A report published this morning (Tuesday) by the Bank of Israel reveals that the ratio between net profit and sales revenue in the residential construction sector currently stands at only 2%, compared to 13% in 2021, citing financing expenses and balloon loans as the leading cause. The report also indicates that the rise in interest rates has reduced the leverage levels of companies.
By Doron Breutman, Nadlan Center
Public construction companies’ profitability level, i.e., the ratio between net profit and sales revenue, has declined significantly over the past three years, reaching only 2% in the 12 months from Q4 2023 to Q3 2024. This is according to the Financial Stability Report for the second half of 2024, published today (Tuesday) by the Bank of Israel.
Thus, while in 2021, the profitability level was 0.13 (net profit of approximately 27 million compared to sales of 198.5 million), in the period between Q4 2023 and Q3 2024, net profit stood at 4.4 million shekels, compared to sales revenue of 212.5 million shekels. The main reason for the decline in profitability is the increase in financing expenses due to rising interest rates and, consequently, the growth in balloon loans (20-80 financing plans).
As a reminder, a record high was reached last December when the volume of mortgages taken amounted to approximately 13.8 billion shekels—an increase of 146% compared to the same period last year. At the same time, short-term balloon loans taken by developers also broke records. According to the data, in December, such loans were taken at a volume of 3.2 billion shekels, accounting for 23.3% of all mortgages—the highest rate ever recorded for these loans.
“Financing plans such as 20/80 or similar structures offered by developers allow for the deferral of most payments until the occupancy date,” the report states. “Under such payment structures, developers require more financing during construction. Additionally, buyers with low equity can commit to purchasing an apartment, with the requirement to raise the remaining equity before taking possession. Furthermore, due to the deferred payments, mortgage-taking is also postponed to a later stage, meaning buyers do not undergo bank underwriting when signing the purchase contract. On the developers’ side, these deferred payment plans erode their profitability.”
Declining leverage and rising financing expenses
However, the Bank of Israel notes that the price-to-earnings ratio, defined as the ratio between market value and net profit, is at its highest level in the past five years, reflecting relatively high market prices for public companies in the Tel Aviv Stock Exchange compared to other sectors. This high ratio may indicate investor expectations for a recovery in company profitability in the future.
The report also states that “the leverage of public construction companies, defined as the ratio of liabilities to equity, has slightly decreased over the past three years from a value of 2.93 in 2021 (liabilities of 502.5 million shekels compared to equity of 171.2 million shekels) to a value of 2.63 in the period between Q4 2023 and Q3 2024 (liabilities of 2.58 billion shekels compared to equity of 979.9 million shekels). Meanwhile, the ratio of financing expenses, defined as the proportion of financing costs to operating profit, has increased. These trends have continued over the past four quarters (0.513), with the proportion of financing expenses exceeding the level recorded in 2020 (0.44). Despite this increase, the financing expense ratio of approximately 50%, reached by public companies in the past year, remains within a reasonable and acceptable range for construction companies.”
Additionally, the report notes that the overall credit volume for the construction sector has continued to grow in recent years. The volume of bank credit allocated for construction processes increased by approximately 80% between Q3 2024 and Q4 2022, while the credit volume allocated for land purchases has remained stable since 2023.
