BRIC Spotlight

Brazil Housing Sector: No sign of the              carnival ending

But that is not to say the country’s current pace of homebuilding is sluggish. On the foundation of this acute scarcity and various favorable factors — a thriving economy, rising income levels, a credit boom, and helpful government policies — Brazil’s housing sector has grown at break-neck speed in recent times. Since early 2008, when homebuilders in the developed world began slipping into what has turned out to be a very deep real estate recession, prices of residential properties in two of Brazil’s largest cities, Rio de Janeiro and São Paulo, have soared 99% and 81%, respectively.

Significantly, apartment prices in some of Rio de Janeiro’s upscale localities are catching up with those in Manhattan and central London. Further, the volume of property transactions in Brazil has grown so much that Brazilians are making a beeline to sign up for real estate broker training courses, according to a Reuters news agency report. In fact, the report said that the number of new real estate brokers in Rio state increased nearly ten-fold between 2005 and 2010. Not surprisingly, the stocks of major Brazilian builders have performed well over the past few years.

Understandably, now that the housing boom in Brazil is several quarters old, its sustainability is increasingly in question. Complicating matters, anecdotal evidence — that of people buying apartments sight unseen, and doormen and taxi drivers becoming real estate brokers — also point to some degree of irrational optimism in the sector and the possibility that a property bubble may be forming. Still, there are several positive factors too, which indicate that Brazil’s housing sector may not yet experience any significant slowdown in growth.

Nevertheless, to understand these conflicting signs and what is going on in Brazil’s housing sector, it is important to analyze the various factors that are stimulating the sector and current market trends.

Growth Drivers

Brazil’s broader economy has been and will likely continue to be the most important impetus for its housing sector. After struggling for long as a third-world economy, desperate to shrug off its difficult experiences with hyperinflation and a currency crisis, Brazil found its place in the sun during the years preceding the global financial crisis. Backed by an insatiable global demand for its rich natural resource reserves as well as a proactive government that ushered in stability and a sense of direction, Brazil experienced the quickest pace of growth in its history between 2003 and 2008. Several innovative government schemes lifted an estimated 30 million Brazilians out of poverty and brought down the unemployment rate from 12.1% to 8.6% during this period.

Moreover, the economy grew at a steady pace, recording its first current account surplus in 25 years and running a trade surplus for successive years. At the same time, exports surged, inflation was reined in, interest rates declined from their historical highs, wages increased more than 25%, the middle class swelled to account for nearly 50% of the population, and the country’s sovereign bonds achieved investment-grade status.

Riding this momentum, Brazil recovered from the recession swiftly, and today the country stands among the top ten economies of the world. Although its pace of expansion has slackened since 2010, the Brazilian economy continues to attract foreign funds on the strength of the growing spending power of its population. More importantly, the demand for Brazil’s iron ore and other mineral resources remains strong in the global market. Over the years, these factors have ensured an increased level of economic activity in the country, which in turn has kept the demand for labor, both skilled and unskilled, relatively high. This has given Brazilians the opportunity to earn more and spend more. All consumer-oriented sectors, from retail to housing, have benefited from this trend. The housing sector has also received a boost from preparations for the 2016 Olympics and the 2014 Soccer World Cup. These two mega events have brought several companies to Brazil from multinationals to smaller shops and even firms from industries never before present in the country. And hence, the need to house their workers and executives has added to the demand for apartments.

However, the aspect of Brazil’s economy that has given housing the biggest boost is credit growth. Until just a few years back, Brazil had a restrictive environment in which individuals and corporations had limited access to bank credit because of prohibitively high interest rates and stringent borrowing norms. But during the second term of the previous Lula administration, interest rates moderated on a sustained basis, as inflation was tamed and the government relaxed lending norms to give the economy a credit boost in the middle of a global recession. Over the past five years, credit growth in the Brazilian economy has run at 2.4 times the country’s nominal GDP, compared to 2.0, 1.6, and 1.2 times for Russia, India, and China respectively.

