The Association of Banks in Israel

The Israeli Housing Problems in the Short and Long Runs and the Government Policy for Solving Them

The present study concentrates on three issues of the Israeli residential sector and the government’s policy to ameliorate their problems. The first issue, which we view as a short-run issue is the sharp increase in the average prices of houses from their bottom of 2008 and did not stop increasing almost everywhere up to the end of 2016, and in Tel Aviv metropolitan area and its close periphery even in 2017. Because this sharp increase in the price of houses was mainly triggered by the decrease in the mortgage rates (which resulted from the collapse of the interest rate associated with the sub-prime crisis), in equilibrium the burden resulting from the increase in the price could not dominate the benefit of the lower mortgage installments. Hence, those who afforded the down payment could improve their housing conditions. However, a large group of new entrants to the housing market could not afford the down payment and, therefore, could not benefit from the low mortgage rates. For new entrants, decent houses became unaffordable, especially in the short run when housing supply was very inelastic. The controversial policy instruments applied by the Israeli government to restrain the continuous increase in housing prices, including almost a complete nationalization of private entrepreneurship in the residential sector, were only partly successful in ameliorating the burden of becoming home owners. They surely distorted resource allocation by the types of auctions where land is provided at less than market price to competitors on supplying at a lowest price a specified dwelling unit to households who are eligible to participate in a lottery and won it.

The second issue explored in the present study concerns the long run where the prices of house increased at an average annual rate 2-3 %. The problem was the long range scarcity of land accessible to the main center of economic activities in and around the metropolitan area of Tel Aviv-Yafo. The population growth and its income contributed to an increase in the demand for accessible housing. This demand was not satisfied by a perfectly elastic supply, though the real prices of inputs in housing construction, excluding land and entrepreneurship, hardly changed in the long run. In view of intense competition among entrepreneurs, the main explanation for the imperfect elasticity of housing supply is the low elasticity of land supply. This low elasticity can be explained by the small size of the country, the public ownership of land which was frequently withheld from residential development and associated with a heavy bureaucratic burden, and, in particular, absence of coordination between residential development and appropriate transportation infrastructure. We believe, that with proper coordination and transportation infrastructure based on modern mass transit system it would be possible to arrive from each point to each point in this small country by less than 45 minutes. Such policy would increase the supply of accessible land and would contribute to moderate the long run price trend and, consequently, the long run trend of price of houses.

The third issue discussed in this study is the tenure choice regime. We discuss briefly the fundamental benefit of renting versus owner occupying and refer to the established literature on the distortion in the tenure choice which results from the discrimination in favor of owner occupier versus a renter by the income tax treatment. Ignoring this distortion and assuming instead that the market is unable to provide in Israel an “established” rental market with long-term tenancy for residential use, the government step in and tried to establish a rental market with long-term tenancy where the rent is controlled, eligible tenants are subsidized. We believe that a better way to develop an “established” rental market with long-term tenancy, if it is efficient, is to abolish the income tax on residential renting and let the tenure choice be determined by individuals’ preferences. A rental market with long term tenancy will be established if its social benefit justifies it, as it is in the case of the established Israeli market for commercial uses.

The complete article in Hebrew

Professor (Emeritus) David Levhari, Department of Economics, The Hebrew University of Jerusalem, and Professor (Emeritus) David Pines, The Eitan Berglas School of Economics, Tel Aviv University.