Latin American Quarterly Outlook JULY 2011
LATIN AMERICA Real Estate Outlook Key Economic Themes Almost three years after the peak of the global crisis, Latin America has two contrasting stories: Mexico is still recovering, while parts of South America are displaying signs of overheating. China is driving growth in Brazil, Chile, Peru and Colombia through the consumption of commodities and direct investment. The recovery of the global economy has fueled demand for goods manufactured in Latin America, which has resulted in high employment and increasing consumption. However, inflation is a concern, especially because access to credit is increasing. Latin America s relatively high interest rates are serving to draw capital from investors from outside the region. If the capital flow is reversed for any reason, local markets would be affected. Mexico s recovery is slowly gathering momentum. Growth this year is expected to be spread out across the economy. Key Real Estate Themes Transaction volume and prices are on the rise in South America, particularly Brazil and Chile. Prices in Mexico remain depressed, with acquisition yields still about 150 bps above pre-crisis levels. Banks in the region are returning to finance commercial real estate. The evolution of local capital markets provide new sources of funding for real estate the IPO market is active in Brazil, the first FIBRA was launched in Mexico in 1Q11 and issuance of listed real estate securities is rising in Brazil and Mexico. Absorption rates are up across the board. Rents are declining in Mexico and increasing in Brazil and Chile. 1
LATIN AMERICA ECONOMIC ENVIRONMENT Latin American Countries are in Different Stages of Recovery Growth is determined by different factors in each country: Mexico s industrial sector is growing. As US demand for Mexican goods stabilizes, growth in the sector is expected to moderate. Brazil will grow at a more sustainable level this year. It is not clear whether the end of government stimulus measures and tighter monetary policies are sufficient to avoid a hard landing. High commodity prices continue to be a boon for Chile, as are the spate of investments that followed the 2010 earthquake. Accordingly, labor markets have been strong in Brazil and Chile, but still lack momentum in Mexico. 9% 8% 7% 6% 5% 4% 3% 2% 1% 12% 1 8% 6% 2010, 2011 and 2012 GDP Growth Forecasts 7.5% 5.5% 4.7% 4. 4.1% 3.6% 2010 (e) 2011 (f) 2012 (f) 6.2% 5.3% 5. Mexico Brazil Chile Annual Unemployment Rates 4% SOURCES: IMF, INEGI, IBGE, INE, PRUDENTIAL REAL ESTATE INVESTORS 2% Mexico Brazil Chile Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 2
LATIN AMERICA ECONOMIC ENVIRONMENT Robust Growth and High Interest Rates Draws Capital to the Region $50 Foreign Direct Investment Levels (US$Bil) 2008 2009 2010 (e) 2011(f) 2012 (f) $40 Foreign direct investment in 2011 is forecast to return to the record levels of 2008. International corporations want to take advantage of growth prospects in the region that result from growing consumption levels and high-profile infrastructure investments. Latin America is attracting capital from outside the region due to its relatively strong economic growth and high interest rates. The influx of capital has led to local currency appreciation, prompting some countries to implement measures to discourage short-term speculative inflows. The currencies of Brazil and Chile should weaken in the long term. $30 $20 $10 $0 200 180 160 140 120 100 80 60 Argentina Brazil Chile Colombia Mexico Peru Latin American Currencies against USD, Relative to Historical Average MXN BRL CLP Average 2000-1Q11 SOURCES: EIU, PRUDENTIAL REAL ESTATE INVESTORS Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 3
LATIN AMERICA REAL ESTATE ENVIRONMENT Transactions: High in Brazil, Modest Elsewhere During the 12 months through March 2011, transaction volume in Latin America totaled US$10.6 billion, an increase of 47% from 2010 and nearing the 2008 level of US$11.2 billion. The office sector was the most active, accounting for US$4 billion of transaction volume in the period. By country, Brazil dominated activity in the region, accounting for nearly 9 of transactions. Local listed firms and private investors led the parade of buyers. Latin American stocks have recovered from their trough in early 2009. Since then, Chilean stocks have posted the best performance, while the gains in Brazil and Mexico have been more moderate. Listed real estate firms have produced mixed results. Investors are increasingly differentiating between companies based on their strategies and efficiencies. $10 $8 $6 $4 $2 $0 180 150 120 90 60 30 Latin America Real Estate Transaction Volume (US$Bil) Mexico Brazil Chile Other 2008 2009 2010 4/1/10-3/31/11 Latin American Real Estate Stock Indexes (Jan 2008=100) Mexico Brazil Chile 0 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 SOURCES: RCA, PRUDENTIAL REAL ESTATE INVESTORS 4
