Dividend Yields To Rule a Little Longer

chart01After preparing the financial markets for a potential interest rate hike in the middle of this month, Federal Reserve’s head Janet Yellen, elected by Forbes the third most powerful woman, decided to be on hold until the economic outlook clears. This Monday’s surprise announcement ignited a new wave of celebrations among dividend and emerging markets investors.

Yellen’s announcement came following the news that employers added a mere 38 thousand jobs in May. The figure was so low that she remained cautious and preferred to wait for more data. Remember that a couple of weeks ago she said an increase would be appropriate. As a result, some financial outlets say that this announcement effectively postpone a potential hike to September, opening a window of opportunity for speculative capital chasing certain types of stocks.

Until yesterday I was 100% confident that it was not worth considering emerging markets investments, such as the one I bumped into, Tierra XP Latin America Real Estate ETF, a new real estate ETF focused on Latin America (click here). Although their real estate investment trusts and real estate operating companies, especially in Brazil, have been underestimated, currency trend has been in favor of U.S. dollars. Currency exchange fluctuations caused by higher interest rates would likely trump any gains in the local currency. The announcement might interrupt the trend for now and favors gains in the short term, but it should resume in the long term.

Dividend stocks, including REITs, should also benefit from the announcement. Rather than interest rates, dividend yields will rule for a little longer, especially when equity REIT yields are on average 4.1%, as opposed to a 10-year treasury bond rate under 2%. This reminds me of what William Koldus said in a recent article. Back in 2009, he couldn’t imagine the current scenario of low interest rates (click here). This is what he said:

“In 2009, it was hard for me to imagine a robust recovery in the financial markets that extended for seven years, while economic growth struggled. It was hard to imagine seven years of zero interest rates, which would entice investors to keep reaching for income. After going through this low interest rate period, today, it is hard for investors to imagine a future that looks different from the current environment, as I could not do in 2009.”

Well, it appears that we’ll have more of the same. With this degree of uncertainty about the future, the status quo seems more likely.

Source: Tierra XP Latin America Real Estate ETF (NYSEArca:LARE), Seeking Alpha, Bloomberg

Disclaimer: 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.

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

Has the surge in share price taken QTS Realty Trust to the clouds?

U.S. REIT – Has the surge in share price taken QTS Realty Trust (NYSE: QTS) to the clouds?

Brazil REIT – Anhanguera Educacional (BVMF: FAED11B) – Changes to the Student Financing Fund (FIES) should affect tenant.


Release: 15 February 2015


REITs

U.S. – Has the surge in share price taken QTS Realty Trust (NYSE: QTS) to the clouds?

Although QTS Realty Trust (NYSE:QTS) is one the fastest growing companies in the sexy sector of data-center REITs, the recent share-price rally has pushed its valuation to higher levels in comparison to its peers. Since the IPO in October of 2013 investors have driven the stock to a 73 percent appreciation. At least for the moment, I feel that the risks surrounding purchasing this stock outweigh any potential future returns.

Chart01

To justify the current valuation, the senior management will have to make an extra effort to put into practice the company’s ambitious expansion plan to double net leasable area and monetize it in a very competitive industry. I don’t see them outgrowing the market pace without losing margins or maintaining lower levels of occupancy.

Despite being bullish on data-center REITs due to the sector’s strong fundamentals, I’ll keep looking elsewhere before considering QTS again. The company will release its fourth quarter results soon, but I don’t expect that this picture will change much in the short term.

Performance

  • On the one hand, QTS’s growth rates have been phenomenal. During the Stifel Technology, Internet & Media Conference, the company’s CEO Chad Williams showcased two-digit grown for revenues and adjusted EBITDA, and three-digit grown for operating FFO.

­­

Chart02

Source: Extracted from QTS presentation on February 9, 2015 at the Stifel Technology, Internet & Media Conference.

  • In addition, QTS demonstrates higher growth rates than its peers, at the same level as the growth experienced by CyrusOne (CONE).

Chart03

  • On the other hand, QTS has been more leveraged than its peers.

Chart04

Chart05

  • And, most importantly, QTS’s Price-to-FFO has been higher and dividend yield lower than its peers.

