Oct 15, 2011

Is There Really a Bubble in Real Estate in Brazil ?

Versão em português: http://brazilfocus.blogspot.com/2011/10/existe-realmente-risco-de-uma-bolha-no.html

When we observe the rapid growth in the value of property in Sao Paulo and remember the real estate crisis in the U.S. in 2008, we can easily be led to believe that there is a bubble in the Brazilian housing market, and this could lead to a crisis in the banking sector, as well as occurred in the U.S. In this article, I would put my personal experience as a resident of São Paulo, trying to detail my observations, in order to understand whether it makes sense to think in bubble.

There is no comprehensive statistical data on the increased prices of property in Brazil. There are some localized content, such as FIPE, which calculates the change in price for some cities. According to FIPE, the increase in property prices between late 2007 and September 2011 was 113% in São Paulo and 150% in Rio de Janeiro. (Source: http://migre.me/5VKLP). In my personal experience, I bought my apartment in late 2007 for BRL 3,500 per square meter and my neighbor want to sell his by BRL 9,000 per square meter, ie, with variation above the increase calculated by Fipe in the same period. (USD 1 = BRL 1,78)

I try to list the main reasons to cause the increase in property prices:

1. The city of Sao Paulo has a chronic problem of traffic and an unfavorable geography. Jobs are concentrated in a few districts, and most people spend a considerable time in locomotion, because urban transport is poor, and the extension of subway lines is not appropriate for the size of the city. For example, I live 6 km from the office where I work, and I take on average 30 minutes to arrive by car. It is normal to a citizen of Sao Paulo takes in traffic 2-3 hours a day on the way to go and back from work, and even more if uses public transportation. Thus, living close to work becomes something very valuable, and much of the population is willing to pay more for it.

2. World economic growth between 2003 and 2007 favored particularly Brazil, which has seen commodity prices soar (see post on http://migre.me/5VJOT) and also made the country to receive a new investment boom. Sao Paulo is the economic and financial center of Brazil, where the staff of most large companies are installed and also concentrates the services of stock exchanges and investment banks. Thus, the country's economic growth made Sao Paulo attract a larger number of executives and professionals with high incomes, and consequently, with  higher demand mainly by the high-level houses in the most valued places

3. In Brazil, the property is still seen as a value reserve. The memory the period of hyperinflation in Brazil (ended in 1994) still persists, when people bought property to protect themselves from inflation. Until today, I know people who have put their resources in real estate, although the return in government securities has a higher yield than the return on rental property.

4. There is a lack of good land in some districts. This makes the builders have to purchase homes and / or property to tear down and build buildings. This has an impact on construction costs and the final value of the property.

5. Being a property owner has always been considered a synonymous of security. The idea of ​​own a property has been seen considered a "dream." I remember that in my childhood, pay rent was seen as derogatory by others. This means that the decision to purchase the "home" has an emotional component, not just rational economic.

6. The cost of labor for construction have risen sharply. The cost of labor rose 40% and the other construction costs have risen 25% between December 2007 and September 2011 compared to an inflation of 23% over the same period. (Sources: FGV and IBGE)

7. Change in law for rental properties. By 2008, the punishment for non-payment of rent was very mild: the removal of a tenant deliquient  demanded a judicial process for over 6 months to 1 year. With the change in law, the process became easier, providing more security for those who bought a property for the purpose of renting

This list of reasons for the high prices of real estate in São Paulo should not modify the short term, and therefore, house prices should remain high. But if this analysis is wrong, and indeed housing prices fall, what are the consequences? Before entering the answer, we understand how the real estate loans works in Brazil

1. Banks, in general, do not lend 100% of the value of the property. In general, they finance between 70% and 80% of the total, and the borrower must pay in cash the difference, but entire property is given as collateral. This means that the price have to drops more than 30% for the borrower have an incentive for not paying the loan. This significantly reduces the risk of deliquency.

2. When buying a property in the plant in Sao Paulo, the buyer makes payments to the builder during the construction phase, and then ask a loan of the remainder with a bank in the delivery of the property. We return to the same situation: the bank finances only part of the property, but has the entire property  given as collateral. And if there is a crisis, banks are likely to be more selective in granting credit, and therefore, the burden will be greater with the builder.

3. The volume of mortgage lending in Brazil is very small compared with most countries. In 2011, mortgage credit to GDP reached 6%, and represented 12.5% ​​of the total loan portfolio of banks. This means that, in the event that there is a total default, banks will bear a loss affordeable.

My conclusion is that, despite the increase in property prices, we cannot say that there is a bubble, but if, for any reason, there is a fall in house prices, there is no risk to the banking sector, and the big losers will be those who bought houses at high prices, and the builders who are not with reasonable costs or strong cash. I can´t see a crisis on the horizon with higher dimensions as the U.S. in 2008 or Japan in 80´s.

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