Credit in the Brazilian economy has nearly doubled since 2007 to stand at around 50% of GDP, as of March 2011. Although interest rates have started rising again and the government has put in place measures to cool inflation and prevent a credit bubble, banks continue to report robust loan growth. Today, bank credit has become an integral part of the average Brazilian’s life and everything from cars, appliances, and beauty treatments to houses are increasingly being bought through loans and credit cards. In fact, despite charging an average per-annum interest rate of around 40%, Brazil’s banks project a double-digit rate of credit growth in 2011.

Mortgage lending has accounted for a major chunk of the credit boom. For decades, millions of Brazilians stayed away from the housing market due to a lack of financing. However, the rapid growth in mortgage lending has helped many Brazilians get a toehold on the housing ladder. Mortgage lending in Brazil soared 58% in 2010, but it is expected to increase around 30% in 2011 due to the government’s efforts to slow down credit growth. Curiously though, mortgage debt still is a lowly 4% of Brazil’s GDP, compared to about 65% in the U.S. and 13%-15% in China. In fact, according to one estimate, the total number of mortgages that had been disbursed in Brazil by May 2011 was a mere 400,000. Given its rudimentary state, mortgage lending in Brazil is expected to continue driving housing-sector growth in the long term.

Mortgage lending has been gaining momentum in Brazil not just because of the credit boom but also due to various legal and regulatory changes over the years. For instance, a 2004 law reduced a lender’s mortgage origination risk by making it easier and quicker to repossess a property in the event of a default. Earlier, in the case of delinquency, it used to take as much as six years for a bank to foreclose on a property.

Brazil’s government too has played an important role in giving a fillip to the housing sector. More than 90% of the estimated 6-8 million housing deficit in Brazil is in the low-income space. To address this deficit, the Lula administration launched an affordable housing scheme called Minha Casa, Minha Vida (My Home, My Life) in 2009. The scheme, which was launched with the initial aim of creating 1 million subsidized homes across Brazil, has been the primary driver of low-cost housing in the country over the past two years.

Minha Casa, Minha Vida has various attractive provisions. It not only loans up to 90% of the value of a house to a low-income buyer, but also protects the borrower from high interest rates. The initiative includes subsidized insurance for the borrower as a protection against job loss. Caixa Econômica Federal (CEF), a fully government-owned savings and mortgage bank and the biggest player in the housing loan market, handles loan disbursements and approves projects under this scheme.

Among some of the other housing sector-friendly steps the government has taken, taxes on construction materials have been reduced, and private banks have been given subsidies for offering long-term residential loans.

Market Players

The Brazil housing market is rather fragmented, with about 25 publicly traded homebuilders and private players. The major firms in the industry include:

• Gafisa, which operates in 99 cities across 20 of Brazil's 26 states. It builds homes for all income segments through its Gafisa, Alphaville, and Tenda brands. Gafisa expanded its footprint in the low-income housing market by purchasing a 60% stake in Construtora Tenda, a publicly held Brazilian homebuilder focused on the low end of the market. As a part of the deal, Gafisa merged its low-income housing subsidiary Fit Residencial with Tenda. Tenda operates in Brazil's fastest-growing metro regions, which have the biggest housing deficits.

• Cyrela, which has a 10% market share in Sao Paolo and 25% share in Rio de Janiero, two of the most lucrative markets in the country. Presumably, Cyrela is best placed to benefit from the 2016 Olympics because it has a plot of land worth R$14 billion in Rio and 90% of this plot is in the city’s Barra da Tijuca area, the site of the Olympics Training Center and Village.

• MRV Engenharia, which is the only pure-play affordable housing player among the publicly traded homebuilders in Brazil.

• PDG Realty, which acquired real estate company Agre last year. Agre has a strong presence in the poor but quickly developing north-east region of Brazil.

Industry Trends

• Worried that the Brazilian economy may be overheating, the country’s central bank has taken substantive steps so far in 2011 to bring down credit growth to sustainable levels. It has raised the benchmark interest rate at least five times and increased the capital requirements for banks. Despite these steps though, it does not appear that the rate of credit growth has moderated noticeably. Loan portfolios of banks are still expected to expand 15%-20% in 2011 compared to a 21% expansion in 2010. And as of August 2011, employment and wage growth continue to be robust. Thus, given that it has developed on the back of strong employment, wage, and credit growth, Brazil’s housing sector has remained largely unaffected by the central bank’s actions.
  