Chart06

Chart07

*Extracted from the most recent financial for each company as of the date below. For price-to-FFO and dividend yield, share prices as of 13 February of 2015. QTS, CONE, COR, and DFT are small-cap stocks.

QTS, CONE, EQIX – 9/30/2014

COR, DLR – 12/31/2014

Investment Thesis

Over the past three or four years, the need for storing data has increased exponentially. Just think about how many servers are used by some of the Internet’s most popular companies, such as Google, Amazon, or Facebook. Last year, an average of more than 300 million pictures were uploaded to Facebook on a daily basis. Their warehouse’s incoming daily data rate was about 600 terabytes, and their maximum total capacity was 300 petabytes (1 petabyte is equivalent to about 1,000 terabytes). Would you expect these numbers to go up or down in the coming years, and how quickly?

This February, Cisco released mobile data traffic statistics for 2014, as well as projections and growth trends for the next five years. The numbers are daunting: 1) Global mobile data traffic grew 69 percent in 2014, 2) Last year’s mobile data traffic alone was nearly 30 times the size of the entire global Internet in 2000, and 3) Global mobile data traffic is expected to increase nearly tenfold between 2014 and 2019, at a compound annual growth rate (CAGR) of 57 percent (Source: Cisco Visual Networking Index Global Mobile Data Traffic Forecast Update)

Chart08

As data production accelerates, organizations of all sizes increasingly seek sophisticated and reliable information and content management, security, storage infrastructure, and archiving solutions. Not only Internet companies and mobile carriers lean on big data, but also financial institutions (credit cards, for example), enterprises, health care institutions, and governments. This leads to a growing demand for external data-center space and the services associated with it.

Company Description

QTS Realty Trust is a national provider of data-center solutions, operating twelve data centers across several states. They own, build, lease, and operate space that houses the network and computer equipment of multiple customers, and provide access to a range of communications carriers.

Overall, QTS provides three types of service: custom data centers (C1), colocation (C2), and cloud and managed services (C3). C1 and C2 account for the majority of the company’s revenues.

QTS currently has 920,000 square feet in space, and this number is expected to rise to 2.1 million square feet over time.

QTS’s largest data center in Atlanta, Georgia

Customer Base Diversification

QTS has a number of multi-tenant data centers that house companies of all sizes representing an array of industries, each with unique and varied business models and needs. The current base of 850 customers is not concentrated, ranging from Fortune 1000 companies to small and medium businesses. These customers have been engaged in multi-year contracts.

C1 customers are typically large enterprises with significant IT expertise and specific IT requirements. These include financial institutions, “Big Four” accounting firms, and the world’s largest global Internet companies.

C2 customers represent of a wide range of organizations, including major healthcare, telecommunications and software, and web-based companies.

C3 customers consist of both large organizations and small businesses seeking to reduce their capital expenditures and outsource their IT infrastructure on a flexible basis. They include a global financial processing company, a U.S. government agency, and an educational-software provider.

Source: 2013 Annual Report

Chart09

Source: 2013 year end QTS presentation in Germany on March 10-12, 2014

Competitive Landscape

Gartner, a specialist in high technology, published research in October of 2014 laying out the market trends for the online data industry. A number of events are expected to impact the market over the coming three years:

  • Infrastructure efficiency is a big driver in this industry. The customer base is currently looking to do more with less, but a considerable portion of the facilities is aging and needs restructuring. This is leading to an increasing demand for modern data center equipment and networking components, as well as for advanced power and cooling solutions.
  • A mismatch between IT customer expectations and vendors opens up an opportunity for alternative vendors. Traditional vendors have not been able to entirely keep up with customer expectations, and so new vendors able to provide state-of-the-art infrastructure allied with complete solutions could potentially gain the upper hand.
  • Nationalism will play an important role. Following Edward Snowden’s disclosure of classified information in 2013 (one of the most significant leaks of secret affairs since the 70s), international markets are increasingly considering domestically-developed and open-source technologies, and looking for local labor.
  • Traditional in-house data centers have been limited. Organizations are aware that outsourcing can both lower infrastructure costs and be more secure from an IT perspective. In-house data centers have therefore been shrinking, making room for external data-center operators.
  • There’s an increasing perception that “hardware” is disposable. Data-center margins will drop and storage companies will suffer erosion of revenues. The only way to differentiate yourself is to create solutions that complement storage.

