Understanding the Building Construction Index
When buying a property in Israel and determining your budget, there will be additional costs above the purchase price to keep in mind, such as the acquisition tax, lawyer’s and broker’s fees, and other sundry items (click here to read my article on budgeting and closing costs). When buying an apartment under construction, also known as buying “on paper” or “off plan,” an important additional cost to consider is the Building Construction Index.
The Bank of Israel has a consumer price index, or CPI, to track inflation. In addition, it has many sub-indices that reflect the inflation rate within various industries. The Building Construction Index covers all costs associated with the construction industry, including construction materials, such as steel and concrete, as well as the cost of labor.
Back in the early 1980s, when the Jerusalem neighborhood of Har Nof was being built, there was so much construction taking place – coupled with ridiculously high inflation that crippled Israel’s economy – that the price of labor, steel and other construction materials literally tripled. Consequently, many developers who sold apartments “on paper” in projects under construction ran into financial trouble because they sold for prices based on construction costs calculated at the time of contract signing, prior to the costs spiraling out of control. To complete the building projects was a money-losing proposition and therefore many builders declared bankruptcy and walked away from the construction projects. These bankruptcies caused long delays, which hurt the apartment buyers and the entire industry.
In response to this challenging experience, the government created the Building Construction Index to protect all parties’ interests. When someone purchases an apartment in a project under construction, the unpaid portion of the price becomes linked to the Index.
Let’s say that Esther buys an apartment “on paper” for 2,000,0000 NIS in a project that is expected to be completed in eighteen months, and the payment schedule requires her to pay 25% on contract and make additional 25% payments every six months. Upon contract execution, Esther makes her first payment of 25% or 500,000 NIS, and the 75% unpaid portion gets linked to the Building Construction Index based on the contract signing date. If the Index went up by 1% over the first six-month period, the second payment will be 500,000 x 1.01% or 505,000 NIS. The next scheduled payment is six months later, or one year after contract signing. If, during the last twelve-month period, the Index rose by 2%, the third payment would be 500,000 x 1.02% or 510,000 NIS. Esther’s final 25% payment is six months later, or eighteen months after contract execution. If the Index increased by 3% during that year and a half period, the final payment would be 500,000 x 1.03 or 515,000 NIS. In this case, the index adds a total of 30,000 NIS above the sale price.
In this example, we grew the Building Construction Index 2% annually, which reflects the actual numbers over the past decade, where the index rose an average of 1.95% annually. Over the past five years, however, inflation was lower, as the index averaged 1.7% annually.
Keep in mind that only the unpaid portion of the price is subject to the index. Therefore, buyers who are risk averse can accelerate their payment schedule and prepay the lion’s share of the purchase price, thus limiting their inflation risk.
Even though the Building Construction Index, for all intents and purposes, raises the purchase price of the apartment, it takes the risk of bankruptcy due to rising construction costs out of the equation, allowing the builder – and buyer – to rest assured that rising construction costs won’t derail the project.
Gedaliah Borvick is the founder of My Israel Home (www.myisraelhome.com), a real estate agency focused on helping people from abroad buy and sell homes in Israel. To sign up for his monthly market updates, contact him at firstname.lastname@example.org.