GRI: Brazil is expensive, Mexico is cheap

The largest country in Latin America has become a much costlier place to do business than the US’ neighbor to the south, but the high costs still offer a major benefit to investing in Brazil.

While Brazil has captured the lion’s share of real estate capital going into Latin America in recent years, for those weighing the costs and benefits of investing in the region’s two largest property markets, the scales currently tip in favor of Mexico, panelists said at a recent conference focused on the region.

“The difference is that, on relative terms, Brazil is expensive and Mexico is cheap,” said Alfonso Munk, head of Prudential Real Estate Investors Latin America, speaking at the Global Real Estate Institute’s Latin America conference in Miami late last week. “The growth in rent rates in Brazil over the last five years has been exponential. In Mexico, it hasn’t – the rents in real terms for industrial are the same as they were 10 years ago, and the same is true for office.”

Brian Finerty, co-lead of global investments at Equity International, predicted a lot of upside in real estate values in Mexico, not only from a decrease in cap rates, but from an increase in rents. “It’s extremely cheap on a relative basis than any other Latin American country, whether that is Colombia, Peru or Brazil. It’s half in most cases, if not lower, in terms of rent levels,” he said. Nonetheless, he expected limited supply and rising demand to put upward pressure on industrial rents, particularly in central Mexico.

By contrast, “there’s more risk to the downside of Brazil, in terms of prices,” Finerty said. What is particularly worrisome is the structure of commercial real estate leases in the country, particularly in the office sector, where tenants can cancel their agreements with virtually no penalties. Compounded with an increase in supply, the lack of leasing stability could lead to a “downward spiral” in property values in the country, he noted.
 
Munk observed that the leasing structure in Brazil was one reason why financing was more expensive in that country than in Mexico, where loan interest rates currently are about four percent to five percent, compared to six percent to seven percent in Brazil.  “Brazilian banks don’t like commercial real estate,” he said. “Leases are more uncertain, less secure and you can’t really finance an income stream when you don’t really know with accuracy what it’s going to be.”

“If you look at financing in a lot of different countries, Brazil is the worst by far,” Finerty agreed. It is not only difficult to secure financing for real estate but, aside from build-to-suit projects with credit tenants, the terms aren’t that attractive either. “It’s short-term, heavy amortization and high real rates – it’s really not very accretive to the economics.”

However, Paulo Saba, a partner at Brazilwood Partners, a commercial real estate advisory and finance firm, argued that the lack of available financing in Brazil limited the potential of a real estate bubble in the market. He also asserted that the perception of Brazil being expensive was overblown. “This is the typical mistake that we’ve seen among investors that are looking to Brazil,” he said. While São Paulo and Rio de Janeiro and their surrounding areas are indeed experiencing falling cap rates and rising prices, better values can be found along the agribusiness corridor, which connects Mato Grosso do Sul in the central part of the country to the northeastern port city of Belém. 

“Forget about the Rio and São Paulo corridor, which is in the south part of the country,” Saba said. “Look where Brazil creates value, where the agribusiness is, where it has double-digit growth, as in the northeast.”

Likewise, Finerty noted that Equity International held three assets in São Paulo through one of its portfolio companies, Brazilian self-storage owner and operator GuardeAqui. “They’re doing great in terms of performance because nobody else can get permitting to build anything in the city, including us,” he said. That difficulty has led Equity International to look at other areas of the country, such as Belo Horizonte and Curitiba, for potential investments.

Overall, “the cost of doing business in Brazil is huge, and not necessarily just with leasing, with anything” in real estate investing, said Munk. “Mexico is not the US in terms of the standards of easiness of doing business, but it’s somewhere in-between.”

That said, “there’s a benefit to the cost of doing business in Brazil, which is the barrier to entry,” said Finerty. Because of this, the development yields in Brazil can be substantially higher than in Mexico. The key is taking the cost of doing business into account when underwriting investments in Brazil. “You understand the risk you’re taking when you get in, and then you price appropriately and be patient,” he said.