Brazil has been on a steady path of low inflation, declining real interest rates and a consolidation of the institutionalization of fiscal stability. As world markets suffered through recession during 2009 and the first half of this year, the strong growing domestic market brought Brazil to a 10% annualised GDP growth rate during the first quarter of 2010.

An important engine for growth has been credit, and while the OECD countries are undergoing a process of deleveraging, Brazil is at the beginning of a cycle of
credit expansion. The housing sector has benefited from the expansion of credit. With the total outstanding stock of mortgage credit representing only 3% of GDP, the Brazilian housing sector is making up for lost time, with mortgage lending during the first six months of 2010 having increased by 40% as compared with the first six months of 2009.

The increasing availability of mortgage credit for middle class families, combined with both the lower rates charged by mortgage lenders and the extension of mortgage terms to as long as 30 years, has made home ownership a reality for Brazil's middle class. Families with annual income as low as US$10,000 per year are now able to borrow at real rates as low as 5% per annum for thirty years.

The development of the mortgage market has presented unprecedented opportunities for developers of affordable housing which targets the approximately 25m Brazilian families who earn between $10,000 and $25,000 (€8,000-€20,000) per year and who had hitherto been unable to finance the purchase of a home. Underlying the opportunity for developers is an imbalance between the amount of houses currently being built per year and the pent-up demand for affordable housing.

While approximately 300,000 new homes were built over the past 12 months in Brazil, there is a housing deficit of approximately 1.4m units attributable to families who earn more than $10,000 per year, as well as vegetative growth in demand for housing due to new family formation of approximately 1.5m families per year—a consequence of Brazil's young demographic mix. At the current rate of homebuilding, the housing deficit will persist in Brazil for at least the next decade.

The Lula da Silva administration has enacted measures aimed at further stimulating affordable housing development and financing. Minha Casa, Minha Vida, a natural evolution from pre-existing state-sponsored housing finance programmes, endeavors to stimulate the construction of 3m affordable housing units and provides lower income families with subsidies for down payments on housing purchases. At the centre of Minha Casa, Minha Vida is Caixa Econômica Federal, the federal government-owned savings bank which is responsible for 70% of mortgage loan origination.

Several of Brazil's traditional homebuilders have adjusted their business models to accommodate the new opportunity in the affordable housing sector, and a handful of new companies have emerged to focus exclusively on affordable housing development. Traditional developers of high-end housing have launched new brands and business units to adapt to the needs of the affordable housing segment.

However, it remains to be seen whether builders for the luxury segment will be able to adjust to the rigid cost controls and industrial construction processes required to build for lower-income consumers.

New entrants to the affordable housing sector have an opportunity to enter the
market on an even footing with the few incumbent developers. With the largest developer responsible for fewer than 30,000 units per year, and the top five largest developers responsible for fewer than 100,000 units per year, in a market with pent-up demand of more than 500,000 units per year, it remains to be determined who the dominant players will be.

The logo and brand of Caixa Econômica Federal, the dominant mortgage lender in the affordable segment, is the only brand that is widely recognised by home buyers.
Institutional investors seeking exposure to the Brazilian affordable housing development sector can invest in either the handful of publicly-traded homebuilders that invest in the sector, or in private equity real estate funds that invest in the sector. Of the approximately 25 publicly-traded Brazilian homebuilders, only one, MRV, is a pure-play affordable housing developer.

The others provide exposure to the luxury segment, commercial real estate development, or urbanisation strategies entailing the transformation of rural land to housing developments. Real estate private equity managers with local teams focused on the affordable housing sector offer the highest returns with lower correlation to equity market indices.

Despite the tailwind of strong pent-up demand, increasing credit availability, and proactive federal government policy, investors in the affordable housing sector are exposed to the risk of land price inflation in the more densely populated urban areas (such as Greater São Paulo and Greater Rio de Janeiro), as well as the risk of construction cost inflation exceeding overall income growth.

While the IGP-M inflation index has increased by 4.2% during the 12 months ended May 31, 2010, the construction cost inflation index has increased by 6.1% over the same period.

In the event that construction cost inflation significantly exceeds the broader measures of real income growth, the addressable market for developers of affordable housing will shrink accordingly.

However, the expansion of private sector credit from its current level of approximately 45% of GDP (including consumer credit, corporate credit, and mortgage lending), as long as policymakers maintain their existing commitment to fiscal prudence and support for credit markets, the expansion of the mortgage sector is likely to continue to occur at rates that significantly exceed GDP growth.

Ken Wainer is Managing Principal of Vision Brazil - VBI Real Estate, a São Paulo-based real estate private equity company