Dr. Flug, Deputy Governor remarks at a conference on housing market
Dr. Karnit Flug, Deputy Governor of the Bank of Israel, speaks on the housing market at the annual conference of the Israel Builders Association.
In recent years, housing and rental prices have increased significantly. A long-term view shows that the increase in recent years followed a decade in which real home prices declined, following their sharp increase during the 1990s due to the large wave of immigration that the country absorbed, and that prices are not deviating noticeably from the trend line. The price increases over time are also consistent with the long-term connection between growth and home price increases that exists in OECD countries.
The relatively sharp price increases since 2008 are a common phenomenon in countries that did not experience a significant financial crisis during the global crisis. The main message here is that in every country in which the banking system did not collapse during the global crisis, housing prices increased sharply, since interest rates and market yields reached very low levels in recent years, and in every country where the banking system was able to provide credit, this led to increased demand for housing, which in turn led to rising prices. In contrast, in countries where the banking system encountered crisis, the low yields were not reflected by the provision of credit to the housing market.
An analysis of developments in recent years requires us to assess the factors that affect the supply and demand of homes. On the demand side, the active long-term factors are demographic growth and the increase in the standard of living (as a result of growth), which lead households to want to upgrade their level of housing. The short-term factors include the decline in interest rates and alternative yields in the economy, which lead to an increase in demand for investments. Low rates have made it difficult to find investment options that generate a high yield, so the housing market became an attractive alternative. This phenomenon is not unique to Israel. Yields on homes in Israel declined in a manner similar to declines in Switzerland, Sweden and Canada. Accordingly, we can see that in the past few years, there is an increase in the share of investment homes out of total home purchases.
Regarding the factors affecting the supply of homes, the planning process in Israel is very long: from the time a decision is made until the completion of construction, the process takes almost 13 years. It seems that while the bottleneck at the end of the last decade was at the planning stage, today, following the completion of planning for 60,000 units in 2012, the bottleneck is now at the stage of obtaining permits, meaning the Local Committees, due among other things to limitations in the construction of the infrastructure to support residential neighborhoods.
Another factor affecting the supply of homes is credit to the contractors. Dr. Flug showed data indicating that alongside the sharp growth in housing credit (mortgages) in recent years, credit for construction has also increased such that total housing credit (mortgages + credit to contractors) has reached about 40 percent of total bank credit. This is despite the fact that the risk in construction and real estate credit is higher than in other industries, as reflected in the level of problematic credit as a share of total credit in the industry. The fact that the availability of credit for construction does not constitute a significant limitation to expanding supply is reinforced by the responses of executives in the construction industry to the Business Tendency Survey conducted by the Central Bureau of Statistics, wherein the executives report that the main limitations they face are delays in obtaining permits and approvals, and a lack of available land for construction, while the credit limitation is relatively moderate.
The effects of supply and demand are reflected in activity in the housing market and in the increase in housing prices. Housing market activity increased in recent years, as the level of building starts has been higher than it was in the middle of the last decade. However, in recent months, we have seen a decline in the number of building permits, which negatively affects building starts, and it seems that this decline is spurring the increase in prices.
The Bank of Israel’s interest rate has some effect on housing prices, and the Bank of Israel takes this into account in setting the interest rates. However, the low interest rate supports activity in the market, particularly exports, public consumption and investment in industries. A higher interest rate, while the rates of other central banks around the world are at all-time lows, would have strengthened the upward pressure on the shekel and harmed exports. A high interest rate would have prevented the growth that we had in recent years, and brought about a higher unemployment rate and a decline in the pace of home construction. In order to minimize the effect of the Bank of Israel’s interest rate on the housing market, particularly on the financial risks inherent in a rapid increase in the volume of mortgages, the Bank of Israel took a series of macroprudential steps.
In order to simultaneously stimulate growth in the volume of construction and a decline in housing prices, we must increase the supply of homes. For that purpose, the government must take steps to increase the amount of available land for construction, shorten the time from the project’s initiation to the actual start of building, and synchronize building plans with infrastructure development. It is the government’s job to manage land and planning policy. At the same time, the government can restrain demand on the part of investors through taxation steps as planned in the budget proposal.