rics.org/journals

Residential Property Journal

January-February 2011

Focus on the private rented sector• Tenancy deposit protection update • Rental valuation for buy to let •

• HMOs and council tax • New local authority/PRS partnerships •

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14 Residential Property Journal January-February 2011

Developing world

Building BrazilWith its growing economy and high level of urbanisation, Brazil is experiencing a residential property boom,

assisted by some innovative methods of financing homes for low-income households. Manoj Chawla explains

razil is a country and a market that is probably unfamiliar to manypeople, except for the usual associations of carnival, football andbeautiful beaches. However, Brazil is increasingly gaining

importance and visibility as its economy grows. The fact that it is hostingboth the football World Cup and the Olympics within two years of eachother (2014 and 2016 respectively) is another indicator of its growingconfidence and international credibility on the world stage.

The largest economy in South America, Brazil is also the 8th largest in the world since overtaking Spain and Canada in terms of GDP, and is expected to overtake the UK economy by 2025. The Central Bank ofBrazil and the World Bank forecast real growth of at least 5% in 2010.

B Foreign investment did slump badly when Brazil was finally hit by theglobal financial crisis in 2008, but it was one of the first emergingmarkets to recover. While residential property markets remain underserious strain in the US, UK, Spain and Ireland, Brazil is undergoing aperiod of rapid expansion in this sector. Reduced poverty levels and a growing and increasingly affluent middle class are contributing to thisboom. It was estimated that between 1m and 1.2m new homes wouldbe constructed in Brazil in 2010 alone. The housing deficit is estimatedto be more than 8m houses.

Snapshot of the economyBrazil is the 5th largest country in terms of land and population and,although currently the 8th largest economy in terms of GDP, is forecastby Goldman Sachs to become one of the top five by 2020.

The economic indicators show a country whose solid economicgrowth is backed up by benign inflation rates hovering between 4% and 6% (4.49% in August), strong consumer spending/confidence andinterest rates at an historic low. The Brazilian base rate, the SELIC (theCentral Bank’s overnight lending rate), is 10.75%, compared to anaverage of 17.22% from 1999 to 2010.

The positive fundamentals include practically no government deficit, a credible central bank, a stable political situation and more than $220bnin external reserves, which means the economy is well cushioned. Whileno economy is immune from a global downturn, it would be fair to saythat Brazil is relatively well placed.

Brazil also has strong employment growth, with 1m jobs likely to becreated this year. Unemployment has dropped from 12% in 2002 to arecord low of 6.9% in July 2010, having averaged 7.4% for the first halfof last year. This is lower than both the US (last 12-month average:9.8%; 9.6% for the month of August 2010) and the UK (average for thethree months to end August 2010: 7.7%). There are major governmentprogrammes to develop infrastructure (ports, roads, rail, etc), reducepoverty and increase home ownership, all of which should help the

Figure 1: GDP expectations for Brazil and the UK in 2010

World Bank Estimate 2010 Brazil UK

1. Nominal GDP (US$ billions) 1,879.3 2,157.8

2. Population (millions) 198.2 60.7

3. GDP per capita, current US$ 9,481.0 35,542.0

4. Real per capita GDP growth 5.3 1.2

5. US$ Fx rate 1.8 0.7

Anecdotal evidence has shown that investor interest has increased300% over the last five years. At a global level, investors on the scale of the billionaire real estate entrepreneur Sam Zell, the US’s largest public pension fund, CalPERS, and US-based real estate investmentcompany Hines are investing heavily in and profiting from the Brazilianreal estate boom.

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January-February 2011 Residential Property Journal 17

Developing world

Related competencies include: T041, T069

Free marketThe free market is funding contracted at market rates, typically higherthan the SFH interest rate. It has two components: (i) the bank’s own portfolio(ii) 20% of the 65% of savings account deposits allocated to the

residential mortgage system. The free market provides funding forresidential and commercial properties, mainly at the upper end of the market.

Although much smaller than the SFH, the free market has also beenexpanding, with loans to individuals totalling R$2.8bn in May last year, up 51.1% on the same month the previous year. These loans have beenposting year-on-year growth above 29% since April 2007 (above 34%except for the month of December 2009, at the height of the globalfinancial crisis).

