Powerful tsunami hits December’s balance sheets

Powerful tsunami hits December’s balance sheets – A tsunami of high-end office space has flooded the cities of São Paulo and Rio de Janeiro over the past three years. This situation has led to some casualties that will be more visible in 2015.

Making the hard case to invest in Brazil office space – Rising vacancy rates, decreasing rents, slow economic activity, and lack of room to increase employment indicate that the current tidal conditions aren’t ideal. However, the silver lining is that most publicly traded office REITs have demonstrated resiliency compared to the overall market, especially in terms of vacancy rates.

Find out which office REITs will likely lose its zero-vacancy status

Ranking – Brazil’s Industrial/Logistics REITs in 2014

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Release: 18 January 2015


Making the hard case to invest in Brazil office space

When allocating any capital successfully, it is important to ensure that the economic fundamentals will become increasingly favorable in the long term. One of the most important pieces of the real estate investing puzzle is understanding the macroeconomic forces that drive the market. Essentially, in these waters you don’t want to launch your boat at a falling tide – it will sit stranded until a rising tide floats it ­­­off.­­­­

Rising vacancy rates, decreasing rents, slow economic activity, and lack of room to increase employment indicate that the current tidal conditions aren’t ideal, spooking investors away from commercial real estate as an asset class. However, the silver lining is that most publicly traded office REITs have demonstrated resiliency compared to the overall market, especially in terms of vacancy rates. This was discussed in more detail in the previous newsletter.

We have learned (some the hard way) that publicly traded REITs are vulnerable to capital market movements, and generally have difficulty attracting capital when real estate falls out of favor and there is a perception of better opportunities elsewhere. The performance of the BM&FBOVESPA Real Estate Index (IFIX) has reflected this situation over the past two years, dropping 24 and 14 percent in 2013 and 2014 (respectively) in US dollar terms (13 percent and flat in Brazilian real terms).

IFIXSource: BM&FBovespa, Infomoney

The R-squared between IFIX and IBOVESPA in 2014 is approximately 70 percent.

Older office REITs tend to lag the market when market conditions change. Offices are leased for longer terms than other types of property, often up to 10 years. So, even if the market rate falls office REITs will generally do better, since their lease rates are locked in. However, when leases expire or there’s a lease-revision clause, office REITs will generate less income, lowering their value.

Further, office REITs that rent to government companies tend to be more stable than those that rent to private companies. Indeed, renting to government contractors might even be anti-cyclical to the regular business trends, since the government tends to spend more money when the economy is approaching or in a recession.

Long-term investors who are skeptical of the cyclical activity of capital markets often see these types of opportunities when the tide is low. There are definitely advantages to separating from the herd of investors and instead investing when it is most opportune to do so.

A particularity of the Brazilian case is that a good portion of Brazilian office REITs hold a single property. Although returns are subject to the idiosyncrasies of each building, investors have a bird’s eye view of how the property has been managed. In this context, the management team is more exposed to investor scrutiny than when the team manages an entire portfolio of properties and key data gets muddled.

Powerful tsunami hits December’s balance sheets

A tsunami of high-end office space has flooded the cities of São Paulo and Rio de Janeiro over the past three years. With a growth of 40+ percent since 2011 (Source: JLL), it is surprising that the vacancy rate has not exceeded 20 percent from a 7-9 percent base. Although builders continue to add more space than the market can absorb, this trend seems to be fizzling out. The market is getting accustomed to a new market dynamics until it reaches equilibrium.

This situation has led to some casualties that will be more visible in 2015. Take for example the funds CEO Cyrela Commercial Properties (CEOC11B) and Cyrela Thera (THRA11B), both of which have units in state-of-the-art buildings. Although they have been posting exceptional yields in the office market, they remain vacant according to their administrators’ reports. What is mitigating this low occupancy performance is the guaranteed yields paid by the sellers until mid-2015.

