JERUSALEM -- The global financial crisis has left Israel's real estate market with a problem most U.S. homeowners only dream about: Property values are rising too fast.
Fueled by record-low interest rates and a shortage of new construction, average real estate prices in Israel are up nearly 30 percent since the start of 2009, according to government and industry statistics. Global Property Guide, a trade magazine, recently ranked Israel as the world's hottest market in the two years ending in June.
But rather than celebrate, Israel's government and banking regulators are racing to pour cold water on the overheated market, worried the trends will spur inflation and lead to financial problems and possibly defaults down the road.
The surge is an unexpected side effect of the international financial meltdown, which continues to shrink real estate prices in the United States and other nations. Responding to the crisis in 2009, the Bank of Israel slashed its benchmark interest rate to 0.5 percent. When mortgage rates followed suit, slipping to 2 percent, home sales exploded, particularly among investors and foreigners searching for more attractive returns.
Rising demand pushed the average home price to about $250,000. In Tel Aviv, prices have risen 46 percent since the end of 2008 to an average of nearly $600,000 for a three-bedroom home. Jerusalem is up 15 percent this year to an average price of about $415,000.
That's good news for homeowners, who watched property values fall in the 1990s and again during the 2001-03 Palestinian uprising and the 2006 Lebanon war. On average over the last decade, Israeli home prices have risen about 3 percent a year.
But the recent surge in prices has made life difficult for many Israelis, especially first-time home buyers.
"Real estate prices in Israel, particularly in Jerusalem, are simply crazy," said Yoni Shoshana, 26, who is married and has one child. He spent months looking until he finally found a two-bedroom unit for $235,000. His secret? Perseverance and prayer, he said.
Government officials are also alarmed by the rising home prices.
"The housing market has set off enough crises, and we're not going to let that happen in Israel," said Stanley Fischer, governor of the Bank of Israel, as he announced another interest rate increase last month.
After lowering rates dramatically, Fischer, who has been praised for navigating Israel through the financial meltdown, has raised the benchmark rate six times in the last 14 months in an attempt to cool demand.
The rate is now 2 percent, still well below the 7 percent in 2000.
He's also imposed stricter mortgage-lending rules on banks designed to make large, adjustable-rate mortgages more expensive.
But to everyone's surprise, the market has continued to rise.
Part of the problem is Israel's lack of new construction. Government figures show that during the last two years, sales of new dwellings were only half the number needed to meet demand.
At the same time, Israel has faced growing international pressure to slow its settlement construction in the occupied West Bank, which has been a source of new housing, particularly around Jerusalem. A partial 10-month moratorium on construction ended in September and the U.S. is pushing Israel to renew it.
Israeli Prime Minister Benjamin Netanyahu announced recently that he would eliminate red tape and attempt to free up land inside Israel for new construction. About 25,000 new units were announced between September 2009 and June of this year.
Experts say the added supply will help, but not for two more years.
Meanwhile, some economists warn that Israel's housing bubble is heading for a bust. If interest rates rise again, payments on adjustable-rate loans, which make up about two-thirds of the total mortgage market activity, will increase, potentially leading to defaults.
"People paying 3,000 shekels (about $800) today could soon find themselves paying 5,000 shekels ($1,333), and it's going to be a big problem," said Ayelet Nir, chief economist at IBI Ltd., an investment broker.
Although foreclosures historically have not been a problem in Israel, where down payments average 30 percent to 40 percent, much of the recent activity has been fueled by investors and speculators, accounting for as much as half of the recent apartment sales in Tel Aviv.
A quick fix would be to continue raising interest rates, but the central bank is under pressure to not deviate too much from U.S. rates. The growing gap has strengthened Israel's currency against the dollar and made its exports -- which account for half of its gross domestic product -- more expensive abroad.
"Now he has a real dilemma," Nir said of Fischer. "If he raises rates, it's a problem for exports. If he doesn't, it's a problem for the real estate market."
(Batsheva Sobelman in the Los Angeles Times' Jerusalem Bureau contributed to this report.)
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