubble develops when people buy homes for speculation, in expectation that home prices will rise and they will make a handsome return on their investment. The expected rise in price must be very great, because many buyers take mortgages to finance the purchase. A rise in prices (together with a rise in rents, which the landlord might not see because a bubble means that tenants cannot always be found) has to cover the cost of the mortgage and achieve a higher return than can be expected in the stock market.
Judging by the rise in home prices in the past 4-5 years, it is possible to understand why many people believe that there is a real estate bubble in Israel. The average rise in home prices was 59% between the first quarter of 2008 and the second quarter of 2013; in real terms, discounting the rise in the Consumer Price Index (CPI), the rise was 37%. This means an annualized return of 5.9% in real terms. This gain is for the rise in home prices alone, without taking rental income into account. It is a handsome return.
Is it possible that this return is solely due to real housing demand, and not, at least in part, due to speculation? The answer, which may surprise some readers, is yes.
We know this because, in Israel, in contrast to the US, the test is fairly straightforward, because most construction is of apartments. In the US, a contractor may gamble and build several individual houses without knowing in advance if there will be buyers. However, it is rare for a contractor to build, say, 15 apartments without knowing that he has guaranteed buyers for at least some of them. Even if this occasionally happens, it does not happen on a scale that will affect the housing supply. Therefore, it is unlikely that the housing supply will increase substantially without real demand for housing or demand from speculators.
Therefore, it is possible to rely on the rent-home price ratio to test the existence of a bubble. The reason is simple: rent is the price that represents net housing demand, excluding speculation, and the supply of rental housing. In terms of housing demand and supply, a bubble means that the supply has grown, but prices are rising at a rate the drives homebuyers from the market because they cannot afford the homes whose prices have been inflated by speculation. Conversely, speculators buying homes will want to lease them, which means that the rental supply will increase, driving rents down, even as home prices rise.
This means that if rents rise at the same pace as home prices, there is no strong speculative component in the prices, or if there is such a component, housing demand for rental homes is rising at the same pace as the supply of rental homes.
In such a case, the concept of a "bubble" is basically meaningless. Therefore, it is only necessary to check what has happened to rents in comparison to home prices. The examination that I have conducted here will convert rents into the return on home prices. The data indicate a very slight decline in the return between the first quarter of 2008 and the second quarter of 2013.
However, it is also necessary to add the fact that in January-February 2008, the Bank of Israel interest rate was 4.25%. In other words, the return on an apartment in the first quarter of 2008 - about 3.6% - was not exactly a great bargain. In contrast, the Bank of Israel interest rate in the second quarter of 2013 went from 1.75% in April to 1.25% in June. Under these conditions, a return of 3.45% on the price of an apartment appears much more worthwhile. Therefore, the small drop in the rate of return in the period of this study ended in the first quarter of 2011, after which it increased slightly. The conclusion is unequivocal: there is no real estate bubble in Israel.
The 1977 low
As mentioned above, there is no bubble, but that is not enough to pity people about to begin their lives in the face of home prices that are as out of reach to them as Canaan was to Moses.
An individual's disposable income is the income available to use as he or she wishes. It is the income after paying taxes and receiving all benefits, and no one is sharing this income.
How many years of average disposable income per capita are needed to buy an average apartment in Israel? The data are surprising. Between 1960 and 2012, the figure has barely changed, indicating that buying a home in Israel has always been a mission almost-impossible.
First of all, to clearly show just how dismal and serious this reality is, it is enough to note that, in the US, in the past three years, 7.5 years of disposable income have been needed to buy an average home, and in Australia, the figure has ranged from five to nine years in the past twenty years. In Israel, the long-term average is 14.5 years.
To highlight the seriousness of the constant situation, let us assume that a household with two breadwinners, in which the disposable income is double that of an individual. Assume that this average couple wants to buy an average apartment: the price is seven years and three months of the household's disposable income.
Conventional wisdom holds that no more than 25% of disposable income should be devoted to housing expenses. This means that were this couple to devote the maximum amount to finance a home, it would need 29 years to buy an apartment. If this couple entered the housing market in 1995, it would have needed 34.5 years to complete the purchase (without taking the mortgage interest payments into account).
I will come to the reasons for this situation shortly. Meanwhile, I will turn my attention to the second surprising finding: from a long-term perspective, the current situation is not too bad.
The reason for the current perception that housing has become especially expensive in recent years is the fact that home prices in terms of income have risen since 2007. However, this climb began from a low level that had not been seen since 1977. The reason for the low was government construction of tens of thousands of apartments for which there were no buyers, because of politicians' fears that post 1973-Yom Kippur War Israel would fall into a recession like the one that occurred before the 1967 Six-Day War.
Monopolies and bureaucracy vs. market forces
If things are so good, why are they so bad? There are two reasons: the first is the Israel Land Authority, and the second is the insufferable bureaucracy by the planning authorities.
State ownership of land is a plague not mentioned in the Bible, and it prevents the supply of land from responding to market conditions. The supply of land is determined by the bureaucracy, not by market signals. This is exacerbated by the Israel Land Authority's basic conflict of interests, because it is an important source of revenues for the Ministry of Finance. It is even defined in the budget books as a business entity. Therefore, it has a strong incentive to act as a monopoly, but because it is a statutory body, it is exempt from Antitrust Authority regulations.
As for the planning authorities - the Planning Administration at the Ministry of the Interior and the local and regional planning and building commissions - planning procedures drag on for years, sometimes for absurd eons, so that even when land is released for construction, the time until building actually begins is soul destroying.
Finally, Israel has no serious rental construction, notwithstanding attempts over the years (the latest is by Minister of Finance Yair Lapid, who has even established a new government company to build tens of thousands of rental apartments). The blame for this is Tenant Protection Law, which dates back to the British Mandate and the early years of Israel. This law wiped out rental construction, because it basically seized the landlord's property in favor of the tenant. This is not unique to Israel: wherever such laws exist, rental construction has been destroyed, and has not recovered even after the laws are abolished.
The reason is straightforward: investing in a house is a very long-term investment. Therefore, anything that increase uncertainty deters investors, and the deterrence is especially long term if the reason for the uncertainty is the government. This is because is much harder to predict what a government will do than what "market forces" will do.
In conclusion, there is no doubt: the housing problem has entirely been in the hands of Israeli governments.
The author is an associate professor at the Department of Agricultural Economics and Management, Faculty of Agriculture, Hebrew University of Jerusalem, and a former deputy governor of the Bank of Israel.
Published by Globes [online], Israel business news - www.globes-online.com - on December 10, 2013
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