When the more than one million residents of Campinas, Brazil go shopping, they wander open-air markets and visit a smattering of outdoor strip malls. Despite a swelling middle class, the bustling industrial region about an hour outside of capital Sao Paulo has very little indoor retail space. The lack of a proper shopping mall is the kind of thing that Pierre Lalonde dreams about when trying to decide where to invest Ivanhoe Cambridge’s money.
Ivanhoe Cambridge–the real estate arm of the that specializes in retail space–has about $700 million invested in shopping malls in the South American country and isn’t averse to increasing that amount. Indeed, Lalonde is in Campinas this week to get work started on a new project.
The company is one of a handful of Canadian real estate companies that are together sinking billions of dollars into Brazil, betting that the country’s highly fragmented real estate industry is ready to be consolidated and professionally managed after decades of underdevelopment. They think that Brazil in 2011 is similar to Canada in the 1970s, and that with the right partners Canadian companies will be able to earn outsized returns on their investments that would not be available here.
“There’s a void in that market and we were able to get some land and will start construction soon,” said Lalonde, who is senior vice-president of portfolio management and strategic planning for the Montreal-based real estate company. “Canada is our core market where we developed our expertise, and now we can apply that to countries such as Brazil.”
Brazil has one of the strongest consumer cultures in the world, with citizens among the largest spenders on the planet. Its citizens are already the world’s fourth-biggest consumers of apparel and cosmetics, despite a wide gap between the rich and the poor.
By 2050, PricewaterhouseCooper estimates, it will be among the top three consumer markets on the planet. Yet there are still sizable cities such as Campinas without the large indoor shopping centres commonly associated with the middle class, because the investment climate hasn’t allowed developers access to the money they need to build modern malls.
“From a Canadian perspective, Brazil has really got things under control recently,” said Vanessa Iarocci, vice-president of deals at PwC. “It’s got a handle on inflation and its currency, it’s a net exporter of energy and it has made a lot of progress in the last decade compared to other markets, such as China and India. If you’re coming from the Canadian market, it actually looks quite familiar.”
Indeed, Brazil has a lot going for it–inflation has stabilized since the mid-1990s, it saw its first budget surplus in 1998, and reached investment grade status in 2008.
There’s one key difference between Brazil and Canada, however, and that’s where the opportunity lies. Interest rates in Brazil are more than 11%, which has made it almost impossible for local developers to finance development over the last decade because loans are too expensive.
“Brazilian real estate is still in its infancy,” said Peter Ballon, vice-president and head of real estate investments for the . “There is a lot of pent-up demand across all real estate sectors, and there is still a shortage of capital. We expect the opportunities to be significant, and that we will invest a significant amount of capital there in the next several years.”
CPPIB has already committed up to $250 million in a joint venture with Cyrela Commercial Properties SA, a local partner that develops office buildings, shopping malls and logistics facilities.
While the pension funds have only been investing in Brazil over the past decade, has been active in the country for decades. Today, it has more than $10.6 billion of real estate in Brazil, covering residential, office and retail space. And while it is entrenched enough to act alone, most newcomers to the country prefer to enlist a local partner to help defray the risk and understand local markets.
“There are [Brazilian] entrepreneurs that just can’t do it on their own,” Ballon said. “They could grow at a very slow pace, but the opportunity is now and we can accelerate the growth with long-term investments. The returns are good, and having a solid partner helps to manage risk.”
There are plenty of reasons for caution. PwC warned in a recent report–intended to encourage Canadian companies to consider increasing their merger-and-acquisition activities in the country–that the murder rate was 12 times higher than in Canada, “raising the risk that companies will lose key employees.”
The report lists other challenges, such as powerful trade unions, a complex tax system and “corruption issues typical of a developing country.” “When I wrote the report, I called my colleague in Brazil to see how he would react to those warnings,” Iarocci said. “He was fine with it–and that’s why we tell companies we are working with that they never want to do it alone; you want to involve the Brazilians.”
There’s also the risk of coming too late to the party. While vacancy rates in office towers are notoriously low – some key cities have absolutely no vacancies to speak of–a surge of activity over the next three years is expected to have a major effect on vacancy rates. The Faria Lima district in Sao Paulo has a vacancy rate of 0.4% cent, but will see its office space increase by 40% in the next three years. Lease rates have increased by 17% in the last year.
The new space will draw from older buildings in the region, said Colliers International research co-ordinator Leandro Angelino, because companies “seek the benefits caused by corporate visibility and the glamour of the region.” That will open up retrofit opportunities in outlying areas, however, and that’s where Canadian capital could best be put to work.
“From the very long-term perspective, this sort of market is ideal for pension funds,” CPPIB’s Ballon said.