Is the Market for Brazilian Real Estate Investment Funds Cooling Off?

The growth in the market for Brazilian Real Estate Investment Funds (Fundos de Investimento Imobiliário – FIIs) and Mortgage-backed Securities (Certificates of Real Estate Receivables – Certificado de Recebíveis Imobiliários – CRIs) over the past few years has been phenomenal by any measure.  While a FII is most often compared to a Real Estate Investment Trust in the United States, it is legally an investment fund and fundamentally similar to funds that invest in shares of stocks or bonds.  CRIs are very similar to mortgage pass-through securities issued in the United States.

The rules issued by the Comissão de Valores Mobiliários (CVM – the Brazilian equivalent of the SEC) restrict FII investments to real estate until 2009.   The rules were relaxed in 2009 to allow FIIs to buy other types of real estate securities, such as CRIs, as well as the pure real estate.  The new regulations also allowed CRI-backed FIIs to pass-through the tax advantages embedded in CRIs.  Since then, the market for FIIs has taken off.

According to the CVM website, 23 FIIs with a total value of R$561 million where registered in 2008.  In 2010, 39 FIIs were registered with a total value of R$9.7 billion.  As of August 2011, 26 FIIs have been registered with a value of R$4.8 billion versus 16 FIIs in the same period of 2010 with a value of R$2 billion.  In 2008 there were R$4.7 billion CRIs issued, R$3.8 billion in 2009, and R$8.53 billion in 2010, almost twice as high as the previous record in 2008.

However, there are signs that the market is cooling off.  The performance of the FII market has fallen in the last four months according to Uqbar (a Brazilian firm that tracks the FII market and provides data through its Orbis service).  In 2010 the 22 most actively traded FIIs returned a capitalization weighted average of 21.2% (Data from Uqbar, LatAm Structured Finance calculation).  Just the price appreciation of FIIs was 13.2% in 2010.    In April 2011 the average 12 month return was 16.5%, in May and June 14.6%, and dropping to 12.2% in July.

Like the market for FIIs, real estate in Brazil is experiencing some hiccups after increasing steadily over the last few years.  On August 31, 2011, Estado de São Paulo reported that the unit sales in the city of São Paulo fell 31% in the first half of 2011 and fell 28% in the São Paulo metropolitan area.  While the level of activity is cooling off some, the São Paulo real estate market is still seeing lots of activity with 80% of the listed property being sold in 6 months or less.  However, the market makers warn that this level of activity can only be maintained with continued economic growth and the availability of credit.

http://www.estadao.com.br/noticias/impresso,sinais-de-acomodacao-no-segmento-imobiliario,766321,0.htm

In a side article Ana Maria Castelo, an economist with Fundação Getúlio Vargas (FGV), writes that Porto Alegre and Belo Horizonte also experienced weaker real estate sales.  She notes that this slow down started before the growing global credit problems and arises from domestic factors. Demand in 2010 was overheated and credit expanded very rapidly.  This increased building activity also impelled the price of construction to increase 7.71% in the last twelve months.   Castelo argues that this is still not a bubble because the growth is sustainable and that Brazilian real estate will continue to perform well despite these recent setbacks.   “Prices may not increase as dramatically, but they will not fall.  Buyers will become more cautious as the prices continue to increase and financing will be limited by the level of income.”

http://www.estadao.com.br/noticias/impresso,nao-temos-bolha-o-mercado-vai-continuar-aquecido,766325,0.htm

Regardless of all of the positives, the market for FIIs and CRIs in Brazil should be followed closely if the investor is planning on entering at these levels.  The Brazilian economy is still growing but the growth is slowing dramatically.  While delinquencies on real estate for business and residential purposes are at multi-years lows, Brazil is experiencing a bubble in the consumer credit markets and non-performing loans in this sector are rising rapidly.  Banks are cutting back on credit and tightening their underwriting criteria.  It is time to use some caution and look at the possibility of muted price gains for the foreseeable future in the Brazilian real estate market and the market for securities backed by real estate and real estate debt.

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