Real Estate Financial System (SFI)The SFI was created in 1997 to regulate the acquisition andsecuritisation of real estate credits and ensure the market was strongenough to sustain all funding needs in the long term. Whereas SFH isessentially a government scheme, the SFI can operate as a privatesystem similar to the system in the US. The most important innovation ofthe system was the creation of securitisation companies: entities that

on entry-level, low-income residential housing and implementingsubstantial subsidies, increasing the state-owned banks’ exposure to the property sector and reducing paperwork and other legal constraints.

As a consequence of this three-stage process of change, thelandscape of the property market looks completely different today. Foreigninvestment is a daily reality, with large institutional players having directexposure to the market, while house prices have adjusted materially inresponse to the improvement in affordability. Until 2005/2006, loan tovalue was just 40% to 45% and maturities up to 15 years; nowadays70% to 80% and maturities of 25 to 30 years are the norm.

The total volume of constructions under way at any one time, andconsequently the importance of the sector in terms of overall economicgrowth, has increased. The size of the players has also changedmaterially. Prior to the wave of listings, most companies were familyowned. Increasingly, the listed companies are expanding nationallythrough partnerships. They are also expanding their project pipelines to meet shareholder expectations of top-line growth. The marketcapitalisation of listed property-related stocks was just R$12bn (£4.5bn) in 2007, compared to R$80bn (£30.2bn) now.

This growth phase has been led by homebuilders, with mall operators(developers who also manage the properties) slightly behind them. Morerecently the rest of the property segment has been gaining relevance and sophistication. But the reality is that lending to property companies

issue a new type of mortgage-backed security, the CRI (Certificates ofReal Estate Receivables).

CRIs are used by companies to get new credit on the back ofdelivered receivables. They are the securities that will most likely gain inimportance in the sector in the medium to long term as a new source offunding. All real estate companies have large accounts receivable ontheir balance sheets. In the current market, homebuilders havesucceeded in selling their receivables at par value, and in general theyield is equivalent to the IGP-M inflation index (Brazil’s broadest measureof inflation) plus 12% per year.

Overall perspectiveThe Brazilian real estate market acquired a more mature, formal andinstitutional framework in 2003/4 when: • developers and commercial banks started to believe in the

effectiveness of the new regulatory framework, specifically the ability oflenders to repossess assets on delinquent loans

• banks started looking for the creation of long-term assets, such asmortgages, once the healthy macroeconomic fundamentals andconfidence in political stability began to take effect.

At the same time, capital markets became more interested in the realestate sector. This led to a wave of developers and property companieslisting their stocks on the Brazilian stock exchange, Bovespa, whichresulted in US$15bn (£5.7bn) being raised between late 2005 and mid-2007. The new capital, plus the more professional management andtransparency that comes with listing, boosted motivation to meetcustomer needs and grow the market.

The 2007/2008 global financial crisis actually acted as a spur to themarket, thanks to the federal government taking an aggressive stance

is still very limited, short term (around 10 years) and relatively high cost at interest rates of 10-14%. (The exception is the mall segment, where locally owned companies can access Brazilian Development Bank finance.) As a result, there is no speculative development;everything is built to order. This means that there are no ready-madeempty properties to buy.

Valuation of property is still very subjective in Brazil. Propertycompanies tend to hire the same consultancy company to evaluate their properties, undermining the credibility of valuations. For their part,banks have not developed very sophisticated valuation methodsbecause relatively few properties are financed and loan to value ratios are low. In many cases, there are few ‘good’ comparables, and thebanks focus simply on expected cash flows and to what extent they will cover the interest rate and notional repayments.

As Tomás Awad (previously equities strategist at the Brazilian bankItaú, now a partner in Landix Real Estate Investments) explains: “All in all, the Brazilian real estate industry is in its early- to mid-stage ofdevelopment, and this is very clear when we look at the valuationmethods being applied, as well as the financial tools available. But weshould expect the evolution of the market to track what happened in alldeveloped markets; there are no significant legal or market constraints to limit it.”

Manoj Chawla is MD of Alexander Richards Ltd, a UK-based consultancy

focused on consultancy and asset management in Brazil

manoj@alexanderrichards.co.uk

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Developing world

• target of 1m homes by the end of last year • unemployment protection scheme • mortgage rates of 5-8% provided by the federal state bank Caixa

(from domestic savings)• LTV of 50%-100%• exemptions/reductions in property taxes.

