Brazilis currently experiencing an unprecedented real estate boom. Although the financial system is apparently operating under stable conditions, analysts are increasingly worried because of the similarities between the current economic scenario in Brazil and the situation that set off the subprime crisis in the United States in 2008.

One of the first people to sound the alarm was Paul Marshall, CIO of Marshall Wace, a London investment fund. Last February, Wace warned readers of the Financial Times about the high financial cost of Brazilian debt. Brazilians, he said, "must pay real interest rates of between 20% and 25% for their real estate loans." He added that he is worried about the impossibility of creating a national registry of bad debtors in Brazil, given that the country's system of compiling information about debts is operating far behind schedule.

This much is certain: The figures that are available speak volumes. Roberto Attuch, analyst at the São Paulo branch of Barclays Capital told the local press that Brazilian's residential real estate debt "went from being about 25% of their incomes in June 2006 to about 40% [in November 2010]."

That amounts to an increase of about 15 percentage points in barely four years, notes Attuch. The time period coincides with the second administration of former president Luiz Inacio Lula da Silva, who promoted a powerful social welfare program called "My House, My Life." Created in 2009, this program financed about a million homes that year alone. The Caixa Economica Federal, the public entity that provides 70% of the real estate loans in Brazil, released almost US$5.4 billion to help residents buy houses or apartments during the first quarter of 2010, an amount that represents double what it provided during the same period in 2009.

While the Brazilian government has played a major role in the real estate boom, the private sector has also behaved in a remarkable way. According to the Brazilian Association of Real Estate Credit and Savings (ABECIP), the number of housing units financed with resources of its partners (Banco Itaú, Santander, Bradesco, Banco Safra, Citibank and Banco do Brasil, among others) exceeded US$400,000 by the end of 2010, which means an investment of US$26.9 billion.

Facing the extraordinary amounts of money involved in the real estate market, Arminio Fraga — ex-president of Brazil's Central Bank and current president of Bovespa, Brazil's stock exchange — recently warned the local press about the dizzying pace at which credit is growing. "I am curious to know the quality of the credit portfolio. If I had my old job, I would be sending in all of my troops to assess the performance of the credit market."

Marshall went even further, concluding in a Financial Times article that if Brazil does not balance the relationship between savings and investment in order to reduce its excessive loans, "the country could be headed toward a subprime disaster."

Booming Incomes

Nevertheless, Felipe Monteiro, a Wharton management professor, believes that the Brazilian financial system is very far from falling into a default that would set off a subprime crisis similar to what happened in the United States. "Only a small percentage of the Brazilian population has real estate loans — a very small number considering that the market is composed of more than 200 million Brazilians," he says. Although the volume of loans has expanded considerably, only a small percentage of Brazilian home owners have taken out a mortgage. "That's different from what happened in the U.S. market, where most owners had mortgages," Monteiro adds.

Fernando Nogueira da Costa, professor of economics at Unicamp, the state university of Campinas, and ex-president of finance and capital markets at the Caixa Economic Federal, agrees with Monteiro. He notes that "real estate loans will be the equivalent of 14% of the GDP in 2011, according to Abecip." In his view, this is a clear indicator that credit continues to have a low rate of penetration. "There are countries in which the relationship between home loans and GDP has reached 60%, such as in Spain … it is almost 100% in the case of the Netherlands."

Beyond that, he says, what set off the explosive growth of loans in the U.S. market was the fact that interest rates were extremely high. "In contrast, in Brazil, the high interest rate established by the [central] bank makes it hard for credits to jump with as much intensity as they did in the United States," according to Nogueira.

Along the same lines, Miguel de Oliveira, manager of market indicators for Serasa Experian, a local consultancy for loans and businesses, recently told O Estado de Sao Paulo that interest rates for real estate loans in the United States and other developed countries are considerably lower than in Brazil. "This makes banking institutions in developed countries look for ways to make their operations profitable; that is, by trying to seduce people into the subprime market. In contrast, the Brazilian bank does not need to do this."

Another factor, Monteiro says, is that the sort of systemic risk that set off the debacle in the U.S. financial system barely exists in Brazil, "since Brazilian banks are much more regulated by law." The Central Bank's requirement to devote 65% of all savings deposits into real estate credits "does not enable real estate operations to be located off the banks' balance sheets, as often happens in the U.S. market," Nogueira notes. "Brazil regulations do not permit this type of tool, the so-called securitization of real estate credits."

