Construction To Catch Up With Housing Sector Growth In 2013
BMI View: Fundamental demand dynamics coupled with record low interest rates and continued growth in incomes will precipitate continued strength in Brazil ' s residential sector in 2013. Whilst cost pressures in 2011 had led residential construction to underperform the wider market in 2012, we believe tough adjustments have been made in many of the homebuilders, allowing for a revival in new projects from mid - 2013.
Brazil ' s housing market has belied the broader economic picture over 2012, with house prices, rent rates and mortgage lending increasi ng substantially over the year. However, housing starts for the year remained weak as homebuilders pulled back new projects as development costs pressures in 2011 weighed on profits and subsequently cash flow in to 2012 . Indeed, despite strong price rises at the lower end of the market, rising costs have forced homebuilders targeting this market to draw back their operations over 2012 as losses were made. Many have restructured their operations to move away from this end of the market, targeting the higher end, where prices are also seeing strong increases, demand is up, and margins are much more comfortable.
|Residential Construction Slows|
|Brazil Housing Starts, Units|
Cost Pressures Prompt Painful Adjustment
Significant building cost pressures over 2011 and into early 2012 led to a painful adjustment in the homebuilding sector. In 2011, Brazilian homebuilder Cyrela reported a 31.9% increase in the cost of residential real estate construction compared to 2010. These cost pressures, felt across the residential construction sector, saw margins squeezed and consequently reduced cash flow. Many of Brazil's largest homebuilders experienced steep declines in profitability, matched with rapid declines in share prices. Consequently, companies were forced into painful re-adjustments, pulling back in new launches, as they sought looked to offload existing inventory and rebalance their books. This precipitated a decline in residential construction over 2012, with housing starts down an average of 29% in the first 10 months of 2012, compared to the same period in 2011.
This trend was most notable at the lowest, or 'super-economic' end of the market, where profit margins are the slimmest. Many companies sought to reduce exposure to the lowest end of the market, and actively sought to target the middle and high ends. The best performing companies over 2012 have been those who have the least exposure to this segment. Cyrela is a case in point, with the super economic segment accounting for just 8% of pre-sales in 9M 2012, partially supporting the 21% increase in share price seen over the past year (to 17/01/2013).
|Cost Pressures Easing|
|Construction Value Added Inflation, %|
Cost pressures eased off significantly over the course of 2012. Cyrela reported just a 2.4% increase in the cost of residential real estate construction in the 9M12 (compared to 18.1% in Q112). Indeed costs have been falling sharply across the wider construction industry, where inflation fell to 0% in Q3 2012 compared to 8% in Q1. This has translated into improved profit margins across the sector, therefore more healthy balance sheets, and thus should enable a rebound in new projects in late 2013.
This trend further supports our outlook for a rebound in construction industry value growth in 2013, peaking in the second half of the year. Weak growth of 2.1% in 2012, as a result of failure to mobilise infrastructure projects and the sharp drop in housing starts should be followed by 5.7% in 2013, and 5.9% in 2014. Residential and non-residential construction in particular should rebound to 6.1% growth in 2013, following just 1.2% growth in 2012.
|Forecasting A Rebound|
|Construction Industry Value (By Sub-Sector) BRLbn (LHS), And Residential/Non-Residential Building Industry Value Real Growth (RHS)|
Demand Pushed Prices Higher
Whilst new residential construction projects have slowed substantially, demand for housing continues to expand. House prices have been on a meteoric rise over recent years. Between January 2008 and July 2012 average house prices in Sao Paulo and Rio de Janeiro rose by 144% and 178% respectively in nominal terms and this had fed through to rental prices which have become prohibitive for some. For the country as a whole, house prices were up 56.5% cumulatively over the two-year period to December 2012 according to the FIPE ZAP Index. In Knight Frank's latest Global House Price Index (for Q312), Brazil tops the list globally for the largest house price increases over the 12 month period, up 15.2%. However, there has been a definite slowing in this trend, 2012 house prices increased by an average of just 1% on a month-on-month basis compared to 2% in the year prior. A natural slowdown in prices is an encouraging sign when many were calling for a bubble in the real estate market.
|Growing, But Slowing|
|Month-on-Month House Price Gains, FIPE ZAP Index of Real Estate Prices|
Despite strong house price gains, we do not believe that Brazil's property market is facing a bubble. The demand fundamentals are strong, allowing for further gains. It is estimated that there is a housing deficit of 6 million households and this is expanding by 1.2-1.5 million per year. At the same time, the housing sector has been opened up to a greater portion of the population through government subsidised housing finance measures. This includes the 2mn unit second phase of the Minha Casa, Minha Vida housing programme (2011 to 2014), supported in part financially by FGTS, as well as the Housing Finance System, supported by Caixa Economica Federal.
Combined with this has been an expansion in personal incomes, as government measures to expand the middle class over the past decade have been successful. The growing pool mortgage applicants, coupled with repeated interest rate cuts over 2012 have been driving growth in the mortgage market. The Brazilian Central Bank has cut its benchmark Selic rate 525bps between August 2011 and November 2012 to a record low of 7.25%.
Whilst still accounting for only a small portion of GDP, mortgage lending has been increasing significantly over recent years. Steep rate cuts seen over 2012, contributed to a 42% rise in credit for housing in the first 11 months of the year, and we anticipate further growth in mortgage applications and lending in 2013, especially as the economy is expected to pick up. The health of lending to the sector is also strong, leaving room for further expansion. Non-performing loans in the housing sector are lower than the economy in general and, therefore, we expect banks to continue opening up credit for housing.
With considerable room for an expansion in mortgages, and significant untapped demand, we see a strong basis for growth in the residential construction sector, especially as cost pressures ease up.
|Housing Credit Healthy|
|Financial System Credit, Private Housing, BRLmn (LHS) And NPLs (loans in arrears of more than 90 days, % total portfolio) (RHS)|