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Brazilian property: not such a nutty idea

Created:

8 March 2010

Updated:

10 March 2010

Written by:

Claer Barrett

"We're not a bunch of ex-bankers who fancy a bit of property. Most of them didn't have a clue." So says James Morse, chief executive of Squarestone Brasil. The Brazilian shopping centre specialist is hoping to raise £250m on Aim later this month, promising to take the "western mall concept" over to Latin America. If it succeeds, Squarestone will be the first significant overseas property fund (OPF) to list on London's junior index for nearly three years.

The property boom spawned hundreds of OPFs promising investors a high-risk, high-reward gamble on property markets in the emerging economies of India, China, Eastern Europe and beyond. Often run by ex-bankers, these funds were usually highly geared, and paid far too much for assets of dubious quality. The credit crunch ended the foreign holiday; values plunged, tenant markets collapsed and loans remain deep underwater.

Conscious of the chequered history of Aim-traded property funds, Squarestone Brasil has a simplistic management structure (avoiding the OPF cliché of an external fund manager able to cream off extortionate fees). The fund will be seeded by two large retail malls in Sao Paulo which Squarestone already manages (Bonsucesso Mall, which is trading, and a 50 per cent stake in Golden Square Mall, which completes in 2011). Three more development sites totalling 1m sq ft are also being eyed.

Ex-MEPC man Mr Morse is now a Brazilian resident, and his team has spent three years on the ground working up the business plan with local investment bank BTG Pactual, which has signed a letter of intent to potentially partner Squarestone on project funding if the listing succeeds. Looking at the economic statistics, it is easy to get caught up in Brazil's carnival atmosphere. However, investors should be aware of the long-term nature of development projects, and unpredictable nature of returns.

Another BRIC in the wall

The letter "B" in the fast-emerging BRIC nations, Brazil enjoys GDP growth of 5 per cent per annum, and annual retail sales are growing at the same rate. Retail sales are forecast to hit $573bn in 2013 (up from $368bn in 2008). Domestic consumer demand is driving the market - Brazil's middle class has increased by 30m people since 2003. Known as the "C-class", Brazil's middling sort takes its name from the ABCDE grading of the class system. However, magazines and popular culture has reinvented it as the "consumer class".

"The C-class has been lifted out of the comparative poverty of the D and E classes, and they are driving Brazil's social mobility story," says Mr Morse. "The average person has white goods and a car, plus 50 per cent have computers and 75 per cent have a plasma TV."

Unlike Asian economies, Latinos prefer to spend their money rather than save it. Brazil comes third (after the US and UK) for household consumption expenditure as a percentage of GDP. "And now they're going to the mall and buying fashionable clothes, and doing it en masse," he adds, noting the intense brand culture that is evolving.

International retailers are already in Brazil, and unlike India and China, there are no complicated restrictions governing their entry. Nike is expanding rapidly through the franchise route, and Spanish fashion house Zara already has 26 stores. Surprisingly, the most dominant retail anchor in Brazil is C&A ("it's been there for a long time and has no competition yet," adds Mr Morse). At the top end, luxury brands including Armani have landed.

"High street retailers across Europe and the US are eyeing up the Brazilian market," he says. "Part of what we're trying to do is encouraging retailers to come to see Brazil, and come to our malls. If you have a unique tenant mix and can supply new international brands to the market, then bingo."

Squarestone has recruited a formidable board of Brazilian and UK retail veterans to achieve this, including chairman Tony Campbell, the former deputy chief executive of Asda, and Michael Poynor, ex-retail adviser to PricewaterhouseCoopers, who has enjoyed a 40-year career in international retail. Neil Varnham, the president of the British Council of Shopping Centres, has been engaged as a consultant.

There are also plenty of expanding Brazilian retailers for Squarestone to target. Sports department store Centauro is like a Brazilian JJB, and high grade fashion brands include Osklen and Le Lis Blanc. Put any of these names into Google, and you can see for yourself how sophisticated the Brazilian fashion consumer has become. Mass market fashion retailers are also emerging to meet demand (Marisa is the Brazilian equivalent of Primark).

What the retailers lack is international-standard property. "We want to provide malls that are the standard in Europe and the US, making for a longer dwell time, a better variety of stores and a greater concentration of restaurants," Mr Morse adds.

Squarestone is understood to be looking to raise half of its £250m target from US investors, and has spent the last month on the road over there and over here. "In the UK, fund managers are desperately looking for good ideas. We're not a debt-fuelled IPO palmed off from a private equity house." However, UK real estate brokers have a cautious stance about development stories in emerging economies.

Developing brief

"I will be staggered if they manage to raise that amount for development work," says Ian Wild, investment fund analyst at Singer Capital Markets. He points out that there is a long list of development-focused funds on Aim that have been unable to raise finance to complete their grand plans. In some cases, firms have been targeted by activist investors pressing for the distribution of leftover cash to shareholders.

"If you're interested in investing in foreign property companies, I can give you a few ideas on Aim which are trading at an 80 per cent discount to NAV," he says in a wry nod to the huge discounts existing OPFs currently trade at. "The danger is investors will put a pound in, and it will quickly become 85 pence."

Mr Morse is quick to differentiate his fund from others on Aim. "This is not the 2005 bubble, we are post-apocalypse now," he says. "We have assets in place, we have realistic valuations, an internal management structure and there is no crazy gearing."

That's not to say Squarestone is bereft of local competition. The top five multi-mall operators in Brazil control 15 per cent of the market and wish to expand. Although there are no significant international mall operators, for some, this may signal a warning rather than an opportunity.

"It is heartening to see Squarestone taking the plunge into Brazil's retail market," says Lucy Scott, editor of Property Week Global magazine, which specialises in international property investment. "Brazil's demographics are strong, it boasts natural resources and has a much more urbanised population than either China or India. There is very low consumer debt, but the thing to watch for this year is interest rates, which are touching 9 per cent."

Brazil has suffered from double-digit inflation for years, and pressure to keep it down means fears of a rate rise are growing. "The shopping centre business in Brazil is also very management–intensive," Ms Scott adds. "With standard lease lengths of three years, tenants will vote with their feet if they're not happy."

Tapping into Brazil's consumer growth story will definitely appeal to investors, but a competitive retail market, uncertain income streams and the long-term nature of property development all require a high risk appetite.