AMERICAS NEWS: From developers to lenders

To hear Ken Wainer tell it, developing properties was not part of the original plan when he helped to form VBI Real Estate a decade ago. 

While the São Paulo-based firm sought to acquire commercial real estate assets in Brazil, it was difficult to do so, because properties were mostly held in strata title format, where each floor of a building belonged to a different owner. “Out of necessity, we all became developers,” he said. “We wanted to hold property but there was nothing that we could buy, so we had to create our own.”

Now, after 10 years of developing institutional-quality properties, VBI is going back to its “real DNA” as a private equity fund. “There's much better things that we can do other than the headache of developing,” said Wainer. “We can provide capital to others that need it.”

Much of that need is concentrated in the Brazilian residential sector, where many public homebuilders are said to have expanded too quickly and aggressively during the sector's IPO boom in the mid-2000s, and in recent years have been struggling to turn around their companies. The sector's challenges, moreover, are exacerbated by Brazil's credit environment, which has deteriorated fairly rapidly over the last six months. 

Government banks, which had been very active real estate lenders over the past several years, have cut back on their funding to residential developers amid the country's fiscal woes. Meanwhile, Brazil's private banks, which previously have lent heavily to some homebuilders, also now are trying to reduce their exposure. 

“In a way, the sector has leprosy right now,” said Maximo Lima, founding partner of São Paulo-based Hemisfério Sul Investimentos (HSI). “No one wants to touch it.” 

And, just as bank financing is drying up, some developers are facing debt maturities over the next six to eight months. Enter firms such as VBI and HSI, which have become an alternative source of liquidity to developers, primarily by providing financing using the underlying projects as collateral, or directly acquiring projects that are well-sold and at or near completion, so that commercial or execution risk is minimal. 

In providing financing, even if the developer doesn't repay the capital, HSI is able to take over the property, monetize the asset and get repaid that way, Lima reasoned.  As for direct acquisitions, the business plan is simple. “We buy the projects, and we keep the developer on the hook so they finish it,” he said. “Once the project is finished, we get paid by the banks, who take the receivables from the projects.”

For VBI, one recent investment was providing R$120 million (€37 million; $40 million) in mezzanine capital to a Brazilian public homebuilder during the third quarter of last year, at a loan-to-value of approximately 50 percent to 75 percent. The financing is backed by nine for-sale residential development projects in progress. Once the projects are delivered, the developer will need to repay both VBI and the senior lender before being entitled to the receipt of dividends.

 In fact, VBI has invested about $150 million of capital in preferred equity and mezzanine debt-related transactions over the past six months – more than any other six-month period in the firm's history. “We plan to do substantially more investing over the next three years than we've done in our entire history,” said Wainer.

One reason for this is that Brazil's economy could potentially recover faster than one might expect, given the country's overall sound banking system and the fact that the country's fiscal policy changes could potentially result in much lower interest rates, he noted. “This opportunity, it's very specific to the moment and could change very quickly,” he said.

As for HSI, it raised $200 million last year for HSI High Yield I – its first debt fund in more than 10 years. Similar to the firm's private equity funds, the debt vehicle targets 20 percent to 30 percent returns, but has a different multiple because of its five-year investment life – about half of that of the private equity funds.

Over the past six or seven years, investing in debt in Brazil was not an attractive opportunity, given the country's artificially low interest rates and abundance of credit, said Lima. “You want to be a debt investor in environments like you have today, where the credit is very dry and the yields are high,” he said.

Lima anticipates that the Brazilian residential sector will continue to worsen over the course of the year. By mid-2015, “we're going to see even more distressed opportunities and chances to buy assets at even more attractive levels than where we are today,” he said. “The deal that sounds horrific today might sound really good for them six months from now.”