The near future for the development and construction sector in Israel does not look good. The sector has several structural problems that cause bouts of manic depression, manifest in unpredictable rises and falls in prices. If fourteen years ago we felt how hard it was for the sector to get going, in the two years between the first Covid lockdown and the middle of last year we felt powerful acceleration, while lately the sector has been putting on the brakes.
In an attempt to put a finger on the structural problems, we dived into recently released data and analyzed the market over the past twenty years.
Delayed ignition: A cumbersome market reacts slowly to change
The real estate is sometimes expected to behave like the capital market. That’s a mistake that is repeated every time the real estate market faces a change that the capital market would respond to within days, or hours. But the real estate market is not the capital market: it’s cumbersome, weighed down by constraints in finance, planning, law, inputs, construction methods, manpower, and more, and it has almost no chance of reacting in time when change hits.
The best example is what happened in the Israeli real estate market in the first decade of this century. The first two thirds of that decade were a continual crisis of declining prices, which caused a significant decline in building starts, and a standstill in initiation and planning of projects. Israel Land Authority tenders met low interest.
In 2008, the trend switched, and home prices started to rise. But another three years went by before the construction industry started to respond with more building starts, during which time home prices rose by more than 50%. In fact, only in the middle of the last decade did the pace of building starts begin to match the price trend.
Looking back, it is clear that the price rise was mainly caused by the fact that the construction sector woke up so late.
Accelerating too fast: The market fails to stop in time
There is no rational explanation for what happened in the real estate market between the final quarter of 2020 and the end of 2022. In that time, home prices rose by some 33%, and demand took off. In 2021, more than 150,000 housing units were purchased, 25% more than in the previous peak year of 2015.
But whereas the 2015 peak could be explained by suppressed demand that broke forth following the cancellation of the "zero VAT" law, and out of a desire to beat the taxation that then minister of finance Moshe Kahlon imposed on investment buyers, in 2021 the cause was completely different.
In that year, demand surged as the series of elections meant that no housing policy was formulated and the government gave the public no horizon.
At that time, the industry was ready and went full steam ahead. Building starts were double or more what they had been during the comatose years at the beginning of the century. Developers invested more and more in land and construction to meet the high demand.
But while the construction industry acted energetically, the economic numbers changed, and with them demand, construction costs, and finance costs.
Hard to brake: Signs of crisis apparent even in 2021
On the face of it, real estate developers had enough time to prepare for a rainy day. One of the surprising facts published by the Central Bureau of Statistics recently is that the slowdown in sales of new homes began as early as September 2021. In other words, on paper a developer could already have spotted the changes and changed his behavior. That didn’t happen, and for good reason: apartment prices continued to rise dizzyingly, and no developer will halt construction when prices are rising.
So 2022 began with price rises that continued the momentum of 2021, while at the same time a strange economic situation arose: the public reduced demand for new homes by the month, but the index of prices of new homes sold on the free market (i.e., excluding government subsidized schemes) kept rising.
April came. The decline in sales of new homes worsened, but those who did buy homes were prepared to pay more, and still the index rose. In July-August 2022, the rate of decline in demand reached a peak, but only in October did the index of prices of new homes show a fall. Where in the capital market would you see such a lag in the response of prices to changes in market data?
The result: those who benefitted from the two initial phenomena of late ignition and fast acceleration are liable to pay the price of not braking in time, and the price is liable to be high.
The great question: Is the construction about to crash?
A crisis in the real estate market has three stages. First, a substantial fall in demand and transaction numbers; second, after a few months, bargain offers by developers followed by real price falls; third, a general price decline, including the secondhand market, which is a more inelastic market in this respect.
The Israeli real estate market is currently at the second stage. It’s only a matter of time, and not a long time, before homeowners realize that they are in a new situation.
Recently published home price numbers indicate a 4.3% fall in prices of new homes sold on the free market within two months. In money terms, that means a fall of NIS 80,000 for the average apartment, which is not a small sum.
The Central Bureau of Statistics reports that developers currently hold more than 53,000 unsold homes. At a very conservative estimate this stock is worth NIS 80 billion, financed mainly by ever more costly bank loans. Meanwhile, finance is becoming dearer for homebuyers as well, and they are abandoning the market.
In order to avoid cutting prices, developers initially tried special offers on the technical specification side, such as a better kitchen, air conditioning, and vouchers for bathroom accessories. Such offers, however, only suit a certain section of the population, and many potential buyers have been rejected by the mortgage banks, or have been put off by the size of the loan and the monthly repayments. Kitchen cupboards can’t solve those problems.
The next stage was price cuts. Data released by the chief economist in the Ministry of Finance and by the Central Bureau of Statistics show that even after these price cuts, buyers have not yet returned to the market, suggesting that the cuts are far from ending. And if interest rates continue to rise, as expected, the cuts will be correspondingly larger.
In such situations, what counts is the quality of management at the real estate companies. Leveraged companies with large stocks of unsold homes are liable to get into an unpleasant situation. It will be recalled that at the end of the 1990s and the beginning of the 2000s companies failed to survive the recession in the sector, after the boom years of the wave of immigration from the former Soviet Union.
At that time, a liquidation lawyer boasted that he managed the leading real estate company in Israel. Will we hear similar boasts now, twenty years on?
Published by Globes, Israel business news - en.globes.co.il - on February 16, 2023.
© Copyright of Globes Publisher Itonut (1983) Ltd., 2023.