One way or another, all these trends place QTS in a favorable position.

Example of Efficiency: Virtualization of Servers

One way to add server capacity to data centers without adding hardware is to utilize a software technology called virtualization. Since servers often operate at low capacity, virtualization allows the creation of multiple virtual servers using the same machine. Virtualization software sits on top of the server’s operating system, rationing resources into several virtual servers at once. This boosts capacity and keeps costs contained. Players spearheading this technology include VMware of Palo Alto and Citrix Systems of Fort Lauderdale.

Source: Plunket Research Online


Brazil’s Anhanguera Educacional (BVMF: FAED11B) – Changes to the Student Financing Fund (FIES) should affect tenant

Investment Thesis

As real income rises and the search for a better lifestyle intensifies, young Brazilians have been increasingly looking to for-profit institutions of higher education in order to achieve their professional ambitions. However, this movement toward education is still a relatively recent phenomenon, and therefore it has excellent potential for higher returns because the market hasn’t yet been completely tapped.

Higher education in Brazil is a huge market. According to UNESCO, Brazil is the world’s fifth-largest market, and 73 percent of students have been enrolled in private colleges, universities, or vocational schools. In 2013, out of the approximately 7.3 million students enrolled in higher-education institutions, 5.4 million attended private schools. Just to put the size of this industry into perspective, the U.S. has 21 million students enrolled in higher-education institutions.

Chart10 Source: Brazil’s Ministry of Education

Already large, the Brazilian higher-education sector is still growing. In 2013, the number of enrolled students in private institutions grew by 4.5 percent, as opposed to only 1.9 percent in public institutions. Also, the sector has low penetration compared to other countries – only 19 percent of Brazilians between ages 18 and 24 go to college, while this rate is 41 percent in the U.S., 29 percent in Chile, and 64 percent (at least begin college) in Argentina. There’s still a lot of wiggle room to grow and catch up with comparable economies.

What makes higher education compelling is that pursuing a college degree is certainly worth it in Brazil. Contrary to the popular debate in the U.S., Brazilians are not skeptical about the returns of higher education. You are likely to reap meaningful rewards by taking loans and investing time to get a diploma. There’s a wide wage gap between those who hold an advanced degree and those who stopped at high school, which many see as an opportunity to make an income leap. Also, with its historic low employment rates, Brazil’s economy has been starving for more skilled workers.

Chart11 Source: Brazil’s Ministry of Education

Over the past decade, the perceived importance of education has become deeply rooted in Brazilian society. As the educational sector evolves and offers more alternatives, families have not only demanded greater access to school for their children but also become significantly more concerned with the quality of education provided. This is creating a trickle-down effect that will influence higher education for years to come.

In addition, due to the continued support of the federal government for private higher education, it is now easier for middle and lower-middle income students to attend college. The government has launched programs that finance monthly tuition fees, such as the Programa Universidade para Todos (PROUNI) and Fundo de Financiamento ao Estudante do Ensino Superior (FIES).

Overall, the fundamentals for investing in higher education are strong, and growing enrollment is driven by a number of factors: 1) the prospect of career advancement, 2) the significant increase in individual income for those who hold an advanced degree, 3) the substantial unmet and growing demand for skilled workers, and 4) the increasing availability of educational alternatives for the middle and lower-middle income population.

Fund Description

Anhanguera Educacional’s primary revenue source is the lease proceeds from its three properties in the state of São Paulo – Taboão da Serra, Leme, and Valinhos. The Taboão campus has offered both undergraduate and graduate courses since 2005, while the Leme campus offers additional in-person courses and also houses the installations for the distance-learning department. The Valinhos location contains the company’s administrative offices.

