(An excerpt of Fitch’s recent report on the housing bubble in Brazil).

Hot Market Begins to Cool: After increasing roughly in line with inflation between the mid- 1990s and 2007, prices of residential properties in Brazil’s large metropolitan areas soared. From January 2008-July 2012, real prices increased 92% in São Paulo and 118% in Rio de Janeiro, according to the FipeZap Index. However, in recent months, price growth has fallen in line with income growth.

Macroeconomic Conditions Underpin Surge in Home Prices: Increasing average household incomes in combination with improving income distribution and massive credit expansion in the context of lower interest rates facilitated demand for residential properties. This new demand for housing has not been fully met by supply of quality existing housing. Moreover, new construction in large metropolitan areas is limited by lack of space, qualified workers, and building material. The resulting housing deficit pressures prices upward.

Mortgage Growth Drives Boom: Credit expansion is widely considered the most important driver of property prices. Factors contributing to mortgage growth include: sustained decrease of historically high interest rates; availability of cheap and growing savings deposits to fund mortgage lending; loosened lending standards; and legal reforms, such as changes in mortgage laws to streamline the foreclosure process.

Prices Expected to Stabilize: Prices may be reaching their limits and have started to grow in line with incomes in the past couple months. Although prices look expensive by any measure, Fitch Ratings does not expect prices to go down significantly in a benign economic environment given medium-term supply and demand imbalances.

Risk of Price Declines in Crisis Scenario: House prices are expected to be very sensitive to availability of affordable credit, which hinges on a sustained moderate-interest environment and lenders’ continued access to cheap funding. A highly concentrated mortgage market dominated by government-owned Caixa Econômica Federal (CEF, 75% market share) is a source of risk. Additionally, homeowners are more indebted, both with mortgage and nonmortgage consumer debt, and therefore could be exposed if unemployment increases from current record-low levels.

RMBS Criteria Reflects Market Evolution: Fitch addresses these risks in its RMBS criteria by applying very conservative stressed house price declines in higher rating scenarios. In a ‘AAA(bra)’ scenario, house prices are assumed to fall below levels observed in 2008 in real terms, and market value declines (MVDs), which include additional quick sale adjustments, reach up to 69%. The highest MVDs are applied to properties located in Rio de Janeiro and Brasília, where prices grew most rapidly, and current values are among the highest in the nation.

House Price Growth

In recent years, Brazil’s largest cities have experienced the highest home price increases in Latin America, placing São Paulo and Rio de Janeiro among the most expensive property markets in the Americas. From January 2008-July 2012, home prices in São Paulo and Rio jumped 144% and 178%, respectively, according to the FipeZap Index, which tracks offer prices every month in the country’s seven biggest cities. After adjusting for inflation (using the consumer price index IPC-A as a deflator), prices went up by a still impressive 92% in São Paulo and 118% in Rio de Janeiro.

The current housing boom follows a long period of subdued housing market activity dating back to 1995, when the economy stabilized and inflation came under control with the introduction of the real (BRL). Property market data tracking prices before 2007 is limited, but information from Empresa Brasileira de Estudos de Patrimônio (Embraesp) on prices for new construction in the metropolitan area of São Paulo suggests that residential housing prices remained flat in real terms between 1995 and 2007.

The housing sector has developed alongside Brazil’s broader economic success. Rapid growth of the middle classes and expansion of credit (discussed in the next section) are two key factors behind the boom. In the context of sustained economic growth and low-to-moderate inflation, real per capita GDP rose 18.6% from the beginning of 2006 through the end of 2011, according to Fitch. During the same period, unemployment dropped to 6% from 10%, the ratio of formal-to-informal employment increased, and the wide gap between the wealthy and poor narrowed a bit. Real income growth also boosted savings deposits, which grew by more than 140% between year-end 2005 and year-end 2011. This, in turn, increased the availability of cheap funding sources for mortgage lending, which was further propelled by a sustained decrease of interest rates and legal reforms.

Meanwhile, supply has not kept up with surging demand, creating an imbalance that likely will not be solved in the short term. Brazil suffers from a general lack of good-quality and welllocated residential properties. Furthermore, large cities lack space to build new residential buildings, qualified construction personnel, and building materials.

As residential real estate prices were boosted by high demand and inadequate supply in all major metropolitan areas, most notably São Paulo and Rio de Janeiro, speculators have entered the market and influenced prices at least in parts of the market. However, their influence on prices is difficult to measure.

