Following on from the widespread changes in purchase tax and capital gains tax in 2013 and Lapid’s attempts last year the new Finance Minister Moshe Kahlon also has similar campaign promises to fulfill to those who swept him into power, namely bringing down property prices in Israel.
His proposed law has a number of elements, the most immediate of which is the change in purchase tax rates on investors and foreigners which comes into effect this Wednesday June 24th. It was originally slated to come into effect on July 1st but since so many people were trying to get their deals in under the wire and save themselves tens of thousands of shekels in doing so the Knesset rushed the changes through the law to commence earlier. The law will be in effect for the next five years or until the next finance minister is voted in promising to reduce property prices.
The increased purchase tax brackets affect anyone who is not an Israeli resident purchasing their first residential property in Israel and the effective date to look at is the date a binding contract is signed. The lowest bracket will no longer be 5% but will start at 8% from the first shekel and the next increase is at 4.8m shekels where it goes up to 10%. On a 2m shekel property the difference is over 50,000 shekels and on an 8m shekel property the difference is over 150,000 shekels. This is continuing the pattern of the past few years in increasing the purchase tax on investors and foreigners.
The finance ministry is hoping that this increase in purchase tax will deter potential investors from buying real estate and they will instead put their money elsewhere, thereby decreasing demand for real estate and lowering prices. There are a number of factors involved in examining whether this would have the desired effect on the markets.
The incredibly low interest rates currently available for mortgages encourage potential investors to borrow as much as they can right now with the expectation that their return on investment either by way of rental income or through capital gains will cover the mortgage and provide some return on top of that. Although rentals generally provide a return on investment of 2-4% in most cities in Israel, there is a 0% tax rate on total rental income below around 5,000 shekels a month or alternatively an investor can choose to pay a flat tax rate of 10% on rental income to the Israeli government.
Capital gains over the last ten years have provided significant returns to almost anyone who purchased residential real estate in Israel. Low interest rates also discourage investors from investing their spare cash elsewhere, which combined with a distrust of the stock market for many and a love of real estate for Israelis leave buying apartments as the most attractive and tangible proposition for those investors looking for a solid return.
Although the Bank of Israel restricted investors and foreigners to mortgages no greater than 50% of the Loan To Value of the property, this is still a more attractive proposition to many investors than the current alternatives. And with currency wars still taking place and no great desire from the Bank of Israel to increase interest rates any earlier than the rest of the world which would cause an export crisis in Israel, it appears that interest rates will stay low for quite some time and may even get lower before they rise again.
The finance ministry is hoping that an increase in tax of 3-5% of the purchase price will discourage potential investors from buying property and will instead divert them to other horizons, claiming a 1% rise in purchase tax rates will result in a 10% decrease in the number of investors. It is far more likely in the real world that investors will either take a higher mortgage LTV if they weren’t planning on taking the full 50%, try and negotiate a lower price with the expectation that other investors will leave the market or as seems most likely they may purchase a slightly reduced property to invest in to cover the difference in tax if they are not able to make up the difference with their funds. Although this will have an effect on the market it is far smaller than the one predicted or hoped for by the government. It is also unlikely that those first time buyers who cannot currently cobble together the 25% down payment needed to buy their first property somewhere desirable will suddenly be able to do so should 10% or 30% of investors pull out of the market as claimed. Investors already only have around 20-30% of the total market anyway.
It’s going to be very difficult to discern over the coming months if there has been any effect on the housing market. There is the ongoing problem of getting accurate readings in housing trends due to there being a number of different bodies using various methods to ascertain house prices including the finance ministry, the housing ministry, the government appraiser-in-chief and the central bureau of statistics, not to mention private bodies such as Yad2 etc.
There have also been a number of periods where market trends have been warped due to outside influences and the law of unintended consequences (see the attached table taken from Globes online), such as during the housing protests of 2011. Similarly once Lapid announced he would reduce VAT on first time buyers in early 2014 then for almost the whole of 2014 while the draft law was working its way through the various governmental bodies many potential buyers who could gain from the discount were sitting on the fence thereby effectively reducing demand, softening the market and for a while slightly improving the bargaining power of those who did go ahead and purchase. Once Bibi called for elections in late 2014 and it was clear the law would never pass all the fence sitters got back into the market suddenly, increasing demand and creating a bottleneck. Similarly when it was first publicised that Kahlon would increase tax rates (to 20% which he quickly backtracked from) and as the July 1st date approached, more deals were being closed to such a degree that it necessitated pre-empting them by enforcing the increase earlier. The same thing happens whenever the mortgage rules change, people rush to get their mortgages done sooner which causes a massive increase in the number of deals and mortgages done during that period and it’s difficult to conclude if prices have increased or decreased due to these outside influences.
It’s always good to ask who benefits and who loses from a particular change in regulation. If property prices don’t decrease the finance ministry will continue to rake in large amounts of income from purchase tax, capital gains tax, VAT etc. Almost everyone who currently owns an apartment in Israel – which is the large majority of the country – ultimately wants prices to continue to increase. Those who were lucky enough to get on the property ladder in the past were able to take advantage of the increase in value and refinance in order to purchase more properties for family members or investments.
Some concerns have been raised that this increase in tax will directly affect the already overburdened, unregulated marketplace for rentals. It seems hard to believe however that those investors purchasing from this point on will be able to pass on increases in rentals that the rental market would not support anyway and that would not have been achievable prior to the new regulations. The influence the “new” investors have on the market when demanding rents should be minimal. A rent control law was proposed by Lapid and Livni in the last Knesset and has been floated by Kahlon too but this too when being discussed can have the unintended effect of persuading landlords to hold out for higher rents before the law goes into effect giving them a higher baseline from which to make their restricted increases.
There are far more structural issues in the supply side of the Israeli housing market as I discussed back in 2011 here which are influencing the final price for new properties and as a consequence second hand properties too. A number of changes have been proposed and implemented over the last few years but the results of these changes take a long time to trickle through to the market and no government wants to oversee a sudden crash in the market causing developers, banks and property owners to lose a huge amount of equity which is why these changes have been incremental. Also an increase in population together with a “right” of young marrieds to a new apartment continues to influence the demand side of the equation more than in other countries.
The other main proposal of Kahlon on the supply side to provide land for the bidder who commits to the lowest final sale price is a rehash of one proposed by Uri Ariel in the last government, and will bring with it much political infighting and intrigue as before. When the government tries to benefit a particular class of people it becomes a political free for all and in a government of only 61 Knesset members the potential for political blackmail is always present. There are other proposals on the supply side but these all take years to come to fruition.
To conclude it doesn’t appear that the market will see a significant change downwards until many of the supply side policies have had an effect, investments in the periphery have been completed, together with an increase in interest rates and a reduction of the public discussion and headlines about how much property prices are increasing.