It pays to buy real estate for investment purposes

Fall in interest rates should increase demand for real estate.

real estate 88 (photo credit:)
real estate 88
(photo credit: )
During the past month the Bank of Israel has reduced the benchmark interest rate twice in an attempt to stop the appreciation of the shekel. In February it reduced it from 4.25 percent to 3.75%, and on Monday it reduced it to 3.25%. The moves will have far-reaching effects on the whole economy, and not just on the exchange rate. The real estate industry is one of the sectors most sensitive to changes in interest rates because it is dependent on bank credit. Lior Bruchim, CEO of AMG Mortgages, told The Jerusalem Post the developments would affect the real estate industry, both on the corporate level and the individual level. "Most Israeli real estate companies are heavy users of credits," he said. "They finance most of their building projects in Israel and abroad by taking out bank loans. As a result, they pay very large amounts of money to service their loans. Interest payments make up a large part of their expenses, and when interest rates fall, their expenses decrease and this means increased profits." This is good news for anyone who invests in real estate stocks. Apartment buyers, as well as those who have bought apartments in the past, will benefit from the sharp drop in interest rates through lower mortgage costs. "The fall in the basic interest rates," Bruchim said, "will have an immediate effect on mortgages. Mortgages are sophisticated financial transactions. Clients can choose what kind of mortgages they want - whether in foreign currency, shekel mortgages linked to the cost of living, or unlinked shekel mortgages bearing floating interest rates based on the prime rate. Most take a mortgage mix of shekel-linked and prime rate-linked on a 60% to 40% ratio. Some also take a small part of their mortgage linked to the US dollar. "In Israel, the prime rate equals the basic rate plus 1.5% basic points. And this means that servicing a mortgage based on the prime rate will be 1% basic points cheaper than before. This also means that those who have taken such mortgages in the past will also benefit, because interest rates rise and fall with the prime rate. "Those few who have taken dollar-linked mortgages will also benefit. Their benefit is twofold, because they stand to gain both from the fall in the US dollar against the shekel and because of the fall in US interest rates." Most Israelis take out shekel-linked mortgages, or at least did so in the past. The long-term interest rates on shekel-linked mortgages are determined are by the cost of raising long-term finance in the money markets, which is influenced by the yield on long-term Israeli government bonds. It usually takes between four to eight weeks for a change in the Bank of Israel's basic interest rate to effect the yield on government bonds. But in the near future, interest rates on mortgages linked to the cost of living will fall, and those who have taken out such mortgages in the past should take advantage of the current low rates to refinance their mortgages. "I strongly advice mortgage holders who have taken out mortgages linked to the cost of living in the past, with annual interest rate of 5.5% and even 6.5%, to check their options," Bruchim said. "They should examine the possibility of repaying the current mortgage with cheaper mortgages, even it means having to pay an early repayment penalty. "Look at the figures. Currently, the average mortgage amounts to NIS 500,000 repayable in 25 years. The average annual linked interest rate is 4.15%. If a family with a mortgage of NIS 500,000 that initially bore a 6% annual interest rate were to repay their existing mortgage with a new mortgage bearing an annual interest rate of 4.15%, it would mean NIS 115,625 less in interest payment. And this is something one should think about." And at such low interest rates it pays to buy real estate for investment purposes. An average apartment costs NIS 1 million. Some banks will offer mortgages of 90% if they receive insurance from the EMI. Thus means monthly payments of approximately NIS 4,500. So why pay monthly rent of some NIS 3,500? You are better off buying a two-room apartment in north Tel Aviv or Givataim for NIS 750,000; take out a 90% mortgage with a monthly payment of NIS 3,400 and rent it out for that amount or more. Under these conditions, demand for real estate from those who want to acquire a home or invest in real estate is expected to grow.