Private Equity Funding Brazilian Home Builders: Mortgages
Billionaire Sam Zell’s Equity International, Paladin Realty Partners LLC and Prosperitas are offering to fill a funding gap as Brazil’s President Dilma Rousseff tries to make good on her promise of 2 million new homes by 2014. The portion of bank deposits used to finance home construction fell 17 percent in the first quarter to 6 billion reais ($3.1 billion) from a year earlier as loans to buy houses rose 32 percent to 11.6 billion, according to Abecip, Brazil’s mortgage lenders association.
“That gap is very profitable and it’s virtually unlimited in terms of potential opportunities,” said Gary Garrabrant, Equity International’s chief executive officer and a co-founder with Zell. “I’d be delighted to invest hundreds of millions of dollars into this sector.”
Banks are tightening credit to homebuilders after surging labor costs shrank margins and triggered costly delays, according to Guilherme Rocha, an analyst with Credit Suisse Group AG, even as Brazil’s central bank cuts interest rates to a near-record low to bolster economic growth. Investors are being enticed to lend directly to construction projects with returns of as much as 23 percent, almost three times the 8 percent yield for global high-yield, or junk-rated debt.
More Aggressive Lending
“Brazilian banks really don’t like to lend,” said Garrabrant, who’s based in Chicago. That caution, in the midst of a real estate boom, contrasts with U.S. and European banks, which helped inflate housing markets prior to the 2008 financial crisis, creates openings for foreign investors, he said. “If Brazilian banks would be more aggressive, there wouldn’t be investment opportunities for international lenders,” he said.
Homebuilder Gafisa SA (GFSA3) has seen its borrowing costs rise after projects were canceled and margins narrowed. It posted a 31.5 million reais loss in the first quarter, following a 1.03 billion-reais loss in the prior period.
The Sao Paulo-based company last month had to increase the yield spread it pays on real-denominated floating-rate debt due 2018, after breaching bond covenants, taking the all-in cost to 11.5 percent from 10.2 percent. Gafisa fell 0.6 percent to 3.61 reais as of 10:35 a.m. in Sao Paulo, extending a 58 percent decline in the past year.
While debt capital markets are expensive, there is ample funding available from private-equity firms, fund managers, and strategic investors, said Gafisa Chief Executive Officer Alceu Duilio Calciolari.
‘Much More Attractive’
“We continue to see a lot of interest from investors to participate at the project level, not exactly at the company level,” he said. “Now with the interest rate going down, it’s becoming much more attractive for this type of investor.”
Central bank President Alexandre Tombini has lowered Brazil’s target rate 350 basis points since August to a near record low 9 percent after growth in the second-largest emerging-market economy slowed to 2.7 percent last year, from 7.5 percent in 2010. Policy makers may cut another 50 basis points this month, futures trading shows.
In a typical project, homebuilders put up the first 30 percent of financing, the private-equity firm invests the next 20 percent, and bank lending covers the remaining half, according to Max Lima, founder of Sao Paulo-based Prosperitas, which oversees $2 billion in equity investments.
“Homebuilders in general are in trouble, they’re over- levered on the corporate level,” Lima said in a telephone interview. “We’re going into the project level and putting money in there. We get returns that are not as attractive as equity but better than debt.”
Mezzanine lending for construction projects in Brazil can produce 18 percent to 23 percent returns, he estimated. Yields on global high-yield debt have fallen from 9.4 percent at the start of the year to 8 percent, according to Bank of America Merrill Lynch index data, as central banks globally try to lower borrowing costs.
Paladin, which has invested in emerging markets since 1995, recently bought preferred stock in a private homebuilding company, departing from its typical role of being a pure equity investor, according to CEO James Worms.
The company, You Inc. Incorporadora e Participacoes SA, needed additional capital that it couldn’t get from banks or equity investors, Worms said. The investment is similar to mezzanine debt because it included mandatory redemptions of underlying stock, he said.
“Brazil is a market where mezzanine lending makes sense, especially for international investors who are new to the market,” Worms said by telephone from Los Angeles. “Equity investors in emerging markets are going to look for a 25 percent type internal rate of return regardless of what and where the investment is. Mezzanine lenders accept a lower return, probably closer to 20, because the risk is a little less.”
The Brazilian government may aid local homebuilders in financial distress by asking state-run lender Caixa Economica Federal to extend credit to the sector, Planning Minister Miriam Belchior told reporters in Brasilia last month.
Belchior said industry leaders complained during a meeting with government officials in February that working capital had become scarce.
Rousseff, a former Marxist guerrilla who became Brazil’s first female president in January 2011 vowing to maintain the market-friendly policies of Luiz Inacio Lula da Silva, said last month that the interest rates charged by Brazilian banks are too high. In her weekly radio address on May 7 she said Brazil’s banking system is so profitable “it can perfectly do its part” by reducing loan rates.
Lack of Financing
Caixa and Banco do Brasil SA, another state-owned lender, said last month they will cut rates and Itau Unibanco Holding SA and Banco Bradesco SA (BBDC4), Brazil’s biggest non-government banks, are preparing cuts in interest rate on loans to companies and individuals, newspaper O Estado de S. Paulo reported May 9, citing the lenders’ chief executive officers.
Lack of financing for homebuilders conflicts with the expectations of the government to meet housing targets and the demands of an emerging middle class.
While some sectors of Brazil’s economy have been hit by Europe’s sovereign debt crisis and a three-year currency rally that’s undermined exports, consumer demand has been buoyed by record-low unemployment and an expansion in credit.
Mortgage lending equals 4.7 percent of gross domestic product in Brazil, compared with 67 percent in the U.S. The government wants to raise that ratio to 10 percent by 2014.
“The unmet demand for housing remains at a very high level,” said Garrabrant of Equity International. “That’s where demand lies.”
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