These days, it is hard to find much positive news coming out of Brazil.
Latin America’s largest country is in the throes of its worst economic slump in 25 years. Its economy is projected to contract by 3 percent this year, inflation has hit a 12-year high, and its currency, the real, remains at historic lows.
Reform efforts to address the country’s economic challenges, however, are being held up by political gridlock. While President Dilma Rousseff faces possible impeachment for allegedly mismanaging the federal budget, congressional house speaker Eduardo Cunha – who has been called to take up Rousseff’s impeachment case – himself is under pressure to resign because of his alleged involvement in the corruption scandal of state oil company Petrobras.
Against this political and economic backdrop, the country’s commercial real estate market – after four years of booming development activity and skyrocketing property prices – is now grappling with oversupply and low demand, which is leading to rising vacancies and falling rental rates. “That’s when you have the perfect storm,” said Andre Germanos, director of capital markets at property services firm Cushman & Wakefield (C&W).
Such turmoil may lead to assumptions that Brazil has distressed real estate deals ripe for the picking. That hasn’t been the case so far, however.
Where’s the distress?
Germanos said that his firm gets calls every week from investors seeking distressed assets, but there are few such assets. After all, because financing in Brazil is expensive, most property transactions involve little to no leverage. “You can’t just go to the banks and buy assets,” he said.
Buyers can’t easily acquire assets directly from owners of distressed properties, either. “The fundamentals have weakened considerably, so that would suggest there should be a reasonably larger discount,” said Peter Ballon, head of real estate investments Americas at the Canadian Pension Plan Investment Board (CPPIB). But “if a distressed asset originally was bought with 100 percent equity, owners aren’t as compelled to sell.”
Yet, while there are few distressed deals in the traditional sense, Fernando de Faria, director at C&W’s rival CBRE, said real estate assets can still be bought at or below replacement costs. “It’s still possible to do good deals if you buy something special that’s not easily replaced and you are a long-term investor,” he said.
“There are some good values,” agreed Marcelo Fedak, managing director at The Blackstone Group. Some high quality properties currently are trading at 60 percent to 75 percent below their peak pricing in 2011, he noted.
In August, Blackstone agreed to buy a portfolio of 10 industrial and office properties from Brazilian commercial property company BR Properties for R$1.07 billion (€275.8 million, $301.28 million). Those assets had traded at double the price in 2011, according to Fedak.
However, making acquisitions tends to be far from straightforward, said João Teixeira, head of GTIS Partners’ São Paulo office. “You always need some structure to get to the asset level,” he said. “You have to go through two, three steps to get access to the real estate.”
A case in point was the New York-based private equity real estate firm’s privatization of Brazil Hospitality Group, Brazil’s largest hotel owner, through a $400 million tender offer that closed in May. “We were targeting the quality of the portfolio,” Teixeira explained. According to the firm, the transaction represented a 50 percent discount to replacement costs.
GTIS took three years to complete the transaction, including waiting one year to receive approval from the Securities and Exchange Commission of Brazil for the tender offer. “Every transaction takes a long period of time,” he said.
Paladin Realty Partners also has been acquiring properties through structures, focusing specifically on publicly-traded real estate investment funds known as FIIs (Fundos de Investimento Imobiliário), most of which are trading at 30 percent to 50 percent discounts to their underlying net asset values, according to the firm’s Brazil country head, Ricardo Raoul. At the moment, the firm is pursuing an investment in a FII that invests in a single AAA office building in São Paulo. Paladin intends to partner with other funds to buy a 20 percent controlling stake in the fund over the coming months in order to gain control of the underlying asset, Raoul explained.
He adds that he considers FIIs to be the only distressed real estate opportunity in Brazil currently, although low liquidity and control issues are potential challenges with such investments. “A lot has been said about distress, but assets have not been repriced accordingly yet,” Raoul said.
Look to home mortgages
Paladin has however found distress in the Brazilian residential market as a lender. “Today, mortgage and construction financing is more difficult to get than six months ago,” said Raoul. Homebuilders are further constrained by the country’s economic slowdown, which has resulted in slower sales and more cancellations, as would-be homebuyers cancel sale contracts because they are unable to obtain mortgage financing or find better deals from competitors offering discounts.
The firm consequently has shifted its strategy from investing equity with its existing joint venture partners to – for the first time – providing only preferred equity to those operators. “It’s to lower our risk,” explained Raoul. “At the end of the day, we get the equity and return first.”
VBI Real Estate, a São Paulo-based real estate fund manager, also has been focusing on opportunities as a capital provider to developers with liquidity issues. “The return is very high relative to the risk,” said managing principal Ken Wainer. “The opportunity that exists right now – replacing the banks – might not exist a year from now.” Indeed, the firm has identified a pipeline of credit deals for which it expects to deploy capital next year.
Investor sentiment
The challenge, however, has been getting investors on board. “I don’t think we can expect our investors to see over the hump at the moment,” said Wainer. He said VBI will give its existing investors a first look at its credit deals before approaching other capital sources such as hedge funds and credit funds to invest with the firm.
One existing VBI fund investor said its reservation about making a follow-on commitment did not have to do with VBI or its performance as a manager, but rather Brazil’s currency devaluation, since the institution would suffer dollar losses on its investment if the real depreciated further. After all, the currency is not expected to appreciate any time soon, given the weakened position of emerging markets and the expectation of an imminent US Federal Reserve interest rate hike.
At the same time, there could be ways VBI could limit the level of currency risk, perhaps through use of a credit line, the person said. “It’s not like it’s the first time in financial history Brazil has faced currency issues,” the investor added. “Oftentimes, when there’s a lack of capital, others have gone in and done very well.”
For GTIS’ Teixeira, the likelihood of an investor deploying capital in Brazil at the present time largely depends on its investment history in the country. From a fundraising perspective, longtime investors are the easiest to get to reinvest or upsize their tickets. “They know the country pretty well and feel comfortable with the scenario,” he said.
Such is the view of CPPIB, which has been deploying capital in Brazilian real estate since 2009. “We have a very long term perspective, so nothing that has happened in today’s market environment has diminished our view that Brazil is a good place to invest in the long term,” said Ballon.
Investors that are less familiar with the country, however, are a harder sell. “It’s much more difficult for them to get comfortable,” said Teixeira. In such cases, “there’s nothing we can do.”
Pricing gap
But attracting investor capital isn’t the only challenge for Brazil-focused managers; it’s also being able to agree with sellers on pricing.
“People still have high expectations in terms of price,” said Fedak. Although prices have declined significantly in the last year and half, “the market has to stay that way for a while before it sinks in.”
Teixeira said that a large gap remains between the minimum price at which sellers are willing to sell and the maximum price that his firm is willing to pay. He expects that it will take another year before they converge on pricing. “There are not many deals closing, because there has been a gap,” Germanos agreed. “But the gap has been closing, and in the next six months, we’ll see many more transactions.”
The window of opportunity to be investing in Brazil, however, is fairly limited, said Wainer. “When things are messy and there’s blood on the streets, that’s when you should be investing,” he said.
“You have to be ready,” added Germanos. “If you move when things are good, it’s too late.”
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