To view as Word doc


Prof. Nathan Sussman, Director of the Bank of Israel's Research Department, spoke today at the Globes newspaper's Real Estate Conference. His main points follow.

Prof. Sussman described how, in the past half year, the increase in housing market prices has resumed, while the rate of increase of rental prices has moderated. He explained the developments in the housing market as the combination of supply and demand factors. Prof. Sussman showed a diagram with equilibrium points in the residential housing market. The diagram indicated that, generally, between 2003 and 2008, there were changes in demand for housing, without significant changes in housing prices. In other words, we can say that there was no problem of supply—the supply of homes was perfectly elastic. Beginning in 2009, demand increased, but encountered supply limitations. In 2009 and 2010, most of the growth in transactions beyond the 2008 level was due to investors, while demographic factors affecting demand did not change. In 2011, the social protest apparently acted to reduce the volume of activity in the market, with both buyers and sellers sitting on the fence, which was reflected in both a decline in demand and a decline in supply. In 2012, demand returned to its 2010 levels, while supply was slightly lower than in 2010. As such, Prof. Sussman concluded, the developments in the housing market are not simple, and both demand factors—mainly that of investors—and supply factors came together to create the current situation in the housing market.

From the perspective of demand, Prof. Sussman explained that one of the factors affecting demand for investment properties is the decline in yields in conservative investment alternatives in Israel and abroad. A home is not just a place to live, but also an investment asset. The income from the investment is the rent received, and the yield is equivalent to rental receipts divided by the price of the asset. When the yields on alternative assets decline, investors stream toward the housing market, and the increase in home prices acts to equalize the yield on homes to the yield on bonds.

In recent years, long-term yields declined both in Israel and abroad, with the Bank of Israel's monetary interest rate contributing only partially to this, since yields are determined mainly in the global markets and are also dependent on the policies of the major central banks. Prof. Sussman showed data illustrating the correlation between long-term yields and the yields on owning a home in Israel, and data showing that the phenomenon is not unique to Israel.

According to Prof. Sussman, the demand for homes for residential rather than investment purposes is relatively stable, so restraining investors' demand will contribute to a decline in prices in the housing market. Through the macroprudential steps taken in November 2012, the Bank of Israel limited the financing available to investors. At the same time, the government's assistance is necessary to reduce demand for investment homes without harming young couples. This assistance may take the form of taxing investments in housing. As of today, housing investment is not taxed like an investment in the capital market, and given that investment activity in the housing market endangers the market's stability, there is no reason to encourage it over other investments at the current time. In this context, a variety of tools can be used, such as tools that will affect capital gains, for instance the cancellation or extension of time until being entitled to a betterment tax exemption on an investment property, or tools that will affect yields by cancelling, or at least reducing, the gap between taxation on capital market yields and that on yields from rents.

In analyzing the supply side, Prof. Sussman also related to the issue of financing in the housing market, and showed data indicating that the balance of housing loans continues to increase. He presented estimates from a research study being conducted at the Bank of Israel showing that the leverage of those taking out mortgages compared to their income has increased from about 30 percent of household income at the beginning of the last decade to about 35 percent today. According to these estimates, the loan to value (LTV) ratio also increased, from about 35 percent to more than 50 percent. This development led to the most recent steps by the Supervisor of Banks, since an increase in leverage increases the risks in the bank's loan portfolios. While the levels of risk in Israel have not reached those in other countries, it would not be prudent to wait without doing anything until the risk materializes, as happened abroad.

Prof. Sussman noted that mortgages also have an effect on the supply of homes, since they constitute a source of financing for construction activity. Total credit to the industry continued to grow this year, although at a lower rate than in the past 2 years, and speakers from the housing sector who participated in the conference also noted that, in their view, the issue of financing for contractors does not currently constitute a problem at the systemic level. Prof. Sussman added that there is an inventory of about 20,000 unsold homes. In the supply context, Prof. Sussman also mentioned the trends regarding the labor force in the industry. The data he presented indicate that the number of those employed in the industry continues to grow, while in recent years, the main growth has been among Palestinian and foreign laborers. It is clear that the growth in the cheap labor force solves the problem of supply in the immediate term, but, Sussman added, it delays technological improvements and increased productivity in the sector to a certain extent. In any case, as such, the trends on both the financing side and the labor input side show expansion, and can at best partially explain the receding supply.

Prof. Sussman said that one of the explanations for the decline in supply is a decline in the volume of building permits, some of which derives from the planning process. In addition, there was an increase in the inventory of unsold new homes. It is possible that this comes from the fact that the contractors are not putting homes up for sale in the hope of selling them at higher prices in the future, leading to the apartments being deleted from current supply. Prof. Sussman showed that the process—from reaching the decision to build until the completion of construction—is long, almost 13 years. It seems that if the bottleneck at the end of the last decade was at the planning stage, then after completing the planning of more than 60,000 residential units in 2012, the bottleneck today is in the permit stage, meaning at the local planning and building councils, mainly due to limitations in building the infrastructure to support residential neighborhoods.

And what about using the Bank of Israel's interest rate to cool demand in the market?  Prof. Sussman mentioned that the Bank of Israel's interest rate is just one of the factors affecting demand for homes. However, the low interest rate supports activity in the entire economy, and increasing it while the world is still gripped by crisis, and while the interest rates of central banks are at all-time lows, may cause widespread damage to the economy through negatively impacting exports, investments and employment. Reducing the interest rate enabled the Israeli economy to successfully get through the crisis. Therefore, when considering whether to use the interest rate in order to deal with the housing market, we must consider all the damage that this step may cause.

Sussman emphasized that despite the great benefit of the interest rate policy adopted, the Bank of Israel has not treated its partial effects on the housing market lightly, and has taken macroprudential steps intended to protect the stability of the banks, and for some of the effects also acted to reduce the transmission between the Bank of Israel's interest rate and the demand for housing.


In summation, Prof. Sussman noted that there are additional tools that can deal with the housing problem—tools that are in the government's court: The government has effective tools to restrain demand for investment properties by taxing this activity. The government also has tools to increase the supply of homes by shortening the building permit process and creating a planning inventory for the next few years.