Double whammy of high rates and no workers leaves Israeli builders with high debt
And the specter of a housing shortage is triggering a rise in demand and price rises
Shoshanna Solomon was The Times of Israel's Startups and Business reporter
Aharon Galili, a developer and contractor, has been building and selling homes in Israel for over 40 years, but he and his company have never been through a tougher time, he said.
The Gaza war, sparked by the devastating October 7 Hamas attack on southern Israel, and the shortage of Palestinian workers that has ensued, have compounded the woes of a sector that has also seen debt balloon amid high interest rates. The Bank of Israel’s decision to keep its key lending rate unchanged in February, after cutting it in January, dashed some hopes in the industry that a respite may be on the way.
“This is the hardest time I have ever seen in my over 40 years in the field,” said Galili in a phone interview with The Times of Israel. “The war, with its shortage of workers, along with the high interest rates create a very bad situation for the industry.”
After cutting its key lending rate by 25 basis points in January for the first time in almost four years, to support businesses and households battered by the effects of the war, the central bank decided to leave the rate unchanged at 4.5 percent in February, given the high uncertainty surrounding the progress of the war and the risk of an escalation of fighting in the north with Hezbollah.
“The high interest rates are not good for the construction industry,” said Tal Alderoty, the head of the real estate program at The College of Management Academic Studies in Rishon LeZion and a former chief government appraiser at Israel’s Ministry of Justice.
Contractors generally take out loans to finance a large share of their projects, either from banks or non-banking financial institutions, the latter charging higher rates than the banks for their loans.
Until 2022, said Alderoty, when global rates and rates in Israel were close to zero, there was a “financing party.” Because the cost of money was negligible, builders took loans and initiated a large amount of projects, under the assumption that the party would continue. But then, as inflation loomed from 2022, both globally and in Israel, interest rates have surged. In Israel, rates started rising in April 2022, gradually spiking to a level of 4.75% from a record low of 0.1%.
If the central bank’s rate goes up to almost 5% as it did in Israel, that means that contractors pay an annual 8% to 11% for the loans they have taken. This translates to higher financing costs that then have a “dramatic impact on profitability,” said Alderoty.
And because high financing costs persist as long as the loans do, contractors prefer to repay them as soon as possible through the sale of the units they have built, he explained. If they don’t manage to sell, they are in trouble.
That is exactly what is happening now, said Alderoty. Because of the high rates, which have increased the price of mortgages, the “pace of [home] sales has slowed down completely, almost to a standstill,” as families cannot afford to take on the burden of such a high mortgage.
“Because loans have become more expensive, people are buying less,” Alderoty said.
Shortage of workers drive up costs
Due to the acute shortage of Palestinian workers, on whom builders rely on for their projects, construction times for projects have also been extended. This means that units are coming onto the market for sale at a much lower pace than before, further extending the burden of the loan.
After the start of the October 7 war, most Palestinian workers disappeared overnight, as Israel enacted an immediate ban on workers from Gaza and restricted access to many from the West Bank. Thousands of foreign workers from Thailand, China, the Philippines and other countries also went home following the shock attack, as the economy ground to a halt.
In this new reality, Israeli contractors are competing for fewer workers, paying higher hourly wages, while hoping the re-entry of foreign laborers to the sector will help ease some of the pain.
There are thus three factors weighing on financing costs, explained Alderoty: the higher rates, the slower pace of home sales, and the shortage of workers that is prolonging construction times.
“You pay more money for each shekel [you take as a loan] and you pay it for a longer period of time,” Alderoty explained. “This is the blow that is affecting the contractors.”
According to data compiled by the Bank of Israel, and published in its Statistical Bulletin for 2023 Report, the number of new mortgages households took from banks shrunk considerably in 2023 compared to the two previous years, totaling NIS 71 billion ($19.33 billion), down from NIS 118 billion ($32.13 billion) in 2022 and NIS 116 billion ($31.59 billion) in 2021.
The decline started in the second half of 2022, as interest rates rose in Israel, the report said. In October, at the start of the war, the number of new mortgages dropped even further.
Since September 2021, there has been an average decline of 2.7% in the number of home sales, according to data compiled by the Central Bureau of Statistics. At the end of January, there was a stock of 67,980 new units that still needed to be sold, enough for 26.8 months of supply, according to data compiled by the Central Bureau of Statistics in its November 2023-January 2024 real estate transactions report.
