Housing Rebound On Schedule, But Unlikely To Be Sustained
BMI View: Despite housing starts picking up as expected in the first half of 2013, the momentum behind the rebound has quickly dissipated. The major risk to our Brazil housing view has eventuated , with the country's central bank already hiking interest rates by 125 basis points over 2013 . We believe this will place downside pressure on any rebound through reduced demand for mortgages. The country's largest homebuilders are reporting mixed new launch data, despite undertaking tough restructuring measures which were aimed at improving profitability. Consequently, we believe that the recovery in the housing sector is unlikely to be consistently sustained at current rates.
Brazil's housing market has belied the broader economic picture over the past 18 months, with housing prices, rent rates and mortgage lending increasing substantially. However, residential construction has not felt the benefits, with housing starts weak in 2012. Homebuilders had pulled back from new projects as development cost pressures in 2011 weighed on profits and subsequently cash flow in 2012. In 2011, Brazilian homebuilder Cyrela reported a 31.9% increase in the cost of residential real estate construction compared to 2010. Indeed, despite strong price rises at the lower end of the market, rising costs forced homebuilders targeting this market to draw back their operations over 2012 as losses were made. This precipitated a decline in residential construction over 2012, with housing starts down an average of 37% year-on-year (y-o-y) in 2012.
Cost pressures eased off significantly over the latter half of 2012 and have continued to compress in 2013. Costs have been falling sharply across the wider construction industry; inflation averaged just 3.1% for 2012, compared to 8.2% in 2011 and in Q113 deflation was reported (-1.9% y-o-y). This should translate into improved profit margins across the sector and more healthy balance sheets. Cyrela reported just a 2.4% y-o-y increase in the cost of residential real estate construction in the 9M12 (compared to 18.1% in Q112), and reported a 20.5% y-o-y decline in costs in Q113. This improvement in financials should filter across the residential construction sector, and help improve profitability and new project launches. It should also help see a revival in the lower end of the market as many of the housing launches reported in Q213 are for that segment.
|Cost Pressures Easing|
|Construction Net Output Inflation, %|
With costs easing significantly in late 2012 and into 2013 , and homebuilders undertaking restructuring measures, we had highlighted the potential for a rebound in new housing activity in 2013 ( see ' Housing Rebound From 2013 ' , April 16 ). New launches (as reported by the country's homebuilders) were promising in Q113 . Overall housing starts were up 115% y-o-y in the first four months of 2013 (compared to the same period in 2012), and increased over 150% y-o-y in March and April. This trend is closely in line with our view for the housing sector to show signs of recovery in 2013.
Cyrela, the strong performing home builder in Q113, managed to sustain this growth trend into Q213, reporting a 37.3% y-o-y increase in new launches in H113. However, new launches, an indication of the future health of the market, have been inconsistently reported in Q213. MRV reported a 19% y-o-y decline in new launches in the first half of 2013, whilst Gafisa saw a 24% y-o-y drop.
Rossi Residencial has been one of the worst performing homebuilders; its share price is down 31% over the past year (to 16 July 2013). The company announced a new strategy in April 2013 which includes decreasing its exposure to low income housing, and focusing instead on the higher end of the market, and concentrate its presently extensive geographic exposure on a handful of larger cities. This should bode well for the company's ability to rebalance its books. However, we believe it adds additional near-term uncertainty to any recovery in homebuilding as the company's strategy of focusing on profitability saw no launches in Q113.
PDG Realty, on the other hand, is taking a slightly different approach following its poor fourth quarter results where it reported a loss of BRL1.8bn and BRL1.4bn in cost overruns, and an 80% reduction in new projects. The company which was the largest homebuilder in Brazil in 2011 following a rapid expansion, is now pursuing a three-year recovery plan. The strategy includes focusing on fewer cities, the low and middle income housing segment, as well as cutting the volume of new units over the near term - aiming to launch between BRL5bn and BRL6bn housing per year compared to a peak of BRL9bn in 2011. This is a much riskier strategy, and the market has not responded favourably to this. PDG Realty's share price was the worst performing stock among the major homebuilders, with a 42.4% decline seen over the last year.
|Seasonal Rebound Running Out Of Steam|
|Brazil Housing Starts|
In addition to mixed data regarding new construction, we remain concerned about the impact of rising interest rates on demand for mortgages.
Mortgage applications and approvals could see a marked slowdown as the Central Bank has entered a hiking cycle in an attempt to target rising inflation. Already in 2013, we have seen 125 basis points of hikes, and our Country Risk team anticipates a further 75 basis points increase before the end of 2013, bringing the interest rate to 9.25% by the end of the year. This increase in the interest rate has already filtered through to the banking sector, with lending rates increasing over the first six months of the year in reaction to, and anticipation of, hikes.
|Housing Credit Vulnerable To Interest Rate Hikes?|
|Financial System Credit, Private Housing, BRLmn (LHS) And NPLs (loans in arrears of more than 90 days, % total portfolio) (RHS)|
The mortgage market has been growing exponentially in line with housing price growth. Between January 2008 and June 2013, average house prices in Sao Paulo and Rio de Janeiro rose by 174.5% and 216.2% respectively in nominal terms, and this had fed through to rental prices which have become prohibitive for some. Based on data from FIPEZAP, house prices across Brazil are, on average, up 11.6% over the past year and this rate of growth is outpacing inflation (house pricing data on a country level is only available over 2012 due to methodology adjustments). In Knight Frank's latest Global House Price Index (for Q1 2013), Brazil had slipped to fourth spot for house price increases over the 12 month period and this is due to a slowdown in the rate of increase in prices. Although housing prices are up 12.2%, the rate of increase is definitely slowing, with just 2.7% growth seen on a q-o-q basis.
|Prices Outstrip Inflation|
|Brazil Average: Month-on-Month House Price Change And Inflation|
Even though interest rates are rising , there is still a lot of pent up demand for housing in Brazil. As such , there is room for further expansion if financing for housing is available. Consequently, residential building activity is most likely to be seen at the lower end of the market as cost pressure ease and the government continues to provide subsidised capital. It is estimated that there is a housing deficit of 6mn households and this is expanding by 1.2-1.5mn per year. The second phase of the Minha Casa, Minha Vida housing programme (2011-2014) is expected to develop 2mn housing units and is financially supported by FGTS, as well as the Housing Finance System (which is financed by Caixa Economica Federal). Thus far, the government has only invested BRL46.3bn on the programme under the second growth acceleration plan (PAC II 2010-2014); however, a total of BRL224.4bn is expected to be spent in 2014, thus there is significant room for expansion at this end of the market.