Anhanguera Educacional – Taboão Campus

 

Fund raising has taken place in two tranches. The first tranche, which happened in November of 2009, was earmarked for purchasing the Taboão unit at R$37.4 million. Later, a second tranche in October of 2010 financed the purchase of the Leme and Valinhos units at R$4.9 and 9.3 million (respectively).

Initially, monthly leases were fixed at 1.0 percent of the real estate value, and through negotiations over the past five years this has remained the same. The table below, extracted from the fund administrator’s December report, provides more details about the leases.

Chart16

Source: BTG Pactual

Tenant Profile

Announced in April of 2013 and completed in June of 2014 following the approval of Brazil’s antitrust agency, the merger between Anhanguera and Kroton formed the world’s largest private education institution in market capitalization, with one million students. Anhanguera has now merged into Kroton, whose shareholders in aggregate kept the majority of the new company. The second-largest private educational company is New Oriental, a Beijing-based company listed on the New York Stock Exchange, with 2.5 million students.

Student Financing Fund

The search for better wages and employment opportunities by young workers explains why the Student Financing Fund (FIES) has become an absolute success. Since the redesign of FIES in 2010, the number of student loans has spiked from 76,170 in 2010 to 1,029,107 in 2013. Nonetheless, a tighter 2015 federal budget has prompted the government to propose changes that might limit further growth.

FIES is a Ministry of Education program to finance the higher education of students enrolled in private institutions. Although it has existed since 1999, the 2010 redesign expanded the program to better reach lower and lower-middle income segments, which historically had no access to higher education. The National Fund for Education Development took control of the program’s operations and implemented several meaningful changes. Perhaps most significantly, interest rates fell from 6.5 to 3.4 percent a year, students can apply for funding at any time of year, and the repayment grace period after finishing school has increased from six to eighteen months.

According to Anhanguera’s 2014 Q2 report, FIES has been the primary tool for improving the company’s accounts receivable and will continue to be the focus of collection and retention efforts. Over 44 percent of the students enrolled in Anhanguera’s campuses at the end of June 2014 were part of the program.

FIES Enrollments at AnhangueraChart12

Source: Anhanguera Educational’s Q2 2014 Report

Potential Threat

Late last year the Ministry of Education established new rules for FIES that will potentially reduce the number of contracts and limit the growth of private-sector enrollment. Students can now benefit from the loan only if they reach a minimum score on the national standardized exam for high school graduates. Also, not all students who enjoy a federal scholarship will continue having access to FIES. It remains uncertain how these new rules will affect educational institutions.

So far, Anhanguera Educacional share price (FAED11B) has remained stable and dividends have grown, yielding 11.8 percent.

Chart13 Source: Infomoney

Paid Monthly Dividends R$Chart18

Source: BTG Pactual


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Written by Heli Brecailo

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

Aesapar (AEFI11) – Real estate investment fund, or corporate bond secured by real estate?

Rather than a college REIT, Aesapar (AEFI11) looks more like a fixed-rate collateralized bond whose issuer is its tenant Anhanguera Educacional. 

ECB announces its asset-purchase program.

US quarterly GDP growth back to “normal” 

Brazil’s unanimous interest-rate increase of half a percentage point 

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Release: 01 February 2015


Fundamentals/Indicators

ECB announces its asset-purchase program

On January 22 the European Central Bank announced its asset-purchasing program. Initiating at a rate of 60 billion euros per month, the program is intended to continue until at least September 2016. By purchasing sovereign bonds, the ECB encourages investors to free up funds and place them in riskier funds. Analysts are expecting that the Euro-zone’s commercial real estate market will strengthen, since this is a natural asset class for investment after bonds and stocks. The ECB signaled its determination to respond more forcefully to the decline in inflation and threat of long-term deflation, and this move has the potential to boost inflation over time.

Chart01

 Source: European Central Bank, Marc to Market

Brazil’s REIT activity slows down in 2014

In 2014, Brazil-based publicly traded REITs issued a total of R$4.7 billion (approximately US$2.0 billion) through secondary equity offerings, down from R$14.0 billion in 2012 and R$10.7 billion in 2013. Due to the slowdown of the economy and the prospects of a tightening credit environment, this decline was expected.

