AMERICAS NEWS: Blackstone’s Brazil challenge

As the world’s largest real estate owner, The Blackstone Group has conquered much of the globe, building up a formidable presence in the US, Europe, Asia and Australia. Now, the private equity and real estate giant is taking on Latin America.

Blackstone recently broke into the Brazil retail real estate market with a $500 million investment in a retail development joint venture with Pátria Investimentos, in which it owns a 40 percent stake. Under the program, Blackstone and the São Paulo-based investment manager plan to build between 10 and 20 shopping centers in Brazil’s secondary cities over the next several years. 

Pátria, which incidentally is raising its first Brazilian retail real estate fund, is managing the joint venture and owns a majority stake in Tenco, which has built more than 20 shopping malls in Brazil during its 25-year history. Tenco currently is constructing four shopping centers on behalf of the program, although Blackstone is in discussions with other local developers to work with the new venture.

On paper at least, Blackstone appears to be making all the right moves in its entry into Brazil. A recent report from Prudential Real Estate Investors stated: “Retail markets present opportunities in Brazil, especially secondary cities, and likely will for years.” Meanwhile, a new Cushman & Wakefield report noted that Brazil had five square meters of shopping mall space per every 100 people, compared with nearly 200 square meters in the US. “The opportunity for future growth is apparent when compared to more mature retail markets,” the report added. 

Although Blackstone declined to comment, it’s evident from the size and nature of its planned investment that the firm is very optimistic about Brazil. However, the country’s retail real estate market has reached a point in the cycle where it is best for a firm to be pessimistic in its underwriting, noted one Brazilian real estate developer.

The shopping mall market in Brazil – even in some secondary cities – already is crowded with both local and international competitors. For example, Ivanhoe Cambridge, the real estate subsidiary of Canadian pension Caisse de dépôt et placement du Québec, built Porto Velho Shopping, a 312,160-square-foot mall in Brazil’s Amazon basin, with local partner Ancar back in 2008. 

For this reason, Blackstone’s biggest advantages as a real estate player – its scale and deep pockets – may not serve it as well in Brazil as it has in other markets. “There’s way too much money looking to develop shopping centers,” the developer said. Blackstone’s main resource is capital, but “it’s the one resource that’s not needed for this sector.”

Because both Blackstone and Pátria lack retail real estate experience in Brazil, the two firms will rely heavily on local developers to build the shopping centers. Partnering with the right developer is paramount to being successful in the country since many fail to deliver projects on time and at cost, said Alfonso Munk, head of Prudential Real Estate Investors Latin America. Therefore, any real estate player in Brazil, but especially a newcomer, would need to be extremely cautious in how it selects local partners. 

“It’s a very specific issue to Brazil,” Munk said, noting that construction costs in Brazil have more than doubled in recent years. “A lot of people have gotten burned by partners that didn’t deliver projects according to original underwriting.”

Another Brazil-specific problem is the financial instability of smaller retail tenants, which therefore are more prone to defaulting on rental payments. This has led to higher levels of turnover and retail vacancy rates as high as 30 percent in some malls that have opened in the country in the past year, according to the Brazilian developer.

Additionally, because financing for shopping centers is difficult to obtain in Brazil, those projects often need to be built with equity – as Blackstone initially plans to do with its development program. However, not using leverage on a project typically will lead to more modest returns, which may go against the expectations of investors putting capital into an emerging market. 

What is most worrisome to Munk, however, is the level of consumer loan delinquencies at Brazilian banks. Bank credit to consumers, after all, has been a major driver of the country’s retail sector. While consumer delinquencies in Brazil decreased by 3.4 percent in February – its fourth consecutive monthly decline – delinquencies were up 10.1 percent from the same time one year ago, according to Serasa Experian, a Latin American data provider.

“Consumers are overextended in terms of debt,” Munk said. If Brazilian banks were to start pulling back on consumer lending, “that would be a bad thing for retail.”

The conventional wisdom in the industry is to never bet against Blackstone, and the investment manager could indeed triumph over the challenges and make a success of its first foray into Brazil. The odds, however, currently aren’t stacked in its favor.