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Housing the young guns of South America

Managers are tailoring more residential projects to Latin America’s millennials and Generation Z. But with that comes the risks of investing in emerging strategies.

Youth demographics are increasingly becoming a key driver of residential investment decisions across the world, and Latin America is no different.

“Latin America has plenty of untapped potential,” the CAF – Development Bank of Latin America, Economic Commission for Latin America and the Caribbean and Development Centre of the Organisation for Economic Co-operation and Development jointly stated in an outlook report on the region last year. “The region is young, facing a unique demographic opportunity. One quarter of the Latin American population – 163 million residents – are aged between 15 and 29.”

Real estate managers investing in the region have taken notice. “We’re starting to do more and more millennial-type products,” says Gregorio Schneider, co-founder and chief investment officer at TC Latin America Partners.

Schneider: investing in butterfly apartments

Among those products is the so-called butterfly apartment, one of several apartment layouts offered at two of TC Latin America’s projects in Lima. The typical layout of a butterfly apartment in the Lima projects consists of two identical bedrooms and bathrooms, as well as a shared common space comprising an open kitchen, a laundry room, half bathroom and a living-dining room.

Butterfly apartments, typically below 650 square feet in size, and other small apartment layouts are currently experiencing greater sales velocity than the larger layout options. “We’re starting to see more and more the need to do smaller units, with bigger common areas with spaces where you can work,” says Schneider.

Millennial-type products currently account for 10-15 percent of TC Latin America’s residential strategy, which targets middle-income housing for young urban professionals, child-free couples and couples with children. Aside from Lima, the firm also has invested in a mixed-use project in Medellin offering millennial-focused units ranging from 441 to 1,237 square feet and amenities including a gym, pool, multipurpose rooms and pet-friendly areas.

With demand from millennials, butterfly apartments could become 30-40 percent of the firm’s residential business in the next couple of years.

Residential projects in Latin America typically need to be sold in phases in order for a developer to obtain construction financing. Homebuyers of individual units typically finance their purchases with 20-30 percent equity and 70-80 percent debt, according to Schneider. “As long as there’s financing, this strategy will work,” he says. “There’s a young population and the deficiency of apartments in the cities is still here.”

Early stages

Meanwhile, student housing has been gaining traction with real estate managers in Latin America, albeit through disparate approaches.

Earlier this year, São Paulo-based real estate fund manager VBI Real Estate acquired a majority stake in Uliving, a local student housing operator, with the intention of owning and operating more than 1,000 beds by the end of the year and 5,000 beds, or approximately 20-25 properties, by 2020.

Ken Wainer, founding partner at VBI, notes the pent-up demand for student housing in Brazil, which has the world’s fourth largest university population, with more than eight million undergraduates.

“Thirty to 40 percent of students live away from their nuclear families and are required to find housing arrangements,” he says, noting that Brazil currently lacks an institutional student housing market.

Meanwhile, Paladin Realty Partners is developing its first student housing units as part of a project known as 33 DC, in Bogota, where a handful of projects in the nascent sector have been initiated in the past five years. “It’s in the very early stages, despite the fact in Bogota alone, there are an estimated 250,000 students,” says Alex Krell, head of Central and South America at Paladin, which is investing in the project with partners that include Bogota-based real estate company Grupo Valor.

Given the dearth of university-owned housing in Latin America, out-of-town undergraduates typically live in improvised accommodations, such as rented apartments, fraternity-type housing, student hotels or with relatives.

“For many college freshmen, parents want them to be in a safe environment and well taken care of,” says Krell. “It’s much better than having your kid in someone’s apartment with no supervision.”

Unlike in the US, student housing in Latin America often offers more privacy to undergraduates, with apartments where each bedroom has its own private bathroom and even studios have private kitchenettes. However, common areas where students can congregate are ample. In the case of 33 DC, they include a pool, gym, movie theater, games room, music room and cooking lounge.

A greater focus on common space is one of the key differences in Latin America between the living preferences of ‘Generation Z’ – an even younger cohort than the millennials, with birth years typically between 1995 and 2010 – and their Generation X parents, typically those born between 1965 and 1980. “Gen Z is willing to share common space and will settle for less private space,” says Wainer. By contrast, their parents are dependent on private cars and domestic servants, and consequently require larger private spaces to accommodate both, he adds.

With student housing, other generational differences also need to be addressed. “The need to appeal to both parents and students is one of the main challenges in student housing,” Wainer notes.  “For example, the sales process must accommodate the mobile device-centric buying habits of the students with parents’ desire to pick up the phone and speak to a human representative of the company.”

33 DC: the Bogota project’s young residents will have ample common space
Wainer: careful to consider the economics of student housing

When it comes to developing student housing, however, both Paladin and VBI have factored the potential risks of investing in a niche residential sector into their decision making.

Wainer notes that “the economics of the emerging sector don’t work if you pay the market price for land and build something new.” However, VBI and Uliving’s strategy would be to buy and repurpose existing assets at 50-60 percent of replacement costs and complete the retrofits within 12 months, thereby avoiding the development J-curve.

VBI is targeting internal rates of return in the mid-20s and 2x-3x multiples in student housing, Wainer says. Exit options would include a local real estate investment or trade sale.

Meanwhile, Paladin is building its millennial-focused units as part of a larger mixed-use project rather than a standalone property. For example, although student housing – 517 units – is the largest component of 33 DC, the high-rise building includes ground-floor retail and 102 for-sale condominiums on the property’s uppermost floors.

Similar to its other investments, Paladin will apply a self-liquidating strategy to 33 DC to lower the exit risk. The firm will put the entire project in a fideicomiso, or trust, where investors can buy individual units that will be leased and managed by a single management company. Each investor will receive income, most likely monthly or quarterly, proportionate to the unit’s size relative to the whole rental pool.

Paladin had originally planned to pursue a retail strategy for the student housing units, selling to individual investors, but was subsequently approached by an institutional investor that wanted to purchase a large percentage of the units.

“It shows that the product is well-received and the market has an appetite for it,” Krell notes. “Bogota has a limited number of assets that are AAA, so if you are able to produce assets of that quality, institutional investors will come to you.”

Paladin, which along with its partners is investing a total of $9 million in 33 DC, is targeting returns in the mid-20 percent range. If the project is successful, the firm would consider pursuing more student housing developments as well as other niche residential strategies. “If it goes well, we’d like to expand it not only to Colombia, but the entire region,” he says. “We also could be stepping into multifamily. There’s also other opportunities within the income-producing residential asset class.”

And while 33 DC is intended primarily for students, Paladin could potentially open up more of the units to millennials who have already left their student days behind “if we find strong demand from young professionals who work downtown, don’t want to commute and want to take advantage of the pool, sauna and gym,” Krell says. “That’s definitely a lifestyle that is becoming more common in this part of the world.”