Expansion of Credit as Main Driver

The expansion of the country’s mortgage market is widely seen as the most important driver of the property price boom. Hundreds of thousands of properties were financed with new mortgage loans each year. Since 2005, mortgage lending as a percentage of GDP grew to 5.4% in May 2012 from 1.5%, based on figures reported by the Central Bank of Brazil (BACEN). However, by developed world standards, this percentage is still paltry.

In Brazil, mortgage lending taps traditional funding sources, especially savings deposits and, for subsidized lending, the Fundo de Garantia do Tempo de Servico (FGTS), a Brazilian workers’ fund. Under Brazil’s Housing Finance System (SFH) created in 1964, banks must direct 65% of savings deposits to housing finance, which includes mortgages, but also other assets related to real estate lending. By law, interest rates on mortgage loans funded via savings deposits are, to a large extent, capped. Once the benchmark rate goes below a certain level, mortgage lending becomes  increasingly attractive to banks, which can offer reasonably priced loans to borrowers without sacrificing returns. Since 2006, mortgage lenders have benefitted from decreasing benchmark interest rates, in addition to a growing volume of savings deposits.

The benchmark interest rate (SELIC) hit historic lows during the past couple years, both in nominal and real terms, helped by economic stability and an environment with reasonable inflation levels. The SELIC rate, which never dipped below 15% until 2005, averaged 12.5% in 2008, 9.9% in 2009, and 9.75% in 2010. In 2011, rising inflation forced the BACEN to increase rates up to 12.5% before starting to cut them again in August of the same year. As of the publication date, the SELIC stood at 7.5%.

The development of the mortgage market was also enabled by legal reforms, including changes in mortgage laws and the introduction of alienaçaõ fiduciária (AF), or fiduciary lien, which streamlined the foreclosure process by considerably reducing time needed to seize and liquidate property of defaulting borrowers. AF was introduced by law in 1997, but started to replace the traditional mortgage (hipoteca) only in 2004.

Large banks dominate residential mortgage lending. Caixa Economica Federal (CEF), a government-owned savings and mortgage bank, is far and away the leader, commanding about a 75% market share. CEF increased its portfolio to BRL156 billion in March 2012 from about BRL20 billion in 2005. Other major lenders include private giants Banco Itaú-Unibanco, Banco Bradesco, and Banco Santander, together with government-owned Banco do Brasil.

By increasing loan volumes, extending loan maturities and modifying LTV and DTI standards, lenders have opened up the mortgage market to millions of new borrowers. In this regard, mortgage terms extended to 30 years in 2008 from an upper limit of 20 years and maximum LTVs expanded to 90% in 2009 from 80%. More recently, in June 2012, CEF further increased loan terms to 35 years and provisioned for LTVs to go up to 95% for certain clients. Notwithstanding certain changes in underwriting criteria, some loan characteristics still remain simple by developed world standards; for instance, all mortgages in Brazil are fully amortizing with fixed interest rates (with or without indexation).

In spite of price increases, buyers have been able to purchase homes without increasing their down payments or initial monthly debt service. This is especially true if current credit conditions are compared to the previous environment. Before the expansion of the Brazilian mortgage market, mortgage financing was scarce and often consisted of expensive and relatively shortterm loans provided by homebuilders to buyers of newly constructed residences. In the new lending environment, home buyers can afford pricier homes at the expense of taking on more debt, albeit cheaper debt by historical standards. By way of example, for a given income, maximum DTI, and down payment, the property price can easily be more than 50% higher if financed with a standard 30-year bank loan rather than a short-term loan from a construction company. This “affordability” has contributed to price inflation.

Prices May Be Reaching their Limits

The sizable price increases in some cities have prompted talk of a housing bubble. During the past three years, rental yields have been sharply lower than mortgage rates (the latter starting at about 8% annually) in Brazil’s major metropolitan markets. Rental yield reflects a property’s annual net income divided by its purchase price. When it becomes cheaper to rent a home than to purchase one, buyers might retreat from the market. Decreasing rental yields (see the  chart below) in São Paulo and Rio could be an indication that properties are overvalued unless there are expectations for further income growth or significant capital appreciation.

In addition, house prices have increased very disproportionately to the rise in household incomes both in nominal and income-adjusted terms, as evidenced by the chart below. Although statistical information is limited and there is a wide dispersion of prices and incomes across and even within neighborhoods, available information clearly shows that reasonably sized and good quality properties in Rio de Janeiro and São Paulo have become very expensive for the broader middle classes. House price-to-income ratios (average property prices divided by estimated average household incomes) are above 5.0x in São Paulo and above 7.0x in Rio de Janeiro. These ratios are far greater than those in Western Europe and North America. Home ownership thus requires increasing leverage and longer-term debt, which may explain the recent move of government owned CEF to increase the maximum loan term to 35 years.

