The world economic crisis got its start due to housing speculation. My BBS colleague Ricardo Torres and I have been considering what is going on in the local housing market here in São Paulo. Here are some of our thoughts.
Housing markets in major world capitals are living through a depressed period resulting from the crash and recession that started in 2007. Prices of residences in New York, London, Paris and other major world cities have tumbled and are proving very slow to recover. This contrasts sharply with the stock and other capital markets in these centers, which recovered rather rapidly (until 2 weeks ago).
In São Paulo and other Brazilian cities, the housing market has been expanding during this same period and so far continues its growth as demand rises and supply is slower to respond. However, as with all economic trends, at some point, a serious correction will come.
Housing prices go up and down for a variety of reasons related to demand factors such as the availability of financing and increases in family income, others related to the perception of housing as an investment and still others related to ability of the housing industry to supply product.
Demand factors first. For the first time, Brazil has developed a viable housing finance system, parallel to the housing finance system in use in North America and Europe. Consumers can take out loans secured by the residence they occupy in large numbers for the first time in Brazilian history. The legal impediments that previously reduced the ability of a lender to foreclose on a property have largely been removed. This has opened significant lines of credit, especially through the Caixa Econômica, that is enabling Brazilians to buy residences with borrowed funds with reasonable payments. This is particularly opening opportunities for the emerging and rapidly expanding Classe C market and increasing demand throughout São Paulo and other urban centers.
Second, there is a high degree of confidence in the Brazilian economy, both within and outside the country. Brazil did suffer a recession in 2008, but it was much more the marolinha that President Lula predicted than the tsunami that most analysts feared. Family income has continued to grow and unemployment in São Paulo is at historically low levels. This obviously creates more demand for units and for a “succession” effect. Families throughout the region want to improve their living situation. Thus, families seek both “better” neighborhoods and larger units. The pressure on prices moves them steadily and rapidly upwards. An informal survey of brokers in Jardins, Higienópolis and Morumbi indicates that, in these bairros, prices may have as much increased by 50% in the past year.
With the emergence and rapid growth of an emerging middle class ("Classe C" in local parlance) in São Paulo, the pressure to trade up increases. Previous residents of Mooca, Vila Leopoldina, Vila Romana and other similar bairros seek larger units in more prestigious neighborhoods. The owner of a sobrado in these neighborhoods happily sells to an incorporadora and opens an opportunity for families in Classe C.
Perhaps because of the demand pressures, Brazilians’ understanding of the nature of housing is changing as well. A family’s principal residence is a special type of asset. Families have tended to remain in their houses for many years focusing on creating a stable environment for the growth of their children. This period may extend for multiple generations. However, the experience in other countries is being repeated here now. We are starting to view housing not as a special kind of asset that we do not trade like a share of stock, but rather as fungible with all our other investments. We are starting to see people “flipping” housing units, rapidly buying and re-selling units to either trade up or invest a portion of the proceeds in other types of assets (stocks, fixed income investments). This is a dangerous indication that we are entering a speculative “bubble” that parallels the experience in property crashes in the United States and Europe and can only end in tears.
A further contributing factor to this bubble trend is that investors are beginning to see housing as a viable alternative investment to organized capital markets. There have always been investors who have focused on housing units and who live from the rental proceeds of these units. An increasing number of investors today in São Paulo view housing units as investments that should be bought and sold rather than held for the long-term. They look at housing units in terms of short-term appreciation in value and sell on these terms. This behavior as well contributes to a speculative mentality that will destroy wealth in the long run rather than create it.
Prices are rising as well because of limits on supply. The most obvious supply limit is land availability. Jardins and Higienópolis, for example, have little land remaining that can be developed for apartments. This makes these remaining parcels very valuable and expensive.
As well as the price of land, construction necessarily lags far behind demand. From the time a developer obtains a parcel, designs a building, obtains approvals and can initiate the sale of units, a period of 1 to 3 years can elapse. Then, there is typically a two-year construction period before the units can be occupied. This time lag, in itself, creates pressure on prices. Thus, the delay between the time that consumers perceive the value of a neighborhood until the time that developers can deliver units puts an increased price pressure on the existing units that goes beyond the scarcity factor. This too represents a speculative pressure on prices.
Finally, the situation of new housing construction is only going to get worse over the next decade. TheWorld Cup, the Olympics and the PAC II (President Lula's development program, Mark II) are all predicted to create severe shortages in construction materials. The ability of the building materials industry expects to double in size between now and 2016. However, this increased demand for materials for these special programs and for infrastructure development will put further price pressures on residential construction. This has already been reflected in significant increases in the IPCC, the construction price inflation index.
We believe that the current housing situation in São Paulo, and possibly in other capitals, shows signs of a speculative bubble due to these pressures. And, like all bubbles, it will burst at some point. At that point, who will reap the whirlwind?
