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On the back of comments made by Capital Economics that Brazil’s property market is somewhere in between 30 and 50 percent over valued, the latest figures via Itaú BBA on the performance of the country’s largest real estate developers have also showed generally negative results for quarter one of 2012 (bar Cyrela and Directional) – summarised on the Brazilian Bubble website as follows:

PDG: Earnings Power Still Under Pressure Due to a Low Gross Margin. PDG reported revenues slightly lower than our estimate, but the main negative highlight was the low gross margin (at 27.3%, excluding financial expenses booked in COGS [Cost Of Goods Sold], not very different from the 26.3% posted in 4Q11). The company also revised downward its expectation of units delivered in 2012 to 34-35 thousand (from 35-38 thousand previously) and achieved only 5%-8% in 1Q12.

Cyrela: EPS Beats Our Estimates, Mainly Led by Higher Top Line. The positive results were based on higher revenue recognition (R$ 1.4 billion, versus our R$ 1.3 billion estimate) and a slightly higher-than-expected gross margin (32.7%, versus our expectation of 31.9%, excluding financial expenses booked in COGS). The company had an almost neutral cash burn rate (measured by change in net debt) in the quarter. Overall, we expect a good market reaction to the reported results.

MRV: Disappointing 1Q12 Results; Better-Than-Expected Cash Burn Offset by Lower Margins.  Even though we saw a better-than-expected recovery in CEF [Caixa Econômica Federal] regarding the transfer of receivables process and cash burn surprised on the positive side (decelerating QoQ to BRL 111 million), the company posted lower-than-anticipated operating margins, with EBITDA [Earnings Before Interest, Taxes, Depreciation and Amortisation] margin at only 19.0% (versus our 25.6% and compared with the company’s guidance for 2012 of 24%-28%).

Rossi: Lower-than-Expected 1Q12 Results; Numbers Again Affected by Land Sales. Once again Rossi released results affected by land sales. Nevertheless, excluding the effect from land sales in the quarter, numbers came in lower than expected from the top to the bottom line, mainly based on: i) lower revenue recognition; ii) higher-than-expected SG&A [Selling, General and Administrative] expenses; and iii) heavier income taxes.

Tecnisa: Weak 1Q12 Numbers; Still Recovering From Budget Revisions in 4Q11. Tecnisa posted a modest top line, mainly on the back of lower-than-expected revenue recognition combined with heavier SG&A and other expenses, which pushed the bottom line to  R$ 11 million in the period. On the positive side, cash burn remained under control, at R$ 91 million, fairly in line with the R$ 83 million attained in 4Q11.

Direcional: In-Line 1Q12 Results. Direcional maintained the positive trend seen over the last few quarters, posting numbers pretty much in line with our estimates for the top line and slightly better at the bottom line based on healthier-than-expected operating margins. Additionally, cash burn remained at low levels, and Direcional reiterated its guidance for reduced cash burn in 2012 against last year.

90 construction workers on a Minha Casa, Minha Vida (“My House, My Life”) building site in São José do Rio Preto, in the Fernandópolis region of São Paulo were recently found working in conditions that have been described as akin to “slavery”.  The project has subsequently been embargoed and the local Public Ministry for Labour has initiated an investigation related to a wide range of irregularities whilst ordering the termination of all contracts.

The employees – many of whom were from the north eastern states of Maranhão and Piauí –were falsely promised salaries of R$ 2,000 per month and found residing in highly insalubrious and unhygienic lodgings without beds to sleep in.  It has also been pointed out that they had been labouring some 15 hours per day and wages were being received in small proportions at a maximum of R$ 300.  The project was financed via capital via the Ministry of Cities and the Caixa Econômica Federal – the latter of who were held responsible for verifying the necessary regulations prior to releasing any of the funds.

"Minha Casa, Minha Vida" development working conditions have been described as akin to "slavery" - São José do Rio Preto, Fernandópolis, São Paulo

Press officer from the Public Ministry of Labour Rafael Almeida stated: “These workers are sought via outsourced contractors hired by the builder – this particular contractor sources from the northeast in a clandestine manner without formal registration papers being in place.”

Almeida also confirmed that “as the law determines, the workers are entitled to receive severance pay, unemployment insurance, wages, the 13^th salary, vacations and employment guarantee fund contributions (FGTS).”  The development incorporation company responsible – Goldfarb – has stated that it will pay for a hotel for the workers however they would have to return to their homes as the project will not be continued until the full investigation is completed.

