Institutional capital has been making good money investing in residential in developed markets over the past decade, so the argument for moving into emerging markets has not been hugely compelling. Add political tensions in markets like Brazil, China and Russia into the mix and it is perhaps understandable that investors have approached with caution.

Adam Alari, head of European residential research at Savills Investment Management, says this is a factor but also points out that there are other challenges.

“The scale of opportunity is so large in our own backyard,” he says. “I believe that in the context of Europe, including the UK, the scale of the issues affecting or forming directly out of the lack of residential are so enormous that the opportunity is significant enough that you needn’t be concerned with emerging markets. There is a huge need for affordable housing in Europe.”

That is not to say emerging markets do not present very compelling opportunities, caveats Alari, but it will take time for the wider market to really acknowledge that.

Fewer foreign investors in Brazil

Joao Teixeira, senior managing director at GTIS Partners and the person responsible for the firm’s Brazilian investments, says GTIS has not been attracting the same level of European and US institutional investment that it used to in the Brazilian residential market. There is a problem of governance where there has been a lot of political friction under President Jair Bolsonaro.

“To a certain extent, I think European investors have been in ‘wait and see’ mode when it comes to investing in the local residential market,” says Teixeira.

Also, Brazil lost its investment-grade rating in 2014/15, which eliminates a lot of institutional capital. There has also been a lot of currency volatility.

Teixeira says some Chinese and Middle Eastern investors have invested in the real estate segment recently, but “they are not enough to replace the European and American investors that used to be in our markets, and in real estate specifically,” he says.

“We have also been facing difficulties because the scenario in the last two years during the pandemic was not easy. Most of the companies were shrinking and capital markets were not very easy to access.”

For VBI Real Estate, which invests solely in Brazilian residential, capital flowing into the sector has been domestic rather than global. The firm’s founding partner Ken Wainer says: “The argument is that in the past several years a US-based pension fund or endowment based in the northeast of the US could invest in almost any real estate in that region.

“If they did so well over the past decade, then why would they go into a market they don’t know where there’s a different rule of law, currency risk – that explains why it hasn’t been that compelling to invest in an emerging market like Brazil.”

Bright future for affordable housing

Looking forward, however, GTIS’s Teixeira believes opportunities for foreign capital in Brazil residential space are good. São Paulo is the biggest and deepest market in South America in terms of residential development and real estate transactions in general, while Rio de Janeiro is the second biggest market in Brazil for residential development.

Teixeira says there is a strong development of new projects in affordable housing segments in São Paulo and across Brazil. “We’re now seeing a development in a kind of barbell strategy, meaning that the most promising areas for residential development are in the high-end and affordable housing projects.” he notes.

Under the Casa Verde e Amarela program, the affordable housing market has an incentive from the government to homebuilders to produce homes providing mortgage credit with a special level of interest rate for affordable housing. Teixeira says this is boosting the activity and production of affordable housing nationwide.

“Brazil has a shortage of affordable housing – the most recent data shows a shortage of seven million affordable homes – and this is a consistent government problem of providing homes for low-income Brazilians. Demand is nationwide and we’ve seen very strong production. It’s very dependent on the cost of land because there is a ceiling on the total price you can sell an apartment for.”

In the Northern regions, it is easier to buy land for affordable housing in the urban areas, Teixeira explains. “Whereas in the Southeast of the country, it is much more difficult to produce this type of affordable housing due to the cost of the land, especially in areas such as São Paulo and Rio de Janeiro, even though the production has increased materially in recent years.”

In São Paulo, 40 percent of residential units offered in the market last year were in the affordable housing segment, Teixeira says, adding that affordable housing projects can deliver returns in the range of 20 to 25 percent IRRs.

“Affordable housing has been attracting foreign investment through direct partnerships allocating equity to local developers at project level, or specifically institutional investors providing equity as shareholders at the entity level of private and public traded homebuilders,” he adds.

“The most promising areas for residential development [in Brazil] are in the high-end and affordable housing projects”

Joao Teixeira
GTIS Partners

Student housing in Brazil

The student housing market also provides opportunities for institutional investors to make residential allocations. Brazil is the fourth-largest university market in the world with nine million students.

VBI Real Estate started investing in Brazilian student housing about three years ago, making its first investment with UK-based property giant Grosvenor Group, which created some of the first purpose-built student housing in Brazil. VBI’s Wainer says the residential real estate market is being forced to find new ways to add value, particularly in this segment.

“Universities do not provide housing and the Brazilian real estate players, apart from the shopping mall owners, are generally not used to managing real estate,” says Wainer. “Brazilian developers know how to sell real estate and how to rent on a triple net-basis on office and industrial, but gross renting and operating is not something this market is very familiar with. We built the whole property management operation from the ground up and we looked to the UK and US as references.”

One of the attractions for an investor such as Grosvenor in the Brazilian residential market is that in very few markets is it possible to put $50 million to $60 million to work and be the number one market player.

“In Brazil, because there’s a lag and new ideas evolving, they could put $60 million to $70 million to work. Along with VBI’s money, they’re now the enabler of the number one player in market share for Brazilian student housing, so that’s going to be exciting for them,” says Wainer.

Some recent student housing projects are delivering 10-12 percent stabilized annual yield on cost, according to Teixeira.

Multifamily prospects in China

There are also opportunities in the multifamily residential sector in Asia-Pacific, which is a nascent asset class across many parts of the region. Claire Tang, co-chief investment officer for Asia-Pacific and head of Greater China, both at LaSalle Investment Management, says the demand is driven by investors that view the sector as relatively resilient through the pandemic and investors seeking to diversify after over allocating to the office and retail sectors.

“In China, for example, various purchase restrictions in tier one markets, such as Beijing and Shanghai, have contributed to delays in home purchases among younger white-collar workers, creating strong appetite for well-located, institutionally managed rental properties in these locations,” Tang says.

“With rental housing identified as a solution to combat prevailing housing issues, the government has put in place favorable policies such as reduced tax rates for multifamily operators and owners. This has led to the growth of multifamily rentals in recent

In addition, the new pilot program for domestic multifamily REITs will also improve overall liquidity and supply longer-term capital to the asset class, she adds.

Multifamily is a key asset class for LaSalle in Asia-Pacific, and Tang says that in China, with limited land available for development – especially in Beijing and Shanghai – she is seeing more opportunities to convert existing hotels or offices to apartments with attractive margins. “Throughout the pandemic, multifamily rental assets have also been more resilient in terms of occupancy rates and rent collection compared to retail, hotel or office assets,” she says.

There are clearly several prospects in residential real estate in emerging markets such as Brazil and China. While there are various reasons why developed market investors are focusing less on emerging markets right now, there are pockets of opportunities worth exploring.