In contrast to the recovery and growth anticipated in other economic sectors as a result of the lowering of the interest rate, the long-awaited awakening of the real estate and mortgage market is not expected to take place.
First, the facts – the interest rate for mortgages has fallen substantially in the past two weeks. This is not a 0.1-0.2% drop (even that has a significant effect on mortgages of tens of thousands of dollars spread of many years).
The interest rate has fallen by 0.75% - from 6.25% a month ago to 5.5-5.6% now, with a more extreme drop of up to 1.5% in long-term interest, from 6% a month ago to 4.5% now. The short-term rate serves mostly borrowers seeking bridging loans or borrowers taking loans at variable interest rates.
In addition to index-linked mortgages, the most popular type, interest rates have also fallen substantially for other types of mortgages. One example is prime interest mortgages, for example, the interest rate on which obviously fell 2% when the prime rate was lowered from 7.3% to 5.3%. Another is dollar-denominated mortgages, on which the interest has fallen from 9% a year ago (LIBOR +2%) to 4% currently, thanks to US Federal Reserve Board chairman Alan Greenspan.
This steep fall comes on top of the interest rate decline that had already taken place in 2001. According to Bank of Israel data published at the end of last week, the average mortgage interest rate fell from 7.2% to 5.97%, constituting a total interest rate decline of at least 2% within one year and one week.
How does the lowering of the shekel interest rate affect the interest rate on mortgages, most of which are index-linked, and which have interest rates linked to the index?
There are a number of explanations. The main one is that when inflation does not change, a fall in the shekel interest rate causes a fall in the real interest rate (the shekel interest, minus inflation). A fall in the real interest rate reduces the return on index-linked bonds, which leads to a reduction in the interest on mortgages, which is determined by those bonds.
Another reason is that lower interest on shekel investment instruments makes them less attractive. The investors, in this case institutions, search for the most worthwhile investments and find linked bonds. Purchase of these bonds raises their prices and lowers their returns. The shekel depreciation that usually follows a lowering of the interest rate also contributes to the process. The depreciation contributes to a rise in inflation expectations, which also raises the prices of linked bonds and lowers the returns on those bonds. The shekel depreciation mostly affects short-to-medium-term bonds, which explains why the fall in the interest rate on short-to-medium-term mortgages was steeper.
The link between index-linked bond returns and the interest rate on mortgages lies in the sources from which the banks raise money for loans to home buyers. This is true, even though in most cases, these bonds are not the direct source used by the banks to finance mortgages.
Union Bank chief analyst Amir Hayek: “The main sources from which the mortgage banks derive the money they loan to the public are long-term savings plans and the provident funds. The provident funds are major players in the linked instruments market. They have large funds from their members that they can invest in either linked bonds or mortgage banks. When the yield on bonds falls, the mortgage banks can allow themselves to lower the interest rate they offer the provident funds, thereby leading to a fall in the interest rate on mortgages.”
Hayek responded negatively to a question on whether the sharp fall in the interest rate will revive the real estate and mortgage markets: “I don’t think this will immediately stimulate the market. Keep in mind that apartment prices are expected to rise as the depreciation continues. The market will recover when the public wants to buy apartments. This isn’t happening now, because of the general economic slump. Furthermore, a change in the interest rate doesn’t usually immediately affect the public, which generally waits a little before becoming accustomed to a low interest in the long term. The current change in the interest rate is likely to cause a marginal recovery of the real estate sector, but not a complete turnaround.”
The mortgage banks also concur with Hayek’s forecast.
”Globes”: Do you think the public will rush to take cheap mortgages after closing a deal with the nearest contractor?
Leumi Mortgage Bank CEO Reuven Sabag: ”Unfortunately, no. The public is still confused. On the one hand, new apartment prices are currently not dollar-linked, and contractors who want to sell continue to advertise the pre-depreciation shekel-dollar exchange rate. On the other hand, those who have renovated their old apartments are trying to sell them according to the new shekel-dollar exchange rate, i.e. at substantially higher prices in shekel terms. While it was really difficult to sell second-hand apartments before the depreciation, it’s doubly hard to do so now at the new prices being asked. This slows down the entire market, because someone unable to sell his old apartment isn’t going to buy a new one from a contractor and certainly isn’t going to the bank for a mortgage. There’s a little liveliness, particularly among young couples, but nothing significant.”
What about apartments for investment, an investment instrument favored by Israelis before the slowdown, which is now ostensibly becoming more attractive, because of the upward trend in rents and the lower interest rate, which makes it easier to leverage these deals?
”Israelis found investing in apartments attractive not because of the annual return, but because the value of the apartments rose. Real estate will not regain its status as a preferred investment until an upturn in apartment prices takes place.”
If such a sharp drop in the interest rate, which is expected to revive many other sectors, will not put life into real estate, what will do so?
”The most important factor is the economic-security situation. Only a significant improvement there can move the real estate market forward.”
Published by Israel's Business Arena on January 20, 2002