CEOCSource: BM&FBovespa

More recently in the December financials,

  • CEO Cyrela Commercial Properties posted a whopping drop of almost half of its book value, from its initial amount of R$159.4 million in issued shares (November 2012) to the current R$82.3 million.
  • Cyrela Thera reported a decline of 22 percent in book value, from R$150.9 million in December of 2013 to R$117.1 million in December of 2014.

Both funds were appraised down to market value.

South Corporate do Edifício Corporate Executive Offices (CEO), Barra da Tijuca, Rio de Janeiro CEO. Cyrela Commercial Properties owns seven floors totaling 11,943 square meters.

Thera Corporate Building, Brooklyn Novo, São Paulo. Cyrela Thera Corporate owns five floors totaling 9,496 square meters.

A  close examination of the appraisal reports would explain the exact reason for both declines, but we can reasonably deduce that it is related to the high vacancy levels. Given the magnitude of the fall – greater than one year’s worth of full potential revenues – the appraisers must believe that these two properties will reach full occupancy only in the mid or long-term (that is, in a few years). Unfortunately, fund administrator BTG Pactual informed GilverBook that even in situations like this they don’t release appraisal reports.

Source: BM&FBovespa, BTG Pactual


U.S. average hourly earnings fall in December of 2014

Average hourly earnings in the United States decreased 0.20 percent in December of 2014 over the previous month. Although recent data show that the unemployment rate decreased to 5.6 percent (its lowest level since 2007), the drop in average hourly earnings is nonetheless an indication that the labor market is not tight enough. The other indicator that reinforces this thinking is that the level of participation in the labor market is at its lowest level since the 1970s at only 62.70 percent.

US Unemp Rate

Source: U.S. Bureau of Labor Statistics, Trading Economics


Which one of these office REITs will likely lose its zero-vacancy status?

BB Progressivo (BBFI11B) – LIKELY

When a fund’s administrator and its sole lessee are both the largest government-owned banks in Brazil, you would think that nothing could threaten a long-term steady stream of dividends. That was the case until the ten-year lease contract expired in December of 2014. Administrated by Caixa Economica Federal, the fund leases two office buildings to Banco do Brasil: Sede I in Brasília, DF and CARJ in Rio Janeiro, RJ.

Banco do Brasil has been driving a hard bargain in order to keep the lease renewal low, and has been pushing at all costs not to absorb annual inflation adjustments. The bank filed a revision lease lawsuit, requesting a lower amount to renew the lease for CARJ. In addition, Banco do Brasil decided to renew only a portion of Sede I, reducing its lease from R$2,401,157 to R$700,000 – an approximate 36 percent drop in total lease revenues.

Although Banco do Brasil continues to pay the rent, none of the proposed renewals has been signed yet.

Sede I – Brasilia’s banking sector

FII Ed. Almirante Barroso – FAMB11B – UNCERTAIN

FII Ed. Almirante Barroso is included in this list because it is one of the most convoluted renewals in the REIT space nowadays. An ongoing legal dispute with the sole tenant Caixa Economica Federal that has lasted four years created uncertainties related to the lease terms. In December of 2010, the fund filed a lawsuit requesting to double the monthly rent from R$1.82 to R$3.63 million. Although the contract expired in November of 2012, the terms of the renewal have been unclear. When we contacted  the administrator BTG Pactual this past week, they indicated that they would publish new updates as soon as possible.

The fund has nonetheless been able to reap positive results. In November of 2012 it was awarded an interim monthly lease of R$3.05 million, plus a one-off payment of R$20.6 million related to the retroactive lease difference. In February of 2013, an independent expert set the final lease at R$4.28 million, but Caixa has been disputing this amount since then. Last October’s lease proceeds (the most recently available information) were R$3.47 million.

On the same avenue as Torre Almirante and two blocks away, the Almirante Barroso Building has been occupied by Caixa Economica, which sold it to the fund in 2002 and became a tenant. Almirante Barroso opened in the late 70s and has undergone several renovations since. The investment thesis is that there has been an increase in demand for high-standard office spaces in downtown Rio, but few free areas for new construction. Thus, many old buildings like Almirante Barroso have been revamped for modernization and subsequent resale or leasing.