The latest update from the most referred to index of Brazilian real estate asking prices – FipeZap – has indicated that there has been a further deceleration in April.  After a phase of slowing down between April 2011 and January 2012, the index rose by 1.5 percent in February, 1.4 percent in March and 1.2 percent in April.

Salvador saw negative growth at -0.6 percent and Fortaleza grew by just 0.1 percent.  With a 1.2 percent rise, São Paulo saw its slowest pace of growth since the index was initiated in 2008 (the accumulated rise of the four first months of the year was 5.3 percent in 2012 compared to 9.2 percent in 2011).  In Rio de Janeiro, the Federal District and Recife – there was a rise of 1.4 percent and Belo Horizonte reported a rise of 2.5 percent.

The index also demonstrated that the rise in property prices has continued above inflation – since 2008 properties prices have risen by 170 percent in Rio de Janeiro and 135 percent in São Paulo.

In addition to the Promo Imóveis site that was mentioned on this blog late last year, another discounted property site – RealtON – has been recently launched, claiming that a direct relationship with São Paulo’s leading property developers enables it to offer units at discounts of up to 30 percent.

The site is currently selling R$ 5 million worth of real estate per day with units priced at between R$ 300,000 and R$ 4 million and has indicated that 60 percent of its clients are investors.  According to the company, real estate buyers benefit from the fact that there are “no delays in deliveries, since the units for sale are completed or semi-completed.”

With RealtON planning to expand into Rio de Janeiro, Brasília, Manaus, Salvador and Curitiba, it states that it is directly negotiating with publically traded homebuilders who are listed on the Brazilian stock exchange and that there exists an unsold stock inventory valued at over R$ 33 billion.

Investors should note that the discounts are being offered off the open market launch values (and not based on sold prices).  Specialist lawyers should be contracted to undertake detailed background checks and due diligence – particularly exploring the exact reasons as to why the unit is being sold at a lower price and if there are any encumbrances, debts or other obligations (financial or otherwise).

As well as exploring a range of issues related to Brazil’s global economic position, a recent conference held by the University of São Paulo Real Estate Centre saw some commentary made with regards to the current position of the country’s housing sector – some of the salient points of which have been highlighted below (click here to see the full commentary in Portuguese via PINI Web):

Housing Credit

Considering that housing credit represents a small proportion of the country’s GDP when compared to other countries, there is still room for growth – particularly considering that incomes look set to rise and interest rates are falling.  Real estate credit related products have gained an increasing amount of space as a result of a Brazilian public more receptive to financing their home purchase.

Real vs. Artificial Demand

Whilst the demand for residential real estate is still high, it should be considered that the demand that was witnessed between 2010 and 2011 was not sustainable and exemplified by speculative price rises.  An indebted market formed during the market peak; the slower pace of sales and a backlog of stock are likely to collectively represent barriers to growth.

Real Estate Related Financial Products

As well as property being purchased for investment purposes, there has (and should continue to be) a growth in the demand of real estate related financial products – examples include Property Receivable Certificates (Certificados de Recebíveis Imobiliários), Property Investment Funds (Fundos de Investimento Imobiliário) and Property Credit Letters (Letras de Crédito Imobiliário).  Their popularity has grown not just amongst institutional investors but also the Brazilian private investors due to income tax exemption guarantees, a search for more competitive interest rates and a common perception that there is a certain protection against inflation.

Savings

The current level of savings in the medium term is limited in its ability to generate new mortgage credit finance.  However, there are alternatives currently under analysis which could well have a sustained capacity to support growth.

Stocks and Launch Volumes

The market has been reporting unsold stock levels above what were originally hoped for and it can be seen that there has been an increasing amounts of units being sold at discounts.  Understanding that – based on a construction production time of 3 to 4 years and the normal selling period usually reaching up to a year – developers became accustomed to selling completely within a few months.  However, these patterns began to alter towards the end of 2011 and in 2012 it is likely for there to be more equilibrium between supply and demand, taking into account the lower launch volumes being announced by the larger constructors.

Price vs. Product Adequacy

Considering existing stock levels, it should not be assumed that prices will continue in an upward curve above the construction cost inflation indices.  The rise of prices witnessed over the last 5 years has been disproportionately above market incomes and this difference will prejudice how demand will be met as housing has become unaffordable.  For there to be order in the sector, there are three possible options: lower interest rates, price discounts and product adjustments.  New launches should be catered differently to what was the case in 2011, considering the needs of the target market (particularly related financial accessibility).  However, with unsold stock remaining, developer’s priorities should be to sell – even if that means compromising on profitability – in order to be able to enter a new market cycle with readjusted parameters.