LATIN AMERICA REAL ESTATE ENVIRONMENT Growing Capital Markets is New Source of Real Estate Funding $12 $10 Real Estate Equity Offering Volume, US$Bil Mexico Brazil Chile Number of Offerings (r) 24 23 30 25 Real estate companies are among the most active segments in terms of raising equity in public markets in the region. $8 $6 15 11 20 15 Most of the equity is being raised in Brazil. Four Brazilian real estate companies raised public equity in 1Q11. Strong investor appetite for real estate has produced a favorable environment for real estate firms to go public. $4 $2 $0 8 3 1 2005 2006 2007 2008 2009 2010 2011 10 5 0 CKD Issuance in Mexico (MNX$Bil) Development Capital Certificates were introduced in Mexico in 2008. CKDs, as they are known, enable Mexican pension funds and other institutional investors to invest in real estate, infrastructure and private equity funds via publicly listed trusts. $25 $20 $15 Real Estate Other Sectors Since 2008, CKDs have raised US$3.4 billion of capital, including US$880 million for real estate. The total represents only 2.8% of Mexican pension fund assets, which indicates there is room for considerable expansion. SOURCES: PRUDENTIAL REAL ESTATE INVESTORS $10 $5 $0 2008 2009 2010 Through 4/1/11 5
LATIN AMERICA State of the Market Mexico Market Fundamentals 15% 1 5% Annual Department Store Sales Growth (3-mo Rolling Avg) Department Store Sales (l) Consumer confidence is positive in Mexico, although it has not yet translated into a significant improvement in retail activity. Leading the recovery is the manufacturing sector, which is sensitive to demand from the US. Security issues are serious and create headlines, but their impact on investment activity is limited to a small subset of the country. A full recovery in Mexico s retail sector is dependent on stronger employment and credit growth. Bank credit to consumers is starting to expand. Business credit is returning as well. Commercial real estate transaction activity remains weak. In contrast, housing sales were less affected by the global economic crisis, and were first to recover. -5% -1-15% Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Annual Unemployment Rate (3-mo Rolling Avg) 7% 6% Unemployment Rate 5% 4% 3% SOURCES: INEGI; PRUDENTIAL REAL ESTATE INVESTORS 2% Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 6
LATIN AMERICA State of the Market Brazil Market Fundamentals Two years of steady job creation has resulted in record low unemployment, which is boosting demand for real estate. Construction costs are rising due to the increasing cost of raw materials and higher overall inflation. The strong demand, combined with higher construction costs, has pushed housing prices higher, especially in large cities such as Rio de Janeiro and Sao Paulo. To meet demand, many listed housing developers raced to expand nationally, which in some cases led to serious losses in efficiency. Overall, companies are now retrenching by focusing on core markets. Credit is relatively abundant for homebuyers, but still scarce for commercial real estate. Commercial real estate players are increasingly turning to new sources of funding, including private funds and bonds. FipeZap Housing Price Index, Accumulated Appreciation 8 Sao Paulo (Sale) 7 Sao Paulo (Lease) 6 Rio de Janeiro (Sale) 5 Rio de Janeiro (Lease) 4 3 2 1-1 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 SOURCES: FIPEZAP; PRUDENTIAL REAL ESTATE INVESTORS 7
LATIN AMERICA HOUSING Housing in Latin America is Growing, But Potential to Expand Remains Credit to housing has expanded in Mexico, Brazil and Chile since 2009. The high pace of growth in Brazil is testing the capacity of homebuilders and financing providers. 700 600 500 400 300 200 Credit to Housing Levels (Jan. 2003=100) Mexico Brazil Chile The largest homebuilders in Brazil are facing execution issues as they seek to expand into new markets. 100 0 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Despite the expansion in credit available for housing, mortgage debt in Latin American countries remains low as a share of GDP compared to other parts of the world. This indicates that there is further room for growth in mortgage originations in countries such as Mexico, Brazil and Chile. 7 6 5 4 3 2 1 Housing Credit as % of GDP U.S. England Germany Canada Japan France Chile Colombia Mexico India Brazil Peru Argentina SOURCES: JPMORGAN, CENTRAL BANKS OF MEXICO, BRAZIL & CHILE, PRUDENTIAL REAL ESTATE INVESTORS 8
