Last Thursday, we learned of a smaller-than-expected rise in the Consumer Price Index (CPI), up just 0.2% in May. Analysts had expected a much higher reading that would keep the annual inflation rate at 5%, but in fact the monthly reading was the lowest since November 2022, and puts inflation in the 12 months to the end of May at 4.6%.
The number of concern in the CPI is residential rents. The housing item, which consists mainly of changes in rents, and which accounts for 26% of the overall index, rose 7.5% in the twelve months to the end of May, after rising by another 0.4% in that month. For comparison purposes, food items, excluding fresh produce, increased by 4.2% in that period, while the clothing and footwear item decreased by more than 8%.
“Rents in Israel continue to rise sharply, with no real indication of a moderation in the rate of increase,” says Modi Shafrir, chief market strategist at Bank Hapoalim. “This is a very different situation from the situation in the US, where the rental market has weakened, and we are seeing a moderation in the rate of rise in rents.”
Figures from the Central Bureau of Statistics show that, since last December, the general consumer price index has increased by 2.2%, while the housing item has increased by 2.3%, mainly, as we mentioned, due to changes in rents. This consists of three elements: tenants with an existing lease, who are not incremented; tenants renewing their lease, whose rents increased by 3.6% on average; and new renters, with average rents up 8.6%. This is a worrying number, because June-August is the peak period in the rental market, with many changes in rents, which could mean that really sharp hikes are still ahead.
But the real picture is much more complex. Increases in interest rates have the opposite effect on demand for rents, says Danny Ben-Shahar, professor of finance and real estate at Collier School of Management at Tel Aviv University and director of the Alef Institute for Real Estate Research, and that “the rise in rents does not stem from higher interest rates.” This phenomenon, he says, stems from three factors. “First of all, there is a decline in disposable income due to general inflation, which puts pressure on people’s ability to pay rent, which should in fact lead to downward pressure on rent levels.
On the other hand, however, anyone who was thinking of buying a house cannot afford it because of the high cost of mortgages, and they have to keep renting. In addition, the third factor is that the family is a captive that has to live somewhere , which puts upward pressure on rents, due to the high demand for rental homes.”
Opposing forces affecting demand
Jay Petour, chief economist at Sagot Investment House, explains that the impact of interest rates on the market has different time constants. “Things don’t move as quickly as people think, and it can take more than a year for a rate hike to pass through to the market,” he explains. “For this reason, despite the rise in interest rates, construction does not necessarily stop immediately, and therefore it can be expected that the housing supply will continue to grow in the short term. On the other hand, the effect of rising interest rates on demand, whether it is for buying or renting, is faster as a result of lower disposable income.”
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Shafrir also believes that higher interest rates do not necessarily lead to higher rents. “On the one hand, the real estate market has stalled and construction has started to decline, which is causing a decrease in supply. But on the other hand, we are seeing people’s disposable income drop, and that will start to make it difficult for them to raise rents very sharply in the short term. We will not see rents falling, but we can already see a moderation in the rate of increases, although there is no horizon for rents to fall.”
Professor Ben-Shahar says that higher interest rates can shake up the real estate market in the long run, and not necessarily in a positive way. “Repeated increases in interest rates from the Bank of Israel could lead to a situation where people will wait to buy a house until interest rates come down. But when interest rates go down, the market could find itself in a severe state of undersupply due to a decline in construction which could lead to Prices go up again.”
Published by Globes, Israel business news – en.globes.co.il – on June 19, 2023.
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