In the past decade, during which housing prices rose at a rapid pace, the real estate sector experienced stagnation and uncertainty three times.
The first time was from late 2011 until early 2012, when then-Governor of the Bank of Israel Stanley Fischer started raising the interest rate to curb inflation, which was caused mainly by a steep increase in rents. Raising the monetary interest rate by 3% in two years halted the sharp rise in housing prices, with prices stabilizing in mid-2012. After the Bank of Israel resumed cutting its interest rate, however, housing prices began increasing by over 10% (the best proof of the argument that the source of the housing prices boom is the Bank of Israel's near-zero interest rate).
The second period of uncertainty began in early 2014 when then-Minister of Finance Yair Lapid announced the elimination of VAT on purchasers of a first apartment - and ended in late 2014 when he was fired from the cabinet and early elections were held. The number of new housing units sold dropped sharply at the time, and the rate of increase in housing prices fell from 9% in mid-2014 to 4% at the end of the year. The government's failure to keep its promise quickly brought the annual rise in housing prices back to 9%.
The third period of uncertainty is the present time. Demand for new housing has been falling for the past year and housing prices have gone down by a cumulative 2.15% over the past five months.
Are we at the outset of a change in trend, or will the housing prices resume their upward climb, as in the two previous cases? Before attempting to answer this question, one common assumption must be disposed of - a direct connection between building starts and housing prices. Most building starts are apartments that have already been sold; they do not affect the supply of housing available for sale, and do not detract from the demand for housing.
The effect of building starts on housing prices goes through its later effect on the number of housing units on which construction has been completed, which in turn affects supply and demand in the rental market and the return on equity obtained from the purchase of a housing unit for investment. A steep drop in building starts shows only one thing - an absence of sufficient sales in projects with building permits to justify beginning construction of them.
The three main factors affecting housing prices are the number of building permits, the difference between the interest rate charged for financing and the return on the purchase of a housing unit for investment (carry trade), and the number of months that the supply of new housing units lasts.
Building permits: equilibrium has been reached
The number of housing units added each year to the supply of units for sale is derived from the number of housing units for which building permits have been obtained. Receiving a building permit issued by the local authorities enables a developer to begin the marketing process and in effect puts the housing unit "on the shelf." Selling a housing unit after the building permit for it is issued, even if it is sold "on paper," detracts from the demand for housing, regardless of the date on which construction begins. Assuming that population growth remains stable and that 50,000 households are added to the economy each year, this number of building permits reflects a state of equilibrium between supply and demand in the new housing market (excluding investors).
The number of building permits in Israel was lower than 50,000 for many years, resulting in a shortage of housing that pushed up prices. Over the past three years (2015-2017), however, the number of housing units with building permits has averaged 53,000 a year. This rate matches the number of additional households. Therefore, excluding purchases by people who are already homeowners, the new housing market has been at equilibrium bordering on a surplus for the past three years. It can be argued that the supply has to make up for the shortage in previous years, but this argument does not apply after three years of surplus in the housing market.
The carry trade cash flow has become negative. This is where investors enter the picture. When considering whether purchasing a housing unit for investment is worthwhile, the prevailing practice is to compare the expected return with the alternative - the return on an investment in the stock market or state bonds. Since a housing unit for investment is purchased with leverage that is almost completely unavailable to a unsophisticated investor in the capital market, however, and in view of the taxation gaps, these two investment instruments are not comparable. The viability of investment in the housing market should therefore should be assessed solely according to financing criteria - i.e. by comparing the cost of financing with the return on the investment.
In mid-2009, following the beginning of monetary expansion, the average mortgage interest rate fell below the return obtainable from purchasing or renting out an apartment. As a result, a leveraged purchase of an apartment generated a positive monthly cash flow for an investor beyond the return on equity obtained from the increase in the value of the apartment.
In 2017, seven years later, the average mortgage interest rate was once more higher than the return obtained from a leveraged purchase and renting out of an apartment. The result is that a leveraged housing purchase now generates a negative monthly cash flow for an investor. This means that buying a housing unit for investment requires additional capital investment beyond the initial capital, with the investor expecting future capital gains when the property is sold.
This situation is restraining demand in the investment housing market, reflected for the past year in a decrease in the proportion of housing units purchased for investment purposes.
The supply of housing
Several weeks ago, the Central Bureau of Statistics resumed its reporting of the number of months of supply in the new housing market. This figure reflects the ratio of housing units left for sale at the end of each month and the total number of housing units sold during the month - in other words, how long it takes a developer on the average to sell his entire stock of housing for sale.
Historically, when the number of supply months was 12 months or more, the increasing in prices slowed or was even reversed. In other words, a developer who believes that he will be unable to sell his stock of new housing within a year is willing to compromise on the price, and vice versa.
For example, in 2008-2011, the period of the big boom in housing prices, the number of supply months was less than 10 months, and even reached seven months in late 2010. Housing prices responded with an annual increase of 15%. During the two periods of stagnation in 2011 and 2014, on the other hand, the number of supply months was 14.3 and 16, respectively, and the rate of increase in housing prices slowed or came to a halt.
As of January 2018, the number of housing supply months was 13.4, which is likely to generate pressure on developers to reduce their inventory of housing units by compromising on the price. This is already being reflected in the housing prices index.
In summary, these three indicators - the number of building permits, the difference between the financing interest rate and the return obtained by buying a housing unit for investment (carry trade), and the number of months of supply in the new housing market - show that for the foreseeable future, housing prices are likely to continue falling - without a word about the Buyer Fixed Price plan. Time will tell.
The author is a market analyst at Rimon Solutions
Published by Globes [online], Israel business news - www.globes-online.com - on May 15, 2018
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