PREI Latin American Quarterly April 2011 Market Perspective Executive Summary The favorable economic environment in Latin America is supporting an increase in real estate development and transaction activity. Property professionals in the region are optimistic that market fundamentals will improve in the second quarter. The evolving sophistication of Latin America s capital markets has led to new sources of funding for real estate. For example, Mexico s first REIT made its debut on the local stock exchange in March, raising US$300 million. Stronger absorption levels have reduced industrial vacancies in Mexico and Brazil. Demand for space is expected to pick up even more as companies expand their operations to meet global demand. South America s middle-class consumer boom is driving demand for retail space, leading to construction of new shopping centers. Mall developers are moving into smaller cities to gain access to new markets. Bank credit for housing is continuing its steady upward trend, which is fueling growth in the middle-income segment. Meanwhile, government support for low-income housing remains strong. In Brazil, housing prices are rising rapidly due to vigorous demand and higher inflation. Economic Environment Prudential Real Estate Investors 8 Campus Drive Parsippany, NJ 07054 USA Tel +1 973.683.1745 Fax +1 973.734.1319 Web www.prei.com Latin America experienced a widespread recovery in 2010, posting regional GDP growth of 6.4%. Growth is expected to moderate to a more sustainable level this year as fiscal and monetary stimuli are removed. Internal demand is expected to remain a key driver of growth due to the recovery of the labor market, greater credit availability and the expansion of the middle class. External demand will also play a role in regional growth this year as the global recovery strengthens. In particular, Asia has become an outlet for Latin American exports, so growth in that region will boost industrial production in some Latin American countries. The challenges for policymakers in Latin America this year include rising inflation and currency appreciation. Higher energy, commodity and food prices are producing higher inflation, while favorable growth and interest rates in Latin America compared to other parts of the world have attracted foreign capital, leading to local currency appreciation.
Capital Markets Real estate companies are increasingly tapping the public securities market in Latin America. The first issue of a Fibra, the equivalent of a REIT, was sold on the Mexican stock exchange in March. The vehicle owns 13 retail, industrial, office and mixed-use assets and will use the US$300 million it raised to expand. Mexican investors bought 77% of the securities, with the 23% balance bought by international investors. Another US$130 million was raised by Mexican real estate companies in 1Q11 through development capital certificates (CKDs). These vehicles enable Mexican pension funds and other investors to invest in real estate, infrastructure and private equity funds via publicly listed trusts. Some US$2.3 billion have been raised for CKDs since they were introduced in late 2008. Real estate companies in Brazil and Mexico raised US$1 billion of public equity in 1Q11, with the lion s share coming from Brazil (Exhibit 1). A Brazilian shopping mall operator raised US$260 million in an initial public offering (IPO) in February, with the proceeds going to finance acquisitions and new developments. Additionally, a Brazilian real estate brokerage firm and two homebuilders raised a combined US$500 million in follow-on equity offerings. Exhibit 1: Brazil Is Producing A Steady Number of Real Estate Equity Offerings Real Estate Equity Offering Volume, US $Bil (l) and Number (r) $10 30 $8 27 21 24 $6 $4 $2 2 13 9 11 5 18 12 6 $0 2005 2006 2007 2008 2009 2010 2011 Mexico Brazil Chile Number of offerings (r) 0 Bloomberg A Brazilian retail developer is planning to build a US$230 million mixed-use project in Votorantim, Sao Paulo state, which will be financed in part by a US$178 million debenture sale. The 57,600-square-meter project, the largest of its kind in the region, encompasses a shopping center and four office towers. Meanwhile, a Brazilian investment bank and a London-based investment firm have formed a venture that will use a convertible bond to fund the construction of a mall in the city of Sao Paulo. Colombia s investment profile was strengthened in the first quarter when S&P raised its sovereign rating to investment grade BBB-, from BB+. This will increase the number of investors around the globe that can invest in Colombia, which joins Mexico, Brazil and Peru as Latin American countries with investment grade ratings. Brazil's sovereign ratings were upgraded by Fitch to BBB from BBB- during the quarter. As both developments are likely to attract more foreign investment and US dollars, they will have an impact on the measures that central banks will take to control currency appreciation. 2
