Real Estate, Credit, and the Emerging Middle Class in Peru

Peru’s real estate market has experienced explosive growth over the last decade, with new construction springing up throughout the country and prices rising quickly. Several factors have contributed to this phenomenon.

The first is obvious. Peru’s unprecedented economic growth – approximately 7% annually over recent years – has facilitated the emergence of a robust middle class with increasing disposable income. According to the Inter-American Development Bank (IADB), the percentage of Peruvians considered “middle class” doubled to 70% of the population between 2005 and 2011. And according to Peru’s socioeconomic level system — a widely accepted scheme for classifying the socioeconomic demographics of the nation’s population, with segments ranging from A to E — the middle-class population is represented by strata C and D. In addition to experiencing strong growth, this new middle class has enjoyed increased purchasing power through newly attained disposable income. For example, average monthly earnings for the Lima metropolitan area climbed by 41.8% between 2003 and 2010, with much of this increase concentrated in segments C and D.

Second, while the demand for housing has expanded vigorously, the supply has fallen behind. Peru faces a significant housing deficit, particularly in its urban areas. Lima’s population exploded from about half a million people in 1945 to about nine million today. Peru’s population is concentrated in the typical age of a first-time home buyer – about 26.5 years. Given these factors, the country  faces a projected shortage of 1.9 million housing units in the short term.

Third, the unprecedented macroeconomic and political stability has enabled families to adopt a more long-term view of the future and encouraged them to make longer-term investments in housing. According to Alberto Pascó-Font, general manager of Enfoca Inversiones, the investment division of the Peruvian private equity firm ENFOCA, Peruvians who enter the emerging middle class tend to focus their discretionary spending on three main areas: housing, health, and education. Of these, the lion’s share of spending has been devoted to housing improvement and acquisition, suggesting that these consumers seek to significantly invest in their future in order to consolidate their status as part of the middle class over the long term.

The unprecedented macroeconomic and political stability has enabled families to adopt a more long-term view of the future.

The financial sector, however, is not living up to the higher expectations of the middle class. Access to credit among the emerging middle class in Peru remains very low as banks have focused traditionally on the small high-income segments of the population. In recent years, a number of innovative new financiers have entered the Peruvian market and have begun to provide mortgages and other financial products to the new middle class, further driving real estate growth (and prices) in Lima. Peruvians have reacted to the various bottlenecks in creative ways, of which the self-construction and pre-fabricated housing markets are the most important.

Self-construction and the New Middle Class

Home ownership and urban development in Lima have taken place as a process of progressive formalization of the housing stock. According to Hernando de Soto, a prominent Peruvian economist, the informal settlements that burgeoned in Lima throughout the last seven decades were developed as inhabitants occupied a parcel of land, constructed a dwelling, and only then attempted to obtain a formal deed for the land or house. Over the years, much of the housing stock in the peri-urban areas of Lima was built on informal “invasions,” which were then formalized, and its inhabitants were eventually granted access to basic services. Areas that were once home to the city’s poorest now house the city’s emerging middle class, who live in “formalized” areas; the poorest, particularly rural migrants, build in more precarious spots, predominantly in the marginal areas on mountainsides.

Peruvians in the lower- and middle-income segments have traditionally constructed their own houses. This generally involved a multi-year piecemeal process, given the lack of access to credit, as families saved money to purchase construction materials. According to a May 2013 article in the newspaper La República, 60% of homes in Peru are constructed by owners, representing about 3.6% of GDP, or US$2 billion annually. Even within metropolitan Lima, nearly 60% of the territory comprises “invasions” or informal settlements, which has created a state of permanent construction as these homes evolve. Despite rising incomes, the majority of Peruvians in the lower-middle classes still build their own homes. This continued self-construction trend, paired with rising middle-class incomes, has created a robust market for construction materials.

A number of companies have begun to capitalize on this emerging opportunity set, with three large home-improvement retailers, in particular, expanding to address this demand in lower-middle-income areas in the peri-urban areas of Lima. For example, Maestro, a local chain of home-improvement stores that traditionally served higher-income segments, has expanded exponentially in the last six years to serve low- and middle-income neighborhoods. Competitors Sodimac and ProMart have experienced similar growth by offering a wide range of products for home self-construction or improvement, including appliances, cement, tile, and plumbing materials.

Not only have these businesses widened their focus to include the middle-class strata, but they have also adjusted their services, now offering credit to lower-income customers through store-branded credit cards, such as Sodimac’s CMR card and Maestro’s Presta card. The presence of these credit cards is notable in that it allows households to speed up the self-construction process – which historically took years — promoting greater spending on construction materials in the short term.

Similarly, select construction-material brands that are popular among lower-income segments of the population have extended financing schemes to their self-construction consumers. ProgreSol, for example, has traditionally been the retailer of choice for low-income households in the self-construction market through its network of small hardware stores in low-income neighborhoods. To capitalize on increased construction spending, these stores have initiated new financing programs targeted at self-constructors.

HatunSol, a lending program that provides credit to purchase materials through a group of cement providers, offers free delivery, design services, and technical support. According to Gena Pepoli, professor of marketing at the Universidad del Pacífico, this program positions itself explicitly in its advertising campaigns as a substitute for the pollada bailable, a traditional party thrown by poor households to raise money to construct their houses. She suggests that it is not trying to replace traditional construction techniques but, rather, to facilitate the purchase of construction materials through financing.

To capitalize on increased construction spending, these stores have initiated new financing programs targeted at self-constructors.

