Bloomberg News

Real Estate Fund Alternatives Stealing Spotlight

April 16, 2013

Investors in builders from PDG (PDGR3) Realty SA to Brookfield Incorporacoes SA (BISA3) are swapping their shares for real-estate investment funds as developers struggle under mounting debt from cost overruns and delays.

Investments in FIIs, the Brazilian equivalent of a REIT, surged to 29.3 billion reais ($15 billion) at the end of the first quarter, from 14.3 billion reais a year ago, according to BM&FBovespa. The IFIX index of 49 funds in Brazil returned 19 percent in the 12 months through yesterday, compared with drops of 57 percent for Brookfield and 50 percent for PDG. Sao Paulo- based Cyrela Brazil Realty SA, the nation’s biggest builder by market value, posted a gain of 12 percent.

Four of the top six homebuilders -- MRV Engenharia & Participacoes SA, PDG, Rossi Residencial SA (RSID3) and Brookfield --are still burning through cash almost a decade after going public, data compiled by Bloomberg show, prompting investors who want to benefit from Brazil’s building boom to seek alternatives. FIIs offer a defensive strategy because they hold mortgage-backed securities that provide steady returns, and rents on offices and malls are inflation-indexed, said Renato Damaso Maruichi, a Banco Fator SA analyst.

“This model may be where we are going,” Marcelo Mesquita, a fund manager who helps oversee 650 million reais at Leblon Equities, said in an interview in Rio de Janeiro. “Real estate funds are growing because investors are not buying company stocks. These funds are buying projects. For investors, they are a much better deal.”

Worst Margins

Rio de Janeiro-based PDG posted the Bovespa index’s worst operating margin in the fourth quarter at a negative 835 percent as negative cash flow from operations swelled to 1.79 billion reais. Rio-based Brookfield and Belo Horizonte-based MRV also had negative cash flow, spending more cash than they brought in.

PDG rose 0.8 percent to 2.59 reais at 4:37 p.m. in Sao Paulo, while Brookfield gained 1.8 percent to 2.23 reais. MRV rose 1.1 percent to 8.88 reais.

After going public in the mid-2000s and capturing investor attention by promising rampant growth, homebuilder shares are tumbling as the companies face higher-than-expected labor costs and delays. The businesses are restructuring to focus on their areas of expertise, said Joao Arruda, an analyst at Votorantim Corretora.

PDG, MRV, and Brookfield did not return requests for comment on their strategies to bolster returns for investors. Rossi’s press office in Sao Paulo declined to comment.

PDG is focused on slimming down after growing “out of control,” Chief Executive Officer Carlos Piani said on a call with analysts on March 27.

‘Geographically Smaller’

“We don’t want to look back to the past anymore,” Piani said in a phone interview from Sao Paulo on the same day. “Our objective is to be geographically smaller, focusing on the areas that have the best potentials.”

Mexico’s largest homebuilders are also falling in stock and bond markets on concern a shift in government policy favoring construction of apartment buildings, which require more upfront capital than single-family homes, is cutting into cash flow. Corp. Geo SAB said last week it will seek to restructure debt, a day after a person familiar with the matter said competitor Urbi Desarrollos Urbanos SAB had hired Rothschild to provide advice on a possible restructuring.

Urbi confirmed yesterday that it hired Rothschild and other advisers to analyze alternatives to improve its liquidity and restructure its financial liabilities.

Credibility ‘Problem’

“The problem with this sector is credibility,” Andre Parize, head of research at Votorantim Corretora, said about Brazilian homebuilders in a Sao Paulo interview. “The multiples are cheap, but you don’t know what hole will come next.”

Brookfield traded at 5.4 times estimated 2013 earnings yesterday and Rossi at 6.5 times, making them the cheapest stocks on the Bovespa index after state-run utility Centrais Eletricas Brasileiras SA. (ELET6) MRV and Cyrela traded at 7.3 and 8.9 times earnings, respectively, compared with an average of 16 for all stocks on the gauge.

Brookfield is “adjusting to the new realities of the sector,” Alessandro Vedrossi, executive director of Brookfield’s Rio de Janeiro business unit, said April 4 by telephone from Sao Paulo. “2012 is a year for readjustment for the industry and for Brookfield.”

Cyrela, which reported 424 million reais in cash flow in 2012, began restructuring in 2011 to correct “operational problems,” said Chief Financial Officer Jose Florencio.

‘Superior Margins’

“We have shown investors that we are capable of generating superior margins,” he said in a written response to questions. “Cyrela was the first company to go to the market and communicate that it had operational problems. This transparency is part of our culture. Since then, we have executed a broad operational restructuring plan that has shown consistent results.”

Funds are gaining in popularity amid an explosion in mortgages after regulatory changes boosted access to borrowing, said Antonio Barbosa, head of real estate mortgages for HSBC Holdings Plc. Since the rules were passed in 2004, mortgages have risen 20-fold to 80 billion reais, he said.

“This is a market that can continue to grow 15 to 25 percent,” he said in an interview in Sao Paulo.

Interest Rates

Low vacancy rates at offices, apartments and malls and good management help explain the sudden upsurge of interest in the funds, said Jose Diniz, director of real estate investments at Rio Bravo Investimentos, which created its first fund for Shopping Patio Higienopolis in 1999. It has returned almost 30 percent every year since, Diniz said.

Stalling economic growth and the specter of rising interest rates as inflation accelerates may pare returns, he said.

“Since the economy is stagnant, there is some risk that there could be vacancies,” Diniz said in a telephone interview. “This is temporary and maybe investors won’t find big returns, but we still think it’s a good investment.”

The total volume traded in FIIs in Brazil reached 2.2 billion reais in the first quarter, more than two-thirds of the volume negotiated in all of 2012, according to the BM&FBovespa.

“If you want to be in the industry, you can have a good return and your risk is diversified,” said Maria Eduarda Lassance, a partner at Jardim Botanico Investimentos, which manages 800 million reais, in Rio de Janeiro.

To contact the reporter on this story: Christiana Sciaudone in Sao Paulo at csciaudone@bloomberg.net

To contact the editor responsible for this story: Jessica Brice at jbrice1@bloomberg.net


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