The Jerusalem Housing Bubble - Investing in Real Estate in Israel
Copyright 2006 by Morris Rosenthal - - contact info
Copyright 2006 by Morris Rosenthal
All Rights Reserved
I last updated this article in 2006 but the bubble is still inflating. Investing
in property in Jerusalem has worked out very well for almost everybody who
bought in the recent past. There was a short-term bubble around five or six
years ago when the market got so ahead of itself that properties have fallen
somewhat in value, but for the main part, prices remain so inflated that
losses can still be viewed as temporary setbacks. The problem is that the
high valuations can't continue forever, whatever arguments you can make about
the rarity of land, cost of building and taxes, because real estate values
are ultimately limited by the willingness and ability of potential of buyers
to pay. The Jerusalem market is also subject to special a distortion, the
desire of some well heeled Jews from America and other western countries
to own a place in the Holy City. A large number of these properties are purchased
as vacation homes, and aren't rented out for the fifty weeks a year they
stand abandoned, because the owners can't justify renting a million dollar
property for $1000 dollars a month.
As reported by the Bank of Israel, mortgage rates have averaged in the 5.0% to 6.0% range over the last 10 years. for the sake of the discussion, I'm going to use the lower end, 5.0%, because that's the old rule of thumb figure for American real estate investing. At a 5.0% rate, the cost per $100,000 of mortgage is $536.82 per month. Note, that doesn't include any closing costs, utilities, taxes, insurance, condo fees or budget for maintenance, it's a pure financing cost. So, if you are buying purely as an investment with borrowed money, ignoring for the moment all the extra costs and property appreciation or devaluation, you would need to rent that property for $536.82 per month per $100,000 of the price you paid. Depending on the neighborhood (ignoring the super expensive stuff), you can expect to pay anywhere from $250,000 to $750,000 for a family size apartment. The minimum rent you would need just to cover the cost of money would be from $1400 to to $4200 per month. Don't worry about the fact that I'm ignoring down payments and lumping them into the mortgage, the ultimate carrying cost is the same, since a down payment is $X you don't have in the bank earning interest.
Can you get $1400/month rent for a family apartment in a low cost Jerusalem neighborhood? Not unless you're a crook with a sucker on the line. The average apartment rental throughout Israel is still under $600/month, and $700/month would make a fair guess for Jerusalem. So, on your cheap apartment, you're already upside down by a factor of two, and as you move into the higher priced properties, that factor increases as there isn't much of a long term rental market in Jerusalem for expensive properties. The old rule of thumb I mentioned before that's used as a quick calculation for residential real estate in America is the 100 to 1 relation between property value and rent. If you can buy a property for less than 100 times what you could rent it for, it's a good deal, and if you can't, it's buyer beware. By the America formula, that $250,000 property should rent for $2500/month, more than three times what you could expect to get in Jerusalem, but there are some differences. For one thing, in Israel, it's customary for the party living in the residence to pay the real estate tax (arnona) rather than the owner, and the building maintenance fee as well. Since taxes and maintenance are a big part of the picture in America, we expected the 100 to 1 relationship to need adjusting here, which is why I went with the simplified math.
But, as a good punter, you're probably counting on appreciation to make up for the fact that the property is costing you at least twice as much what you could hope to rent it for. And that, my friends, is as good a definition of a bubble as any. Everybody is counting on values to go up for their investments to make sense, in this case appreciating at a rate at least equal to the deficit left by the the failure of the rent to cover the cost of money. Using our low end property again, your $250,000 family apartment would have to appreciate by about $700/month just for you to break even (ignoring taxes when you sell). That comes to $8400 per year, or $84,000 in ten years, which in the past has seemed like a reasonable gamble. At the low end it still might happen, but at the high end, where foreign investors like to speculate, the rent to mortgage gap is much worse, the the market demand barely extends into Israeli society, most of whom simply can afford the prices. Your $4200/month mortgage on a property that on a lucky day with all the stars lined up you might just rent for $2000, leaves you with a $2200 a month deficit. That's over $26,000/year, or another quarter million dollars in 10 years. Will somebody be willing to buy your family apartment for over a million dollars in 2017? Where will they get the $5368.20 a month to pay the mortgage with?
And all of that ignores all costs (except for the money itself) and just gets you to break even. Sure, some of the investment is borrowed money, but the down payments in Israel are usually much more substantial than in the U.S. Some Israeli banks have been known to offer mortgages for as much as 75% of the assessed value, but that's with guarantors, individuals (usually soon to be ex-family and friends) who sign legal guarantees to make the payments if you can't. And if you get a 75% mortgage on a typical American standards $500,000 apartment, that's $125,000 you'll be taking out of circulation for the length of time you remain invested. Over 10 years, earning 5.0% interest in a fixed government security with tax benefits, that interest would be over $75,000.
An even more interesting comparison comes if we forget the mortgage and say you have enough money to buy a house outright on speculation. Again, ignoring costs except for the property value, and assuming a renter covers all maintenance and tax costs, your low end $250,000 apartment earns about $700 per month in rent or $8400 per year. After ten years, you've earned $84,000 in rent plus what you hope will be some appreciation on the property, though both of these earnings streams are subject to income tax. On the other hand, if you put your $250,000 into a simple government security paying 5.0%, you'd earn over $150,000 in cash with some tax advantages. At the high end, your $750,000 investment earns $240,000 in 10 years of ideal rent, subject to tax, plus some hoped for property appreciation. The same $750,000 invested at 5% would earn over $470,000 in a secure government investment.
In the end, it comes down to speculation on whether or not growth in property values will continue to outpace people's ability to pay for them, which seems like an impossible outcome. That's probably why banks all around the world are in the business of loaning money rather than buying houses, and in Israel, the banks are particularly profitable. If you've bought a property in Jerusalem and you want to earn some of the mortgage back without going into the landlording business, you should consider a property manager.
Interestingly enough, I just watched a long news segment on Channel 2 (Israel) in which they looked at what you could buy for $160,000, from Kiryat Shmona in the North to Eilat in the South. Israel can be loosely divided into the center (mercaz) and the periphery (peripheria). Outside of the Tel-Aviv, Haifa, Jerusalem triangle, you can get a pretty substantial apartment or a stand-alone home with land for $160,000. In Tel Aviv, in the trendy Shenkin area, you can get 1.5 rooms, if you call a kitchen corner a half a room. In Jerusalem, you can find smaller apartments on the fourth floors of building without elevators in need of renovation. As one of the commentators put it, the rents you can get are less than the interest you would earn on an American government security, so buying a low cost apartment anywhere in Israel for investment purposes is suspect.