Production Capacity

Development companies have been revising down their launch levels in 2012 owed to a number of production related issues such as delivery delays and labour shortages.  The sector is searching to revise its own concepts and parameters related to production and control in order to be better prepared to handle unexpected differences between real and budgeted costs – as was seen in 2011.  There is also a need to find ways in which costs can be lowered in order to restore profitability to acceptable standards whilst also ensuring that the prices are realistically affordable.  Compared to other countries, construction productivity in Brazil is low as a result of factors such as a lack of training and a common practice of third party outsourcing.

Brazil’s Gafisa real estate group has announced that it will be re-launching stock under its “Tenda” brand – marketing approximately 3,000 units in 2012 with an aggregated gross development value of between R$ 300 and R$ 400 million.  Units are expected be sold at the next Caixa Econômica Federal fair (mid-May) at a minimum of R$ 94,000.

As illustrated in a blog post written for our partner base of the pyramid housing blog, Tenda was purchased in 2008 for what was then deemed a highly competitive price but subsequently went on experience a range of difficulties related to bureaucracy, negative approvals, client inaccessibility (unaffordable end buyer prices), issues with Caixa Econômica Federal and labour contractual complexities.  The Gafisa group reported a liquid loss of R$ 944.8 million in 2011 – largely as a result of Tenda’s dysfunctional operations.

According to Gafisa president, Duilio Calciolari: “with the market potential in low income housing being enormous, the company has developed a long term strategy.  If our competitors can earn money, so can we.”  The strategy being referred to relates to the company’s claims of adaptation to the requirements of the Caixa Econômica Federal – the pre-demand customer base will be passed to the bank before the completion of the development, theoretically anticipating receivables and avoiding negative cash flows.

The most recent research undertaken by Brazil’s Confederation of Industry (Confederação Nacional da Indústria, CNI) in partnership with the Construction Industry Chamber of Commerce (Câmara Brasileira da Indústria da Construção, CBIC) – referring to the first quarter of 2012 – published information related to general activity in the sector, employment levels, impending expectations, financial positioning and current profit levels of 437 development companies.

The overall conclusion was that the sector’s recovery “has still not happened” – even though there was a reported increase in activity in March.  One of the factors that contributed to this result was the lack of credit availability which was stated as likely to continue to impede the growth of the smaller construction companies.  Another concern stated by the majority of companies surveyed was the lack of qualified labour and the smaller companies also underlined the issue of high tax burdens impeding their sustainable growth prospects.

The data split the sector into three broad categories: (i) special service companies who, on a performance basis on a scale from 0 to 100, scored 53.9 points (compared to 51.4 points in the same period of 2011); (ii) building construction companies which reached 50.4 points (down from 52.1 points in the same period of 2011); and (iii) infrastructure works companies which scored 45.8 points (compared to 47.7 points in the same period of 2011).  The expectation over the three sectors in the coming months is optimistic at over the 50 point mark.

The research also reported that the level of activity amongst the largest real estate companies has grown from 53.6 points in March compared to 49.3 points in February.  The smaller construction companies’ activity saw a slight drop to 48.5 points in March (compared to 49 points in February).

The new measurement entitled the Utilisation of Operational Capacity (Utilização da Capacidade de Operação, UCO) looks at the average percentage of how much of a particular company’s resources are being used to undertake their construction related services.  The UCO reached 70 percent in March (compared to 71 percent in February) – with the larger companies seeing a higher level at 73 percent (smaller companies stood at 63 percent).

A recent report by the Curitiba news site “Gazeta do Povo” has pointed to a disproportionate number of new housing units being delivered with a range of problems including holes in masonry, badly completed painting, poor quality / uneven flooring, gutters problems, leaks and damaged doors.  The developments have fallen under the scope of the Minha Casa, Minha Vida (“My House, My Life”) programme and have been valued at around the R$ 150,000 open market price range.

The incidences were found repeated across various projects analysed in one of the most modern cities in Brazil – destined to a demographic being referred to as the “new middle class.”  The site spoke to Gustavo Machado whose “Spazio Compostela” unit has still not received its Habite-se (“fit to live in” local government mandatory approval), 6 months after the stated delivery date and he has pointed to over 100 irregularities.  João Costa Kieltyka, a support analyst stated: “the quality of the material that is being used is very bad and the company is showing no interest in resolving the problems.”  She also stated that a representative from the company claimed that the apartment was a “border line COHAB unit” (low cost social housing) and therefore a first class finishing should never have been expected.

