In previous articles we’ve seen the high long term returns of the stock market. The historical total return (with reinvestment of dividends) of the S&P 500 since 1928 has been roughly 7% per year after inflation.
But I keep hearing it claimed that buying an apartment in Israel to live in is also a great investment: not only will it appreciate in value, it will also save you from paying rent. Israelis certainly seem to believe in it as a solid and unrivaled path to wealth: I’ve frequently heard that it only ever goes up in price.
I decided to take a look at the historical data to see if it supports the common wisdom. Perhaps Israelis are on to something, and it’s worth owning in Israel as part of a portfolio, or even prioritising this? To get a fair comparison of the cold hard numbers, we must compare like for like. We’ll start by assuming that the benefit you get from living in an apartment is identical whether you are renting it or own it (even though in practice, there are multiple differences both ways), and we’ll assume that you would live in the same apartment either way. After seeing the raw returns, we’ll discuss additional factors.
Raw comparison of returns
The data for this analysis come from the Housing Price Index, measured by Israel’s Central Bureau of Statistics. Their index goes back to 1994, although we can also get prices back to the 1980s. It tracks the value of apartments controlling for changes in quality such as the size and age of the apartment, number of rooms, location and socioeconomic level of the area. The graph below shows the value of the index (blue) since 1994.
As can be seen, if prices in 1993 were an average of 100, then by the end of 2018, the average price is just over 400 – an increase of 300%. That’s equivalent to receiving an interest rate of 5.1% per year – and that’s before we even consider the savings on rent!
However, we must also consider the effect of inflation, which completely alters the picture. In the 1980s, Israel suffered from hyperinflation, and even by the mid-1990s, annual inflation was in the double digits1 (by contrast, in the last decade it’s averaged around 1%). A large part of the increase in the property price was just the property retaining its value against a wildly depreciating Israeli New Shekel. Once correcting for this, we get the orange curve: the change in housing price beyond inflation. Here we find that the return is more like 1.5% to 2% per year over and above inflation. Looking at the numbers back to 1980 shows a similar picture2, and less reliable figures going back to 1948 also give the same result3. We can also see that apartment prices do go down in real terms, even for long periods, such as the 13-year drop from 1996 to 2009.
Moreover, the index does not control for less measurable quality improvements, such as renovation of the apartment. If the general trend is that more and more apartments are undergoing renovation and improving their value, simply buying an apartment and maintaining it would not be enough to keep up with the graph. This suggests that the returns may be even lower than shown.
To these returns, we must of course add the income accrued while holding the property. Saving money by not paying rent can be equivalently viewed as earning the same amount: you have more money as a result of owning the property. How much does this add to the total return? This information is harder to find historically, but at the moment, yields hover around 2-4% of apartment value4. The annual real return of the apartment is therefore somewhere between 3.5% and 6% (although see next paragraph). This somewhat closes the gap, but it still appears that the stock market has won out historically.
However, there’s a subtle difference between how income from property and income from stocks is treated. Whilst dividends can easily and automatically be reinvested in the same fund because of the easy divisibility of stock units, property income cannot. You can’t incrementally add territory to your property every month. You could reinvest the money in renovating and improving the property, but this obviously has its limits, and can’t be done as frequently or as automatically as dividend reinvestment. This means that stocks get the full exponential benefit of compound interest, whereas housing has a component comparable to compound interest (the capital growth) and a component more akin to simple interest (the income).
Now, an asset that retains its value against inflation and even exceeds it in the long term is not to be sniffed at, but many other assets can hold their value against inflation. Among them are stocks, which return fully 7% beyond inflation in the long term5, a much higher rate of return.
As mentioned previously, multiple additional factors come into play. Firstly, there are the tax considerations. These mostly come down strongly in favour of the apartment. Tax on not paying rent is zero, and tax on rental income is very low (10% or lower depending on how much income); compare this to 25% tax on income from dividends. For your first residential property, tax on the increase in value of the property (capital gains) is also zero, as compared to 25% on real gains for stocks and shares. There are downsides to the apartment: a purchase tax somewhere between 0-10%, depending on the value of the apartment; other initial costs for a lawyer and agent; and surprise taxes which fall on homeowners such as Hetel Hashbaẖa (betterment tax – imposed when plans by the local authority will improve the value of your property). Home ownership also comes with the extra costs of repairs just to retain its value, both to the apartment itself and the apartment block.
Also in favour of home ownership is the ability, through a mortgage, to leverage someone else’s money at a lower interest rate to tap into the higher overall returns from fully owning a property. In theory, you could do the same thing for a stock market investment – but this is generally regarded as more risky, and you’d find it difficult to get a loan with as low interest as a mortgage, where the bank can use your home as safe collateral against the risk of default.
Yet another technical factor to consider is the price spread when buying and selling. Whereas on the stock market, the spread is minimal, so your purchase price and sale price will both be essentially at the mid-market rate, the price at which you buy or sell an apartment could be quite drastically different from its “true” market value. This all depends on your negotiation skills, level of urgency and luck: you might lose out a lot by overpaying and/or underselling, or gain significantly by underpaying and/or selling at a great price.