Not surprisingly, recent figures show signs of a slowing market. In both São Paulo and Rio, income-adjusted prices have leveled off since year-end 2011. However, Fitch does not expect significant broader property price decreases in a base economic scenario, since supply and demand imbalances likely will not be resolved in the near term. Also, when compared with other booming emerging markets, Brazil’s largest cities still seem relatively affordable. For instance, Fitch estimates average house price-to-income ratios in Shanghai and Moscow to be far greater than the average ratio in São Paulo.

Risk of Price Declines in Stress Scenarios

In the event of stressed economic scenarios, Fitch acknowledges the risk of a considerable decrease in home prices. Reasons are manifold. House prices are expected to be very sensitive to availability of affordable credit, which hinges on a sustained moderate interest environment and lenders’ continued access to cheap funding. Furthermore, Brazil’s highly concentrated mortgage lending market relies on just a few big lenders, mainly CEF. In addition to the risk of a decline in mortgage financing, housing prices are sensitive to employment. Home owners are more indebted than in the past and therefore could be exposed if unemployment increases from current record-low levels. Besides mortgage debt, many households have considerable consumer debt, which is usually not captured in the DTI limits set by the banks. Since home buyers are often first-time owners and borrowers, they may not plan for periods of lower income and may underestimate the costs of maintaining a property.

In a recession scenario featuring an increase in unemployment, default rates and forced sales of properties can be expected to rise and subsequently drive down property prices. Solvent borrowers may choose to walk away from underwater properties since the AF foreclosure process does not envisage further recourse to borrowers after property seizure, exacerbating the situation. Lenders may end up with a large stock of properties and corresponding losses, and lending may dry up. This, in turn, would make houses unaffordable for potential acquirers, further driving down prices.

Property prices could also be negatively affected if cheap funding ran out or if the central bank were forced to increase the SELIC rate to contain inflation.

It should be noted in this context that alternative funding sources for bank mortgage lending like securitization and portfolio sales are more expensive than traditional funding and still play a minor role in residential housing finance. However, the growth of traditional funding sources has been slower than the growth in mortgage lending since 2005, spurring the need for alternative funding sources in the next few years. This projected deficit could spark Brazil’s nascent RMBS market, but could also drive up mortgage rates. Currently, Brazilian RMBS pay interest rates well above rates on savings deposits and also above certain mortgage rates. Consequently, the SELIC rate will have to stabilize at record-low levels to allow mortgage rates to remain stable.

Updated Fitch RMBS Criteria Reflect Property Market Developments

The development of residential property prices and associated risks play an important role in Fitch RMBS criteria. When rating RMBS transactions, Fitch calculates stressed recoveries for defaulted loans, which are, among other factors, determined by estimated house price declines in tested rating scenarios.

Fitch therefore cautiously monitors Brazil’s real estate sector and constantly adapts its rating criteria to market developments. The increased risks resulting from the recent property price increases are reflected in Fitch Research on “RMBS Latin America Criteria Addendum - Brazil,” dated February 2012, available on Fitch’s Web site at www.fitchratings.com.

As a consequence, Fitch applies very conservative stressed house price declines in higher rating scenarios. In a ‘AAA(bra)’ scenario, real house prices are assumed to fall by 50%-55%, depending on the region. The highest house price declines are applied to properties located in Rio de Janeiro and the Federal District, where prices grew more rapidly and property prices are amongst the highest in the nation.

Additionally, Fitch reflects the expected premium a seller is likely to have to suffer for selling a property in a depressed market through quick sale adjustments, which equal 30% of the stressed property price. The resulting MVDs reach 65%–69% in a ‘AAA(bra)’ scenario.

Source: Fitch Ratings

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8 Responses to Fitch: “Home price growth in Brazil slows, hence reducing the risk of a bubble”

  1. Gordon D says:

    If you read what happened in the USA, then anything reviewed by a rating agency was a complete sham. Fitch, Moodys and S&P rated all kinds of MBS’s as stable investable instruments and many people lost significant money. How is Brazil different? Repackaging of loans away from originators is a flawed system with high risk. Anybody have better clarity? Lets discuss.