Almirante Barroso Building, Downtown Rio de Janeiro


The proximity to a ten-year lease expiration in February of 2015 has naturally raised concerns about the renewal. The fund owns 40 percent of Torre Almirante, a tower located in the commercial corridor of Rio Branco Avenue, one of the most traditional business areas in Rio de Janeiro.

Despite concerns, this situation seems to check the boxes for lease continuity:

  • The lessee, state oil company Petrobras, demonstrated interest in renewing the contract six months before expiration.
  • There has been a tenancy history since the contract signing in 2004. Since 2008, the lease has been adjusted every three years.
  • The fund also owns part of a gleaming thirty-six story high-rise at the heart of downtown Rio de Janeiro, leased entirely to Petrobras.

Torre Almirante, Downtown Rio de Janeiro

As you can see below, Almirante Barroso (FAMB11) shares have not been affected as much as BB Progressivo (BBFI11B) and Torre Almirante (ALMI11B). Is the market confident in Almirante Barroso’s renewal?


XP Corporate Macaé FII XPCM11 – NOT LIKELY

The fund owns a brand-new building that has been leased by oil company Petrobras. The lease agreement was signed on August 2013 and has a 10-year term. The base lease amount was R$1.5 million per month, corrected annually for inflation.

The Corporate was built to address the lack of premium office space in the city of Macae, which is a base for pre-salt exploration.


SP Downtown’s investment thesis is the classic example of what investors expect from their office REITs. The fund has provided a solid stream of monthly income to its investors and also offers the potential for long-term capital appreciation through property value growth. Last October, the lease agreement was renewed for another five years.

This fund offers quality office space in a central neighborhood dominated by low to medium-standard players. The location is a highlight due to its infrastructure and excellent access to public transportation. The lessee Atento is a global customer-services provider with 92 contact centers in 15 countries, and was initially founded to provide services to the phone carrier Telefonica. Bain Capital Partners purchased Atento in 2012.

SP Downtown has been leasing two office buildings in downtown São Paulo to Atento.


Ranking – Brazil’s Industrial/Logistics REITs

Click here to download table

Amounts in Brazilian real (R$)

# Ticker REIT Share price 12/30/13 Share price 12/30/14 Dividend 2014 Yield 2014 Percent Total Return 2014 Percent
1 HGLG11 CSHG Logistica 1,080.00  1,091.00 151.60  14.0 15.1
2 EURO11 Europar    174.00     185.00   11.92    6.9 13.2
3 GWIC11 GWI Condomínios Logísticos    184.98     189.90   16.43    8.9 11.5
4 CTXT11 Centro Têxtil Internacional        3.31        3.25     0.35   10.5 8.7
5 FIIP11B RB Capital Renda I    159.78    148.60     15.80     9.9 2.9
6 GRLV11 CSHG GR Louveira* 1,000.00 1,000.00       9.00      0.9 0.9
7 SDIL11 SDI Logistica Rio      89.80      78.50       8.98   10.0 -2.6
8 TRXL11 TRX Realty Logistica Renda I    105.50      92.00     10.07     9.5 -3.3
9 FIIB11 Industrial do Brasil    334.99     290.00     28.45     8.5 -4.9
10 CXTL11 Caixa TRX Logistica    714.00     600.03     49.51     6.9 -9.0

*Started on 19 Mar 2014

Written by Heli Brecailo

This newsletter is not engaged in rendering tax, accounting, or other professional advice through this publication. No statement in this issue is to be construed as a recommendation to buy or sell any security or other investment. Please do your own due diligence before making any investment decision.
Some information presented in this publication has been obtained from third-party sources considered to be reliable. Sources are not required to make representations as to the accuracy of the information, however, and consequently the publisher cannot guarantee accuracy.

The author has no positions in any shares mentioned, and no plans to initiate any positions within the next 72 hours.​