July 30, 2014
Interviewed by: Privcap
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Risk Premiums, Returns & Brazil

GID International quantifies the risk premium it requires to invest in Brazil and India: up to 1,000 basis points over U.S. development yields. Senior managing director Kenneth Munkacy explains GID’s residential strategy for emerging markets.

GID International quantifies the risk premium it requires to invest in Brazil and India: up to 1,000 basis points over U.S. development yields. Senior managing director Kenneth Munkacy explains GID’s residential strategy for emerging markets.

Risk Premiums, Returns & Brazil

With Kenneth Munkacy of GID International

Zoe Hughes, PrivcapRE:

I’m joined here today by Ken Munkacy, Senior Managing Director at GID International. Ken, thank you so much for joining me today.

Ken Munkacy, GID International:

Thanks for having me.

Hughes: There’s a big conversation among institutional investors about the risks involved in investing outside their domestic base, particularly whether that additional risk of foreign investment is worth the net returns that come back to them. GID is well known for its U.S. multi-family development, and before we dig in to what you’re seeing in terms of risk and returns, could you explain why GID expanded into the emerging markets?

Munkacy: We went overseas for a variety of reasons—among them that we were heavily weighted in the U.S., and being heavily weighted in one asset class is never a good thing—but really to capture some of the arbitrage of a middle-class growth in the emerging markets to capture the great demographic premiums. In places like Brazil and India, the average population below 35 is about 65% of the population. It is significant. They are also creating a new middle class, and if you step back from it and you see that this is a lot like U.S. in the 1960s and 70s, when you had this huge surge.

Hughes: When did you move into both Brazil and India? Give us an idea of how those portfolios look in those two countries.

Munkacy: I have been doing overseas international business for about 20 years, but GID first started in 2006, and there was a time when some institutional investors were starting to look abroad. It was really that first wave of institutional investments and GID said, “Let’s evaluate these markets and see where the voids were in the markets,” and they set out upon India as the first market. That was in 2006. Then, in 2011, it became Brazil. Since then, we’ve looked at a variety of other Latin American markets.

Hughes: How many deals do you have in India versus Brazil?

Munkacy: In Brazil, we started out with a venture with a third or fourth-largest construction-development company called OAS, and we focus on middle-income housing. We have a JV with them that they do the local day-to-day development and construction, and we jointly created an entity that does asset management. The idea is to grow the platform and to eventually bring in institutional investors. Also, we’ve been looking at the middle-income markets there; right now, we have roughly 2,000 units going on in four cities.

In India, the approach was a bit different. We wanted to create a new organization. We created a joint venture with some local executives and with a firm out of Washington, DC, called Akridge. We created Piedmont Development Company with the idea to create a vertical that could execute an implement. We really wanted to instill our best practices into the venture, to be able to control costs and to bring in new techniques involved with housing and programming and the like. Our approach has been to create a services company, and then do principle development. Right now, we have about one to three million square feet of residential, middle-income projects underway.

Hughes: When you look at returns, how do you compare the development yields really you’re seeing in the U.S. versus Brazil first, but India as well.

Munkacy: The development returns or requirements are about 25% IRR and a 2x, and the reason is that we try to get roughly 500 to 1,000 basis points spread over what we can be domestically here in the U.S. That’s been part of the problem, because as the development yields in the U.S. have been increasing and cap rates compressing on the residential market here, finding really good deals on a risk-adjusted basis in both Brazil and India is tough.

When we first came into India, the returns were well over 40% (IRRs), and as more capital came in, landowners got smarter, and the market became more competitive, those yields have consistently dropped. Despite high inflation and bad economic growth, the demographics are still there and landowners tend not to flip out of property. They’ll just hold and wait out the cycle. So, you never quite see that lower land cost occurring as they do here in the U.S.

Brazil’s much the same. When we first entered that market in 2011, it was very much a north of 40% (IRR) market. Yields have been coming down and down, so again, you have inflation, which has been pernicious, and you have a lot more competition. So, right now, we’re still able to achieve mid returns in the mid-20s (percent).

Hughes: What are your expectations on returns? Particularly for Brazil, because we have seen an outflow of capital coming from there.

