Luisa F., who prefers not to give her surname, is an Argentine woman who had to lower the price for renting out her apartment in Punta del Este, the famous beach resort on the coast of Uruguay, during the upcoming summer vacation season, which begins in December. The local real estate market, which operates in American dollars, has run into problems because of the so-called "foreign exchange trap" facing Argentinians who make their summer homes in Uruguay. The measure by the government of Argentine President Cristina Fernández de Kirchner imposes near-total restrictions on the purchase of foreign exchange in the domestic market. The only option left open is to buy U.S. dollars on the black market for a price of 6.30 pesos per dollar.

The regulations, which have been in place for the past year, are intended to prevent the flight of foreign exchange. The official exchange rate of 4.7 pesos to the U.S. dollar has remained in effect only for those purchases that are made via credit cards outside Argentina. Only those Argentines who have dollar-denominated bank accounts in Argentina are able to withdraw dollars at automatic teller machines (ATMs) in Uruguay or other countries. In September, even purchases with credit cards became more difficult, following the imposition of a 15% surcharge, which the payer can then deduct from his taxes on personal income and goods. According to Argentina's Central Bank, this measure has led to a 15.2% reduction in the use of credit cards in the country.

The Argentine government does permit citizens to buy foreign currencies destined for use in tourist activities; that is to say, dollars in the case of travel to the United States and Uruguayan pesos in the case of a vacation in Uruguay. However, this is possible only a week before traveling, and generally speaking, the authorized amount is not enough to cover the costs for families that usually spend two weeks visiting the coast of Uruguay. The authorized amount of foreign currency depends on the income of each citizen, but it is usually an average of $100 a day per person.

"I prefer not to tell you my last name because the AFIP [Argentina's federal tax bureau] goes after us in Argentina and Uruguay," says Luisa F. "Until now, I was able to rent [my property out] for all of January, but I've reduced prices by more than 10% from last year." She adds that she needs "at least $6,000 to cover annual expenses for a three-room apartment in Uruguay."

The case of Luisa F. reflects the impact of the Argentine government's foreign exchange regulations. The government is having success at containing the flight of capital, which has fallen to $3.6 billion so far this year, compared with $20 billion during the same period in 2011, according to official figures. However, the real estate sector, which traditionally functions in U.S. dollars, is paying the price. After sufferingseveral economic crises in which their pesos always wound up losing their value, Argentines have turned to the dollar as the safest way to preserve their savings.

Compared with the same period last year, the number of real-estate agreements in August fell by 35% in 2012. According to monthly figures from the city clerk of Buenos Aires, 3,776 housing contracts were signed. It was the ninth consecutive year-on-year decline and the seventh double-digit decline this year alone.

"At the pace we are going, it is not preposterous to believe that we will finish the year with sales below the level registered in 2009, which was the worst year in the last decade," warned Néstor Walenten, president of the Argentine Real Estate Chamber (CIA), in La Prensa, the Argentine daily newspaper. The Chamber focuses on addressing the interests of real estate firms. Three years ago, slightly more than 49,000 properties were sold in the city in a market seriously damaged by the international real estate crisis set off by the collapse of Lehman Brothers in the U.S.

Given this situation, some real estate developers were forced to give up their licenses and close down, while others opted to cut their costs. "Construction is a labor-intensive sector, so this endangers thousands of working jobs," Walenten told the newspaper.

A Market Upended

According to Laura Belly, who heads the academic department that trains public auctioneers at the Universidad del Museum Social Argentino (UMSA), the biggest problem these days is determining the sales price of apartments because they have always been quoted in American dollars. Owners are getting used to the idea that they have to sell in pesos, but they can't help keeping their eye on the reference prices in dollars.

The U.S. currency has various prices in the marketplace, Belly notes. "On the one hand, there is the official dollar rate (4.7 pesos per dollar); on the other, there is the currency in the informal market, known as the 'blue' market (6.3 pesos per dollar). And now there is a new rate, the 'sky blue' rate, which establishes an intermediate value between the official rate and the blue rate." For example, Belly adds, the Mendoza daily newspaper reports the unofficial gap between the official dollar and the 'blue' dollar at 35%. "This data illustrates the degree of confusion among the players, who cannot establish the value of their assets."

