While transaction numbers in Israel’s secondhand homes market are at an almost twenty-year low, in the new homes market the situation is quite the reverse. The developers’ method for boosting sales despite the challenging times in Israel is simple: Buy now, and pay just a small fraction of the price of the apartment. When will the rest be paid? We’ll talk in 3-4 years, when the apartment is handed over. The pressure on developers and contractors to present to the market "business as usual" and sales has led them to the 80/20 method - buyers pays just 20% of the apartment price when they sign the contract, and the remaining 80% when they occupy it. In some cases there are more extreme offers of 90/10, and even 95/5. Another kind of offer is benefits such as interest-free loans or loans without linkage to the Consumer Price Index and other forms of financial aid in financing a home purchase.
So, after a difficult year because of the rise in interest rates and the outbreak of war, which left contractors’ sales offices deserted, and for a short period even led to a certain decline in apartment prices, prices are rising again, at least according to official Central Bureau of Statistics numbers.
In the real estate market, however, there are those who cast doubt on those numbers, because they do not take into account the aggressive sales offers. Developers have considerably raised their rates of sales of new apartments in the past few months, but in practice they are receiving small amounts of money when sales agreements are signed, leading to low, or even negative, cash flow.
The gap between construction costs and low down-payments is pushing developers into taking out bank loans at high rates of interest. Their profits on the projects thus shrink, and there is even talk of losses. Is there a real risk to the residential real estate companies?
"Anyone who knows the market knows that prices are falling"
According to recently released figures from the chief economist in the Ministry of Finance, Dr. Shmuel Abramzon, in March this year "sales by contractors in the free market are the fifth highest in the past 23 years." Sales totaled 2,990 apartments, 46% more than in March 2023. The Central Bureau of Statistics’ figures indicate a similar trend.
"Just don’t ask the contractors to cut prices officially, so that the public won’t sense that prices are falling and that it’s worth waiting before buying an apartment, and then the contractors will have a problem, or alternatively that they should revalue their stock of apartments downwards and post capital losses," a market source says.
This is apparently also the reason that the Central Bureau of Statistics figures indicate a renewed rise in housing prices, when everyone in the market agrees that the special offers mean a fall in prices in practice. "Anyone who knows the real estate market from the inside knows that the impressive robustness of the housing market is nothing but an illusion, and that in the past year apartments prices have actually fallen by about 14%," says Yaakov Nitzan, joint CEO of Ruby Capital, which specializes in real estate finance and investment.
No free lunches
Another angle on the success of the special offers by the contractors is provided by the Ministry of Finance’s data showing that home purchases by young people, excluding government subsidized homes, shot up by 36% in March this year in comparison with March 2023, despite the fact that they usually have low equity.
On the face of it, the buyers benefit from cheaper prices, but it’s not certain that that is really the case, as explained by Yigal Tzemach, CEO of Bridges, which provides non-bank real estate-backed credit. "Since, historically, the Building Inputs Index rises, it could be that, in another few years, when the buyers come to complete the 90%, they will discover that they have to add another 15%, because of the index. That is to say, there’s a risk in paying more of the money at the end of the road. Nothing is really for free. If you’re prepared to accept a benefit in the form of a better kitchen or parking, you forego a genuine discount, in cash, on the price of the apartment."
The Ministry of Finance chief economist states in the housing survey for March: "Cash flow continued to decline, mainly because of financing offers meant to stimulate sales in the free market, allowing easy payment terms, among them that the lion’s share of the payment takes place on handover."
Credit rating agency Midroog writes: "The new contracts currently being signed are accompanied by payment schedules that benefit the buyers - a fairly low down payment and the main payment when the apartment is handed over, instead of a high down payment or payments in accordance with progress in construction, as used to be the norm. Besides the financing benefit, the developer bears more costs until payment is received from the customer, a situation that creates a deficit on working capital and greater utilization of bank credit."
Midroog’s figures on the seven largest residential developers show that in 2023, their cash flow from regular activity was NIS 3.5 billion lower than in 2022. The shortfall is mostly financed by bank credit, bond offerings, and bringing in investors, Midroog explains, and says that it does not recall such extensive bargain offers in the past and that the situation is "abnormal." ""We have switched from one extreme of cash flow surpluses to a reverse extreme in which contractors do not receive down payments, and their cash flow is in decline."
Sources in the construction companies try to sound reassuring. "The main thing is sales," they say. "That’s what interests the bank. The cash flow will come eventually, and if the company has no cash it can issue a bond or obtain a bank loan. The bank will finance the project if there are sales. After all, most people won’t give up on their apartment, and will pay for the purchase."
S&P Maalot agrees with this assessment for the big companies, but points out that the local real estate market is also made up of many small companies. "Payment methods of this kind (such as 80/20, N.A.) and exemptions from index linkage increase the exposure to a high interest rate environment and to a rise in the cost of inputs and inflation. Small companies that do not have access to a range of sources of finance are more exposed to erosion of their cash flow, with an elevated risk of collapse."
"People aren’t buying an apartment, but an option on an apartment"
The risk to the contractors could, however, come from a different direction. Tzemach of Bridges keeps repeating the word "option." "People aren’t really buying apartments now, but rather an option on an apartment, like on shares. In a another few years, they will be able to decide whether to exercise it and actually buy the apartment, or not.
"The problem is that the contractors are turning themselves into financers, and that increases their leverage. If up to now a person would put in 30% equity, now they’re putting in almost nothing, and what will happen if apartment prices fall by, say, 10%? Those people are liable to forego the apartment, and the contractors will be left with a large stock at lower prices, and in a situation in which they have actually sold far fewer apartments than they thought they had.
"That is what happened in the US in 2008. The banks therefore need to treat at least part of the contractors’ stock as speculative and to recognize the possibility that it may not be realized. If prices fall, the contractors’ losses will grow."
Published by Globes, Israel business news - en.globes.co.il - on June 3, 2024.
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