The Peruvian government itself has recognized the importance of the self-construction phenomenon by providing subsidies and a government lending program for financing self-constructed homes. As part of the Fondo MiVivienda (My Home Fund), two subsidized lending programs — TechoPropio and MiConstruccion (My Own Roof and My Construction, respectively) – are helping lenders extend credit to lower-middle-income households to build or expand current housing stock themselves. In addition, a new program, MisMateriales (My Materials), specifically underwrites the purchase of new construction materials.

These credits are provided through either municipal cajas (banks) or other registered financial entities. As such, these programs are facilitating rapid access to construction materials for wide swaths of the population who previously had to save for many years to build or improve their housing, fueling consumer-credit growth and increased sales among home-improvement retailers.

Mortgages and Low-income Housing Developments

While self-construction continues to be an important phenomenon on the Peruvian landscape, a new real estate trend has emerged among segments C and D as a growing number of households move away from self-constructed housing into prefabricated homes with the aid of traditional mortgages.

The emerging middle class has generally been excluded from the credit system. Historically, 95% of mortgages have been disbursed to households in the upper-class segments A and B through large banks, such as Scotia and Interbank, due to stringent credit requirements that require formal employment. Mortgage products had been poorly suited to the unique needs of households in the emerging middle class, and the large percentage of the labor force in the informal sector had also faced a barrier in seeking formal financing.

With mortgage penetration in Peru at just 6%, a number of players have begun to recognize the potential value of the middle-class consumer within the credit arena. The government itself has acknowledged the critical constraints posed by a lack of access to credit and has established a number of government funds, most notably the Fondo MiVivienda, to underwrite mortgage risks, provide guarantees, and subsidize mortgages for lower-income Peruvians. These subsidies and guarantees are disbursed through qualifying financial institutions and have aided substantially in improving the supply of low-income housing developments and facilitating access to mortgages for new home buyers.

One of the prime implementers of these government programs is miCasita Hipotecaria, a private company founded in 2004 by Roberto Baba Yamamoto with the goal of filling the credit-access gap for the middle class. MiCasita is one of the first financial institutions to specialize in mortgages in Peru, with the specific goal of meeting demand from lower-middle-class households. The company offers various financial products, including mortgages for housing acquisition and for housing improvement, targeted specifically toward customers in the emerging middle class. Its most popular product, Credito Hipotecario Nuevo MiVivienda, is guaranteed and subsidized by MiVivienda, demonstrating the extent to which Fondo MiVivienda is stimulating Peru’s mortgage market.

Will increased credit consumption help Peru remain [a] shining star … or will it prove to be a systemic risk, as it was for so many advanced economies at the onset of the financial crisis?

In addition, miCasita works closely with small-scale real-estate developers to finance their projects in lower-middle-class areas. It also serves as the mortgage provider for the eventual home buyers in the real estate developments it finances. As Yamamoto notes, “these credits have fomented the growth of pre-fabricated housing for lower income segments and further facilitated access to credit for these first-time home buyers.”

Similarly, Los Portales is a large real-estate developer that has developed apartment complexes throughout Peru, targeted historically toward high-income consumers. In recent years, it has developed a series of products for lower-income consumers, drawing on the Fondo MiVivienda subsidies. Under these programs, Los Portales builds large neighborhoods of small and relatively simple units in the peri-urban areas of Lima and provides mortgages directly, underwritten by the governmental programs. These developments, among others, are revolutionizing the social and economic behaviors of the members of these segments who are moving from formalized settlements into planned neighborhoods in the same areas.

What’s Next?

In many ways,Peru has become a poster child for strong economic growth, not only within Latin America, but also globally, given its significant reduction in total poverty and the undeniable expansion of its middle class.

When it comes to credit, a key question remains: Will increased credit consumption help Peru to remain the shining star it has become or will it prove to be a systemic risk, as it was for so many advanced economies at the onset of the financial crisis? Rosanna Ramos-Velita, co-founder and chairperson of the board of Caja Rural Los Andes, a Peruvian microfinance firm, points out that a major risk associated with the growth of credit in Peru is that the emerging middle class will assume too much debt and fail to pay it back. MiCasita is just one part of a trend in significant credit consumption in Peru, one that has represented a more than 800% growth in mortgages and consumer credit between 2002 and 2012. With bank credit growing at an annual rate of about 20% in Peru and the price per square meter for apartments in posh Lima districts doubling since 2007 in constant Nuevo Soles, it is hard not to wonder whether Peru is on the brink of a credit and housing boom.

The jury is still undecided in this debate. On one hand, experts, such as economists at the International Monetary Fund, have noted that strong credit growth in Latin America has taken place primarily in countries with shallow penetration and low initial credit-to-GDP ratios, such as Peru. This mindset highlights a near-“normalization” process in which supply has been introduced in order to meet the demand for credit among the Peruvian population. According to a recent IMF Western Hemisphere Department report,Peru’s “central bank stands ready to react to risks associated with strong domestic demand, large capital inflows, and rapid credit growth.”

On the other hand, old habits seem to die hard, and some observers are sounding the alarm about a replay of 2007, when credit ruled the world – before sending the world into a downward spiral. Carlos Parodi, a professor at the Universidad del Pacífico, warns that Peru manifests all the components of a housing bubble: excess credit, overindebtedness, and a mismatch between credit growth and income growth.

Only time will tell if Peru will avoid the pain other economies have endured.

This article was written by Andriana Diez, Julia Hazen, Liliya Ivanova, and Joel Simpson, members of the Lauder Class of 2015.

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