The Biggest Housing Bubble of Them All?

rechavia picturesThere has been talk of housing bubbles in China, Australia and Canada; among other countries. While, I am less familiar with the data from Canada, the evidence from China in Australia seem to indicate a huge housing bubble. In China’s case the bubble already seems to be bursting, the  question is how bad the impact will be. Ironically (or maybe due to strong housing demand), all these countries fared relatively well during the economic crisis (at least compared to other countries). However, there is one small country (the size of New Jersey) that also weathered the crisis that appears to be experiencing a massive housing bubble; Israel.

The global economic crisis hit the world in 2008, and reached its peak in the months after the collapse of Lehman brothers. The Bank of Israel, in order to minimize the impact of the global crisis, decreased the interest rate from 5.25% to 0.5%. This very measure adopted by Stanley Fischer (Ben Bernanke’s former teacher and mentor), the Governor of The Bank of Israel, to curtail the effects of the global economic crisis is believed to be the main underlying reason for the escalated housing prices in Israel. The record-level low interest rate caused the prices for assets to increase, especially in the housing sector.

The status of Israel as one of the global leaders in the real estate market, the strong consistent economic growth despite the present and past political instability and furthermore, the consistently rising prices of houses and apartments over the past years have made Israel’s real estate market an attractive and safe investment option for both international and local investors.

Due to the lack of stock investment culture in Israel the inclination of local investors towards real estate investment has increased. Additionally, there has been a massive inflow of foreign capital from Jews living abroad. There are parts of the country which are known as ghost towns, because the property is owned by Jews who have a vacation home in Israel. In parts of Jerusalem, some of the prime realty is nearly unoccupied except for a week or two a year, when the owners come to visit. A tiny, two bedroom apartment in an affluent, English speaking, part of Jerusalem can easily sell now for close to $1 million.

During the period between 1999- 2007, the housing prices of Israel only rose by 19%, meanwhile CPI increased by 24%. However, there was a 36% increase in housing prices in 2008, and a 14% increase since the beginning of 2009. The exorbitant prices of real estate and relaxed loan policies of Israel emulate the features of the housing bubble experienced by US. Along with rapidly increasing housing prices and easy loans, loose monetary policies and speculative buying of investors, all signal towards the housing bubble. Speculative investment, which is a dominant cause for the rapid increase in demand and resultantly the prices of housing, is also additionally fueled by the loose monetary policies of Israel as it is easier for interested investors to access and acquire the funds required to make the investment in the real estate sector.

Various warning signals indicating the housing bubble in Israel are starting to arise. The Bank of Israel has increased the interest rate from 0.5% to a ‘normal level’ of 1.25% after witnessing the soaring prices of houses and the possibility of inflationary problems. Stanley Fischer stated that housing prices increased another 20% in 2010!

To combat this, the bank tightened the mortgage lending policies in attempt to alter the loan-to-value ratio from 70% to 60%. Additionally, the government of Israel has taken necessary steps to increase the supply of the houses to better meet the demand and has further brought about changes in the real estate tax laws to control investor demand; but according to Shay Lipman, a real estate analyst at an investment house in Tel Aviv, IBI Ltd., the real cause of unmet demand of houses is due to the 92% ownership of Israel’s land by the state.

In addition to the major factors contributing to the housing bubble in Israel there are other irrefutable factors highlighted by various entities. Regardless of the presence of such hardcore facts, there are individuals and analysts who argue against the existence of housing bubble in Israel. Fischer (like his student, Ben Bernanke did in 2007) argues that the increase in the housing prices is a crisis that exists in Israel which is wrongly perceived as being a bubble.

Regardless, it is evident that despite the strong economy, Israel has highly inflated housing prices. Perhaps the strong economic growth, as stated before, is a causal factor which makes housing investment in Israel attractive and safe, further increases the unmet demand for housing. In order to control the demand and the resultant exorbitant real estate prices, the government of Israel should consider taking more intense measures to directly control the economic factors that are contributing to the increasing housing prices.

Disclosure: None