Remarks by Prof. Nathan Sussman, at the Calcalist Real Estate Conference
Prof. Nathan Sussman, Director of the Bank of Israel Research Department, spoke at the Calcalist newspaper's Real Estate Conference in Tel Aviv, and primarily discussed home prices. His main points are below
Prof. Nathan Sussman, Director of the Bank of Israel Research Department, spoke at the Calcalist newspaper's Real Estate Conference in Tel Aviv, and primarily discussed home prices. His main points are below:
As we know, there has been a marked increase in home prices and in rents in recent years. There was a large increase in home prices, followed by rental prices, too, until 2009–10. This was followed by a moderation in the increase of rents, despite the continued increase in home prices. Later on, the increase in home prices stopped, and it seemed that the upward trend had ended and that we were returning to a normal situation. However, as we know, in the past six months, the sharp increase in home prices has resumed. This trend certainly concerns all those who have come to this conference today, as well as us at the Bank of Israel.
As economists, we analyze the phenomenon through an analysis of supply and demand. On the demand side, the basic factor acting to increase home prices is GDP growth. Over the long term, from 1980 to 2012, there is a connection seen between economic growth and the increase in home prices in many OECD countries. Economic growth means an increase in population and in income, and both lead to an increase in demand, both for the number of homes and for the quality of homes. Focusing on Israel, we see that from 1980 until now, we are not far from the regression line. This means that over the long term, there is no large deviation in home prices in Israel from what we would expect based on theory, meaning based on the connection between income and price. Even looking at just 2010-2012, we are close to the regression line. We can also see from the graph that there are a few countries where prices are rising much more than what we would expect based on the growth rate (such as Germany, Norway and Canada).
They say that the trouble of many is the comfort of fools. In any case, there are a number of countries, such as Australia, Sweden, Canada, and others that, like Israel, have "exploited" the financial crisis, and have adopted proper monetary and fiscal policies. In all of them, we see that the public is purchasing homes, and prices there increased even more than in Israel.
The demand for homes also derives from the demand for homes as an investment property. This demand is determined by yield—the ratio between rental prices and home prices. We compare this ratio to the long-term yield on a debt security, such as the yield on long-term government bonds, and we see that the market works. When long-term yields decline, the yield on homes decreases as well—investors go to the housing market and purchase homes until yields equalize. This phenomenon is not unique to Israel. Yields in Israel are similar to yields in Switzerland and Sweden, and are even higher than in Canada. Yields are affected by global trends, and in this context, the main factor is obviously the monetary expansion by major central banks that are pushing yields to historic lows.
On the supply side, things work more slowly than on the demand side. When the price increases started, there was also a supply response: there was an increase in building starts and in permits, but it takes time from there to the completion of construction. Since the middle of 2011, there has been a decline in building starts and in building permits. In our opinion, some of the decline is the result of a bottleneck in the planning processes, due to which the number of permits has declined, which has not allowed an increase in building starts. The duration from the beginning of the process—examining the feasibility and preparing the plans for submission to the District Planning Board—until the completion of construction is close to 13 years! It is therefore clear that there is a lag in supply, which is not expected to end soon. It is important to note that there is also an inventory of almost 20,000 unsold homes. Contractors apparently prefer not to sell these homes right now, and in this regard, we can also think of contractors as investors who prefer not to sell assets at their current prices.
What is the Bank of Israel's role in this matter? The Bank of Israel interest rate is a partial factor which explains part of what causes demand. It partially contributes to what happens in alternative yields, which push investors to purchase homes. Global yields also constitute a significant factor. The Bank of Israel's monetary policy has also had an indirect effect on the increase in home prices since it has contributed to economic growth, and as we have seen, growth is directly connected to home prices. We do not believe that there is anyone who would be sorry about this.
According to the Bank of Israel Law, the Bank is required to maintain price stability, to support growth and financial stability. Let's say that the Bank of Israel would not have acted according to the law, but would have set housing as a target and not reduced the interest rate when the global crisis broke out. What would have happened? It is important to illustrate this, because people feel home prices, but don't really feel macro-economic aggregates such as exports. If we had left the interest rate at a high level while the rest of the world was lowering theirs to very low levels, our analyses (which should obviously be taken cautiously like any economic analysis) indicates that for every 100 workers, we would today have five more unemployed people than what we currently have. Wages would be low, and purchasing power would be diluted. Anyone who has recently visited Portugal has seen that there are no new cars on the roads—this could have happened here as well. The high interest rate would have meant that those among us who have loans or mortgages would have needed to pay more interest on the loan, and their disposable income would have declined. The government also would have needed to pay higher interest on its debt, which means it would have had fewer sources for the services it provides to the public, which would have had to be cut back.