Herman Faigenbaum, director of the executive education program in real estate management at Di Tella University, agrees. He notes that "the main problem is that it makes it hard to value assets in such a way that all of the players in the marketplace are in agreement. The result is a decline in the volume of transactions taking place." One of the trends that Faigenbaum forecasts for the short term is that properties will "decline in dollar value while rising in peso terms, finding a new leveling off point."

In fact, previously occupied properties, marketed in dollars in the past, have left the market but continue to be sought after by buyers, who pay for them with their dollar savings, although at a lower price. Thus, those new units that are now sold in pesos have risen in their peso prices, in order to cover the rate of inflation, now above 25% a year. "Those buyers who have paper dollars want to make it worth their while to hold that currency by getting discounts in such a way that it reflects the foreign exchange gap," Belly says. "Sellers do not accept the idea of getting rid of their assets by initially acquiring dollars at a rate that is 35% to 37% less than what they paid for them."

When it comes to real estate development and construction projects financed by financial trusts and pools of investors, "it is possible for them to be undertaken in pesos because the costs of construction — such as buying materials and the value of labor — have been "pesified" — [that is to say, such prices are now calculated in peso terms, not in dollars]," notes Marcos Ochoa, an economist at the graduate business school of the University of Belgrano (UB).

Loans to help Argentines buy their first homes or expand the conveniences they have in their current properties are also scarce. "For several years, mortgage market volume has been very low, so the current situation may have no impact on the market" for housing loans, which have been at historic lows in recent years, Faigenbaum says. Given the current situation, those people who take out mortgage loans do so only in those cases where the seller or the real estate developer carries out the deal in pesos, or the loan is directed toward making modifications in the buyer's current property.

A Domino Effect

The domino effect of the foreign exchange trap has reached neighboring Uruguay, which shares a border and the channel of the Rio de la Plata with Argentina. Uruguay is one of the most desirable destinations for Argentina's middle and upper class when it comes to spending their summers and investing their dollars in real estate. Although the shortage of dollars in Argentina puts a brake on some projects in Uruguay, it continues to be an attractive alternative for Argentines with higher incomes.

Facing the possibility of a summer with fewer visitors, the Uruguayan government of Jose "Pepe" Mujica has decided to provide incentives, including refunding the 22% VAT (Value Added Tax) on credit card payments made in hotels and restaurants. The government also foresees refunding 10.5% of the amounts committed by rental subscribers; extending "tax-free" status to border crossings made at Salto, Paysandú and Fray Bentos, Uruguayan river towns on the border with Argentina), and authorizing a voucher worth $25 to anyone who enters Uruguay by car, which they will then be able to exchange for fuel. The total cost of this package of measures for Uruguay will be $10 million.

In any case, according to a report by CINVE, a Uruguay economic research institute, the new regulations in Argentina, combined with regional economic uncertainty and the bankruptcy of a local Uruguayan airline called Pluna, will lead to a 6.5% drop in the number of Argentine visitors to Uruguay. Each year, more than one million Argentine tourists spend their vacations in Uruguay, according to estimates. "Given that individuals will not be able to take any currency abroad, it is expected that there will be agreements on a smaller number of rental properties. Usually, authorizations for buying dollars for traveling abroad involve very small amounts," notes Ochoa.

Are these restrictions on foreign exchange here to stay? Will Argentines get used to saving in pesos? Will they begin to buy and sell properties in their local currency? No one knows the answers to these questions. For the moment, experts suggest that these measures will continue for quite a while and that "the market will get used to operating with them, and will recover to a higher level of activity in the medium term," says Faigenbaum. "The fundamental question is, what is the market and where is the profitability for real estate developers? There is still no answer to that question."

In August, construction permits in Buenos Aires rose for the first time in a year, at a rate of 14.8% compared with July. However, the number of permits fell by 37.2%, and the land area covered by these permits dropped by 35.3%, if compared with the period from January to August 2011. Over the short term, Ochoa predicts that if Argentina maintains a high rate of inflation while there is a continuing deterioration in expectations about its economy, the real estate market will continue to be "dollarized". He adds that only those property owners who have a significant need to sell will be accepting pesos for their properties. Over the long term, however, "if price stability ever returns as a result of efforts to control inflation, then the market may once again be based on the peso. [However,] I think that there a low probability that this will occur," he says. Ochoa adds that the "pesification" of the economy will only be possible "if the currency is stable. To the extent that inflation remains high, we are moving toward a smaller market."