October 14, 2016
Interviewed by: Zoe Hughes
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How Far Will Brazil’s CRE Pricing Fall?

Commercial real estate deal volume in Brazil will increase markedly in the second half of 2016 and early 2017, as owners realize the country’s recovery will take a long time and valuations need to be written down.

John Druckman, principal and managing director of advisory firm Fontis Capital Group says opportunities are emerging in Brazil, but for owners the light at the end of the tunnel is a “long way away” and pricing expectations need to be adjusted in response.

Commercial real estate deal volume in Brazil will increase markedly in the second half of 2016 and early 2017, as owners realize the country’s recovery will take a long time and valuations need to be written down.

John Druckman, principal and managing director of advisory firm Fontis Capital Group says opportunities are emerging in Brazil, but for owners the light at the end of the tunnel is a “long way away” and pricing expectations need to be adjusted in response.

How Far Will Brazil’s CRE Pricing Fall?
With John Druckman of Fontis Capital

Zoe Hughes, PrivcapRE:  I’m joined here today by John Druckman, Principal and Managing Director of Fontis Capital Group. John, thank you so much for joining me.

John Druckman, Fontis Capital: Thank you for having me.

Hughes: There’s a lot of negative headlines when we look to Latin America and commercial real estate investing. And I think that, for many investors, they’re actually scared. They don’t see much risk-adjusted returns or rewards within the region today. But is the perception of risk blinding them to the fundamentals and the opportunities that actually might be within the region? Given all the volatility that we see within the region, are you scared or are you excited for commercial real estate investing in Latin America?

Druckman: I’m always excited about it but you have to look at Latin America…and break down each country individually. Each country is not created equally. Just like for investors in Europe, Italy and Greece are completely different. Mexico and Brazil are completely different. There are definitely opportunities within these countries. It’s just a question of which asset type and which country one wants to commit their resources to.

Hughes: Let’s have a look at particularly countries that you are…actually quite excited with. Let’s start on the good news. Where are you most excited when you look to Latin America in terms of countries?

Druckman: We’ve been always active—most active—in the Andean region and Peru and Colombia, and also within Mexico. That’s where we feel the most comfortable. However, there will be opportunities as Argentina’s leadership changes and things progress in that country. For certain types of investors with different risk tolerance, Brazil will be presenting opportunities. But, for us, we feel most comfortable in the Andean regions and in Mexico. And there’s been some very positive news out of Colombia with the peace agreement that was overshadowed by news on Brexit; that will have long-term, positive ramifications in that country.

Hughes: I will ask you in terms of the property sectors you’re really looking at, but when you mention Colombia—I know that, for some investors, some of the economic news is a little bit scary. They’re the better-performing economy, but inflation is rising. We’ve got declining GDP in some areas, we’ve got rising inflation. How do we offset the opportunities against some of the economic news? It seems as though there’s mixed news and mixed signals.

Druckman: There’s definitely mixed news out of Colombia. Oil prices and that result on the GDP of Colombia…has been significant. And the big question going forward in Colombia is how will the country replace the revenues as it relates to oil? In the short term, in the near-short term or in mid-long term, there are significant investments in the infrastructure of that country that will be going forward and will be interesting to see how that happens. For us, the other factor that was significant was a significant drought over the past year due to El Niño in Colombia as well. That had some ramifications, but we still see a lot of strength in our core focus, which is projects that cater to the middle income and growing middle-income populations in these countries. So, in housing and in certain aspects of retail, but one has to be very careful into which city and to which asset type. We’re not actively looking at office transactions in Bogotá today. I think you’ve seen there’s an issue on supply, and rents have dropped in some capacity.

Hughes: Let’s look to Mexico, and some of the investment and the property types you’re targeting. When you look to Mexico, where are you bullish? Where are you perhaps bearish?

Druckman: We’re extremely bullish in a relatively newer asset type for Mexico: rental housing. That’s a trend you’ll see throughout Latin America, but it’s been particularly impressive and interesting to see how it’s evolved in Mexico. Specific to Mexico City, we see the demand for rental housing significantly due to a number of factors, some of which are the cost of purchasing a home and the increased amount of expats in Mexico City specifically. There’s also a huge void in Mexico for middle business travel-focused hotels. For inner Mexico travel, on the business side, there’s a lack of quality hotels and specifically foreign-flagged and foreign-branded hotels.

