Local real estate beginning to feel the crunch of commodity prices

An interview with Erez Cohen, chairman of the Real Estate Appraisers Association of Israel.

Large hikes in world commodity prices, especially oil, will begin to have a negative effect on local real estate prices, said Erez Cohen, the chairman of the Real Estate Appraisers Association of Israel. The rise in commodity prices is having a very negative effect on the world's economy. The dramatic price rises in oil, foods and metals have made life more expensive and has resulted in inflationary pressures all over the world. In the first quarter of 2008 the annual inflation rate in the US was 4.2 percent, in the UK 3.3%, in the Euro area a record 3.9% and in Israel 5.4%. Inflation is above target in most countries of the world, widely attributed to the rise in the price of basic commodities. Until now, however, the effect of these trends on the real estate market has been muted. This is perhaps because that particular sector of the economy has been buffeted by the sub-prime crisis, and in consequence was less susceptible to inflationary pressures. But Cohen thinks that may be changing - at least in Israel. "The rise in commodity prices, namely in the price of metals, oil and wood, has increased the building costs in Israel, and the industry at these times cannot sustain any price rises." In this special interview, Cohen told The Jerusalem Post about where he sees the market moving. "During the past two years there have been very hefty price rises and, in consequence, prices have risen beyond the affordable range for the bulk of the population. "Developers know this and they are worried. During the past weeks I have had talks with many of them, and they have all told me that in the present circumstances there are big risks in building residential projects, because it may be difficult if not impossible to sell them. "By my reckoning, building costs have increased by over 10% since the beginning of the year due to sharp rises in the price of iron, cement, aluminum, plastic tubing, etc. And the developers believe that they cannot pass on the price rise to the buyers. "If developers are reluctant to start building projects, I expect sharp falls in housing starts in 2008. In the first quarter of 2008, housing starts fell to 6,900 - a fall of 14% compared to housing starts of approximately 7,860 in the first quarter of 2007. And this trend will continue through 2008." Cohen explained that a price rise of over 10% in building costs translates into a rise of between 5% to 6% in the price of an apartment, because the rise in the price of building materials has not affected the price of land, which in the center of the country amounts to from 40% to 50% of the final price of an apartment. Does such a relatively small rise in the price of an apartment make it un affordable? Cohen believes so, because at these times the middle classes who make up the backbone of the real estate market will not pay more for real estate than what they are paying now. "Their monetary reserves have been depleted by the fall in the stock exchange, interest rates are set to rise and this will increase the cost of the mortgage and the talk of a possible economic downturn discourages the outlay of the large sums of needed to buy an apartment," said Cohen. Normally, a drop in housing starts would trigger a rise in prices, as supply begins to dry up. That seems to be a contradiction to Cohen's prediction of a fall in housing prices. Cohen explains that we will see lowered real estate prices because the drop in demand will be even greater than the cut to the supply due to material costs. "Those who would have liked to buy a new home will prefer to wait for better times, and demand from overseas Jews is expected to fall because the recessionary signs in the USA, Western Europe and the UK - coupled with rising interest rates - will dampen demand from the Diaspora." Meanwhile, as buyers hold off on their purchases, the rental market is likely to heat up. "Those who have temporarily suspended their plans to upgrade their style of living have a roof over their heads. Not so those newlyweds or bachelors and spinsters who leave the parental nest. These need alternative accommodation, and the only alternative in these circumstances is to rent." Meanwhile, the price of very expensive real estate is rising, with an apartment in the Rothschild 1 Tower selling for NIS 67 million (approximately $20 million), netting a neat NIS 574 million (app. $170 million). And the price of a sq. mt. in Hayarkon street is peaking at $40,000. Shouldn't the boom in the luxury market help raise prices in the rest of the market, as well? Cohen thinks not, because the super-expensive segment of the market is insulated from economic trends as the very rich always have the resources to buy the kind of accommodation they want. It has very little influence - if at all - on real estate prices for mere mortals.