  
• Despite robust demand in the low-income housing space, most homebuilders in Brazil remain focused on catering to the upper and middle classes because this segment promises better profitability and lower risk. However, amid rising inflationary pressures, sales prices in the low-income housing space have increased, in some cases faster than the pace of wage or salary growth in the country. This seems to have affected sales in the segment despite favorable demand conditions.
  
  
• Since government spending played a big role in the 7.5% GDP expansion Brazil recorded in 2010, the federal government has reduced its planned expenses for 2011 by R$50 billion in a bid to control growth-led inflation. As a part of this proposal, the government has cut the outlay on its flagship affordable housing program by USD4.6 billion. Notably, despite the cut, the outlay this year has turned out to be R$1 billion more than the government’s expenditure on the scheme in 2010.
  
  
• Brazil is taking steps to set up a positive credit registry, which will help banks review the credit histories of all borrowers and not just defaulters. Given that the majority of Brazilians who have participated in the current credit boom are first-time borrowers, the new credit registry will help banks monitor loan disbursal more effectively. On the flip side, though, an enhanced level of monitoring may lock out a section of mortgage seekers from the housing market.
  
  
• The number of credit defaulters in Brazil appears to be growing. The Brazilian arm of a credit rating agency has reported that defaults rose 20.6% in the first five months of 2011. The agency expects consumer defaults to increase by a third by the end of 2011. Notably, consumer defaults in Brazil now are below the country’s historical average of 10%, but higher than those in most emerging markets. However, more importantly, the average Brazilian now spends 26% of his income on debt payments, and this figure is projected to rise to 30% by 2012. To put these numbers into perspective, the sub-prime crisis hit the U.S. when the average debt payment to income ratio of Americans was about 14%. Worryingly for Brazil, its citizens are charged a much higher rate of interest on loans and mortgages than Americans ever paid. In contrast though, Brazil has a non-existent securitization market, which exacerbated the sub-prime crisis in America.
  
  

Long-term Outlook

At the moment, Brazil’s housing sector appears vulnerable to factors such as a general slowdown in the economy, weakening credit growth, a possible rise in mortgage loan defaults, and soaring prices. But it is reasonably safe to say that the sector’s long-term prospects seem set in concrete. Two key points drive this idea home. First, the number of new families that will be created in Brazil over the next two decades is projected to touch 95.5 million, a pace of increase equivalent to 58% or double the rate of population growth across the globe.

Secondly, Brazil’s housing deficit is likely much larger than it is believed to be. The current deficit of 6-8 million units is not small, but combined with an additional deficit of 3.5 million units in lieu of dwellers in favelas or urban slums, it appears gargantuan. In reality, 75% of Brazilians own homes but around 85% of all homeowners live in low-quality, self-built, single-room housing units located mostly in shanty towns. It is this category of Brazilians that is most in need of affordable housing.

Short-term Outlook

Given the phenomenal rise in housing prices over the past couple of years and the absence of any noteworthy indication of a price correction or slowdown at present, the short-term prospects of Brazil’s housing sector center around this question: Is there a housing bubble?

The question is best answered by time, as there are compelling arguments on both sides of the debate. The most important reason for not worrying about a bubble is the minuscule size of Brazil’s mortgage lending industry. Being just 4% of GDP, mortgage lending in Brazil can only grow, not create a bubble. Further, the luxury and upper-middle segments of the housing industry are believed to have reached a point of saturation. The middle- and low-income segments of the market, which still have a massive scope for growth, are too price-sensitive to allow prices to escalate to the level of a bubble. The absence of a securitization market also adds strength to the argument against a housing bubble.

The key argument for the possibility of a housing bubble is the fact that mortgage lending in Brazil is in a nascent stage and, therefore, more prone to excesses. Another contention is that the rate of increase in rental receipts has not kept pace with the rise in home prices. So, buying with the intent to rent is much less profitable now and, therefore, a drag on the demand for houses.

Given these arguments and counterarguments, it is not easy to put a finger on the exact future course of Brazil’s housing sector. But as long as each new household created in the country needs a roof over its head, the sector holds promise. Clearly, scarcity, not abundance, is the driving force this time in the ‘land of plenty.’