  2. alexNY says:

    Repackaging of loans away from originators is a secondary problem, that was a way to further inflate the bubble to try to prevent it from popping, the bubble itself was created by people purchasing properties to sell later at a profit inflating prices artificially
    Same thing happening in brazil , lots of people buying to flip , prices super inflate , then government finds ways to keep the bubble going until elections ,
    I thing the biggest difference is that in Brazil rates are much higher and culture in general in brazil is, ” just don’t pay, government will help you”

    also , USA subprime loans are very similar to Brazil’s pre-built (‘na planta’), you start paying lower rates then it doubles after a couple of years , but by then property has come out of the market creating a false demand creating the bubble

    In brazil there is not “credit scores” , no control if a person purchases 3 or 4 pre-built houses/apartments with no credit to actually close the deal once the building is done, and it happened over the country , millions of people went into this line of investment with no means to actually buy the property

  3. Thomas says:

    Be careful when looking at the “Gross Rental Yield” chart. Don´t think the rent prices are going down, they are just not going up as fast as the property prices, but they are going up, not down.

  4. Gordon D says:

    I think whats important in the chart is the trend and indication of acceptable risk and purchase dynamics. What the chart tells me is that buyer’s focus is now on the capital appreciation. They are willing to pay rich prices for lower rental yields in hopes of gains else where. Are they looking to flip the property?

    Why invest in real estate when the bank pays a safer return versus inflation if rental yields are at 5% to 6% per year? Because prices go up. BUT, prices do not go up forever…look to the USA AND many people got wiped out because they depended on the capital appreciation as a fundamental strategy and they got the timing wrong.

    I looked at prices in a small town outside of Rio and saw the same dynamic of lower rental yields (lower than inflation). What I did not find was a corresponding increase in high paying jobs to justify the increased prices. So it made me pause.

    Does anybody have clarity into the number of investor buyers in the real estate market versus actual buyers to live in?

  5. Gordon D says:


    what do you mean by “na planta payments double”? I assume you make the same payments throughout your purchase cycle…from initial signing of contract, through construction into possession. Also, do the developers not check your credit to be able to buy multiple properties? I understand the credit system here is lacking but what you say is it’s completely non existent or the process provides false information.

    IF what your saying is true then Brazil has a far bigger problem than is being portrayed, no?

    Thanks in advance.

  6. alexNY says:

    Gordon , as i said , a person in brazil can buy as many apartments pre-built (‘na planta’), and there are no records of it anywhere , the buiding company can check on `cerasa` where they keep the defalts records only they don`t keep records of how much credit the person has already taken .
    Regarding the month payments double ,people buy a apartment pre-built that will be ready say 2 years from now , for those 2 years they will be paying a small monthly payment of lets say 800 reais , then when the apartment is ready that person has to go to the bank and ask for a loan for the remaining(meantime final amount has been adjusted to a much bigger amount) , if that person is aproved monthly payments will go to something like 2000 ,
    The intresting thing also is that the moment the person is signing this `promise to buy` document the construction company contabilize it as a real sale. but the person in most cases is not going to be able to actualy buy the property when it is ready, if you can read portuguese ill post some text from the actual government in brazil showing thay are trying to solve the problem of many people are returning the properties later , (numbers are from gov in brazil so you can always multiply by 1000 to get the real value)

  7. alexNY says:

    Secovi tenta reduzir distratos do Minha Casa, Minha Vida

    Autor(es): Por Ana Fernandes | De São Paulo

    Valor Econômico – 24/09/2012

    O sindicato da habitação em São Paulo, Secovi-SP, está negociando com a Caixa Econômica Federal uma solução para que pequenas e médias construtoras fiquem menos expostas a riscos de distratos com clientes do programa Minha Casa, Minha Vida.

    O vice-presidente do sindicato, Flávio Prando, que participou da elaboração da medida, disse ao Valor ter recebido uma sinalização da Caixa que uma resposta deve ser dada nas próximas semanas. Em negociações mais avançadas nos últimos quatro meses, o sindicato acredita que a resposta do banco estatal seja positiva.

    A ideia é facilitar o acesso das pequenas e médias empresas ao chamado “crédito associativo”. O mecanismo permite às construtoras repassar seus mutuários para a Caixa logo no início dos projetos.

    Antes, o contratante financiava a entrada do imóvel com a construtora e era repassado, às vezes mais de um ano depois, para o financiamento da Caixa. Nesse momento do repasse, muitas vezes, a renda do cliente havia subido, ultrapassando o teto do programa habitacional e ele era obrigado a distratar a compra do imóvel.

    Uma solução para o problema é o crédito associativo. Esse sistema, no entanto, exige que uma porcentagem do empreendimento (geralmente mais de 50%) esteja contratada, garantindo a capacidade de pagamento da pequena e média construtora. Alcançada essa cota de clientes que compraram as unidades, a Caixa então libera o financiamento para a construção efetiva do empreendimento.

  8. alexNY says:

    Does anybody have clarity into the number of investor buyers in the real estate market versus actual buyers to live in?

    no , that number is a big secret , im sure is more then 70%

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