Other than costs and returns, there are other economic differences between housing and stock market investments. As can be seen from the graphs, the volatility in the housing prices is lower. However, liquidity is also much lower – stocks can be sold or bought more or less instantaneously if needed, whereas an apartment takes months to change hands and involves an extremely manual process. Asset diversification is also very low – you own one apartment in one building in one neighbourhood of one city of one country, so something affecting any one of those things could strongly influence the price of your single asset. In contrast, a stock market tracker fund has a basket of many different companies of all different sizes, representing different industries, geographies and markets.
Lastly, we must consider the non-financial utility involved in owning a home. Many prefer ownership because of the greater sense of pride, stability, homeliness and ability to redesign as they please. Advantages of renting include mobility, flexibility, lower responsibility and a more predictable budget.
Why do Israelis think home ownership is such a great investment?
If home prices don’t grow much beyond inflation, why then is it perceived as such an unrivaled investment?
Firstly, we have the hard facts. As discussed above, home ownership is greatly tax advantaged, amplifying returns. The fact that it’s common to leverage the investment with a loan (mortgage) also helps amplify the returns.
Other effects may also be at play.
- We may be seeing recency bias: a tendency to focus on the much higher returns of the last decade and negate the long-term trend.
- Additionally, many people will look at the nominal gains in the housing prices and see astronomical increases, not realising that much of this simply reflects retention of value in the face of a depreciating shekel.
- Many are simply not be aware of the long-term surety of returns in the stock market, so the housing market looks like the market with the highest returns.
- Moreover, volatility in the stock market is a lot more visible and well-known; volatility in the housing market is less often perceived, as apartments are illiquid and usually sold only after a long period of time, when their value will most likely have increased.
- Some suggest there is a historical-ideological factor motivating Israelis to buy land in Israel.
- Cherry-picking / survivorship bias: people may unwittingly be focusing on individual cases they’ve heard of which have performed better than the average, or areas that performed better than the average. Well-known new developments such as Modi’in or Yavneh proving successful means that we tend to focus on those. It’s much easier to say “I should have bought in Modi’in when it was being built, look how much my apartment would be worth now” than it is to notice the less successful projects and the areas where home prices have increased below the average rate.
Skill and greater risk
Indeed, this last point is particularly important. You can significantly improve your return on Israeli real estate by taking a riskier route, such as by buying a housing start before construction has begun (or even before planning permission is obtained, a practice which is apparently widespread). But then you run the risk of the contractor going bankrupt or costs increasing – the potential for greater return comes are greater risk. You may have great skill at selecting an area or apartment that is undervalued and/or will go up beyond the average, or you might be lucky and achieve the same thing.
But in these cases, we are no longer comparing like for like – a passive and unthinking index tracker fund purchase, with no skill at analysing company reports and spotting trends, must be compared to an equally ordinary property purchase with no exceptional planning or foresight. Indeed, it is possible to beat the market average for real estate, just as it’s possible in the stock market, but the ordinary person is not usually adept at either.
In conclusion, the stock market has clearly outperformed Israeli apartments based on the limited historical data available to us. However, Israeli apartments are still an appreciating asset, strongly inflation-proof, and probably worth having as part of a larger, diversified investment portfolio, particularly as you grow older and closer to retirement. Personal considerations, such as the trade-off between stability and flexibility, will have a strong influence on the equation. This conclusion refers to a first apartment, in which you live – a second apartment for renting out would be less worthwhile financially due to the reduced tax breaks, although could still have a place in a lower risk portfolio. The major differences between Israeli apartment investments and stock market investments can be found in the table below.
|Consideration||First Israeli apartment (to live in)||Stock market (passive index tracker fund)|
|Annual return – capital value||1.5-2% after inflation||Total return of 7% after inflation, with dividend reinvestment|
|Annual return – income||2-4%|
|Reinvestment of income||Limited – could be used on home improvements||Easy, any amount of the same asset can be bought repeatedly|
|Diversification||Very low||High: range of industries, company sizes, markets|
|Liquidity||Low: takes months to buy/sell||High: can trade immediately|
|Tax on income and capital gains||None||25% on dividends
25% on real capital gains (upon sale)
|Tax on purchase||0-10% (apartments up to 4.5m shekels will have purchase tax less than 3%)||0%|
|Other purchase & sale costs||3% (agents, lawyers)||Depends on broker, usually less than 0.2%|
|Spread from “true” market value||Depends on negotiating skills, urgency and luck||Almost none|
|Leveraging||Low-interest mortgages available and commonly used||Rarely done by non-professionals, considered highly risky|
|Other costs||Repairs: budget up to 1% per year||Brokerage fee and investment manager fee: generally less than 0.5%|
|Non-financial utility||Sense of pride
Sense of stability
Ability to renovate and redesign
|Investment itself: None
Renting: flexibility, mobility, lower responsibility, predictable expenses
1. It’s for this reason that the graph starts in January 1994 at around 120 – inflation was so high that the value had already increased rapidly from the basis of 100 which represents the average price in 1993.
2. This can be achieved by setting the index basis as avg 1980 = 100.
3. See graph here
4. It must be noted that this figure is calculated against inflation in the dollar, whereas in the case of the apartments, I have used inflation in the shekel. However, in the second graph, I have used shekel inflation in both cases.
5. A cursory analysis comparing the historical rental price figures from the Central Bureau of Statistics with the apartment prices from the same source gives an average nationwide rental yield in 2017 of 3.1%. According to the same comparison, it peaked 2001-2003 at roughly 4.6%. The average for the last 20 years has been 3.8%.