The Cusp of a 2012 Brazilian Property Bubble Burst?Brazil’s reputation, after a lulled period during the initial phases of the 2008 crisis, was fortified as a real estate destination well worth paying attention to – with a massive housing deficit, a well-capitalised banking system and several other solid economic fundamentals. Nevertheless, in an ongoing climate of global economic uncertainty, it would seem that no property market is immune.

Particularly over the last year, however, prices have reached levels that even the most bullish of onlookers are viewing with some trepidation. 

Take São Paulo, where it was recently reported by the Lello estate agency that the prices of resale homes in prime areas rose by as much as 175 percent in the last two years.  The Fipe-ZAP index also recently indicated that prices in Rio de Janeiro and Recife had increased 34.90 percent and 30.70 percent respectively in 2011 alone.

While the so-called “independent market specialists” are invariably maintaining that the Brazil property bubble will not burst (reverting to factors such as the country’s unprecedented demand levels fuelled by an unsaturated housing credit market), a closer look at the facts points to a picture that may not be so rosy.

Market trends

The performance of the leading real estate developers is a prominent example of the fact that the market has been moving out of sync with reality.  The country’s 4th largest developer Gafisa took a turn for the worse after Sam Zell of Equity International’s share sale in May 2010, tanking 64.94 percent and losing half of its market value during the course of 2011.  Gafisa was not alone: Rossi fell by 44.74 percent on the year, Brookfield by -40.95 percent, Cyrela by -30.67 percent and MRV by -30.57 percent.

The basis of these drops can be attributed to a number of factors. Fundamentally, despite higher disposable income levels (and a recent increase in the national minimum wage), the majority of the Brazilian population have been pushed out of the property buying market.  This is noticeably the case for the low income demographic that form the lion’s share of the national deficit who – despite the ill-executed social housing programme Minha Casa, Minha Vida (“My House, My Life”) – largely remains in shanty towns (favelas) or other forms of undignified housing.

Related to this, the soaring costs of land, construction and – most notably – labour have forced developers to elevate prices beyond the means of even middle-income groups (to achieve sufficient margins), all under a seeming lack of industry control to curb the effects of speculation. 

Cyrela, despite the upbeat comments made on the future of the real estate market in late 2011, made a loss of USD 533 million due to over-estimated construction costs.  In the case of Gafisa, the acquisition of affordable housing developer Tenda served to exacerbate the company’s difficulties with average project profitability reaching barely above zero; 11,000 ‘problem’ housing units and only 16 percent of customers having the means to pay mortgage commitments.

Property Bubble?

With reputations continuing to be stained by media exposés and a rising number of legal actions, early 2012 signs are pointing to developers applying the operational brakes in a market that has simply grown out of control. 

Nevertheless, to label what is happening in Brazil as a bubble in the same light as what has occurred in the US, the UK and European real estate markets can be strongly debated as an extreme standpoint. 

Brazil’s banking system, for instance, is based on well guided underwriting principles that operate well beyond the minimum standards set by the Basel Accord – a sub-prime debacle is therefore very unlikely to happen. 

Furthermore, after many years of low activity, the growth potential of the country’s property market is still at its infant stages, particularly considering the very low supply of adequate housing and that gross housing credit forms approximately 5 percent of the country’s GDP (compared to 68 percent in the USA).  A bubble burst of sorts may indeed be what is needed to bring affordability back into the marketplace for the average Brazilian.

For investors, the opportunities in Brazil real estate are massive and will remain so for a long time – but much caution needs to be undertaken to avoid falling victim to false marketing, hype and the abundance of distorted information that simply does not reflect the truth.