There’s obviously a lot of players in Mexico who have been very successful in industrial and catering to manufacturing. The local REITs, the FIBRAs, have been very aggressive in their pricing for stabilized assets, specific in industrial and other types of income-producing assets. So, we try to not be in competition for assets with those type of entities, but we see them more as our exit in some capacity.

Hughes: In regard to the for-rental housing, the multifamily market, that emerging market—it does sound exciting because it is such a nascent start in its growth. Do you think it’s got the legs to grow almost akin to what we’re seeing in the U.S.?

Druckman: I wouldn’t compare it directly to the U.S., but when we look at the market, we maybe look at U.S. in the 1970s or an earlier stage in the U.S. We think it’s a product type that is in high demand by the local population, the end users of this—the renters. Also, we think it’s an asset class that the local pension funds and other types of investment funds will gravitate toward. In a lot of the Latin markets where we’re focused, for many years, you’ve had a lot of for-sale product being built. The advent of building and renting and having income-producing assets has been slower to develop.

Hughes: But it’ll take someone with, or an investor with, a long-term time horizon, wouldn’t it?

Druckman: Yes.

Hughes: Because you can’t get the yields or the returns like you can for sale.

Druckman: Exactly! And you have to…strategize and be very particular on which sites you target. One needs to really be part of mixed-use projects to make the pricing and the cost of these developments actually work in our estimation. To start in a Mexico City and some of the major cities is probably the ideal place to do this. But, we do think that there is demand. Then, it’s a question of can you build a rental incomeproducing property and have the investors who have that long-term thinking as well? Because historically, in the emerging markets, there hasn’t been more or less that long-term thinking, so that’s the tricky part of that equation.

Hughes: When you look to the Andean region, one thing people question or challenge is the depth of the market and that seems to be a key hurdle, as it were, particularly for some of the large investors. The scale of market is just not deep enough. How do we overcome that?

Druckman: That’s a significant challenge. We’ll take the Andean region, where we’re day-to-day active. In a country like Colombia, you have multiple cities with significant populations, so one could have a platform in the country of Colombia in multiple cities. When we’re looking at Peru, more or less we’re looking at Lima, potentially in Arequipa and some of the other smaller cities. But to get that scale for a global pension fund or a global sovereign-wealth fund—that is the challenge. To look at the region collectively is something that some large institutions have done to try to create a regional platform. But each country does have its challenges.

As the markets are changing and are evolving to building for income and building toward for rent versus building for sale, there are significant gaps in the industrial sector and the retail sector. So, to some extent, there is a large need and a large amount of equity need to build a platform of income-producing assets. But certainly, to get a global firm comfortable [with what] the scale will be, there is a challenge that one has to either attack by finding multiple potential projects at one time or looking at it regionally and doing Colombia and Peru and Chile.

Hughes: Obviously, when we talk about volatility in Latin America, the news is always dominated by Brazil. So, let’s talk about opportunities and challenges there. Is there blood on the street in Brazil today?

Druckman: Today in Brazil, the most significant opportunities probably have not yet presented themselves. This will happen. It starts to happen, I believe, toward the end of the summer and going into the first quarter of next year. You have seen a few minor transactions. There’s a lot of buzz over significant M&A, but as the new president takes over and he has assembled great people and cabinet around him with strong thinkers in economic policy, people or owners on the real estate side will start to realize that the light will be at the end of the tunnel, but it’s a long way away. [They’ll realize] that their pricing expectations will have to be adjusted downward, thus probably creating more transactional volume in the market.

Hughes: Obviously, we’re looking at markets throughout Latin America and I’d love to get a sense of emerging markets within this emerging region. Is Argentina the next emerging market in Latin America?

Druckman: In a lot of ways, I think it is. Argentina, historically, has gone through a lot of boom and bust. So, as people look to Argentina, they have to keep in mind what’s happened historically. But they certainly have a great, pro-business, new president who’s attempting to make the reforms needed to put that country on the right track. We’ve looked at our thinking of opportunities as it relates in the residential sector in Argentina and that’s something we’ll continue to look at.

Hughes: As you look to 2016, do you think this is going to be the year of Latin America or do you think we have to wait a bit for the volatility to calm down?

Druckman: I think you have to look at it country by country. There are exciting things happening. Politically, you had a very favorable election for investors in Peru. In Brazil, you’re having a new leader come in. In Argentina, you have a leader come in. But, with all these new leaders, it takes time for them to implement their economic and social policies. So, while more investors will start to look in 2016, I think 2017 might be more favorable toward the actual investment into Latin America.

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