Journalist Eduardo Correa attended a meeting at the Vivare condominium (in the Tingui area) where he witnessed the development company’s engineer attempting to convince buyers to accept the units as they were – despite problems related to paintwork and the structure itself.  Purchased 4 years ago at costs of approximately R$ 140,000, Correa commented that: “when one of the residents stated that he was not going to accept, the engineer stated that property was bought for a low price and people could therefore not complain.”

Maria Elisa Novais of the Brazilian Institute of Consumer Defence (Instituto Brasileiro de Defesa do Consumidor, IDEC) stated that this justification being made by development companies of buyers getting what they pay for is an act of bad faith: “The unit has to be well built and there cannot be compromises on the structure. Just because it is cheaper, does this automatically mean that it has to be inferior?” she asked.  Luiz Fernando Pereira, legal consultant at SINDUSCON-PR also commented that: “if the consumers were to be informed that a lower price would equate to an inferior end-product, they would not buy.”

The various complaints have resulted in an investigation by the Paraná Public Ministry (Ministério Público) who, whilst not divulging names, stated that developers of all sizes have been involved.  PROCON-PR, the complaints handling agency reported 317 cases in 2012 related to qualitative issues such as leaks, blocked pipes and other defects which were not being resolved by the construction company.  The Public Ministry, after verifying the facts, takes the responsibility of ensuring that the issue is resolved and buyers are compensated accordingly – this is undertaken directly with the construction companies themselves via the use of extra-judicial agreements.  If these are not acted upon, formal civil action is undertaken via the courts.

Late last year, the São Paulo Public Ministry signed a Conduct Adjustment Term (Termo de Ajustamento de Conduta, TAC) with the Housing Syndicate SECOVI with the aim of establishing clearer rules in the relationship between the developer and the buyer – which have subsequently become introduced in Paraná.  State deputy Cesar Silvestri Filho has also proposed the creation of a law that will require construction companies to provide progress reports and more transparency with regards to the reasoning behind the delays.

The latest figures from the Getúlio Vargas Foundation’s Brazilian Index of Construction Costs (Índice Nacional de Custo da Construção – Mercado, INCC-M) pointed to the average variation being 0.83 percent higher when comparing April to March – rising 7.94 percent since the same period of 2011.

Looking at the figures specifically, the “Materials, Equipment and Service” group saw a 0.65 percent rise in the month (for example structural materials rose by 0.47 percent, installation materials rose by 0.37 percent and finishing materials rose by 0.33 percent).  The “Labour” group saw an overall rise of 1.08 percent (for example bricklayer costs rose by 1.25 percent, specialist helpers rose by 1.09 percent and engineer professional costs rose by 0.46 percent).

The largest construction rises were seen in Salvador (by 0.92 percent) followed by Brasília (0.32 percent), Rio de Janeiro (0.23 percent) and São Paulo (by 0.20 percent).  Belo Horizonte, however, witnessed a drop of 0.22 percent.

The data broadly supports the latest government SINAPI statistics, demonstrated below in comparison with auditable costs under the Fez Tá Pronto Construction System:

Brazil’s leading housing finance institution – the Caixa Econômica Federal – has recently announced that it will be reducing its interest rates under the Melhor Crédito (“Better Credit”) programme from 4^th May 2012.  For properties valued at up to R$ 500,000, the annual pay rate has dropped from 10 to 9 percent – with existing clients being able to access a reduced rate of 7.9 percent.  For properties above R$ 500,000, the rate will drop from 11 to 10 percent – with a client rate of 9 percent.

Whilst some are estimating that the revised rates should help the market prop itself up and somewhat curb the effects of rapid price declines, Miguel Ribeiro de Oliveira of the National Association of Finance and Accounting Executives (Associação Nacional dos Executivos de Finanças e Contabilidade, ANEFAC) – speaking to the Estadão news site – doubts that the other private banking institutions will follow suit: “with the SELIC [Brazil’s national interest rate] at 9 percent per annum and the banks lending at between 8 and 12 percent, the space for a reduction is restricted.” He believed that if there was to be a fall in private home lending rates, it would be owed to “special situations” such as for clients who have guarantees, lower credit risks or an established relationship with the bank.  He went on to state, however, that should the SELIC continue to drop there is a chance that the private home loan rate average will do the same.

Octavio de Lazari, president of the Brazilian Association of Housing Credit and Savings Entities (Associação Brasileira das Entidades de Crédito Imobiliário e Poupança, ABECIP) believes that the private banks will be forced to reduce their rates in order to grow their market share.  With the government keen to bring international competitiveness into the home loan market, Roberto Luis Troster of the University of São Paulo also stated that the banking system needs to introduce more cohesive and streamlined banking processes in addition to a comprehensive revision of fee structures.