Chart02

Source: BM&FBovespa, Oanda

U.S. GDP growth back to “normal”

After posting an exceptional 5.0 percent GDP growth in the third quarter of 2013, the United States posted a more modest growth of 2.6 percent in the final quarter of 2014.

Source: Bureau of Economic Analysis

Central Bank of Brazil announces interest-rate increase

As for Brazil, its Central Bank announced a unanimous interest-rate increase of half a percentage point, to 12.25 percent. The minutes of the Meeting of the Monetary Policy Committee (Copom) state that the organization expects inflation to be elevated in 2015, but that it should begin to decline in 2016. High interest rates are never good news for home borrowers, but the minutes do suggest a better environment in the long run. In addition, Brazil posted the lowest unemployment rate of its historical series: last December the unemployment rate was 4.3 percent, closing 2014 at 4.8 percent.

Source: Central Bank of Brazil


REITs

Brazil’s Aesapar (AEFI11) – Real estate investment fund, or corporate bond secured by real estate?

Delays associated with its greenfield project don’t seem to be a primary concern for buyers of Aesapar shares. Conceived in a built-to-suit model, Aesapar has not yet been able to fulfill its goal of constructing two campuses for the low and middle-income student college chain Anhanguera Educacional, its sole tenant. Nonetheless, dividends were fixed at inception to be 0.95 percent per month over the total investment – regardless of the actual status of construction. Presently, investing in Aesapar looks more like a fixed-rate collateralized bond whose issuer is Anhanguera.

As risky as a greenfield project can be, since it raised capital in 2011 Aesapar through its tenant has been trying to break past the licensing process in order to start construction. Sixty percent of the raised capital has been used to purchase land, with the rest placed in an escrow account. The campuses will be built in Campinas, near São Paulo (with a capacity of approximately 8,000 students) and in Cuiabá, in the central west part of Brazil (with 5,500 students). Aesapar has prioritized the offering to its employees. The fund administrator is Citibank, and fund manager is XP Gestão de Recursos.

Anhanguera Educacional is a for-profit higher education institution with 67 campuses spread across all Brazilian states. It has almost half-a-million students, and has established a history of building colleges and acquiring property since its foundation in 1994. Following the merger with its Brazilian rival Kroton Educacional in 2014, the combined entity became the world’s largest higher education company with more than one million students.

Anhanguera unit in the district of Vila Mariana, São Paulo, Brazil


The primary source of revenues is (premium) lease proceeds from Anhanguera as tenant of the two complexes. According to the fund prospectus, Anhanguera must honor the following disbursements:

  • Until the final release from the escrow amount – The lease premium is a minimum of 0.95 percent per month over the amount in the escrow account (total investment minus the amount withdrawn). As the funds will be yielding in the escrow, Anhanguera will actually cover only the amount necessary to reach the 0.95 percent yield.
  • From the beginning of the lease – The lease is 0.95 percent per month over the amount that was effectively deployed.

As such, no matter the situation the proceeds will always be 0.95 percent per month over the investment (costs to purchase land and build). This is essentially a loan yielding 0.95 percent over the principal. The only difference is that the principal is corrected by inflation annually. As expected, the dividend payment has been stable since inception. Over the past two years, there has been an annual inflation correction every January and this January has not been different. Presently the dividend is R$1.00 per share per month.

According to the September 2011 appraisal report, Colliers International valued the Campinas project at R$59,020,000 and estimated the monthly lease payments at R$573,000, whereas they valued the Cuiabá project at R$43,410,000 with estimated monthly lease payments at R$435,000. Under their scenario, total market value would then be R$102,430,000 and total monthly lease payments R$1,008,000.

However, in mid-2013 the construction of a shopping mall nearby led to the book value jumping 50 percent, spiking from a net raised amount of R$72.3 million to a market value of R$109.0 million. I assume that for this new market value, the estimated monthly lease payment would have gone up to R$1,073,000.

Nonetheless, the current proceeds from both projects total R$758,326 a month (as of December of 2014).

