A tax reduction on the purchase of second homes went into effect last week in a bid to get investors back into the real estate market, boost the construction sector and increase tax revenues, as the government struggles with the economic fallout of the coronavirus crisis.
The move, proposed by Finance Minister Israel Katz and approved by the Knesset, will indeed bring investors back to the market, experts say, but is also likely re-trigger a rise in home prices, further hobbling an unsuccessful multi-year government effort to bring down the cost of housing.
According to the new law, a lower and graduated purchase tax rate now applies. Purchase tax is now 5% on properties costing up to NIS 1.29 million ($378,000); 6% for any portion of the purchase price over NIS 1.29 million and up to NIS 3.88 million; 7% for any portion of the purchase price over NIS 3.88 million and up to NIS 5.34 million; 8% for any portion of the price over NIS 5.34 million and up to NIS 17.8 million; and 10% for any portion of the price above NIS 17.8 million. The new legislation does not affect the purchase tax rates for Israeli residents who do not already own another property.
The move aims to counter a slowdown in housing supply that could be caused by lower demand, as the coronavirus has curbed spending amid a surge of unemployment. As of August 8, there were 875,227 people seeking employment of whom 577,633 were on unpaid leave from their jobs, according to Employment Service data. The economy is expected to contract this year for the first time since 2002, and it may take up to five years for it to fully recover from the crisis created by the pandemic, the Finance Ministry said in a forecast on Sunday.
“At the present time, when we are witnessing a decline in the volume of transactions, it is very important to accelerate the real estate industry, which is an engine of growth for the entire economy. This step will reduce the expected slowdown in the market,” the Finance Ministry said in an email message.
The nod given by the Knesset last week rolled back a 2015 temporary order that imposed higher purchase taxes on second homes that would have expired anyway at the end of the year, shaving five months off its scope.
That temporary order was implemented in order to deter investors and to make a greater number of houses available to first-time buyers. It sought to make investment in real estate “less attractive, and open up thousands of apartments to people who do not yet own an apartment,” former finance minister Moshe Kahlon said at the time.
Kahlon saw his main agenda as lowering the cost of living, including housing prices.
Kahlon’s idea was that higher taxes on the purchase of second homes would generate less demand and prices would fall, said Tali Yaron Eldar, a former Tax Commissioner at the Israel Tax Authority, in a phone interview. But home prices continued to rise anyway, she said.
“Not only that: rental prices rose as well, because second homes are generally rented out,” Yaron Eldar said. The tax hike deterred investors and caused the supply of homes for rent to fall, triggering a rise in rental prices, she said.
Lowering the tax rate, she added, is “a right step.
“In general, the more taxes are imposed on real estate prices, no matter what kind of real estate, in the end it causes a rise in prices and not a drop,” Yaron Eldar said.
In the acquisition of a home, taxes represent a significant part of the purchase price, she explained. And when that house comes back on the market, its price will reflect the higher price the seller paid for it, thus making the property more expensive even for a first-time buyer, she said.
The aim of the Finance Ministry in now lowering the tax rate on second homes is to “get the investors back” to the housing market, said Eran Lempert, a partner and co-head of the tax department at Yigal Arnon & Co., a law firm. This will help contractors and the construction sector, encourage economic activity and generate greater tax revenues for the governmen, as deals start to flow, he said.
The presence of second-home investors fell significantly since the tax was raised in 2015, said Alon Kol Kreis, a research economist at Leumi Capital Markets, a unit of Bank Leumi Le-Israel Ltd. in an interview.
“The lower taxes could cause investors to come back to the market,” he said.
These investors could now see the residential market as a “flight-to-safety” measure from the volatility of the stock market or from the commercial real estate sector, which has seen stores shuttered and malls closed due to the lockdowns imposed to curb the spread of the coronavirus.
“This hasn’t happened yet, but it could cause investors who are in these markets to take the money from there and inject it into the home market, seen as safer and more solid,” Kol Kreis said. The lower purchase tax could be an added “accelerator” for these investors to come back to the residential housing market, he said.
Both Lempert, the lawyer, and Kol Kreis, the Bank Leumi economist, said home prices could rise because of the lower taxation rates.
“It could push the prices of homes higher — and the original aim was to take investors out of the market and lower the house prices,” said Lempert.
Kahlon’s tax rebate and other programs he undertook did not lead to a decline in prices, said Kol Kreis, though they did manage to slow down the rate of the rise – from a rate of high single-digit numbers in 2015 and 2016 to “low single numbers” now.
The House Price Index has risen to just above 420 this year, from 380 in 2016, according to the Trading Economics website, based on Central Bureau of Statistics figures, with peaks and dips along the way. The impact of the pandemic has helped lower prices this year, and the index declined from a 10-year high of 427 in March to 421.1 in May as the pandemic raged, the data shows. Prices in 2020 were still higher than they were in 2015 or 2016, after the tax hike was imposed, however.
“The attempt to fight investors via this purchase tax was incorrect and in retrospect not successful,” said Lempert. And that is because the purchase tax is not a “sophisticated tax,” because it affects everyone, indiscriminately. “It is imposed on everyone, rich or poor, whether the asset is sold for profit or at a loss.”
And this creates a “a sort of an economic distortion,” he said, because it is a blanket tax that is an added cost to the deal.
“The way to lower home prices depends on supply and demand, and is not connected to taxation,” Lempert said.
“Taxes could be an added tool,” he said. “But they cannot be the main tool. Supply is the main tool.”
The Israel Builders Association, meanwhile, said in a statement that cutting the tax was a good move for the construction industry, and will bring an added 15,000 homes for rent in the coming year. The coronavirus has halted building starts, the association said, calling for the total abolition of taxes on second-home investors for a limited period of time.
The total abolition of these taxes for a year could lead to added tax revenues for the state from other fees related to the sale of homes, of some NIS 5.5 billion ($1.61 billion), they said, as the number of deals rises. Tax revenue from the sale of second homes was some NIS 1.7 billion a year, after the 2015 tax hike, the association said.
The president of the Builders Association, Raul Srugo, said the tax rebate was a “move in the right direction” that will ensure that enough apartments will be built and made available for rent, as people will struggle to acquire homes and pay mortgages amid the economic crisis.
“The current reality dictates the need for added investment activity in apartments, to support the continued operation of the construction industry and help the economy emerge from the crisis,” he said.
Bringing down home prices is not the focus of government efforts anymore, said the former tax commissioner Yaron Eldar, especially in light of the economic crisis triggered by the coronavirus.
House prices in these economic conditions are not expected to go up much anyway, she said.
“This won’t be the main challenge. Today we are in a different world. This is not anymore a main aim,” she added. “People today have a problem surviving economically, and not of just not paying their rent. The government’s focus should be on raising minimum salaries and creating jobs — first of all they must have work and food to eat.”