This press release as a Word document
To presentationThe Governor of the Bank of Israel spoke today at a Knesset Finance Committee discussion on the housing market. Following are the main points.
I apologize for beginning my remarks with a short lesson in economics, which will be about supply and demand in the housing market. Anyone who has learned economics is familiar with the supply and demand curves. An increase in demand, i.e., a shift rightward of the curve, leads to an increase in price which also leads to an increase in the quantity of homes. The second possibility for increasing the quantity of homes is an increase in supply, i.e., a shift rightward of the supply curve. In this case, the quantity of homes increases while its price decreases.
From the long-term perspective of the last 40 years, there was a continuous upward trend in the price of homes from the beginning of the 1990s until 1997, as a result of the large wave of immigration during that period and the stability that characterized the economy following the Stabilization Plan of 1985. Following that, the real price of homes declined until the beginning of 2008, when a steep upward trend in home prices began. From a long-term perspective, home prices have risen by about 1.7 percent annually. However, home prices have been highly volatile. Thus, if you bought a house at the end of the 1990s, for example, you would have lost a great deal on your investment. Since 2007, the nominal price of homes has risen by about 70 percent, or about 50 percent in real terms. Rents also rose but at a much slower pace. Home prices again began to rise during the last year, a phenomenon which is of great concern to us.
An international comparison shows that the price increases of the early 1990s was relatively sharp in Israel, although over a longer period, the increase in Israel is not exceptional. The main message we get from this is that in every country where the financial system did not collapse in the global crisis, home prices increased sharply. The reason is that the interest rates and market yields reached very low levels in recent years, and in every country where the banking system could provide credit (Canada, Norway, Australia, and others), the result was an increase in demand for housing, which brought with it a rise in prices. In contrast, in countries such as the US, Spain and others, where the banking system encountered crisis, low yields did not lead to the provision of more credit to the housing market, and prices fell.
Activity in the housing market has expanded in recent years. As a result of the increase in prices, the pace of construction is higher than it was in the mid-2000s and stands at about 40,000 units per year, compared to about 30,000 a few years ago. In recent months, we have been witness to a drop in the number of building permits issued, which apparently has also had a negative effect on building starts. We can also see that when demand increased during 2007–08, there was a decline in the stock of homes available for sale (which had been at high levels previously and had contributed to the downward trend in prices). The increase in building starts is beginning to have a positive effect on the stock of housing available for sale as well.
What are the factors that determine the demand for housing? The long-term factors are of course population growth and the increase in the standard of living, which encourages households to upgrade their housing. Indeed, we see that over time home prices rise more or less according to the long-term rate of population growth. The short-term factors include the decline in interest rates and alternative yields in the economy, which have also led to an increase in the demand for housing as an investment. The low yields have made it difficult to find investment channels that provide a high return and the housing market has become an attractive option. We see that in recent years, there has been an increase in the demand for homes for investment purposes.
The decline in interest rates has been a worldwide phenomenon, since all the major central banks have been keeping interest rates low in order to stimulate their economies. Since there are no signals that those central banks intend to begin raising interest rates in the near future, the long-term interest rate is characterized by a continuing downward trend, both in Israel and abroad. Thus, the yields on indexed 5-year bonds have fallen by more than two percentage points during the last two years, which is unconnected to changes in the Bank of Israel interest rate. According to the directives issued by the Bank of Israel, two-thirds of a mortgage must be provided with a non-variable interest rate, which is meant to reduce the borrower’s risk. As a result, the prices of mortgages have fallen during the last two years and again this is unrelated to the reduction in the Bank of Israel interest rate.
Housing credit provided by the banks has grown rapidly in recent years. In contrast to what one might have thought, credit in the form of mortgages is the cheapest type of credit provided by the banks, even relative to credit provided to the business sector. The Bank of Israel has taken a number of steps to reduce the level of macroprudential risk facing the financial system as a result of the sharp increase in credit. This has been less out of concern for the banks and more out of concern for households who may have difficulty paying off their mortgages in the future if interest rates increase. The steps which were taken by the Bank of Israel include a limit on the variable rate portion of a mortgage to one-third; the limit on the loan to value ratios, primarily in the case of investors; and the requirement issued by the Supervisor of Banks that banks increase their capital allocations and credit loss provisions against mortgages.
One of the main factors affecting the supply of housing in Israel is the lengthy planning process, which constitutes a major barrier to increasing the housing supply. Obtaining a permit from the planning committees takes about five years (although there are indications that the National Housing Committees have shortened the process); the process at the Israel Lands Administration takes another two years; another three years to get a building permit; and the construction itself takes two years—and the whole process takes a total of 13 years! This is exceptionally long, also in comparison to other countries.
Another factor that affects the supply of housing is credit to the construction companies. In this context, there have been claims that builders do not have sufficient access to credit; however, the figures show that alongside the sharp increase in housing loans provided in recent years, credit to builders has also increased. This is in spite of the fact that the credit risk in the real estate industry is higher than in other industries, as can be seen in the proportion of problematic credit within the industry’s total credit. Despite the industry-specific limit on credit to the real estate industry, the banking system could in theory provide another approximately NIS 20 billion to the industry, even if some of the banks are close to the limit. Recently, the Supervisor of Banks also eased the requirement to allocate capital for Sales Law guarantees, which makes it possible to increase exposure to the real estate industry. However, the fact that not all the banks are to be found at the limit shows that they do not wish to increase credit to the industry. It is not the role of the Supervisor of Banks to force the banks to increase their credit to the industry and he has no intention of doing so. It is the banks who decide on how much credit to provide and the Supervisor will intervene only if the banks are acting improperly.
In summary, the Bank of Israel interest rate has some effect on the price of housing and the Bank of Israel should and does take that into account. However, the interest rate tool cannot be used exclusively to affect only one sector of the economy. If we would have maintained the interest rate at a high level, the shekel would now be much stronger, to the detriment of exports. The low rate of interest also encourages investment in local industries. A high interest rate would have prevented the growth Israel has enjoyed in recent years and would have raised the rate of unemployment. Therefore, although the interest rate in Israel is low, it is not low enough to discourage foreign investors, who are benefiting from the fact that the interest rate is about 1.5 percentage points higher in Israel than in other countries, and this has appreciated the foreign exchange rate.
In order to bring about an increase in the rate of construction while also bringing down home prices, the supply of housing must be increased. To this end, the amount of land available for construction must be expanded and the time required from the planning stage to the start of construction must be shortened. It is the job of the government to manage land policy and land planning. This is not an easy task, but one that must be carried out. In addition, the government must find ways to curb demand by investors through tax measures. In this context, our main proposal is to lengthen the period required for an exemption from betterment tax.
In answer to questions from the Knesset members:
The long-term rate of interest in Israel is higher than that abroad due to geopolitical risk. The government’s annual interest rate payments constitute about 4 percent of GDP in comparison to 2 percent in other countries.
Part of the problem is local democracy but one can’t complain about that too much. None of the local authorities would want the central government to decide for them where and how much is to be built.
According to classical economic theory, when the rate of interest falls and the demand for housing increases the price of housing will rise and the supply of housing will increase. However, in Israel when demand increases people rush to buy apartments and it takes 13 years to build them…. That is problematic.
I am optimistic that this problem can be solved – someone who has responsibility for economic matters cannot be a pessimist.
It is not possible to provide every individual with a housing solution that will cost him one-third of his income in every part of the country.
We at the Bank of Israel knew that it is very easy to kill this market but we didn’t want to do so. We tried to take measures that would reduce the pressure on prices but would not harm the level of economic activity.