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Thursday, 24 April 2014

Safe as houses?

As volatility creeps up and investors become averse to real-estate-related issuance, homebuilding could lose momentum. Office construction, though, will probably remain healthy as cash remains king and private-equity firms step in, as Christopher Langer reports.

As Mexican and Brazilian markets increase in depth and maturity, one of the biggest beneficiaries has been the real estate sector. Homebuilders in Brazil have tapped the equity markets at previously unseen rates, and within three years the sector went from being nonexistent to becoming the single biggest in Bovespa. The Brazilian stock market as 26 real estate companies listed.

In Mexico the driver was the debt market. RMBS issuance went from US$53m in 2003, when the first transaction priced in the local markets, to US$3.1bn last year.

Yet the sector could be about to lose momentum as investors become increasingly skeptical of real-estate investments. The foreign investors who bought stocks of homebuilders in Brazil have been passing on new deals. Real-estate concern Abyara's failed attempt of a follow-on last year is symptomatic of the malaise. The company had planned to pre-fund its needs with an equity deal late last year but saw its stock get pummeled ahead of the transaction, which forced it to eventually pull the deal. Morgan Stanley, Unibanco and HSBC were leading the failed deal.

Brazilian real-estate woes were felt beyond stock issuance as homebuilders began taking advantage of their low leverage after their IPOs and tapped international debt markets. It was a natural development, which should have seen them start issuing debt to finance their cash-intensive activities after raising money through equity. That strategy quickly floundered when the US subprime crisis hit in earnest in the middle of last year. As a result, homebuilders like Cyrela had to switch to the local markets instead.

Cyrela had planned to price a R$500m 10-year bond in global markets in July last year but had to pull the deal when markets tumbled as the US subprime crisis hit in earnest. Eventually Cyrela priced a local R$500m 10-year deal in January this month, creating a benchmark for the sector. But even such big and well-known companies have already been facing problems. For example, in February Cyrela had to postpone its expected follow-on equity deal as its share price was compressed below the floor of the price talk.

This scenario is expected to become increasingly common. As the senior strategist for Itau Securities Tomas Awad explained during a real estate summit at the Brazilian American Chamber of Commerce in New York in the first week of March, Brazilian homebuilders will now enter a round of financing, "and banks and investors will not finance everybody this time."

The situation could make the time ripe for the more solid and well-established players to gobble up the smaller companies. Bankers believe a large-scale consolidation is long overdue in the real-estate sector in Brazil. However, as the market is largely dominated by family-owned companies, a lot of the upcoming transactions are expected to be friendly mergers, carried out through stock swaps. Some companies, for example PDG Realty and BR Brokers, have already positioned themselves as consolidators. Such companies would not be expected to have trouble raising money, having shown impressive growth results lately.

As investors turn a cold shoulder on most real estate companies in Brazil, private equity firms are moving in to take advantage. Carlyle Group, for example, has invested US$100m in Brazilian real-estate ventures since it became active in the sector there about six months ago, according to Eduardo Machado, the managing director of the private-equity's local branch. Sam Zell's Equity International has also been expanding its presence in Brazil and has already committed US$270m to buying stakes in local real-estate companies.

Building on debt

As the markets close out to Mexican homebuilders some will turn to private-equity firms to provide part of their alternative funding requirements, but the federal housing agency, Sociedad Hipotecaria Federal (SHF), remains the safe haven for many mortgage lenders. The agency was created to insure liquidity to the sofoles, but the Mexican federal government had given a January 2009 deadline to the lenders to stop relying on SHF.

As Mexican mortgage lenders find it increasingly difficult to place RMBS deals in the local markets, however, Sociedad Hipotecaria Federal could resume its role of providing liquidity to the sector, albeit in a different way. Metrofinanciera's February US$100m 22.5-year equivalent deal seems indicative of how things may function in the new reality.

Metrofinanciera's deal via Ixe and Deutsche was the only RMBS to price this year and while it came at a 177bp spread over the local benchmark TIIE – versus the 87bp spread of the prior placement early last year – it is understood that SHF stepped in and bought more than 65% of the securities, with only two pension funds taking part in the placement.

The local RMBS market will still see considerable activity as banks ramp up their activities. Last year saw private lenders start securitising their portfolios with Banorte, HSBC and BBVA Bancomer all coming out with RMBS deals. BBVA Bancomer, which has the biggest mortgage portfolio among private lenders, is lined up to come out with another deal this month and ING is expected to follow suit. Investors receive bank-originated RMBS more warmly than those of sofoles because they trust the tight lending-standards of private multiple institutions.

Sofoles may increasingly look to resolve their funding requirements in the convertible bonds market. Infonavit is understood to be studying such a deal in the first half. Such a structure would address the concerns of investors who do not want to hold a mortgage pool containing a number of non-performing loans. The covered bond structure would allow the issuer to shift the underlying portfolio to maintain a certain level of performance and avoid eating into the overcollateralisation. This would improve the rating without strapping up issuer or investor too much. If the Infonavit deal is a success a number of sofoles are expected to follow suit.

A covered bond structure is likely to do well in Mexico, where debt capital markets have come of age. In Brazil, however, the RMBS market itself has yet to evolve into an important niche. This puts it in stark contrast to Mexico, where the government made it a point of financing homebuilding through the markets.

In Brazil, archaic regulations still force banks to allocate at least 65% of their savings accounts holdings to mortgage lending. Banks have to keep most mortgages on their balance sheet in order to meet the quota and have no interest in securitising their mortgage loan portfolios. And that pool seems to be never-ending, since, in the past five years, the savings deposit base has grown on average 9.3% a year.

Slowly, though, this market is picking up. RMBS issuance has grown every year in Brazil since 2003 to reach close to R$2bn (US$1.2bn). In August last year the first transaction backed by bank-originated loans was issued. Senior and junior certificados de recebiveis imobiliarios (CRI), as the RMBS structure is called in Brazil, were issued by Brazilian Securities for a total of R$100m. The underlying loans had been given by ABN Amro Real. Still, this market is not expected to pick-up seriously before the market sees significant regulatory reform.

Hard assets

Investors have been piling into direct real estate too – especially office buildings – doing joint-ventures and closing private financing packages for office building projects especially in Brazil and Mexico. Big institutional investors like CalPERS and Prudential have increased their presence – particularly in Mexico – but are slowly moving farther south as they taste the fruits of their investments.

"Brazil is where the next boom will be," predicted Mario Rivera, head of research for Latin America at Colliers International. Brazil is especially enticing due to the lack of prime office space in its most sought areas. As a rule, vacancy rates in class A buildings in Sao Paulo and Rio de Janeiro remain below 4% – a healthy market figure is around 7% – with some areas like the financial hub Brigadeiro Faria Lima in Sao Paulo having close to zero vacancy.

In other words, revenue from an investment in such a building is almost guaranteed. Mexico is closer to the more mature markets and vacancy rates in Mexico City hover around 6%. Naturally, if Brazil becomes investment-grade, the money flow into the country is expected to grow exponentially, which makes it an even more attractive target.

But it isn’t easy money. Investors have to understand the local markets and build relationships with the most reliable players, as most companies are still privately held and the sector's ownership rules are highly complex and riddled with loopholes.

They are unlikely to be dissuaded, however: as the old adage goes, the bigger the risk, the higher the return.

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