An unusual Brazilian property buying scheme that is relevant to Australia: Cameron McEvoy

I recently came across a method of property purchasing common to the people in Brazil who are interested in buying residential property in their home country.

The concept was initally foreign to me so I felt compelled to write about it, because I've never come across anything like it in my property life.

It is the concept or rather, practice of Consórcios (literally translated, means ‘Consortiums’). This is where would-be property buyers who perhaps either struggled to get a mortgage on their own from a lender, or did not see the value in paying wasted ‘interest’ dollars, or should I say ‘Reais’ (pronounced ‘hay-ice’) to a lender, group together with other like-minded folks, in the interest of a common goal; home ownership.

Instead of approaching lenders for loans, the group do not use loans. Instead, they use a lawyer and an administrative company who, for a fee, underwrite a sound contract between all participants of the consortium. The price of a single property is then agreed between all parties and is kept the same. The value of all properties is added together and split into monthly instalments.

From month #1 onwards; each participant must pay their fee. After a very short time, there are enough fees paid for one property. So who gets the first one?

A lottery is drawn at random and whoever is luckiest gets their property purchased outright – mortgage-free. Participants (including the now lucky new home owner participant) continue paying their monthly allotments for the remainder of the contract. Each month another name gets drawn and a property is bought for that ‘winner’.

I will divulge the flaws and risks in such a plan later on, but astute readers can probably quite easily identify a few challenges with this concept already.

There is more granular detail on Consorcio schemes here.

So let me work with some real numbers as an example, before this gets confusing. Let’s say 10 would-be property buyers group together and form a Consortium. Let’s say they each agreed they wanted a property costing $400,000 each. So that is $4 million of overall property value.

The Consortium Administrator divvies up $4 million dollars across say a 10-year period, into monthly instalments that each participant must pay, month in, month out; regardless of who ‘wins’ their property bought at every annual draw (remember it is annual because in this example, there are 10 participants buying 10 properties over 10 years; to keep it simple; so – one per year).

For the purposes of this example let’s ignore the inclusion of any legal/admin fees for now and just focus on the concept. So, $4 million/10 years/12 months/10 participants = $3,333.33 cost-per-month-per-participant. Not too bad when you consider that this is you fixed monthly repayment for ten years, and then after ten years you own the property outright, huh?

However, this is where the risks and element of chance/gambling comes in to it. Each year, a participant is pulled out of the hat and awarded a property. Because $400K is collected every 12 months, a property can be purchased outright (cash), each 12 months.

So, the best case scenario you could find yourself in, in such an arrangement, would be to be pulled out after 12 months, or maybe in year #2 or #3. This means that you get to move into your new home the fastest, and you ‘own’ it instantly (but of course are committed to 9, 8, or 7 more years of payments like everyone else). It also means that you can ‘go shopping’ for a $400K property when the property you want is actually worth $400K at the time.

Clearly then, the ‘losers’ in this scheme are those who are drawn in years #8, #9, and #10.

Not only have you had to fork out payments on everyone else’s properties for 8-10 years depending on the final year you are drawn; but you are stuck with just $400K to spend at the end, just like everything else. Problem is, $400K, ten years down the track, does not buy what it used to! Suddenly the property type that you fancied 8-10 years ago that was $400K, is now hundreds of thousands of dollars more expensive, right?

However, even in this unfortunate circumstance, I would argue that a participants’ position is not entirely weakened. Remember that for almost ten years you have avoided paying interest; only paying capital. If you took out a $400K interest-only loan at a flat interest rate of say 5% per year (which is very conservative and based only on the record-low interest rate environment in July 2013); you would pay around $200,000 in interest anyways.

So, even as a year #10 ‘loser’, and providing you can save up the amount you would have paid in interest, over ten years; you still end up in a very similar position really; you’ll have $600K in your pocket to go shopping then and there; and own a property outright in year ten.

At the end of the day though; as a year #10 loser, you really do lose out. You would have to live every day with not one but three property outgoing costs; you’d be paying rent (you’ll need somewhere to live whilst you wait!), whilst paying consortium commitments every month (remember, I neglected to include the legal and administration fees payable in addition every month; though this is a minute fraction of the cost you’d be paying in interest to a lender), whilst also saving a little extra to safeguard you should you be a year #10 loser, so you can still afford a relevant property by then.

