Brazilian Real-Estate Bubble Seen Deflating Without Pop

By Christiana Sciaudone and Denyse Godoy

Brazil’s residential real-estate bubble may deflate slowly, not pop, as speculators abandon the market and builders such as Rossi Residencial SA (RSID3) sell off less profitable homes ahead of more lucrative sales.
Prices are leveling off this year, rising about one-third as fast as in 2011, when developers were offering homes due for completion now, according to data compiled by economic researcher FIPE and real-estate website Zap Imoveis. Short-term investors and some individual customers are backing away from their deals.
“We’re seeing an excess of new home deliveries, so the market is adjusting,” Rossi Chief Executive Officer Leonardo Diniz said in an Aug. 27 interview at
Bloomberg’s Sao Paulo office. “For investors to take on the risk, they have to see a high return, so they’re increasingly choosing other opportunities.”
The market adjustment may be good news for home buyers and builders, even after a government report showed on Aug. 29 that Brazil’s economy entered a recession in the first half of the year. Apartments are becoming more affordable as builders offer discounts. Clearing out the inventory of low-margin units should boost cash flow, paving the way for sales of more profitable homes, Diniz said.
Robert Shiller, co-creator of the S&P/Case-Shiller Index of home prices, broached the idea of a Brazilian real-estate bubble a year ago, telling a local audience, “I’m not investing in real estate.”

House Values

With home values doubling in Rio de Janeiro and Sao Paulo over five years, “what could account for that other than excitement?” Shiller, a Yale University professor, said at an event in Campos do Jordao. “I was saying these things in the U.S. during the bubble.”
By the time he spoke in August 2013, interest rates already had been rising since April. That has helped damp price gains, with increases in 2014 averaging 0.64 percent on a month-over-month basis. Three years earlier, the average was 2.3 percent for the same period.
Unmet housing demand and wider access to loans will ensure that buyers stay in the market, Cyrela Chief Financial Officer Eric Alencar said in an Aug. 28 telephone interview. The loss of speculative, short-term investors will keep prices more affordable for long-term and individual buyers, he said.
We expect prices to “increase with inflation,” Alencar said. “Credit is still strong with banks wanting more and more to finance their clients.”

Fixed Income

Speculators began to turn away from real estate to put their money into fixed income once policy makers began pushing up the Selic, as Brazil’s benchmark interest rate is known, according to Marcel Kussaba, the head of equity research at Quantitas Asset Management.
“The stake of speculators in the acquisition of homes in past years was underestimated,” he said in a phone interview from Porto Alegre, Brazil. “But now that the Selic is high, those investors prefer options with better returns than real estate.”
Policy makers are expected to keep the rate unchanged at 11 percent tomorrow for the third straight meeting after nine consecutive increases, according to economists surveyed by Bloomberg. The Selic had been reduced to 7.25 percent, a record low, in October 2012.
Even with Brazil’s economic contraction, unemployment remains at a record low while average income is still high, and that’s what matters most in the real-estate market, according to Raphael Juan, chief investment officer at BBT Asset Management in Sao Paulo.

‘More Solid’

“We may see a worsening in these indicators, but, since we’ve got a more solid basis in the country now, that shouldn’t be a matter of grave concern,” Juan said in a phone interview.
Unemployment stood at 4.9 percent in April, according to the national statistics agency’s most-recent data. Average real income was 2,028 reais ($903.06) in April, or about 14 percent higher than in January 2009.
Gross domestic product shrank 0.6 percent last quarter from the prior three months after contracting a revised 0.2 percent in the first quarter, the national statistics agency said Aug. 29. The second-quarter drop exceeded the 0.4 percent median forecast of economists surveyed by Bloomberg.
Investors aren’t convinced yet that the worst is over for Rossi. The company’s 33 percent drop this year is the most among Brazil’s 13 biggest builders. It also had the least cash among peers in the second quarter, according to data compiled by Bloomberg.

Cash Generation

While CEO Diniz’s strategy to focus on cash generation and the flight of speculators is positive for the market, it’s still too early for the stock to attract investors again, Quantitas’s Kussaba said.
“More stable demand is, in theory, good for homebuilders because they can plan the start of new projects considering a more realistic scenario and adapt costs and structure to that reality,” Kussaba said. “But Rossi is still very indebted and has to improve its situation before thinking of anything else. That’s the only way for it to continue advancing in the future.”
Rossi’s total debt is 122 percent of total equity, above the industry’s average ratio of 103 percent, data compiled by Bloomberg showed.
Chief Financial Officer Rodrigo Medeiros said more buyers will probably cancel contracts this quarter. The company is offering discounts on resold homes of as much as 35 percent, Medeiros said in an Aug. 28 interview with Diniz, helping Rossi work off inventory that’s weighing on margins.
Getting the older projects off the books will help, Medeiros said. Margins of projects started in 2010 are 34 percent compared with 39 percent for those beginning in 2013, according to Rossi’s second-quarter earnings report.
“We have 1 billion reais in stock that we’re aggressively pushing out,” Medeiros said. “It’s a priority to finish that inventory so, with the new projects, our margins can improve.”