By Mary Stokes.
Property prices and housing finance are on a tear in Brazil, leading to fears of a bubble. Housing prices have risen by over 10% so far this year on a nationwide basis. Meanwhile, home loans increased at an annual pace of over 40% in the first half of 2012, much faster than the 18% expansion in overall credit. This eye-catching growth is raising concern. Lending booms preceded the housing busts in Spain and the US. However, Brazil is a different story in a number of important respects.
There is no question that housing prices in Brazil have surged in recent years. In the country’s two largest cities – Rio de Janeiro and Sao Paulo – prices have risen at an annual pace of over 20% (Chart 1). Such fast rises are not sustainable, but we do not foresee a sharp reversal. The fact that the speed of housing price increases has begun to slow should help mitigate concern.
Chart 1: The pace of housing price rises in Brazil’s two major cities has slowed over the past year
Source: Fipe-Zap, Timetric
The other factor that reduces the likelihood of a dramatic housing bust is that the rise in housing prices has been driven – at least in part – by fundamentals, including a scarcity of adequate housing and a growing middle class. A study by the João Pinheiro Foundation, a government think-tank, estimates the country’s housing deficit at 5.8 million homes.
Greater access to finance has played a particularly large role in driving prices higher. But will access to housing finance continue to expand?
The short answer is yes. In contrast with advanced economies like Spain and the US, mortgages are still in their infancy in Brazil. During the country’s years of hyperinflation in the 1980s and 1990s, housing finance was virtually non-existent, and the vast majority of buyers paid for their homes in cash. Housing finance is still not widespread. Less than 50% of property purchases in Brazil are financed with mortgages. Consequently, the growth in home loans is coming from a very low base.
Home loans cannot rise at a double-digit pace indefinitely. Nevertheless, a housing bust along the lines of that seen in Spain or the US is unlikely. Even if home loan defaults were to rise significantly as occurred in these other markets, this would not pose the same degree of systemic risk to the broader economy because Brazil’s mortgage market is tiny.
As seen in Chart 2, the total value of outstanding mortgage debt in Brazil is around 5.5% of GDP. In contrast, Mexico and China have debt-to-GDP ratios of over 10% of GDP, while the UK and US have ratios in excess of 70%. The relatively low credit penetration in Brazil suggests the rapid growth in property lending is part of a broader financial deepening process.
Chart 2: Brazil has a relatively low level of housing finance compared with advanced economies and other emerging markets
Rapid credit growth typically precedes a spike in defaults, but we do not foresee mortgage loans in Brazil following this pattern. In contrast with what occurred in Spain and the US, Brazilian banks have not significantly relaxed their underwriting standards. A rise in the loan-to-value ratio often serves as a warning sign. However, in Brazil’s case, the loan-to-value ratio has remained broadly stable – reaching 71.5% in June. With few exceptions, buyers need to place a substantial down payment and cannot finance 100% of their home purchase.
The profile of borrowers should provide added comfort to those worried about a cascade of defaults triggering a housing crisis. Most of the financing is destined for first-time home buyers and only a small number of borrowers hold more than one mortgage. The average household devotes less than 10% of their annual income to servicing their mortgage debt, which is much lower than advanced economies. Meanwhile, the default rate on home loans in June reached 1.9% – in line with the 2.0% default rate registered at end-2011 and the lowest of any credit segment.