Latin America Lures
International Investors

By Mark Beresford

As real estate markets in the U.S. and many other developed countries are mired in gloom, international developers have started to turn toward Latin America. They are drawn by the region's rapid economic growth, increased access to mortgage financing, and a chronic shortage in real estate supply.

"When I made my first marketing trip to Europe in 2002, there was no interest from any investor. I could have come from another planet," says Phil Fitzgerald, managing director of the emerging-markets business of Los Angeles-based private-equity firm Paladin Realty Investments. "But now we are being actively solicited by investors from Europe to come meet with us."

"We have been investing in Latin America for over a decade," Mr. Fitzgerald adds. "Population growth, job growth, and income growth are all driving demand, and that is being facilitated by the increased supply of capital."

"The common thread in Latin American markets is the emerging middle class, with more purchasing power, and the increasing availability of mortgage financing," says Brett Rosen, senior analyst at Explorador Capital Management, an investment-management firm in Buenos Aires. "It is one of the higher growth areas of the world, and with what is happening in the U.S. real estate market, it is only natural that developers should be looking here."

In the past five years, there has also been a shift in the destination of foreign capital flows, developers and investors say, with Brazil now beating Mexico as the major destination of foreign capital in real estate.

"Most of our capital has gone into Brazil," Paladin's Mr. Fitzgerald says. And most of that investment has gone into residential property. "Demand in Brazil far exceeds supply — it is a lot like Mexico was five years ago."

"Mexico is too mature for us," says Thomas McDonald, chief strategic officer at Equity International, a private-equity real estate investment firm based in Chicago. "We invested in Mexico from 2000 to 2004, but it has been replaced by Brazil — we started to invest in Brazil after monetizing those investments in Mexico. We are seeing a continued inflow of international investors coming into Brazil."

Equity International's Latin American holdings include Brazilian shopping mall operator BR Malls, homebuilder Gafisa, commercial real estate company Bracor, and Chilean mall operator Parque Arauco.

Last year, foreign investors acquired around 70% of the capital sold in the initial public offerings of Brazilian real estate companies such as Agra, which came to the market in April of last year fetching $344 million. And in April of this year, Standard & Poor's rated Brazil investment grade, triggering even greater interest from international investors.

According to Real Capital Analytics, a consulting firm based in New York, $4.67 billion of foreign capital was invested into commercial property in South America in 2007, mainly in the retail sector, with major investors from the U.S., Canada, Spain and France. Brazil has transacted over $1 billion in commercial real estate in each quarter since January of last year, while in the last five quarters there have been more retail property sales in Brazil than in Canada: $4.1 billion compared with $3.6 billion. Foreign capital accounts for 57% of recent investment into Brazil, the consultancy says.

The attractions of the world's fifth-largest country in terms of both size and population are not hard to see.

"There is an eight million-unit housing shortage," says Josh Pristaw, managing director of New York-based real estate investment firm GoldenTree Insite Partners, "and as well as this tremendous shortage of housing, there is also an expansion of credit."

In Brazil, mortgage stock equals only 2% of gross domestic product, compared with 10% in Mexico and 65% in the U.S. But as interest rates come down and banks, led by the state-owned Caixa Economic Federal, start to offer mortgage financing, there has been a surge in residential demand at all tiers of the market. Total mortgage volume rose 70% in Brazil last year.

"There is an opportunity in the residential market that we haven't seen for 20 years," says Horacio Kleinman, managing partner at Sao Paulo-based real estate consultancy Unitas. "The market is opening up thanks to the access to debt financing, which means that people are buying bigger places, and this is leading to a developer boom." Recent legislation, which makes foreclosure easier, has also stimulated the market, as banks can now make loans in the knowledge that they will be able to claim the property in the event of a default.

And it is not just the residential sector that is growing fast. "There is also a shortage of quality office space that is attractive to Class-A tenants and multinationals," says GoldenTree's Mr. Pristaw. "There is less than 1% Class-A space available in Rio and Sao Paulo."

Meanwhile, Explorador's Mr. Rosen says: "The Brazilian shopping mall sector is very interesting — Brazil is under-retailed, and in terms of shopping mall penetration per citizen it is highly underpenetrated. Also, shopping mall rents are adjusted for inflation."

Such is the size of the country that there are also opportunities in various sectors besides the main urban areas of Sao Paulo and Rio de Janeiro. Northeastern Brazil, which is closer to Europe and which has low land prices, is experiencing a surge in the development of upscale leisure resorts and hotels, attracting European tourists and holiday-home buyers.

Latin American opportunities are not limited to Brazil, however. Although investors say Mexico is now a more mature market, providing lower returns, certain submarkets continue to be appealing.

"Mexico continues to be very attractive, but we have to be more selective," Paladin's Mr. Fitzgerald says. "We are not competing with the very large homebuilders, but instead we are finding more attractive returns in smaller niche opportunities, such as infill projects of between 50 and 200 units."

And smaller markets than Brazil and Mexico are also providing an increasingly wide range of options for real estate investment.

According to Real Capital Analytics, in the first four months of this year commercial property sales in Argentina and Chile exceeded the total for last year.

"The $130 million purchase of the Sheraton Hotel and Casino in Mendoza, Argentina, on the eastern side of the Andes, was the largest hotel deal in South America recorded in the last five quarters," the consultancy says. "The $400-a-square-foot sale of the Torre Paris in Santiago, Chile, by Union Investments is another case of investors showing confidence in an expanding circle of regional markets."

More exotic names are also entering this expanding circle, as rapid economic growth in countries such as Colombia and Peru attract international investors in search of high returns in undersupplied markets.

"If Brazil is like Mexico was five years ago," Paladin's Mr. Fitzgerald says, "then Colombia is like Mexico 10 years ago."

But these smaller markets are not without their challenges. While the relative undersupply of developers means that there is less competition for projects, it also makes it hard for international investors to find partners to work with.

"Real estate is all about local submarkets, and it is very important to have a local team," GoldenTree's Mr. Pristaw says. "We spend as much time as on anything, on trying to underwrite the right partner and to create strategic relationships."