Commentary on NYU Schack Institute of Real Estate: Latin American Real Estate Markets in the Near Future

The NYU Schack Institute’s panel, Latin American Real Estate Markets in the Near Future, highlighted where the smart money is going in real estate development in the region. Since real estate investment has to be part of a longer-term strategy, sentiment among these investors can be a useful indicator of trends. Overall sentiment underlined the centrality of Brazil in the Latin America investment story, affordable housing in Mexico and Brazil, and positive trends in Peru, Colombia and Panama, especially the main cities.

Overall, the focus on megacities or the largest population agglomerations appears to be the strongest trend. I was most struck by the increasing understanding that sprawl-creating megaprojects outside city centers were increasingly neither responsible nor responsive to buyer demands. Risks from the US – inflation, overvalued currencies, double dip – and competition from comparable return distressed assets in the US is driving an undercurrent of concern.

Brazil received the majority of the panelists’ attention for the strong demand fundamentals and the boost from infrastructure investments for the World Cup and the Olympics. Key observations:

  • Real estate project lending in Brazil is more scarce as banks are generally not involved. Given the high lending rates of 15-17%, projects generally require all equity. This amplifies the need for project equity, which can be problematic for projects of $10-30 million. Nonetheless, the return calculus in the country is highly attractive with build-out costs at $300/sq ft for Grade A development and sale market at $800/sq ft.
  • Minha Casa Minha Vida, the government’s program to support housing development for low income families: New President Dilma Rousseff has pledged the continuation of this program although government bureaucracy still hamstrings the program with processing backlogs. Brazil’s housing market is still inefficient where the largest builder, Cyrela, only has 10% of the market. The entry of Homex may change this, but it hasn’t made a significant impact yet.
  • Securitization of residential mortgages is coming, but only for high price homes. Panelists and audience noted that there wasn’t any reason for the government to keep the Minha Casa Minha Vida mortgages on the Caixa’s books.

Mexico’s advanced affordable housing market was also pointed up as a result of the government’s proactive development of the housing finance market.

  • Building 1 million houses per year is increasingly seen as an attainable goal. While affordable housing may be a fraction, the volume speaks to advances related to improved access to finance. Compared with Brazil, Mexican banks are very much involved in project lending.
  • Innovations and new directions include a movement towards less sprawl and more medium to higher density urban developments, experiments in building for rental and the possibility of promoting progressive building models.

Argentina’s underdeveloped markets – in the financial sector, in homebuilding and in government initiatives – have been problematic for moving into residential markets.

  • As elsewhere in the developing world, self financing is common in homebuilding in Argentina although payments may be linked to construction progress. The positive of this approach is that buyers have generally paid off the house when they get the keys, but the heavy household financial burden diminishes the accessibility of home purchase.

Financing sources across Latin America appear to have diversified, despite continued constraints, in the wake of the financial crisis in the US.

  • Local bank financing is still unusual with Brazil being the market with the least bank involvement in construction lending.
  • International lenders are still out of the action as they unwind distressed assets and deleverage in the US. Chinese capital is becoming more common in capital-constrained environments (e.g. Panama). Cross-border investors have likewise become more active in sectors like hospitality and retail.
  • State-owned banks are able to finance projects, e.g. Caixa Economica Federal in Brazil.
  • Smaller markets have a harder time attracting international investors despite good fundamentals (e.g. Colombia and Peru). The herd mentality doesn’t help.

The discussion on governance was fascinating in rejecting the inevitability of corruption as an element of real estate development in Latin America. All the panelists agreed that traditionally governments had got involved in real estate zoning and permitting, getting cozy with developers on projects. Yet, each had a reflection on evading the potentially corrosive effect of corruption on returns.

  • Choice of partners and careful due diligence are key. Having detailed conversations about how partners get things done on the ground and trying to identify any unclear explanations or evasive responses. Examining the books for mysterious payments to consultants is another basic approach.
  • Banks are doing more intensive due diligence in the current economic climate, so it’s increasingly difficult to get around this scrutiny.
  • The bottom line is that funneling off cash for payments will always have a negative impact on returns, so to be competitive in markets where returns have been driven down, the expense line items need to be analyzed carefully.

This led directly into a conversation about the oft-heard legal challenges and constraints. It goes without saying that legal contracts should be entered carefully  to define parameters of partners’ spheres of responsibility, to clarify decision-making and to ensure a control position of at least 50% for the foreign investment partner.

  • Certain panelists recommended against having any decisions that would be taken by all partners, as opposed to clearly dividing up responsibilities (financing, design, etc.).
  • All agreed that clear termination at will agreements would help avoid delays due to disputes over whether terminations had been executed without cause.
  • The operational response to these legal challenges lies in communication and relationships. All underlined day to day communication, frequent visits and local oversight, as opposed to expecting the legal and judicial process to work problems out. By that point, it’s almost always too late.

Although all investors are focused on their exit strategies, there wasn’t much anticipation of needing to exit immediately.

  • In Brazil, anticipated strong fundamentals were keeping investors in the market.
  • In Argentina, the panel amused by pointing out that exits in Argentina are better in good times – not at times of crisis.
  • In Chile, exits through the public markets are possible.
  • Everywhere overvaluation of currencies and the potential impact on repatriated returns is a concern.
  • Risks are being managed with dollar-denominated lease contracts with payments made through local-currency denominated, non-inflation indexed contracts.

Panelists:

  • James P. Stuckey, Divisional Dean, NYU Schack Institute of Real Estate, Klara and Larry Silverstein Chair of Real Estate, Clinical Professor of Real Estate (introduction)
  • Dr. Tom Geurts, Clinical Professor, NYU Schack Institute of Real Estate (moderator)
  • Jorge Lizan, International Business Development, International Council of Shopping Centers (ICSC), Latin America, www.icsc.org
  • Matthew Bruck, Managing Director, Royal Institute of Chartered Surveyors (RICS) Americas, www.ricsamericas.org
  • Francisco Andragnes, Chief Investment Officer, Prudential Real Estate Investors Latin America, www.prudential.com
  • Isaac Khafif, Founder and Chief Operating Officer, MKF Group, www.mkf-group.com
  • Andrew B. Stein, MD for Hospitality for the Americas, Savills PLC

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