PREI Investment Activity Property sale volume in Latin America in 2010 rose to US$7.2 billion, topping 2009 volume of US$4.6 billion but still shy of US$11.2 billion of activity in 2008, according to Real Capital Analytics (RCA). Activity reflects the economic growth in each country. Brazil, where economic growth was the most robust, accounted for 80% of transaction volume in the region last year (Exhibit 2). This year, transaction volume is expected to continue upward as the economic recovery solidifies and demand for real estate increases. Optimism is reflected in the RICS Americas Commercial Property Survey, which found that property professionals are more upbeat in Latin America than in most other regions of the world. Brazil continues to rank high in expectations for rental and property values, investment activity and tenant demand. Expectations for Mexico are improving, although they are not as high as in Brazil. Exhibit 2: Brazil Topped the Region In Sales Volume In 2010 Property Transaction Volume, US $Bil $7 $6 $5 $4 $3 $2 $1 $0 2008 2009 2010 Mexico Brazil Chile Other Real Capital Analytics Property Markets Mexico industrial: Mexico s most-active industrial markets include Mexico City, Monterrey and some cities in central Mexico. The bulk of tenant activity involves logistics centers, although manufacturers of autos and consumer goods have been increasing their presence as they resume expansion plans put on hold in 2008. Although acquisition yields for Mexican industrial properties tend to vary widely, for stabilized properties they have begun to stabilize in the 10-10.5% range, down by roughly 100-150 bps since 2008. An uptick in demand last year led to lower vacancy in the Mexico City market, although developers remain cautious about the addition of new space and mostly focus on build-to-suit developments. Some 225,000 square meters of class-a space was absorbed in 2010, concentrated in the Cuautitlan and Tlalnepantla submarkets, while only 77,000 square meters of new supply was added, according to CBRE. That led the class-a vacancy rate to fall 100 bps to 9%, while the average asking lease price rose slightly in 4Q10, CBRE said. Demand for space is expected to be strong this year, which means rents and construction activity are projected to increase. 3
Absorption in Monterrey s industrial market in 2010 totaled 610,000 square meters, leading the 4Q10 vacancy rate to drop to 9.5%, its lowest level since 3Q08, CBRE said. The vacancy rate in the Apodaca submarket dropped to 6.2%, the lowest in the city, reflecting the strong demand for space. Some 133,000 square meters of new space, including five speculative buildings totaling 54,000 square meters, is under construction. Lease prices were stable in 2010 but are expected to increase as strong absorption has left little vacant space, especially in Apodaca. Nissan Mexico is planning to invest US$900 million over the next few years to increase production at its Cuernavaca and Aguascalientes plants in central Mexico. Italian tire maker Pirelli is planning to invest US$210 million by year-end 2012 to build its first tire production plant in the central Mexican city of Silao. Brazil industrial: Brazil s robust industrial growth continues to support a strong demand for space, which is reflected in rising absorption levels and lower vacancies. The class-a vacancy rate in the Sao Paulo- Campinas market fell to a record low of 5.4% in 4Q10, down 300 bps from 4Q09, according to CBRE. Absorption of class-a space in 2010 rose 17% from the previous year, with Jundiai accounting for 24% of the total, CBRE said. Robust demand and limited supply led to near double-digit increases in average asking class-a lease prices in 2010. Lease prices are expected to increase again this year due to limited new development activity, the result of higher construction costs and limited availability of land. The strong demand translated to the investor side. In one of Brazil s largest-ever real estate transactions, Prosperitas bought a portfolio of 30 logistics properties in Sao Paulo from Bracor for US$1.3 billion, which translates into an initial yield of 10.5%. The deal closed in January. Several companies have announced plans for investment in Brazil s industrial market. The Brazilian unit of Italian automaker Fiat is planning to build a factory in the northeastern state of Pernambuco this year. This will be Fiat s second factory in Brazil and forms part of the company s plan to invest up to US$5.9 billion in the country over the next three years. General Motors plans to invest about US$1.2 billion to expand its Brazilian operations this year. Korean appliance factor LG is planning to build a plant in the central state of Sao Paulo this year. Mexico City office: Rising demand has boosted absorption in the Mexico City office market, but absorption is exceeded by the large amount of new supply. The deliveries included nine new office buildings, including the 147,000-square-meter Plaza Carso in Polanco. As a result, class-a office market vacancies climbed slightly to 10% in 4Q10, according to CBRE. With supply expected to continue to outpace demand in the near term, vacancy rates should continue to climb. Brazil office: The heated economic environment in Brazil is creating demand for office space. Absorption in Sao Paulo reached 640,000 square meters in 2010, the second-highest annual total ever, behind only 2008, CBRE said, prompting the class-a vacancy rate to drop at year-end to 5.1%, down by 440 bps. Accordingly, class-a average asking rents rose sharply in 2010, pushing Sao Paulo into CBRE s list of the world s top 10 most expensive office markets. New supply is expected to decrease due to limited availability of land, although there have been announcements of a few new office projects. Commercial developer Multiplan is working on the construction of Morumbi Corporate, a two-building project with 73,000 square meters. The US$270 million project is slated to open in the second half of 2013. 4