Here’s the trade-off:

  • On one hand, Anhanguera “guarantees” a stable cash dividend of 1.00 a month per share, corrected by inflation annually. This is a forward dividend yield of 11.1 percent (based on the January 30, 2015 share price and projected dividend distributions of R$12 per share in 2015). Even if Anhanguera has not been able to monetize the property since inception in 2011 (apparently due to licensing issues), this situation will remain for some time since construction has not yet begun.
  • On the other hand, neither the share price nor dividend captures the upside of asset appreciation.

As construction delays persist, it is possible that due to inflation the construction costs will exceed the funds allocated back in 2011 – especially when the yield over those funds is distributable to shareholders. Anhanguera stated that they will cover any cost overruns, protecting shareholders from a construction cost risk. That arrangement makes sense given that Anhanguera is responsible for hiring the builder and coordinating the construction.

Chart03

Source: BM&FBovespa, Infomoney, Wikipedia, Kroton Educational 


Written by Heli Brecailo

Disclaimer
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.

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

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


Fundamentals

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


Indicators

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


REITs

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

FII Torre Almirante ALMI11B – POSSIBLE, BUT NOT LIKELY

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?

BBFI11B

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 SPTW11 – NOT LIKELY

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.

XPCM11

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

Disclaimer
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.

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

US Dollar bull market ahead of us?

Release Date: 04 January 2015

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Table of Contents

Highlights   Fundamentals     Indicators   REITs


Highlights

The capital markets didn’t want Dilma Rousseff as Brazil’s president, but that’s what they got. The market consensus in Brazil is that 2015 will not be a good year.

US Dollar bull market ahead of us? If the current trend holds true, dollar appreciation has already begun, affecting the Brazilian real.

Vacancy rates in Brazil’s office real estate rose in the third quarter of 2014. Despite higher office vacancy rates, Brazil’s commercial real estate continues to outperform CD rates.


Fundamentals

The capital markets didn’t want Dilma Rousseff as Brazil’s president, but that’s what they got.

After winning the tightest presidential election in recent memory this past October, Ms. Rousseff was sworn in for her second four-year term on January 1. During the campaign, capital markets supported her rivals in response to Rousseff’s populist and interventionist policies. Following the election, Rousseff has attempted to address these concerns by appointing orthodox names to the Ministries of Finance and Planning.

Although her political party has been plagued by corruption scandals, millions of people have been lifted from poverty over the past ten years, and the government handout program (Bolsa Família) for poor families is very popular. Rousseff’s continuity in the presidency is likely a direct result of such efforts.

US Dollar bull market ahead of us?

chart01

The prospect of rising interest rates and the end of quantitative easing in the United States have prompted expectations of a US dollar rally in the next few years. The dollar spike between 1980 and 1985 after former Fed chairman Paul Volcker raised interest rates in the late 70s certainly sets a strong precedent for a rise in the dollar.

This sentiment has been underscored by the divergence in monetary policies between the Fed and the central banks of important US trade partners. Both Japan and Europe have initiated their own versions of quantitative easing, strengthening the trend.

The currency wars continue.

Source: OANDA, Mauldin Economics

If the current trend holds true, dollar appreciation has already begun, affecting the Brazilian real.

DXY, a measure of the value of the United States dollar relative to a basket of foreign currencies, has rallied since September of 2014. So has the US dollar relative to the Brazilian real. In 2014, the DXY gained 12.8 percent, and the USDBRL rose 12.5 percent.

Despite a potentially bumpy ride, Brazilian markets have viewed the depreciation of its currency favorably. The minutes of the most recent monetary policy committee meeting (Copom) of the Central Bank of Brazil detail the expectation that higher growth from major trading partners and the depreciation of the real tend to benefit exports.

The most recent market survey published by the Central Bank of Brazil (on 26 December 2014) predicted that the real would end 2015 at R$ 2.80 a dollar. This is now the ninth week in a row that analysts have revised their expectation upward, suggesting that initial prognoses were too conservative.

Source: CNBC, Central Bank of Brazil

US vs. Brazil GDP growth prospects in 2015

chart03

International markets have been forecasting that high-income countries will carry the global growth torch in 2015, as emerging markets experience economic adjustments (Russia and Brazil, for example). The US economy is now more likely to show greater economic results after surprising positively with its 5.0% GDP growth in Q3 2014. The US growth rate for 2015 is presently expected to fall between 2.5 and 3.0 percent.

