Israel Bank: Over time the increase in apartment prices is similar to the increase in income

The Bank of Israel has published an analysis of the housing market in Israel. Expenditure on housing services is the largest expenditure component of households, buying an apartment is the largest expenditure of most households during their lifetime, and apartments make up about 50 percent of their asset portfolio.
Therefore, the rise in housing prices over the past decade has placed the housing market at the center of public discourse and government policy. All of these point to the importance of understanding developments in the housing market and the need for tools to analyze it.
A study conducted by Yossi Yachin and Winon Gemersny of the Research Division of the Bank of Israel examined the characteristics of the housing market in Israel and the factors that have contributed in recent decades to the development of rents, apartment prices and the volume of residential construction.
Housing prices relative to GDP per capita: The most striking finding is that this ratio is trendless throughout the sample period. This means that over time, the rate of increase in housing prices is similar to the rate of increase in income. The long cycles are also noticeable, and it is clear that the prices at the end of the sample are high relative to income, but on an order of magnitude similar to past records.
Prolonged cycles indicate that deviations from the long-term equilibrium can last for many years. These deviations can already affect the market dynamics in the short term, so it is important to estimate, along with the analysis of the short-term developments, the long-term relationships. To this end, the study is based on a four-decade sample, 1980-2019, and relies on structural relationships, as questioned by a basic theoretical model for the housing market, DiPasquale and Wheaton (1992).
The study estimates three basic long-term relationships: the demand for housing services; Property Pricing Equation - where apartment prices are determined using rents and returns from the capital market; And construction supply. The shortage or surplus in dwellings is reflected in the gap between the existing stock of dwellings and the quantity of dwellings requested; The over- or under-pricing of the dwellings is reflected in the deviation of the dwelling prices from their value derived from the property pricing equation; And the gap between the actual volume of construction and the supply equation, reflects over- or under-construction.
Deviations from the long-term contexts have been found to have a decisive effect on short-term dynamics. A shortage of apartments is pushing for an increase in rents, apartment prices and the volume of construction; Overpricing is pushing down house prices and accelerating the pace of construction; And shortage construction, relative to the supply curve, is also accelerating the pace of construction.
Demand for housing versus supply: The shortage created by the wave of immigration from the former Soviet Union in the early 1990s caused accelerated construction. Accelerated construction in the years of immigration led to a certain surplus in the market from 1998, The excess demand for housing has continued since then and at the end of the sample (2019) there is still a small excess demand.
The rise in prices during the period of the main wave of immigration led in the end - in the second half of the 1990s - to overpricing of dwellings (relative to what is required by the development of rents and capital market yields). However, the gradual decline in the real price after the wave of immigration, against the background of the surplus in apartments created, led to a lack of pricing starting in the early 2000s. The rise in prices in the last decade has led to a certain overpricing, but relative to their rate of increase it is not particularly large. The study estimates that at the end of the sample, in 2019, apartment prices are about 5.5 percent higher than their value derived from the property pricing equation.
The analysis in the study shows that the increase in housing prices in the years 2008-2011, was mainly due to a lack of pricing of the apartments at the beginning of the period. An estimate of the asset pricing equation shows that on the eve of the rise in prices, in the years 2006-2007, the actual prices were lower than their long-term equilibrium level by an average of 13.7 percent.
The estimate of the dynamics of the short term does not explain the sharp rise in prices in 2008-2011, but this is because in the three years preceding them, 2005-2007, it also does not explain the fall in prices in these years.
Therefore, this result also supports the conclusion that apartment prices on the eve of their rise were too low relative to market conditions. We estimate, on the whole, that about half of the rise in prices in 2008-2011 was due to a lack of pricing that prevailed on the eve of their rise.
The short-term real interest rate (the Bank of Israel interest rate less inflation expectations) explains about a quarter of the rise in housing prices in 2008-2011 and in subsequent years it was found that its contribution was nil. The shortage of apartments and the increase in household income have a moderate but sustained contribution to the rise in prices, and since 2012 these are the two main factors that have supported their rise.
The analysis in the study shows that the increase in housing prices in the years 2008-2011, was mainly due to a lack of pricing of the apartments at the beginning of the period. An estimate of the asset pricing equation shows that on the eve of the rise in prices, in the years 2006-2007, the actual prices were lower than their long-term equilibrium level by an average of 13.7 percent.
The estimate of the dynamics of the short term does not explain the sharp rise in prices in 2008-2011, but this is because in the three years preceding them, 2005-2007, it also does not explain the fall in prices in these years.
Therefore, this result also supports the conclusion that apartment prices on the eve of their rise were too low relative to market conditions. We estimate, on the whole, that about half of the rise in prices in 2008-2011 was due to a lack of pricing that prevailed on the eve of their rise.
The short-term real interest rate (the Bank of Israel interest rate less inflation expectations) explains about a quarter of the rise in housing prices in 2008-2011 and in subsequent years it was found that its contribution was nil. The shortage of apartments and the increase in household income have a moderate but sustained contribution to the rise in prices, and since 2012 these are the two main factors that have supported their rise.
The sample in the study ends in 2019, but as of 2020, it was characterized by a temporary shock, but unusual in itself due to the corona crisis, which also affected the housing market: the pace of construction slowed, income was hurt The capital market has declined.
Due to the temporary nature of the shock, it is difficult to deduce from the data an assessment regarding the market situation relative to the long-term relationships.