Property valuations In Brazil, there are few RICS chartered surveyors and there is nonationwide source of data. Historically, valuations were relativelyunimportant because there were few mortgages, lending againstproperty was limited and many properties were self-built.

Valuations for tax (stamp duty) purposes (IPTU – Imposto predial eterritorial urbano) are unreliable, as they are often carried out separatelyand may bear no relation to the sale price of a property. Valuations forbanks are provided by private companies, with build quality, location(especially in relation to poor areas and slums), infrastructure provisionsuch as water, electricity and sanitation, title documentation, securityfrom crime and affordability taken into consideration.

As the market evolves, it will become more formal and institutionalised.The country’s first database of commercial real estate valuations was due to be published at the end of last year and a database of residentialvalues is in the preliminary stages.

These changes have resulted in a great leap in lending activity in the residential sector. Loans were expected to total R$136bn (£51bn) by the end of last year (2010) and to rise to R$455bn (£172bn) by 2015.

Funding mechanismsFunds for mortgages are obtained mainly through the government-subsidised and guaranteed Housing Finance System (Sistema Financeirode Habitação, or SFH) funded by private savings. The free market isanother source of finance, used primarily by middle and upper-incomehouseholds. In 1997 a new, parallel system was created, the Real Estate Finance System (Sistema Financeiro Imobiliário, or SFI), which isincreasingly important as a source of funding for commercial, rather thanresidential, development.

The Housing Finance System The SFH is the government-regulated mortgage system, designed to promote the construction and purchase of residential properties,particularly in the low-end sector. The interest rate is capped at 12% p.a.and amortisation periods vary between 15 and 25 years. The resources for this system come from: (i) the Brazilian Severance Pay Fund (FGTS)(ii) savings deposits.

The mortgage marketMortgage lending in Brazil is low: 2% of GDP in 2004 (compared to 86%in the UK, 66% in the US); perhaps 5% today. The background to this isBrazil’s 40-year battle with inflation, which culminated in a period ofhyper-inflation between 1980 and 1995 when inflation hit 2,076% (1994).Accumulated inflation between 1961 and 2006 has been estimated by some economists at 14,200,000,000,000%, or 14.2 quadrillion. In such catastrophic conditions, many borrowers withheld payment ofboth principal and interest on the grounds that interest charges wereunreasonable. Meanwhile, a weak regulatory framework meant it tooklenders up to seven years to foreclose. It also allowed developers whogot into trouble with one development to bail themselves out by usingthe finance from others, which spread the contagion and put otherbuyers at risk.

Since that period, the regulatory framework has been put in place toprotect the rights of both lenders and buyers. In 2003, changes to realestate guarantees gave lenders much more security and motivation forlending by withholding ownership from buyers until they had paid off their mortgages in full. At the same time, the foreclosure process wasspeeded up, so that a bank can now sell a property before eviction andthe borrower is responsible for paying taxes and fees until foreclosure.Furthermore, since 2004, the principal debt has been uncontested andmust always be paid, and the interest payment, if it is contested, is heldby the courts.

Since 2002, all developments in Brazil have had to be carried out asseparate entities, or ‘special purpose companies’, so that, in the event ofthe developer going bankrupt the project, funding and all the assets canbe taken over by the Development Commission and the investors areprotected. This prevents developers from using the funds from onedevelopment to complete another.

The FGTS is made up of mandatory contributions by employersequivalent to 8% of their payrolls and is managed by Caixa bank. Each employee on the payroll has an individual account and the right to withdraw money to cover certain situations, such as retirement,illness, unemployment and the purchase and renovation of property.Withdrawals totalled R$47.8bn in 2009 (R$15.7bn in the first fourmonths of last year), of which R$5.7bn (11.9% of the total) was relatedto the purchase and renovation of properties.

To be eligible for finance through the FGTS, a homebuyer must bebuying a newly-finished home, or building a home, to a maximum valueof R$80,000 (£30,160) – R$130,000 (£49,000), depending on the citywhere the unit is located. The buyer must also contribute at least 5% ofthe unit price. In the case of units already built or under construction, theunit price cannot exceed R$500,000 (£188,500) and financing is limitedto 90% of the unit price.

