You go back in time to 2008, the nadir of the economic crisis, but you have the financial knowledge that you have today. In what would you prefer to invest - stocks, or real estate?
Home prices in Israel have risen dramatically since 2008: the Central Bureau of Statistics’ Dwellings Price Index rose 2.15 times between then and 2020, a rise that every young couple in Israel feels keenly. Despite the moderation in the rise in home prices in the past few years, the trend is still upwards: between 2018 and 2020, home prices rose by 8.3%. Of course it is not possible to invest in the Dwellings Price Index, only in a specific property. The index is nevertheless a convenient measure of the behavior of real estate prices across the market.
The rise in the residential real estate market, however, is as nothing in comparison with the rise in stock indices. Between 2008 and 2020, the S&P 500 rose 4.47 times, more than double the rise in home prices in Israel. Anyone who invested NIS 100,000 in the S&P 500 at its low point could sell today and receive nearly NIS 500,000. Even someone who hesitated for a year and bought the index at its average level for 2009 has still made 3.45 times his investment. That NIS 100,000 made him another NIS 245,000. The figures relate only to the assets themselves, stocks and real estate, and do not take into account dividends and rents.
If we look at short-term investments, for a single year, we find that in only four years between 2008 and 2020 did homes outperform stocks, whereas in eight years stocks produced a higher return, and by some way. In 2020, for example, home prices rose by 3.5%, while stocks rose 15%.
A one-way trend since 2008
It was not always thus. In the 1990s, the S&P 500 rose to a peak in the dot.com bubble, which burst in 2000. The index declined until 2002, and returned to a rising trend that ended in the economic crisis of 2008. Over that period, real estate had its ups and downs. Housing prices in Israel rose by 74% between January 1994 and December 1998, before gradually declining until 2004. They were then stable until 2008, when they started the steep rise that became a real housing problem.
Similar trends are observable on the Israeli capital market as well. The Tel Aviv 125 Index (then the Tel Aviv 100) rose by 94% between 1994 and the peak of the dot.com bubble in 2000, and was then slashed by more than a third by 2002. It rose again until the economic crisis of 2008, when it fell sharply but swiftly recovered. In 2010, the Tel Aviv 125 was already stronger than its pre-crisis peak.
Between 2008 and 2020, the Tel Aviv 125 Index rose 2.8 times, which is more than the rise in housing prices in Israel, but a great deal less than the rise in the S&P 500. A 2018 study by the Bank of Israel confirms the figures, and shows that the real net annual return on a ten-year investment was greater on the Tel Aviv 125 Index (6.06%) than on an investment in real estate (4.87%).
Real estate safer, taxation complex
It’s important to note that there are substantial differences in taxation rules in Israel applying to stocks and real estate. Taxation of gains on stocks is simple: capital gains tax at a rate of 25% (it was 20% up to 2012).
By contrast, taxation of real estate is complicated. There is purchase tax, capital gains tax, the betterment levy, and VAT. In Israel, there are various exemptions from taxation on the purchase and sale of a property, so that how much tax is paid is very much dependent on tax planning. It can be very high, or very low, depending on the kind of deal in question, the property, and the gain, and of course on the expertise of the lawyer or accountant responsible.
From the point of view of risk, too, there are differences between stock and real estate. While shares in companies can be a matter of boom or bust, with real estate there is always a physical asset that maintains a value of some kind (if only as a place to live), whatever happens in the market. Real estate can therefore be bought with higher leverage. It’s easier to obtain a bank loan to buy a home with only partial equity than it is to obtain a similar size loan for investment in stocks.
Nevertheless, it’s worth qualifying this by saying that if you invest in stock indices rather than in stocks of specific companies, the market is less volatile, and can be depended on in the long term. The S&P 500 recovered to its former level within less than four years after the crisis of 2008, and the Tel Aviv 125 Index did so within just two years. So for a long-term investor, it’s worth putting money into indices carrying higher risk and higher returns. As long as you don’t sell during dips in the market and wait patiently for stocks to rise again, your losses will probably be outweighed by your profits.
The response to the pandemic
The differences between the indices have widened during the coronavirus pandemic. Markets slumped in early 2020, when it became clear to everyone that "the mystery virus from China" would be with us for a long time. At that time, there was little information about the virus, its effects, and how long it would take to develop a vaccine, which contributed to the panic on the markets.
Investors quickly realized, however, that the economic effects would be smaller than had been feared, which led to a substantial rally in all the indices. In Israel, the Tel Aviv 125 Index was back to its former levels by March 2021, while in the US, the S&P 500 posted a substantial rise even in relation to the pre-pandemic peak, with a return of 23.2%. Stretching the data to August 2021 shows the Tel Aviv 125 7.2% above its level of January 2020, while the S&P 500 shot up 37.5% in that period. While the S&P 500 was soaring, the Dwellings Price Index rose just 1.7%.
The causes
Home prices in Israel are rising for several reasons, but the main reason seems to be the simplest: not enough homes are being built in relation to the growth of the population and the rise in the standard of living. More Israelis want larger homes in more central locations, and supply is not matching demand. In the latest Economic Arrangements Bill, the bill that accompanies the state budget, the Ministry of Finance has introduced a number of reforms designed to remove obstacles to residential construction, but architects say that this is too little too late.
The origins of the boom in stock prices are more complex. They are a combination of technological development, growth in developing countries providing business opportunities, economic growth in the US, and expansionary monetary policy. In the crisis of 2008, the US Federal Reserve cut interest rates and printed huge quantities of money that it injected into the capital markets. The cheap credit encouraged companies to raise money and expand investment, which translated into rising stock prices.
The US central bank provided a further injection when the coronavirus pandemic hit, leading to a stock market rally after the initial nosedive.
Will the money printing shortly roll onto prices of goods and generate rising inflation? It’s hard to tell, but it could certainly be that the great boom in stock prices will not come for free.
Omri Shaked assisted in gathering data.
Published by Globes, Israel business news - en.globes.co.il - on August 11, 2021
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