The Real Estate Sector Receives a “Yellow Card” from Chile’s Central Bank

Soccer, in addition to the well-known Asado, is a beloved national pastime in Chile. The most recent recipient of a yellow card, however, was the Chilean real estate market rather than a member of the renowned Universidad de Chile or Colo-Colo teams.

Rodrigo Vergara, the president of Chile’s central bank, stated in reports to the senate that rising price trends that were seen in some areas earlier in the year have widened and deepened. The Central Bank has grown more concerned about the real estate sector and its potential impact on the financial sector due to evidence of rising indebtedness of real estate companies, the possibility of increased credit in the medium term, a relaxation of credit standards, and the prospect of increased real estate investment, all without concluding that a real estate bubble has formed. While the proportion of past-due loans in bank credit portfolios has decreased, Loan to Value ratios is said to have gone up, rising from 79% in July 2011 to 86% in July 2012.

Whether the real estate market is overheated is a topic of ongoing discussion. There is no real estate bubble in Chile, according to the country’s finance minister, Felipe Larrain. Many other real estate industry participants have argued that the country’s rapid price increases have been primarily fueled by increased purchasing power and disposable income as a result of the country’s ongoing economic growth and rising land prices. 2012 is expected to see a 5.5% increase in Chile’s GDP. Participants in the sector have also noted that speculative real estate investment has been at relatively low levels, credit volumes as a percentage of GDP are still low, and banking credit practices are still conservative.

Because Chile’s macroeconomic profile is improving at a rate that is largely unprecedented, the potential market for its primary exports is continuing to grow, the middle class is expanding, and inflation is still largely under control, estimating real estate sector risk in the country can be difficult. It is challenging to set clear benchmarks for price increase caps and sustainable debt levels because the Chilean economy has qualitatively and quantitatively entered new growth territory.

However, when considering negative scenarios, it is likely that the risk of an economic downturn, rather than credit-financed speculation, poses the greatest threat to the sector. Even though Chile’s economy has continued to diversify, it still heavily depends on mining exports, and the mining boom caused in large part by imports from China has contributed significantly to the growth of the residential sector. Prices could drop significantly if take-up declines, especially in regions of northern Chile that are heavily dependent on the mining industry, and if a combination of decreased Chinese demand, higher energy and labor costs, and significant layoffs significantly reduce mining company margins.

Despite the fact that Chile’s debt levels are still low, the country’s secondary credit market is not very developed. While this has aided in containing overall debt levels, it also reduces the ability of banks to structure and distribute credit exposure. As a result, banks may more quickly stop lending if the bank or systemic financial risk increases, which would cause liquidity levels to decline more quickly than they might in markets with larger secondary credit pools. Thus, a potential economic slowdown could have a greater negative effect and further reduce housing affordability.