But I guess that is the gamble of such a scheme. Another gray area of the scheme which I could not get specific clarity on; was insurances. What if participants stopped paying after a few years and skipped town? I would imagine the administration fees include insurance schedules, but these premiums would surely come at significant cost.

In the real world, you can enter much safer Consorcios in Brazil, whereby there are not ten members, but thousands (remember, Brazil is a population of almost 200 million people); and the duration of a consorcio may be more flexible than ten years (either shorter or longer). The best part of this is that you can choose different types, from these Consorcio administrations, depending on your risk profile and needs upcoming.

What surprises me most about this concept is how much Banco Central Do Brasil (Central Bank of Brazil); embraces this practice. Consortiums sound like, to me, a massive ‘middle finger’ to the big banks; and offer a way for like-minded property buyers to have a secure means to effectively chip in and pay for each other’s properties whilst avoiding interest repayments for as long as possible.

Plus, the management/administration/legal/insurance costs would need to be paid by all participants, along the way. In many ways, it is the banks genuinely doing people a favour. It is like saying ‘sorry, we won’t approve you for a mortgage with us, but we do offer administration services for consortium arrangements, should you want to participate in one of those, we can help organise it’.

The bank is happy because it takes on additional revenue, but with much less risk associated. Consorcios are actually more commonly used in Brazil for smaller ticket items such as car purchases, than homes, and this makes sound logical sense. Lower risk and exposure for all participants.

Thinking in an Australian context; there are ways you could make this concept work, and it all comes down to scale.

For example, if you entered a smaller scheme such as my example, then the administrator would ensure that seeing as a property needs purchasing only once every year; for the other eleven months of the year; everyone’s contributions would be working hard in a high-interest savings account. This interest would help pay for the legal and administration costs each year; saving the participants money.

You could take this one step further and perhaps park some of the interest earnings from the first say five years, to offset those participants who have to wait for the last five years, to help offset some of the challenges they face when their name is drawn. This would give the ‘losing end’ of the lottery a ‘fair go’ – something very Australian in itself!

Beyond consortiums though, the concept of ‘group buying’ has been around for a long time in various countries, but just never as refined, legally binding, and prescriptive, as Brazil’s system. Thinking again to Australia; this time to the post-WWII Greek-Australian immigrants, arriving to the country for the first time with very little resources behind them.

The Greek community established itself quickly in Australia and brought with them a renewed sense of family closeness and trust that perhaps culturally, the Europeans exercised better than locals. Greek family and family-friend communities would group together across large extended families (so, sometimes up to dozens of cousins, aunts, uncles, nieces, nephews and so on); to ‘chip-in’ to buy each married-off sibling/cousin within the family; a property at the time of marriage, in cash. Then, once the first couple’s property was purchased outright; all family members (including the new property-owning youngster couple) would chip in for the next cousins’ wedding-property.

The problem is; this concept never took off in any formal capacity in Australia, because, well, there was no infrastructure or 3rd party governing body able to reside over these arrangements, making them high-risk and entirely based on human trust.

If we were to add in the element of legal certainty and responsibility, along with insurance and security in; when introducing such a concept in Australia, these costs would add greatly to the participant cost (It is very expensive to do business in Australia in a legally binding, and insurance-covered fashion!). Plus; if a participant skipped town and stopped paying their share; the entire house-of-cards structure would topple if the insurer challenged the consortium or group-buying association’s circumstances.

Still, one must wonder; even with these legal and insurance costs included, it would still be cheaper than paying all that bank interest on each property, over the years, no?

So from my limited understanding of this scheme, I would still argue that, when you consider the first home buyer market in Australia; the relevance and introduction of a practice such as Consorcios would still be conversation worth having.

The truth is that although the motivator Brazilians entering into a consortium versus Australians is very different, it is just as relevant here as it is there. In Brazil, the major barrier to people getting mortgages to buy property is demanding credit rating assessment approval, which sees would-be house buyers not progress through to finance approval.

Usually applicants are hard-working, reliable people; however on paper, the lenders may not agree that their stability is so, well, stable. In Australia it is a different problem. Lenders have more confidence that applicants have stable incomes; it is just that the marketplace here is so expensive; first-home buyers are hard-placed to agree.

For investors it is a different story. Because you may not own a property for many years; you cannot rent it out, meaning it cannot earn income. This does not make for a good investment.

Cameron McEvoy is a NSW-based property investor and maintains a blog, Property Correspondent.