LATIN AMERICA - RETAIL Consumers Fill Shopping Centers in Brazil and Chile, Less So in Mexico Retail sales are growing in Latin America, fueled by expansion in employment and credit. Chilean retailers are posting double-digit gains after a dip in 2008 and 2009, while in Brazil growth has been more steady. 150 140 130 120 110 Retail Sales Index Levels (12-mo Rolling Avg, Jan. 2007 = 100) Mexico Brazil Chile Retail sales are growing again in Mexico, but have yet to stage a full recovery from the trough level of 2009. 100 90 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Brazil s shopping center sales amounted to R$87 billion in 2010, equal to 24% of GDP. Shopping center sales are forecast to increase 12% this year. Development of new retail space in Brazil has expanded to secondary cities. The main Brazilian developers are all publicly listed. New developments and property sales are still stalled in Mexico, and are not likely to resume until next year. SOURCES: INEGI, IBGE, INE, DANE, ABRASCE, PRUDENTIAL REAL ESTATE INVESTORS $100 $90 $80 $70 $60 $50 $40 $30 $20 $10 $0 Brazil Shopping Center Sales, BRL Bil (l) and No. of Centers (r) Retail Asset Sales Volume (R$ Bil) No. of Retail Assets Sold (r) 2005 2006 2007 2008 2009 2010 2011(f) 460 440 420 400 380 360 340 320 300 9
LATIN AMERICA - OFFICE Diverging Dynamics in Office Markets Office markets reflect the differing economic climate of each country. Office vacancies in Sao Paulo and Santiago have declined steadily for the past four quarters. Rent levels have increased markedly in Sao Paulo over the past year. Demand is coming from fast growing local firms that cater to the domestic market, as well as foreign firms just entering Brazil. Rents in Santiago have also increased. New buildings are benefiting from a flight to quality in wake of last year s earthquake. The vacancy level in Mexico City has been slower to recover, and remains at 1. The increase in vacancy over the last two years has been due in part to the completion of new office buildings in the city. The combination of new supply and little demand for space has left landlords unable to raise rent levels. SOURCES: CBRE, PRUDENTIAL REAL ESTATE INVESTORS 16% 14% 12% 1 8% 6% 4% 2% $80 $70 $60 $50 $40 $30 $20 $10 $- Office Market Class-A Vacancy Rates Mexico City Sao Paulo Santiago Buenos Aires 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 Office Market Class-A Rental Rates (US$) Mexico City Sao Paulo Santiago 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 10
LATIN AMERICA - INDUSTRIAL Industrial Vacancies are Down in Mexico and Brazil Industrial vacancies in Mexico have been falling since hitting peak levels in 2009. Class-A vacancy rates fell to 7.1% in Mexico City and 8.8% in Monterrey in 1Q11. Part of the reason for the rise in occupancy is that tenants are attracted to low rent levels. Until the rebound in manufacturing activity is more visible, rents will remain under pressure. 18% 15% 12% 9% 6% 3% Mexico Industrial Vacancy Rates Mexico City (Class A) Monterrey (Class A) 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 Brazil Industrial Vacancy Rates The vacancy rate in Brazil s main industrial markets of Sao Paulo and Campinas have been falling since 2009, reaching a record low of 5.7% in the 1Q11. 12% 1 8% Overall Class-A In Sao Paulo and Campinas, lower vacancies are due to strong demand in a supply-constrained market. Rents have posted solid increases as a result. 6% 4% 2% SOURCES: CBRE, PRUDENTIAL REAL ESTATE INVESTORS 2005 2006 2007 2008 2009 2010 1Q11 11
LATIN AMERICA Key Investment Themes ATTRACTIVE RISK-ADJUSTED OPPORTUNITIES THEME Residential Development Retail Development Logistics Development Office Development INVESTMENT IMPLICATIONS Mexico Housing sales are supported by well-established mortgage programs and favorable demographics, which creates an opportunity to invest with large local homebuilders. Brazil Government programs have expanded access to credit over the past five years, fueling growth of the housing market. National expansion is attractive, albeit with execution risks. Chile The housing market developed on the back of a well-functioning mortgage system, and is expected to show stable growth, especially in the capital city of Santiago. Mexico Shopping centers share of retail sales remains low. Retail growth is concentrated in mid-sized cities. The consolidation of national operating platforms has yet to occur. Mexico Mexico s prime location and competitive pricing have strengthened its position in production and distribution in wake of the financial crisis. Brazil The expansion of local and international companies in Brazil is generating demand for new logistics space. The quality of existing stock is poor, which presents opportunities for new development. Mexico A good entry point due to low pricing, and the quality of tenants is strong. Leverage is available from local banks. Chile Expanding companies are seeking new office space despite the recent delivery of large buildings. The 2010 earthquake encouraged tenants to migrate to newly-constructed buildings. SOURCES: PRUDENTIAL REAL ESTATE INVESTORS 12
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