Luis Miguel Santacreu, analyst of financial institutions at Austin Ratings, a local risk classification agency, agrees. He recently told O Estado de São Paulo that "the Brazilian central bank has shown itself to be very attentive to any possible distortions in the credit market." For example, he cites the macroeconomic measures announced by authorities at the end of 2010, which point toward restraining the expansion of credit, especially in car buying.

One of the main causes that explain the real estate boom in Brazil, notes Nogueira, is that incomes have experienced a real increase, enabling many people to enter the middle class and increase their buying power. Demand for housing has also increased. "This is not like what happened in the U.S., where income levels were too low to support the increase in the price of housing." In other words, while many Americans were buying houses that they did not have the resources to pay for; many Brazilians are purchasing homes because they now have the means to afford them.  

According to a recent study by MB Associados, a Brazilian macroeconomic analysis firm, the average annual growth in Brazilians' real income was 8% from 2002 through 2008. Expectations are that this growth will continue in the coming years, assuming there is continuity in the government sector. As Sergio Valle, economist and director of MB Associados, told Folha de São Paulo, "In recent years, 26 million Brazilians have joined the middle class, and there are another 20 million people who are about to enter it, thanks to the dizzying economic development that the country is recording."

Roy Martelanc, professor of economics at the University of São Paulo, also believes that rising incomes are the main difference between the situation in Brazil and in the U.S. "They are not selling housing here to people who cannot afford it; nor is there [real estate] speculation as there was in the case of the U.S. market. But there is legitimate concern."

A Growing Bubble?

While that there is a potential disaster brewing in the Brazilian market, Monteiro says the subprime crisis in the U.S. should be "taken as a great case study in what the markets should not be doing." After the American real estate boom, there was a price bubble that kept on growing at a dizzying pace. "The price of residential properties, and especially prime office space, has shot up in some locations in Brazil because demand has grown at a much faster pace than the market has been able to address it. That is why construction companies have fallen behind when it comes to constructing high-quality office buildings."

This bubble, he warns, is gaining critical intensity in Rio de Janeiro. Citing a report in The Financial Times in February, Monteiro notes, "For the first time in history, the price of office space in Rio de Janeiro exceeds the price of a square meter in New York." According to a study by Cushman & Wakefield, one of the principle real estate consultancies in the U.S. market, "the cost of a square meter of prime office space in Rio de Janeiro reached US$1,321 in 2010, which was 47%  higher than during the previous year; making Rio that most expensive place in all of the Americas." Meanwhile, in downtown Manhattan, prices reached US$1,260 per square meter, the report said.

The study established Rio as the fourth-most expensive place in the world in terms of a square meter of prime office space. The most expensive place was Hong Kong at US$2,644, followed by the West End of London at US$2,563, and Tokyo at US$1,827.The growing demand for office space in Rio was due to the significant economic growth in Brazil, according to the Cushman & Wakefield report. "Growth in North America has been slow, but it grew by 7.5% in Brazil, and is expected to grow by about 4.5% in 2011."

Brazil's economic importance has grown recently, largely as a result of the latest oil discoveries made by Petrobras, the country's largest oil company, in the so-called "pre-salt" region off the coast of Rio. "Beyond that, the fact that Rio will be the site of the World Cup in 2014 and the location of the 2016 Olympic Games has contributed to an exponential increase in the value of its properties," Monteiro says. Numerous multinational companies are now making commitments to set up offices in Rio, he adds.

Rioisn't the only Brazilian city beset by skyrocketing prices. São Paulo is also being invaded by a voracious demand for real estate, which has catapulted the value of its properties. "The value of a square meter of housing property rose as much as 81% in São Paulo between January and October 2010, year-on-year," according to Nogueira.Housing prices in São Paulo are at very high levels, but Nogueira discounts the possibility that there will be significant increases in property values in the future. "It doesn't seem as if the growth in prices today is a sign of a bubble that will generate some sort of debacle in the financial system or a possible collapse in housing prices."

Monteiro has a different view, however, arguing that the situation in Rio and São Paulo is "worrisome," because the miniscule supply of property is unable to satisfy the implacable demand.