Last Thursday, we learned of a smaller than expected rise in the Consumer Price Index (CPI), up just 0.2% in May. Analysts had expected a much higher reading that would keep the annual rate of inflation at 5%, but in fact the monthly reading was the lowest since November 2022, and put inflation in the twelve months to the end of May at 4.6%.
The worrying figure in CPI the was residential rents. The housing item, which mainly consists of changes in rents, and which represents 26% of the general index, rose 7.5% in the twelve months to the end of May, after rising a further 0.4% in that month. For the sake of comparison, the food item, excluding fresh produce, rose by 4.2% in that period, while the clothing and footwear item fell by more than 8%.
"Rents in Israel continue to rise sharply, with no real sign of the rate of increase moderating," says chief markets strategist at Bank Hapoalim Modi Shafrir. "This is a completely different situation from that in the US, where the rental market has weakened, and we are seeing moderation in the rate of rent rises."
Central Bureau of Statistics figures show that, since last December, the general CPI has risen by 2.2%, while the housing item has risen by 2.3%, mainly, as mentioned, because of changes in rents. This has three elements: tenants with a current lease, for whom there is no rise; tenants renewing a lease, whose rents rose by 3.6% on average; and new tenants, for whom average rents rose by 8.6%. This is a worrying figure, because June-August is the peak period in the rentals market, with many changes in tenancies, which is liable to mean that the really steep rises are still ahead of us.
The true picture, however, is much more complicated. Prof. Danny Ben-Shahar, professor of Finance and Real Estate at the Coller school of Management at Tel Aviv University and director of the Alrov Institute for Real Estate Research, says that the rises in interest rates have a contrary effect on demand for rentals, and that "the rise in rents does not derive from the rise in interest rates." The phenomenon, he says, stems from three factors. "First of all, there is a decline in disposable income because of general inflation, which puts pressure on people’s ability to pay rent, which should actually put downward pressure on rent levels
"On the other hand, however, anyone who had thought of buying a home can’t afford it because of the rising cost of mortgage loans, and they have to continue renting. In addition, the third factor is that a household is a captive market that has to live somewhere, which puts upward pressure on rents, because of the rise in demand for rental homes."
Opposing forces affecting demand
Psagot Investment House chief economist Guy Beitor explains that the effect of interest rates on the market has different time constants. "Things don’t move as fast as people think, and it can take more than a year for a rise in interest rates to percolate through to the market," he explains. "Because of this, despite the rise in interest rates, building starts don’t necessarily cease immediately, and so housing supply can be expected to continue to grow in the short term. On the other hand, the effect of higher interest rates on demand, whether for purchasing or renting, is quicker, as a result of the decline in disposable income."
Shafrir too believes that rises in interest rates don’t necessarily lead to rises in rents. "On the one hand, the real estate market has ground to a halt and building starts are declining, causing a decline in supply. But on the other hand, we are seeing people’s disposable income fall, and that will start to make it hard for landlords to raise rents too sharply. In the short term, we won’t see rents falling, but we can already see moderation in the rate of rises, although there is no horizon for a decline in rents."
Prof. Ben-Shahar says that higher interest rates could shake up the real estate market in the long term, and not necessarily in a positive way. "The Bank of Israel’s frequent interest rate hikes could lead to a situation in which there will be people who will wait to buy a home until interest rates are lower. But when interest rates do fall, the market is liable to find itself with a severe shortage of supply, because of the decline in building starts, which could lead to renewed price rises."
Published by Globes, Israel business news - en.globes.co.il - on June 19, 2023.
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