Future Finance Minister Moshe Kahlon, has already shown his first idea for reducing housing prices: a 25% purchase tax on buying homes for investment purposes. He plans to implement it immediately. Leaving aside the difficulty in determining what is an investment and what is a home and disregarding the fact that Israelis just purchase homes in the names of their children to avoid these taxes, Kahlon is attacking the wrong problem and his tax idea will also have negative secondary consequences. Let me first explain the negative consequences and danger in his short term proposal and thereafter look for a different solution.
Based on conversations I have had with realtors, I do believe that the tax will stop the increase in housing prices for the time being. It will dampen demand in the market. However, it has a potentially very negative consequence. Investors have an additional role in markets beyond driving up prices. They clear the markets at a market price when there is a crisis. Kahlon’s plan to stabilise housing prices through a 25% tax will work fine as long as there is no economic downturn or recession. However, if there is a downturn or a rise in interest rates and homeowners need to get liquidity because they have debts or mortgages that they cannot pay off, these homeowners will struggle to sell their apartments.
When a credit crunch hits, the banks freeze up and make it more difficult to obtain a mortgage. When interest rates rise (and they certainly will), it becomes more difficult for people to afford mortgage payments and buy houses. That means that new homebuyers that need a mortgage to buy a home will not be able buy distressed homes from those who need to get out from under mortgages. With the 25% tax, investors will not want to pay the price a homeowner needs to pay off his mortgage. That means that the seller will get 25% less money for his home, making it more difficult to pay off his mortgage when he is in distress. It will probably be even less to downward spiralling that usually happens when no investor can clear the market. Khalon’s proposal will kill people in distress at their biggest time of need and is therefore quite myopic.
The reason housing costs so much in Israel is actually reasonably straight forward: there is under-supply. We have under-supply for three main reasons:
1. It takes way too long for the Israel Land Authority to free up land for building so we have scarcity/
2. The government decided about a decade ago to focus on the periphery of the country and thereby froze building permits in the center, reducing supply in key markets where there are jobs.
3. It takes forever and a day to get a building permit due to the bureaucracy, legal advisors and corruption in the system. At a cost of capital of 4%, these delays add 12%-15% to the cost of housing, not including the bribes, lawyers and hassles which probably adds an additional 10%.
The only way to reduce housing prices without killing those with mortgages is to dramatically increase supply. That requires a fundamental rethinking of how we create supply and enable housing to be built quickly. What Kahlon needs to do is free up a bunch of land ASAP in the center of the country and the periphery. He needs to issue permits for dense building (apartments) in all areas. That is obvious but certainly insufficient.
The next thing he needs to do is reverse the process for approvals. Israel has in place land permits and planning rules that define how much one is allowed to build. Despite this, planning committees and regional councils spend endless time looking at building proposals and since you need to go through that hell anyway, it encourages builders to negotiate on the permit. The Housing Ministry and Interior Ministry should tighten all building rules (how much you can build per parcel of land, distance from neighbours etc) and then tell builders that they will receive an automatic permit within 30 days of public submission if there are no objections to the proposal. Take the power out of the hands of the bureaucracy by creating automatic permits. With publication on the internet, enough eyes will see the proposal and critique it. Then, we need to have laws that punish offenders who break the building code and they must be enforced. These penalties should be meaningful and not just fines.
So, if you build within the code, you are off to the races within 30 days. If you want variances then you must go through the councils. This will clear the desk of the councils and take the power out of their hands which will clean up the graft. It will also get many more apartments built faster. This path requires the government to trust the citizenry to be law abiding citizens and to trust the court system to mete out meaningful punishments for offenders. However, it is a critical change we must create in society in order to lower the cost of living and housing. More on this in my next post.