PREI Chile office: The absorption of new office space in Santiago has been roughly equivalent to the completion of new buildings, causing the 2010 class-a vacancy rate fall slightly to 3.8%. Demand is expected to remain steady this year, and rent levels should remain stable. Mexico retail: The recovery in the Mexican retail sector remains slow, which has kept new shopping center construction at a minimum. Retail sales rose just 2.4% in 2010. However, the uptick in the employment market has served to counter the negative impact on rents caused by the sluggish consumer demand of previous quarters. Wal-Mart Mexico announced plans to invest more than US$1 billion this year to open 365 new stores. Supermarket chain Soriana plans to spend US$1.3 billion to open 200 new stores by 2014. Brazil retail: The recovery is old news in Brazil, where a strong retail environment has boosted new shopping center construction. Shopping center sales in Brazil grew 17% last year to R$78.3 billion (US$50 billion), according to shopping center association ABRASCE (Exhibit 3). This rise reflects the purchasing power of Brazil s expanding middle class, a demographic change brought about by lower unemployment, higher wages and an expansion in credit volume. The spending boom has kept retail occupancy levels high and supported a rise in rental rates. A total of 24 new shopping centers are expected to be opened this year in Brazil, with another 32 to follow in 2012. Exhibit 3: Brazil s Consumer Boom Boosts Sales and Development Shopping Center Sales, R $Bil (l) and No. of Centers (r) R$100 R$90 R$80 R$70 R$60 R$50 R$40 R$30 R$20 R$10 2005 2006 2007 2008 2009 2010 2011(f) 480 460 440 420 400 380 360 340 320 300 Shopping center sales (R$ Bil) Number of shopping centers (r) ABRASCE Brazilian retail developers are beginning to focus development efforts on properties in smaller cities that cater to the less-affluent population. The idea is to gain access to new markets because the larger, more developed cities are saturated with retail developments. Of the 56 new shopping centers currently under construction, 36 are located in cities with less than 1 million inhabitants. Credit in Brazil has been growing at double-digit annual rates, making it possible for a large portion of the population to acquire consumer goods once out of their reach. Total outstanding credit rose 21% in February from the February 2010, although that pace is not sustainable. Amid fears of rising inflation, which is at 6%, the Brazilian government is doubling a tax on consumer credit in an effort to slow credit growth. Chile retail: Boosted by strong macroeconomic growth and robust domestic demand, retail sales rose 15.9% in 2010 and continued at that pace in 1Q11, according to government statistics institute INE. Retail 5
rents are showing little movement from last year, although they may be set to rise, given the low vacancy rates in prime locations. Chilean retailers have announced aggressive expansion plans designed to take advantage of the favorable economic environment and growing consumer class. Cencosud unveiled plans in April to issue as much as US$2 billion in new shares to help finance growth in the region. The company plans to invest US$1 billion this year to expand its operations in Chile, Brazil, Argentina, Colombia and Peru. Chilean department store chain Ripley announced in March that it plans to invest US$973 million through 2013 to open stores in Chile and Peru. Mexico residential: Robust job growth, greater access to credit and the expansion of the middle class led housing construction in Mexico to expand 5.6% year-over-year in 4Q10, according to SHF, the federal housing administration, a pace that is 100 bps higher than overall GDP. Overdue mortgage payments as a percentage of total bank credit fell to 3.6% in December 2010, from 4.8% in December 2009, according to CNBV, the national banking commission. Government support for low-income housing remains strong. Infonavit, the Mexican government s largest mortgage originator, said that it wrote 84,340 mortgages in 1Q11, surpassing its lending goal by 9.5%. The agency plans to finance up to 515,000 units this year and more than 2.5 million between now and 2015. Mexican homebuilders which focused on the low-income housing sector since the onset of the global economic downturn in 2008 are now turning more attention to the higher-income sectors. The reasons include the expansion of the Mexican middle class and the expansion in available credit to housing. The cost of housing in Mexico continues to track inflation. The SHF national housing index rose just 0.2% in 2010 in real terms. Brazil residential: Housing prices are growing rapidly due to dynamic demand and higher construction costs, which were brought about by a rise in the cost of raw materials and higher overall inflation. National housing prices rose 13% in the six months through February, according to Brazil s Fipe Zap housing price index (Exhibit 4). Cities with the biggest price increases include Rio de Janeiro, where prices rose 37% in 2010 and have doubled since January 2008, and Sao Paulo, where prices increased 22% in 2010 and 83% since January 2008, according to Fipe Zap. Exhibit 4: Housing Prices Are Rising In Brazil Cumulative % Change In Housing Sale and Lease Prices 120% 100% 80% 60% 40% 20% 0% -20% FipeZap Index Rio de Janeiro (Sale) Rio de Janeiro (Lease) Sao Paulo (Sale) Sao Paulo (Lease) Feb-08 Jun-08 Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Feb-11 6
PREI Bank credit to housing in Brazil grew by about 40% in 2010, according to country s central bank. As in Mexico, this is leading homebuilders to concentrate more development activity on higher-income product. The rapid growth in bank credit over the past two years has prompted the Brazilian government to implement plans to cool the market in order to prevent inflation from ballooning. The Brazilian government s Minha Casa Minha Vida housing program has financed roughly 1 million homes since the beginning of 2010 and aims to provide credit for an additional two million units over the next four years, which will inject US$40 billion into the sector. In order to account for the rising cost of building materials, the government in February raised the price ceiling for the program in the metropolitan areas of Sao Paulo, Rio de Janeiro and Brasilia by 31%, to US$102,000 from US$78,000. The price ceilings were also adjusted in other cities around the