Last week O Globo reported that 10 out of the 22 Brazilian builder firms suffered an aggregate loss of 3.2 billion reals in the first trimester, due to stalled projects and rising costs. Analysts tracking the market also concede that a significant correction is likely to hit in 2012. However, the degree to which a major depreciation will impact Brazil’s economic growth (and subsequent demand for outsourced enterprise solutions) may not be as extreme as some fear.
In fact, a property crash could deter some foreign capital in-flows; there is skepticism over the country’s macro fundamentals as reflected in last week’s issue of the Economist. Despite that, the Brazilian consumer will certainly welcome cheaper rents and mortgage payments, as the lack of affordable housing and office space further stunts economic expansion.
A Top-Earner Bubble
According to London-based research firm Capital Economics, “the current pace of credit growth [in Brazil] is unsustainable. Household balance sheets look stretched and there are signs that the rapid expansion of credit is stoking bubbles. We think the housing market may be overvalued by 30-50%.”Data from the FIPE ZAP property index also show home prices in Rio and Sao Paulo increasing by 22 percent over the last 12 months and 135 percent over the last three years.
So far the number of people that actually own homes in urban centers and that can afford to buy at current prices is actually quite small. According to Brazil-based low-income property investor Ruban Selvanayagam, “in the larger metropolitan areas of Brazil the ratio between income levels and property prices is completely disproportionate. One of the major mistakes that investors in developed countries made was to ignore affordability as an indicator of true market value.”
And while rising incomes, expanding credit, exploding foreign direct investment (FDI) and speculator exuberance have all contributed to the growing demand for real estate, Brazil actually suffers from a serious shortage of housing. Various estimates point to a deficit of 8 to 10 million homes, the majority of which are in the low-income category. “Outsiders tend to forget that Brazil is still a developing economy and that most people live in favelas and very inadequate housing,” explained Ruban. Inflated property prices have also undermined government programs like “Minha Casa, Minha Vida,” established to help low-income families buy homes. Lending caps for the programs are set at levels much lower than what current market conditions make favorable to investors.
Economic Impacts Could Be a Net Gain
Investors are rightly cautious of what’s happening in Brazil, considering the havoc that subprime lending caused to the U.S. and global economy. But while the market distortions that led to the U.S. housing crash were utterly crippling for most involved, the Brazil bubble could actually create more winners than losers. The situation here differs because Brazil’s housing market is still small relative to developed countries. Real estate credit as a percentage of GDP is only five percent, while in countries like the United States and the UK the number is more like 70 percent. This suggests that most homeowners live relatively debt free – probably in legacy homes passed down within families – meaning that a market correction would only hit certain submarkets and not to the degree witnessed in the U.S.
The minority that will get hit the hardest by a market correction will be the large investors buying in bulk and recent homebuyers. Undoubtedly, a market drop would be welcomed by aspiring homeowners and inner-city renters, as rental prices have also skyrocketed in line with sale prices. So while large investors and construction firms might record losses in the short-run, prices more in-line with income levels could free up consumer purchasing power, as well as the debt financing markets.
Brazil’s major lending institutions are in good financial health and mortgage delinquencies are low. “Banks continue to have very tight lending criteria that adhere to international standards,” stated Ruban. Furthermore, according to data from the World Bank (complements of Jones Lang LaSalle), real estate credit as a percentage of GDP made a big three percent jump since 2009 after laying flat for over six years. This is yet another classic signal that a rapid and sudden hike in demand for housing is outstripping supply.
And while country GDP growth has slowed, the unemployment rate holds at a record low of 5.6%, rising nominal incomes (9.2% CAGR) underscore the critical role of the rising consumer class as Brazil’s economic engine.
“You can negotiate hard particularly if you have cash in hand and are aggressive.”
High Price for Commercial & Industrial
According to Sao Paulo based Shay Coker of the Tenant Representation Group at Jones Lang LaSalle, “commercial developers are doing extremely well because they have a product that continues to be in very high demand.” Land for office, retail and industrial is in short supply and doesn’t really compete with residential properties. “Rents in Rio are higher than in Sao Paulo and have increased 140 percent in the last 10 years, but we don’t expect a major drop in the market.” Some potentially good news for contact center operators is that rent hikes for Sao Paulo offices are beginning to slow.
Nevertheless, it is very unlikely that we would see the type of massive correction that analysts forecast in the residential market to hit commercial properties. According to Coker, “rents for offices will likely slow and remain around their current rates.” For this reason many vendors entering the Brazil market are looking outside of Rio and Sao Paulo to second-tier markets like Curitiba or within the SP suburbs like Campinas.
Could be Time to Buy
Selvanayagam asserts that while Brazil is a complex and difficult market to break into, there are still real opportunities for investors that have done their due diligence and get to know the market. Ruban also surmised that the current environment is in a way a buyers’ market, given the uncertainty over the direction things are heading. “You can negotiate hard particularly if you have cash in hand and are aggressive.” Furthermore, part of this uncertainty stems from the fact that property market valuation is still underdeveloped in Brazil.
In short, real estate prices are poorly tracked making it difficult to gauge real market value. Hasty deals based on limited experience and information will inevitably impact careless investors. In the long-run, the sooner market adjustments bring investor expectations back down to earth, the better conditions will likely become for more sustainable economic growth.