IMF: Sudden drop in housing prices could cause recession

Annual report says housing prices overvalued by 25%; there is a 20% probability of housing "bust," real estate could lose over a tenth its value.

February 12, 2014 19:24
2 minute read.
Stone houses in Jerusalem

Stone houses in Jerusalem. (photo credit: Adi Benzaken)


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If housing prices fall too quickly, it could trigger a recession in Israel, the International Monetary Fund wrote in its annual consultation, released Wednesday.

Home prices are about 25 percent higher than their long-term fundamental value, the report said, saying that levels of income and rent do not justify the prices. That level is in and of itself worrisome, but its effects on the real economy will depend on how quickly the prices come down.

“A slow correction would allow the economy to escape a recessionary episode, but economic prospects would be weak for a prolonged period of time. By contrast, a rapid adjustment would lead the economy into recession, with consumption and output recovering two years after the shock,” the report said.

A third scenario, in which prices slowly adjust to their equilibrium value, would leave the economy relatively unscathed.

There is a 20% probability of a housing “bust,” according to the report, in which real estate loses over a 10th of its value, happening in the next five years. If prices were to fall 6.5% in one year, consumption growth would fall 3% in the long run.

That may come as a surprise to both Finance Minister Yair Lapid and Construction and Housing Minister Uri Ariel.

When The Jerusalem Post asked Lapid about the danger of a rapid drop in house prices in September, he responded, “When somebody lives within his house and the price is lower, it doesn’t affect his life in any way. I’m more concerned about not succeeding to lower the price.”

When the Post posed the question to Ariel earlier this month, he said, “I’m familiar with that argument. There won’t be a crisis that will collapse the market. But let’s say that in a few years we’ll see a decline in 10s of percentage points.”

Neither Lapid nor Ariel responded to the Post’s inquiries about the report.

The government is working feverishly to add to the housing supply, offering financial incentives, investing money, cutting fast-track deals with local authorities and working to create an institution to oversee the planning process.

One thing that might actually save Israel is that the supply is so constrained.

In some places, supply revs up to meet demand while prices are high, and keeps pouring out onto the market over time, causing prices to drop. In supply-constrained economies like Israel, however, the supply doesn’t quite catch up with the number of people looking for new homes, so “house price corrections tend to be shorter and faster.”

Indeed, the report said, it takes 11 years between the Israel Lands Authority designating land for development and the granting of a building permit.

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