country based on the number of inhabitants. Chile residential: The government s housing reconstruction program has issued 132,829 credits as of the end of February 2011, and is well on its way to meet the year-end goal of 220,000 credits. Bank credit to the sector continues to grow at a consistent pace, and single-family housing and condominium sales are steady. Closing Thoughts The favorable economic environment in Latin America is providing a boost to real estate markets as demand for space translates into improving fundamentals. Meanwhile, development and sales activity is expected to expand this year as investor demand intensifies and credit is increasingly available. Mexican banks are willing to write mortgage debt and finance new construction, while new products such as CKD securities provide alternative sources of funding. The launch of Mexico s first Fibra was an important milestone that confirms the interest in investing in real estate by local institutions. Meanwhile, Brazilian real estate companies are maintaining an active presence in the equity markets through the placement of IPOs and follow-on offerings. Although the outlook across the region is generally positive, the cycle is not the same in each country. Prices are rising across the board in Brazil as a result of strong demand for real estate. Yet in Mexico, rents remain depressed, transaction activity is low and acquisition yields are just starting to come down from their peak levels. The region also faces concerns about rising inflation brought about by internal factors and higher global prices, which could result in lower real output growth. Governments in the region are no strangers to the challenges of high inflation, and are taking actions to curb inflationary pressures. The expansion of the region s consumer class presents a host of investment opportunities, including the development of low- and middle-income housing and retail services in previously underserved areas. Additionally, the industrial markets of Mexico and Brazil will require the development of quality space as companies expand their operations to fulfill the growing demand of global markets. 7
The Investment Research Department of PREI publishes reports on a range of topics of interest to institutional real estate investors. Individual reports are available by e-mail or via the Web at www.prei.com. Reports may also be purchased in quantity for use in conferences and classes. To receive our reports, change your contact information, or to be removed from our distribution list, please e-mail us at prei.reports@prudential.com, or telephone our New Jersey office at 973.683.1745. Important Disclosures These materials represent the views, opinions and recommendations of the author(s) regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced herein. Distribution of this information to any person other than the person to whom it was originally delivered and to such person s advisers is unauthorized, and any reproduction of these materials, in whole or in part, or the divulgence of any of the contents hereof, without prior consent of Prudential Real Estate Investors is prohibited. Certain information contained herein has been obtained from sources that PREI believes to be reliable as of the date presented; however, PREI cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. PREI has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services and should not be used as the basis for any investment decision. Past performance may not be indicative of future results. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this report. PREI and its affiliates may make investment decisions that are inconsistent with the recommendations or views expressed herein, including for proprietary accounts of PREI or its affiliates. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients or prospects. No determination has been made regarding the suitability of any securities, financial instruments or strategies for particular clients or prospects. For any securities or financial instruments mentioned herein, the recipient(s) of this report must make its own independent decisions. Conflicts of Interest: Key research team staff may be participating voting members of certain PREI fund and/or product investment committees with respect to decisions made on underlying investments or transactions. In addition, research personnel may receive incentive compensation based upon the overall performance of the organization itself and certain investment funds or products. At the date of issue, PREI and/or affiliates may be buying, selling, or holding significant positions in real estate, including publicly traded real estate securities. PREI affiliates may develop and publish research that is independent of, and different than, the recommendations contained herein. PREI personnel other than the author(s), such as sales, marketing and trading personnel, may provide oral or written market commentary or ideas to PREI s clients or prospects or proprietary investment ideas that differ from the views expressed herein. Additional information regarding actual and potential conflicts of interest is available in Part II of PIM s Form ADV. Prudential Investment Management is the primary asset management business of Prudential Financial, Inc. Prudential Real Estate Investors is Prudential Investment Management s real estate investment advisory business and operates through Prudential Investment Management, Inc. (PIM), a registered investment advisor. Prudential Financial and the Rock Logo are registered service marks of The Prudential Insurance Company of America and its affiliates. Prudential Real Estate Investors 8 Campus Drive Parsippany, NJ 07054 USA Tel 973.683.1745 Fax 973.734.1319 Web www.prei.com E-mail prei.reports@prudential.com Copyright 2011