So we think there is a possibility that the Brazilian property bubble is finally popping. Although offer prices are not yet reflecting a downgrade of prices, there is information that developers are cutting down payment prices by as much as 50% and making further deals to liquidate their positions. Like all bubbles, judging the timing may be difficult, but as far as what this means for the average investor or consumer, I’m optimistic.
There have been talks of a property bubble in Brazil for a while now, at least since I arrived here. For those of us who studied the great US mortgage bubble that finally led to a financial crisis in 2008, the scene has been eerily familiar; prices through the roof, wide spreads between rent prices and purchase prices, everyday citizens buying property as “investments” (read: speculations). Of course, like all bubbles, there were naysayers. Property developers claimed it was real income growth fueling the price hike, and that property was undervalued before.
Both are probably true to some extent, but they wouldn’t explain a tripling of prices in some places, or wide desparaties between rent income and hosing price inflation. Luciano D’Agostini, our housing expert published a paper last week comparing the US bubble to the Brazilian one. This graph below shows when both bubbles stopped following income, and began to be driven by speculative capital.
The loss of relation between income growth and housing price
Both follow the same pattern, but there are some important differences
First, and most importantly, we cannot expect the kind of catastrophic price adjustments as we did in the US. Brazil is simply a much smaller and more regulated financial market. The market for asset-backed derivatives like collateralized debt obligations (CDOs) is much smaller, and the kind that drove the US financial crisis, like untraceable CDOs made of other untraceable CDOs made from other CDOs (CDO to the 2nd and 3rd powers, etc.) and so on do not exist. Even similar assets would be easier to trace in intrinsic value because of higher levels of transparency, which is part of the reason why they haven’t made their way onto everyone’s balance sheet either.
Inva Capital estimates that there is only around R$100 billion of credit outstanding in the housing market; nothing compared to US numbers. Credit exansion was a main driving force behind the price increases, but Brazil still has some of the highest costs of capital in the world, with overnight interest rates above 12% for most of the time that the bubble was growing. Although there is, of course, a strong correlation between credit expansion and housing prices, there was not the kind of massive wave of credit that allowed for high levels of 2nd mortgages, home equity loans, or sub prime lending in the US. This can also be seen in higher lending standards to consumers compared to the US bubble period.
Given the lack of comparable size to the US housing bubble, and the fact that there is not as much of a surplus of liquidity from asset backed derivatives floating around, can we assume we’re safe? Depends on who you are. Property developers are set to lose money. It’s said that most of the credit outstanding mentioned are now their liabilities, rather than in the hands of consumers, further evidence that it might be harder for the developers to retrieve adequate returns on their investments (although recent and future moves by the central back should slightly offset this with expansionary monetary policy through 2012)
Since prices began to soar in 2008, talk of over-valuation in the real estate market has not been uncommon. The driver of this price increases was, of course, residential properties, but prices have increased in all sectors, raising the cost of doing business for nearly everyone. On top of that, average middle class families have found it harder to purchase housing, and rent prices have gone up as well, although at a much slower rate.
So, truth be told, as a company that has no position in real estate, having expected price adjustment for a while, Inva Capital sees this as a good thing. It will bring down the cost of investment, and hopefully channel investment out of a price bubble and into more productive assets and infrastructure. So, wait a little bit on that new home purchase, and get ready to the cost of doing business go down to a more sustainable level.
Source: Chris Nichols at Inva Capital