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the housing bubble

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legal warning: The information here should not be understood legally as financial advice. If you believe anything on this site is in error, please contact me. I am always open to corrections, new ideas, and new opinions...

Haaretz has a fantastic article explaining the real issues behind the current housing crisis in Israel.  The piece, written by the CEO of Psagot Compass Investments, explains the rarely heard economic side of the issue

“Five years ago, in the summer of 2005, an investor bought an apartment for rental purposes: a small studio apartment in a new building but in an unattractive, congested area of south Tel Aviv. He paid NIS 430,000, using his own savings rather than taking a mortgage. At the time he could expect to rent it out for from NIS 2,400 to NIS 2,500 a month. Rental income of NIS 30,000 rent a year on an investment of NIS 430,000 translates into returns of about 6.5% a year. Israeli government fixed-income Shahar bonds would have yielded roughly the same return, in nominal terms.

Investing in property isn’t like investing in government bonds. Like every instrument of investment, it has both benefits and drawbacks. On the minus side are the headaches of being a landlord, the risk of getting stuck with a bad tenant and occasional expenses.

Unlike nominal bonds, however, rents and home prices tend to keep pace with inflation, and up to a certain threshold rental income is not taxable. Capital gains from bonds are taxed. In any event our man went for the property, not the bonds.

Five years later, where are we? The monthly rent rose to NIS 3,000 a month, representing an annual increase of around 4.5%, or between 20% and 25% over the five-year period. That wasn’t a meteoric pace, it was roughly the same as inflation.

But the purchase price is another story altogether. Similar apartments sell for NIS 800,000 today, meaning it rose by by 80% in five years, far outstripping the increase in rent.

In 2005 the return on investment was the same as nominal government bonds. Now the equation is NIS 800,000 (apartment value ) divided by NIS 36,000 a year (rental income ), which works out to 4.5% – the same as the return on Shahar bonds. In other words, that didn’t change in the five years.

That, dear reader, obeys the laws of economics and financing. When long-term interest rates drop, the price of income-generating properties rises. The longer the lifetime of the assets, the more their prices increase. Those are the laws of mathematics. Since property has a long lifetime, its price rises significantly when long-term interest rates drop.”

Some points of interest:

 1 – As one commenter pointed out, if this is true, then investors should buy properties when long term interest rates rise and sell when they are low.  The opposite would be true for private individuals buying a home in which to live.

2 – As long as the US keeps interest rates low and we match it (in order not to drive up the shekel and hurt exports), then the housing bubble will likely continue.

3 – Regulations aimed at keeping people from buying homes (more money down, stricter requirements, higher interest rates) will likely remove the buyers that are buying to live in the homes (and are paying via mortgage) but not those who investing (and often have the money up front via a mutually fund of some sort).  As a result, there will be a small dip in price, and then a rush for more investors to push into the market, probably inflating the bubble more before it bursts harder.

Do you think the government can do anything to fix the solution or just make it worse?


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