The amazing case of housing prices

The global economy is in recession – probably the worst since the Great Depression that began in 1929 – and the Israeli economy has been dragged in to the crisis. A major feature of the recession is the real estate slump, which began with the sub-prime mortgage crisis, and one of the main features of this slump is a sharp fall in housing prices in many countries around the world – except, it seems, for Israel.

Since mid-2008, housing prices in Israel have been increasing significantly, even though the demand for housing is clearly weak, as is to be expected in a severe economic slowdown. Here are the facts: during the second half of 2008, the total Consumer Price Index (CPI) increased by a monthly average of 0.2%, while the housing price component of the index increased by 2.2%, on average. During the final four months of 2008, the total index declined by 0.6%, while housing prices increased by 7%. Preliminary forecasts for December were that the total CPI would decline by as much as it did in November (-0.6%: the December CPI was published on 15 January), but it declined in fact only by 0.1% - the main reason: a 1.7% increase in housing prices in December.

What is the explanation for this strange behavior of housing prices in Israel? One explanation brought forward is that it is connected with the transfer of real estate transactions from dollar-denominated to shekel-denominated. For most of Israel's history, housing prices (both rental and purchase) have been denominated in dollars, but when the shekel began strengthening against the dollar, a process that began in 2006 and continued during 2007 and 2008, sellers/renters of real estate began to realize that they were losing money and began to denominate prices in shekels.

It seems that the translation of housing prices from dollars to shekels more than compensated for the loss of value of the dollar against the shekel (sellers/renters sought compensation for the accumulated loss as a result of the continuing weakening of the dollar against the shekel), so that housing prices increased in shekel terms even though real estate demand was weak. For some – not very clear – reason, purchasers/rentees went along with this and allowed housing prices to increase.

But this transfer process from dollar-prices to shekel-prices had more or less worked itself through by mid-2008 (according to official data, the share of new rental contracts denominated in shekels increased from 34.7% in December 2007 to 74.4% in July 2008, and then trickled up to 81.5% in December 2008), and it is not clear that it explains the rapid increase in housing prices in the second half of 2008.

Another possibility is that the recent housing price increase is a result of increasing prices of construction inputs. But even though the price index of inputs to residential construction did increase by 1.1% during the 3^rd quarter of 2008, it declined by 2.1% during the 4^th quarter: so this is not the explanation.

One other simplistic explanation is that the Central Bureau of Statistics does not measure housing prices correctly within the total CPI: this claim has indeed often been made in the past.

All we can say at the present time is that there is no really satisfactory explanation, at the present time, of the recent increase in housing prices. But we are prepared to forecast that housing prices will decline during the first half of 2009, as the weak demand for housing kicks in.