The number of housing transactions and new mortgage volume has stabilized at levels lower than in recent years, the central bank said in February. In January, new mortgage borrowing totaled NIS 5.5 billion ($1.5 billion), up from NIS 4.9 billion ($1.33 billion) on October 31, but well below the NIS 13.4 billion ($3.65 billion) in new mortgages taken in March 2022, before the start of the rate hikes which started in April 2022.
To incentivize buyers, contractors have come up with all sorts of incentives to keep sales going, like offering them the option of paying just 20% upfront for their new home, and 80% upon handover.
That is what Galili has been doing with his potential buyers since interest rates rose in 2022. “It is a huge benefit,” to the buyers, he said. “We absorb the financing cost, but that eats into our profit.”
Galili said his company, Chazon & Galili Construction, which operates mainly in Bet Shemesh, used to build some 300 to 400 units over a period of three years in better times.
Now, because of the shortage of Palestinian workers, he is working on just 104 units at one building site in Bet Shemesh that has been idle for over five months because of the war and the lack of Palestinian workers.
“We have never been shut down for so long,” he said.
According to Central Bureau of Statistics and Bank of Israel data, some 42% of building sites were still idle in January 2024, with the rest partially operating. In October 2023, when the war started, 77% of the sites were shuttered, the data shows.
A return of higher prices and more sales?
The shortage of workers and the lack of buyers is causing contractors to build less, said Shay Pauzner, Vice President for the Israel Builders Association, in a phone interview. “There is a dramatic decline in the building starts,” he said.
Data published by The Central Bureau of Statistics on Wednesday showed that net housing starts in Israel in 2023 declined by 8.6% compared to a year earlier. In the last quarter of 2023, net housing starts dropped by 3.9%; 58% of sites that had received building permits in the quarter had not started work yet; and some 33% of builders said there would be a delay in the completion of homes they were working on, more than half of them attributing the delay to the security situation.
This specter of a shortage in housing is what is causing both a price rise and a renewed demand for homes, Galili said.
Home prices rose 0.7% in the last two months of 2023, the first two-month increase since the December 2022-January 2023 period, Central Bureau of Statistics data showed. That trend continued also in December and January 2024, rising 1.2% compared to the previous two months, data published on March 15 showed. Even so, when comparing the data to the same time a year earlier, prices in the December 2023 and January 2024 period declined 0.6%.
Meanwhile, apartment sales jumped in January 14% year on year, with 8,053 transactions recorded, the highest figure since September 2022, according to the monthly real estate report by the Finance Ministry’s chief economist released on Tuesday. When compared with December 2023, the number of deals in January 2024 jumped 32%.
“This is the first month since March 2022 — one month before the Bank of Israel started to hike interest rates — that an increase in the number of deals has been recorded compared with the same month a year earlier,” the Finance Ministry’s chief economist Shmuel Abramzon said in the report.
Abramzon attributed attractive financing conditions that contractors are offering to buyers as one of the main reasons for the recovery and sharp growth in sales.
Pauzner warned that contractors, especially the smaller ones, could fold under the weight of their debt, while Israel could experience a severe shortage of housing and price spikes down the line – both of which will be devastating for the Israeli economy.
The construction industry accounts for some 6.2% of the nation’s GDP, with the tech sector taking up a lion’s share of the economy, or 17% of GDP. It accounts for an annual NIS 40 billion ($10.89 billion) to NIS 60 billion ($16.34 billion) in government taxes, Pauzner said.
The real estate and construction sectors owe banks and non-banking institutions some NIS 400 billion ($108.9 billion), according to Bank of Israel data in the August 2023 Financial Stability Report. This accounts for about one-third of the business debt in Israel, the central bank’s Statistical Bulletin 2023 showed, and after rising sharply in the past three years, the total number of loans taken moderated in 2023.
“If the sector continues as it is now for a longer period of time, these loans won’t be repaid. And that is a huge danger for the banks and the economy,” Pauzner said.
That is why, Pauzner said, the government needs to intervene, by perhaps providing funding to builders at lower interest rates than those offered by the banks, and also by lowering the costs of construction, by cutting taxes, fees and levies, and significantly reducing bureaucracy and speeding up the building approvals process.
But, he said, “there is no one to talk to. Nothing has been done, and there is no discussion about the matter.”
The only thing that is moving forward, he said, is the possibility of bringing Indian and Sri Lankan workers to replace the Palestinians, even if the numbers are still small and things are moving very slowly.
“We have approved some 17,000 workers out of the total of 45,000 that we have been allowed to bring in,” Pauzner said. “The process is slow and each day that passes is a huge hit for the construction sector and the whole of the economy.”