Former Federal Reserve chairman Alan Greenspan, however, recently reminded on Bloomberg that although the US is indeed doing better than its peers, there are still indications of a weak recovery. He doesn’t believe the US will grow above 3.0 percent in the fourth quarter of 2014.

As for Brazil, the domestic consensus is that 2015 will not be a good year. Some analysts have no hope of an economic reaction, and have simply scrapped 2015. Analysts in aggregate have downgraded 2015 growth prospects for several weeks in a row, with the most recent survey showing that economists reforecast a growth rate of only 0.55 percent. However, there are expectations that manufacturing, which is responsible for a quarter of the overall economy, will fare better than services, which had done well in previous years.

One of the big questions is the oil company Petrobras, which was expected to inject billions of investment money into the Brazilian economy. The Petrobras oil reserve findings, originally considered a godsend for the economy, are no longer as viable in today’s circumstances. Under current oil prices, oil prospecting might simply be uneconomical.

Source: IBGE, US Bureau of Economic Analysis


Indicators

Despite higher office vacancy rates, Brazil’s commercial real estate continues to outperform CD rates.

chart04

After a surge in yields between 2005 and 2010, Brazil’s commercial real estate market has returned to pre-euphoria figures. The year-over-year commercial real estate index (IGMI-C) has declined from its peak at 30.1 percent in Q3 2009 to 15.4 percent in Q3 2014, below the historic rate. This is nonetheless still better than annual CD rates, which are around 10 percent.

IGMI-C, which is reported by Instituto Brasileiro de Economia – Fundação Getulio Vargas (FGV/IBRE) on a quarterly basis, is a total rate of return composite that measures the investment performance of Brazilian commercial real estate (It resembles the United States’ NCREIF Property Index). The IGMI-C consists of three components of return: income, capital, and total. Methodology is based on similar international indicators, which makes it possible both to benefit from the experiences of other countries and to compare results.

Source: FGV/IBRE, Central Bank of Brazil, NCREIF.org


REITs

Vacancy rates in Brazil’s office real estate rose in the third quarter of 2014.chart05Source: GB – GilverBook, JLL – Jones Lang LaSalle

Vacancy within the most negotiated publicly traded office REITs1 inched up in the third quarter of 2014 compared to the same period the previous year, with the estimated vacancy rate on an aggregate basis (total vacant area over total area) rising from 6.9 to 9.8 percent. This rate is still below the rates for São Paulo and Rio de Janeiro, where most of the real estate is located. The median of the vacancies has risen from 3.0 to 4.7 percent for the same period – that is, half of the funds analyzed sport very good rates but a handful of outliers have skewed the overall data.

This increase can be explained mostly by the increase in vacancy at BC Fund (BRCR11), which holds by far the largest leasable area at 288,922 square meters. The BC Fund vacancy rate rose to 10.4 percent in September of 2014, from only 1.4 percent in September of 2013. This past September the fund reported that approximately nine floors of its Eldorado Business Building in São Paulo’s Berrini district had been vacant since March 2014. At the end of November, they announced in a press release that three and a half floors had been leased, decreasing the fund’s overall vacancy rate to 8.3 percent.

FII Tower Bridge Office (TBOF11), FII Cyrela Thera Corporate (THRA11B), and Cyrela Commercial Properties (CEOC11B), which have not announced any lease agreements, also account for a significant portion of the vacancy. The Tower Bridge Corporate and Thera Corporate buildings are situated in São Paulo’s Berrini district, and the Corporate Executive Offices (Cyrela Commercial Properties) are located in Rio de Janeiro’s Barra da Tijuca district.

[1] Office real estate funds that compose the BM&FBOVESPA’s Real Estate Investment Fund Index – IFIX on November 28, 2014. PRSV11, FLMA11, and XTED11 were not included in the analysis due to lack of information.

Source: BMF&Bovespa


Written by Heli Brecailo

Disclaimer
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.

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