Further, the homebuyer must live in the city where the property islocated, have contributed to the fund in the last three years, and not own another property in the same city.

Unemployed individuals also have access to the FGTS for theacquisition of a property, on condition that they reside permanently in the city where the property is located, have no other property in thesame city, and have funds deposited in the FGTS from periods of employment in the past.

Savings deposits contribute to the SFH through a central bankrequirement that 65% of all private savings in commercial banks are allocated to the residential mortgage system – 80% to the SFH and 20% to the free market – to finance loans to homebuyers and homebuilders. For loans obtained outside the SFH, banks are free to set contract conditions, such as interest rates andamortisation terms.

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economy grow. Other positive factors include:• strong domestic demand for housing and other real estate • significant redistribution of wealth (e.g. new car sales growing at 25%

p.a.), with a growing number of people climbing out of poverty thanksto government redistribution measures

• the prospect of the World Cup and the Olympics putting the focus on Brazil and further boosting foreign direct investment.

The middle class is growing and poverty is declining. The formerincreased from 42% of households to 52% between 2004 and 2009,while poor households decreased from 43% to 33% of households in the same period. The top income group grew from 12% to 16%.Mortgage and consumer debt is low (less than 5% of GDP) and thebanking system is conservative and well regulated, which has helped the country stage a rapid recovery from the financial crisis experiencedby so many developed countries.

Raw materials are another of Brazil’s strengths. The country is self-sufficient in oil and is the world’s second-largest producer of ethanol. The Pre-Salt find in 2007 is thought to have made Brazil the 5th largestoil-producing country. The Santos Basin is estimated to contain 2bnbarrels of recoverable reserves. It also has vast reserves of iron ore and other minerals.

With 25% of the world’s arable land (half of it unused), excluding therainforest, Brazil is an agricultural superpower: the world’s number oneproducer of tobacco, sugar, oranges and coffee; producer of 85% of theworld’s orange juice concentrate and the world’s largest exporter of beef,chicken, green coffee, sugar, ethanol, tobacco, and the ‘soya complex’of beans, meal and oil.

The housing marketBrazil has a high level of urbanisation. According to governmentstatistics, urbanisation increased in the 60 years between 1940 to 2000 from 30% to 81% – higher than most developed countries.

A survey conducted by the business school Fundação Getulio Vargasreported that the construction industry supply chain represented 13% ofthe Brazilian GDP from 2000 to 2005. However, Brazil’s total investmentin housing has not been sufficient to meet the country’s housing needs.According to data compiled by the São Paolo State Housing Syndicate(Secovi-SP), there was a shortage of around 7m units in 2000, and asubsequent report by the official statistical agency Fundação JoãoPinheiro showed the figure unchanged in 2005. More recent estimatesput the shortfall at 8m units. Unsurprisingly, the deficit is mainly in themiddle- and lower-income housing segments.The main drivers forproperty development are strong macro-economics, favourabledemographics, pent-up demand, an improved regulatory framework,favourable capital markets and a positive political climate.

Affordable housing The Brazilian government announced its R$34bn (£12.8bn) housing planMinha Casa, Minha Vida in March 2009, with the intention of reducingthe housing shortage in Brazil by 14% and stimulating the nationalconstruction industry. Most of the measures were concentrated in thelower-income segment, limited to families earning up to 10 minimumwages (MW), or R$4,500/month (£1,696), but mainly focused on thosebelow 6MW (R$2,700/month or £1,018). Programme highlights are:• initial government budget of R$34bn (£12.8bn), and up to R$23,000

(£8,671) per home

Source World Bank 2008 2009 2010e 2011e 2012e

1. Nominal GDP (US$ billions) 1,612.6 1,511.3 1,879.3 2,125.1 2,184.0

2. Population (millions) 193.9 196.1 198.2 200.3 202.4

3. GDP per capita, current US$ 8,314.8 7,705.5 9,481.0 10,607.7 10,788.7

4. Real per capita GDP growth 3.9 -1.3 5.3 3.4 3.0

5. US$ Fx rate 1.8 2.0 1.8 1.8 1.9

Figure 2: World Bank growth forecast for Brazil. Below: The skyline of Brazil’s largest city, São Paolo

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