Latin America's greater economic and political stability is catching the eyes of investors, as Stephanie Schwartz-Driver reports
As some real estate markets struggle to shake off the effects of the crisis, Latin American markets seem to be emerging stronger than ever. As investors realise the benefits of looking at the region, they are also recognising the differences between the various markets.
The Spring 2010 Global Commercial Property Survey from the Royal Institute of Chartered Surveyors found that one of the "clear leaders in the real estate cycle" was Latin America. This is true from both investor and occupier perspectives. Rent expectations in Brazil topped the global tables, reaching their highest level since the first quarter of 2008. According to the survey, Brazil "was one of the few that did not see a further rise in available space in the first three months of the year and actually reported a drop in the level of inducement on offer to tenants."
The news is not only coming from the major markets. Peru topped the table on rent rises for the first quarter of the year, with increases also registering in Brazil and Chile, and tenant demand was on the increase throughout the region. In addition, the survey found that new development starts are rising not just in Brazil but also in Peru and Chile.
"At this moment, it is tough to talk about Latin America as a single region," says Ken Wainer of Vision Brazil. "The economies of these countries are driven by different dynamics, and investors are appreciating these differences."
These countries collectively are benefiting from a new stability. "Today the largest economies - Mexico, Colombia, Peru, Chile, Brazil - have their houses in order from a financial perspective," says Roberto Ordorica, CEO and managing director, PREI Latin America, who notes that Argentina and Venezuela, although large economies, have been less disciplined.
Ordorica also pointed out that the recent financial crisis did not have its roots in Latin America: "This is one of the first times that something like that did not originate from our region," he admitted. In addition, "the majority of financial institutions that operate in the region have very little exposure to contaminated paper," he says. "This is very different from Europe.
"For the first time in a long time, we are well situated for the years to come," Ordorica says.
And from the investor's perspective, the proposition should be appealing, for in the context of greater economic and political stability, the markets in the region are generating more attractive yields than many other markets are. But although many Latin American countries are benefiting from a positive outlook now, there are also key distinctions between them.
"In countries like Mexico, the absence of capital has pushed yields up, and cap rates are attractive because of a lack of liquidity," says Palmer Letzerich, managing director, Hines Mexico and Central America. "The massive real estate discounts that were going to result in 20-30% returns in the US - we are not seeing that. We still see a premium in Mexico versus the US."
Although investors had been wary of Mexico because its economy is so closely linked to that of the US, this is also its strength, according to Letzerich. "There is a lot of pressure on US companies to lower costs by moving to offshore manufacturing, and many of these manufacturing applications belong in Mexico." In terms of logistics, Mexico is close to the US consumer market - logistically it makes more sense to produce big-ticket items in Mexico than it is in China. The US buys 80% of Mexico's exports.
The Mexican industrial sector, in fact, has been leading the country's economic rebound. After contraction in 2009, growth returned in force, and the Mexican government forecasts GDP will rise by more than 4% in 2010, the fastest pace in a decade.
Ordorica similarly downplays the risks of the Mexican economy's strong ties to the US. "Yes, the Mexican economy is close to the US but that also means that Mexico is neighbour to the most important market in the world." He points out that production the Mexican automobile sector is surpassing 2008, pre-crisis levels.
Mexico is also developing its own internal market. "The hope is that the Mexican middle class will lessen the country's dependency on the US," says Letzerich, "but growth is not dependent on the domestic market." Mexican customers are not over-leveraged, because consumer credit is a relatively recent development. Nonetheless, retail sales have been slow to recover, lagging behind the rest of the economy. April retail sales were down 1.1% from the previous month and indeed down slightly from the same period the previous year. That said, rents and vacancies in mature markets have stabilised, although there are still significant vacancies in developed markets.
In Brazil there are no worries about recovery, because there was no crisis to recover from, and Brazil did not suffer with the US. "The pent-up demand is huge," says Ordorica, and the situation is set for the creation of a significant internal market that will allow Brazil to weather international storms.
"Growth over the next 10-20 years will be driven by domestic markets," says Wainer. "Fiscal, monetary and political reform over the past 10-15 years have set the stage for the middle class to emerge." The Real Plan, in 1994, began the process. It was one of a series of plans to fight hyperinflation, which was running at several thousand per cent annually. Now, following many years of reforms, there is low inflation, an independent central bank, and declining interest rates.
The big opportunity in Brazil, Wainer says, is putting the equity in. "In commercial real estate there are still real limitations in the availability of capital, so capital should be remunerated well," he says.
In the office market, the fundamentals are sound, with historically low vacancy rates. Because there is no established financing available, the challenge is to aggregate the capital and act as a developer. As a result, says Wainer, "new stock over the next two years is less that you would expect", although he notes that beyond 2012 the market might hit a cyclical soft point.
One of the focuses of Vision Brazil is office retrofits. "It is cheaper to buy a class B property and update it than it is to buy land," he says. However, because of the historic lack of project financing, many properties are strata-titled with multiple owners. Today, it is the real estate private equity managers who are building single-owner projects.
Brazil's attractions are making it a crowded market. For many international investors looking at Latin America, it is a logical starting point. "Typically there is a herd mentality among institutional investors, and now the flavour of the month is Brazil," says Ordorica. "We like that. It helps institutionalise the market - and we don't have a problem with investors taking a look at Brazil first. While staying one step ahead, we also explore other markets in South America that may complement our exposure to Brazil." Europeans tend to go first to Brazil, while US investors turn to Mexico. Canadians tend to feel disadvantaged in Mexico by the US and as a result look at Brazil," notes Ordorica.
There are three routes into the Brazilian market, according to Wainer: through listed equities, such as homebuilders, and there are 20-25 listed companies which trade at around two to three times book value; through investing in core with a local manager; or through real estate private equity, and there are around five managers with local teams.
When looking for a local partner, it is important to know that "there are not very many real estate professionals in Brazil," notes Wainer. Some real estate people who have historical connections, family ties, may not follow best international practices, he warns.
And although it is crowded, Ordorica recommends Brazil, or Mexico, as a starting point, because the economies of scale that can be built around due diligence are better. "I would not recommend writing a large cheque to Peru as a first investment," he says, "although returns are higher in Peru or Chile because more capital is chasing deals in Brazil or Mexico."
Chile is noted as a historically stable and well-run country. Ordorica likes Chile for its management expertise; because it is a small country, there is a tradition of looking outside its national borders, so professionals there are imbued with international standards and ways of doing business.
The February 2010 earthquake means there is a bigger opportunity in the housing sector. Other sectors have been relatively unaffected: retail sales rose in the first quarter of this year, and vacancies in the office market remained steady, although a flight to quality properties is expected.
Hines is interested in Panama. "It is a smaller market, but we have an increasing presence there," explained Letzerich. It is a US-dollar economy that offers some unique opportunities on the industrial side, he explains, because it is a free trade zone in a tactical location.