Munkacy: That big sucking sound we’ve all heard is the disintermediation of about $3 trillion out of emerging markets. In Brazil’s case, that’s a good thing because there was way too much capital and it just created bubble pricing in a lot of sectors and markets, and they needed to sober up, frankly. While the underlying demographics and fundamentals are very much there, it’s our view that with the capital flight out of the marketplace it’s created some dislocations. So, we actually like Brazil. We’re bullish on it going forward because you’re starting to see some dislocation and some recap and restructuring opportunities. Landlords are starting to let go of things at prices they wouldn’t have a year ago, so there is a scarcity of capital in some porters and the banking system is still not enough for the opportunity set, nor are the private equity markets.

Hughes: How are you looking at terms of your growth, GID’s growth, in Brazil? What’s attractive as you look forward?

Munkacy: We’re not a fund. We’re a family office, but we’re a vertically integrated real estate investment operating development company, and we’re not an allocator.  So, when we come into a venture like Brazil, we’re not there for a fund life. We’re not there for a seven-year timeframe. We’re not there to make fees, but to capture that demographic growth and the supply/demand voids over 10 or 15-year views. That’s our window. So, we don’t have a gun to our head in terms of “use it or lose it,” like many fund managers. We’re using house money, as are our partners.

Hughes: Talk to me about how you balance the risks of investing in Brazil. We’re hearing a lot in headline risks. Obviously, rising rates, protests on the streets, there’s unrest within the economy—

Munkacy: Yes.

Hughes: —and the markets, but how you balance that against obviously declining premiums?

Munkacy: There are still premiums to be had. You just have to be a lot more selective and understand your customer better. The risks are tremendous in some ways. Along with this disintermediation of capital since Bernanke announced the tapering (it was over a year ago now), you’ve had a significant decline in foreign exchange value. So, on an FX, in some countries it’s north of 30%, but generally, Brazil has been 15% to 20%. India was around 25%. So, FX risk is the predominant one. Also, you have uncertain tax regimes and lack of transparency. The market data is not there, and firms like yours don’t exist there. They need to exist, and you don’t have that—the metrics we take for granted here. There’s no multiple listing system, for example. Market research is in its nascent phase. Consumer research is virtually non-existent, other than the consumer products sector.

One thing we do in our ventures is to bring in those best practices of market research and consumer focus groups, trying to shape the residential product so it can be competitive. That’s the thing in places like Brazil. They now have choices, whereas five years ago, they didn’t. So, we’re looking for brand development to create premiums in that way so we can hopefully smooth out some of the down cycles with just a reliable, good-quality product with good value.

Hughes: What happens for other institutional investors, when say they are going through the funds? Obviously, they need to bring that capital back. You said there’s an FX risk. You’ve obviously got taxation. What’s the impact on their net returns? Is it worth the risk of investing overseas if you’re not reinvesting that money and keeping it there?

Munkacy: That’s an interesting point because, for that reason, we don’t do funds. The institutional investors who are in Brazil, there’s no question about it—many have taken those kinds of huge FX hits. Nevertheless, many of them are doubling down. They see this disintermediation as an opportunity to stay behind and get some good discounts, so there’s a quotient of investors in the institutional world that want a balanced portfolio. They don’t want to be over-weighted in one country. The emerging markets still provide opportunistic returns—no question. The U.S., they’re investing in a low-teens world net of fees. You could still get high teens sometimes, depending on where you are and what kind of product. You could still get low-20s net of fees in some emerging markets. For most of these investors, it’s not an either/or, but just getting the right mix and balance.

Hughes: Are you more excited today about Brazil than, say, five years ago?

Munkacy: Yes, I am. To me, it’s all about fundamentals. It’s about one-and-a-half million households growing each year. It’s about the young population I mentioned. It’s about the rising middle class, and it’s about the disintermediation. That’s taken some of the frothiness out of the market, and has rationalized a lot of the land prices in the sectors and the players there. Are they without problems? No. Their politics are hamstringing them significantly and there’s an interesting moment historically between going toward a crony-capitalist, market-oriented society akin to say, Philippines or Indonesia, and making a further left turn into Greece or France. So, it’s a very interesting moment, but very strong marketplace.

Hughes: Will GID look beyond Brazil into some of the more emerging Latin America countries? Look at Colombia and Peru, for example?

Munkacy: We have looked at them. In the near term, we wouldn’t look at it in a basket as many of the funds are. We are looking very hard at Mexico. It’s a deep market, with very close ties to the U.S., and it’s a great growth story. Again, it’s middle-income growth. To us, Colombia was too small a market. Chile and Peru are quaint little markets and very dynamic, but we can’t see just focusing on that one small a market. We need a broader spectrum, the way Brazil was. The next closest market probably would be Mexico.

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