More important than absolute property prices is property affordability, or the ratio of property prices to disposable incomes. The chart below shows the number of annual salaries required to buy a 90m² apartment in various cities. In Jerusalem it is 22 years and in Tel Aviv 16.5, making them among the most expensive in the world. Can you believe it costs twice as much to live in Tel Aviv as in San Francisco, Zurich or Sydney?
Affordable apartments are a big issue. Expensive property means saddling yourself with debt to invest in an asset that doesn’t create jobs. It means living in a cramped apartment and spending so much on rent or mortgage that you can’t afford the fun things in life like sushi, massages and hot tubs (not that you’d have space in your tiny apartment for a hot tub.) It means long commutes because you can’t afford to live near your work.
So why is property unaffordable in Israel and what can be done to change that?
Any market price is a function of supply and demand. To reduce the price of property from its current equilibrium, we must either reduce demand or increase supply. A policy that neither reduces demand nor increases supply will not reduce house prices. Period.
Take, for example, Yair Lapid’s flagship policy of VAT (מע”ם) exemptions for qualified first-time buyers. Will it reduce demand for housing? No. Will it increase supply of housing? No. So what will be the impact on prices? Correct: Zero. (Unbelievably, Israel is about to spend 3 billion shekels per year on this policy. If you followed the above argument, then you already know more economics than our Finance Minister! Mind you, he has declared that his policy is ‘not for economists’.)
What policies would reduce demand or increase supply? There are at least two things I can think of that can be done quickly and easily on the demand side. The first is to end the favorable tax treatment of investment property relative to other asset classes. There is simply no reason why rents from residential property should be taxed below dividends from businesses, nor why profits on the sale of investment properties should be exempt from capital gains taxes. Eliminating tax breaks on investment property would reduce the demand for investment property, divert investment to wealth creating asset classes, and generate revenue for the Government. Easy win number one.
The second demand reduction policy is to create meaningful disincentives for non-residents to own ‘ghost apartments’. For example, non-residents could be charged an annual 5% tax on the value of residential property they own in Israel. Like the previous policy suggestion, this would reduce house prices for Israelis and generate tax revenue. Easy win number two.
However, tourists and rental investors are a relatively small part of the overall market so those demand-side changes would probably have only a moderate (10-20%?) impact on prices. That’s not close to the 50% reduction we need for Tel Aviv to match Sydney or Zurich in affordability. Big price reductions can only come from shifting the supply curve, or in other words, producing a lot more apartments.
So the question of how do we reduce the cost of apartments in Tel Aviv is really the question of how do we build a lot more apartments in Tel Aviv and to answer that question, we must ask another: given the high prices for Tel Aviv apartments (5x the cost of construction), why are more apartments not being built?
The truth is that the supply of apartments in or around Tel Aviv is constrained not by the cost of construction but by government (local and national) decisions on (i) the land available for construction, and (ii) the amount you can build on that land.
Now, converting agricultural or park land to residential comes with a quality of life cost. Green spaces contribute to our well-being. We do not want to create a Los Angeles-style urban sprawl, particularly given the small size of Israel. There may be a need to build some new cities and extend existing ones, but that approach should take second priority to increasing density of already built-up areas.
I know increasing building density sounds to many like a recipe for blocking out the sunlight and ruining a beautiful city. Consider this, however: the city of Paris – one of the most beautiful in the world – has a population of 2.23 million in an area of 105 km². That gives Paris a density of 21,200 people per km², roughly triple the density of Tel Aviv (8,000 people per km²) and Jerusalem (6,900 people per km²). If you’ve never been to Paris, take a look at the picture at the top of this post – it’s pretty nice!
It is possible to build at a density double or triple that of Tel Aviv and maintain, or even improve, the urban environment. Dense cities have another advantage as well: driving distances are much less, public transport is more practical, and you can actually walk or bike to many places.
How then do we increase housing density in Tel Aviv? Well, that’s pretty easy. You simply change the planning codes that limit the density of construction (height of buildings and gaps between them). If you’re worried about aesthetics, don’t be. Aesthetic requirements can be included in the planning guidelines, just like the requirement in Jerusalem to face all buildings with stone.
I appreciate that there is work to be done by urban planners to create the masterplans that will enable our cities to increase their density. It’s not only residential buildings that need to grow but also schools, shops, and leisure facilities. That planning work can start right now and costs practically nothing. What’s missing is political will. Israelis need to understand that if we want affordable housing for ourselves and our children, we must increase building density in our central cities. This needs to be the priority of every government and every municipality. Nothing else will move the needle.