Income-Generating Opportunities in Brazil

Monday, August 15, 2011

Dear Reader,

Because Brazil’s economy is on a tear, demand for, and the rents you can command from, all types of real estate are on the up. There’s income to be made buying a condo, an office or a retail unit and renting it to a trendy new coffee shop, a dentist or a young professional. 

And that’s income that isn’t in US dollars or dependent on the US economy. 

The north-east of Brazil is doing particularly well. Traditionally this has been Brazil’s poorest region. It is however ground zero for Brazil’s booming domestic tourism industry. It’s a major infrastructure and manufacturing hub with an impressive new port facility, air cargo hub, and special economic zone. 

Real estate prices here can be lower than in traditional business powerhouses of the south like Sao Paulo and Rio. But rents are still strong. As investors looking to generate income, we care about the yield. That’s the relationship between the rent we earn after we pay our bills and the value of the property. 

In the north-east of Brazil there are strong income opportunities. Quality office space and condos are in hot demand. And there are supply shortages in some areas and high demand for certain types of condo. Demand for these units is growing faster than supply. This pushes rents higher. 

Brazil’s north-east is a place where we can generate strong income and yields. This week…in these alerts… you will hear about some of those strong opportunities. 

Get ready.

But first let’s walk through the process I go through when appraising an income opportunity from macro overview analysis right down to which condo in which building makes sense.

First we pick a place that makes sense…

Buy low: There’s an old saying in real estate circles…you make money when you buy, rather than when you sell. A smart buyer will always be ahead.

The price you pay for your property determines your rental yield (gross yield is simply the annual rent, divided by the property price). You factor in running costs (maintenance, monthly fees, and taxes) to get the net yield. The less you pay for your property, the higher the yield. It’s that simple. 

Let’s take an example. Prices in Iracema Beach, Fortaleza can be 50% lower than in the old boardwalk area. So Iracema might offer a substantially stronger yield measured as a percentage of your investment.

Look for multiple sources of renters: You never want to have all your eggs in one basket, right? For example, if you owned a rental in Natal, in northeast Brazil, your market was mostly northern European vacationers. Along came the economic crisis and your customers stopped visiting. You’re a bit of a one-trick pony.

However, if you were in the rentals business just down the road in Fortaleza, you didn’t have to worry about a drop-off in visitors from northern Europe. Fortaleza is Brazil’s #1 domestic tourist destination. Fortaleza’s target market is wide and deep, including domestic tourists, foreign visitors, young professionals and executives in town for short- or medium-term stays.

Always look for multiple sources of renters so that you have a cushion if one of your target markets disappears or dries up.

Look for shortages in hotels and short-term rentals: In my experience, the best signal for a white-hot, short-term rental market is a chronic shortage of hotel rooms.

You can check out official statistics to get a macro view of hotel occupancy. You should check how hotels are faring in the area or level of the market you are competing with.

Getting this information requires a bit of detective work. Ask the right questions of as many people in-the-know as possible. Ask rental management companies. Ask local taxi drivers. Go to hotels and talk to the reservations manager. Shoot the breeze…then drop into the conversation a question about how busy they are. Draw it out, and you will get specific information.

Of course, sometimes it hits you like a lightning bolt. Like a couple of years ago in Fortaleza, Brazil. It was April (a low month for tourism) and I needed a hotel room on short notice. Each of my first three choices was booked. Hmmm! That told me something. This year Margaret visited in May. Again, it wasn’t easy getting a room. One hotel quoted almost $400 per night for a standard room that would rank as three stars in Europe or the U.S.

Watch the supply pipeline: Look for hotel and condo shortages, but watch out for future supply. If a huge bunch of new hotel rooms and/or short-terms rentals come flooding onto the market, it could flip the supply-demand balance against you. Look for a scarcity of developable land. It will limit future competition from other condos or hotels.

Match unit type with the market: You need to make sure you buy the type of unit that renters want. We’d all prefer to stay in the penthouse, but most likely you won’t be able to charge a high enough price to justify the high investment. In most markets you will find that smaller one- and two-bed units will maximize your yield (the percentage of your investment you recoup each year) and provide the broadest appeal.

Remember though that smaller units work best for short-term rental. If you plan on renting longer-term, most renters will want something bigger than a 40 square meter (430 square feet) condo.

Look for growth markets: For example, today there is a shortage of quality rentals in the Fortaleza area of Brazil. And major growth in tourism and industry is expected here. Around six billion dollars is being spent between now and when Fortaleza hosts soccer’s world cup in 2014 on infrastructure. Much of this infrastructure (like the doubling in size of the airport) is to support tourism growth. 

Then you need to run the numbers…to craft the business plan for your investment. Before you do this, you need to decide what you consider an acceptable yield…the percentage of your investment you expect to generate in income each year. Decide this in advance so you don’t get swayed by the margarita effect. That is, you don’t decide to bend your investment rules because you develop a strong personal attachment to a place. 

I calculate how much I’m into a property for. I include all costs:

• Purchase price
• Closing Costs
• Legal Fees
• Furniture package
• Total Costs

Then, I calculate how much rent I expect to generate. If you are renting short-term, in a market with a low and high season, you’ll need to run low season and high season figures, and get a total.

• Number of days
• Daily rate
• Occupancy %
• High season rent
• Total annual rent (high season and low season)

Next, I deduct my expenses. In Brazil’s case tax is figured from income not profit. Rental management fees are a flat percentage that comes off the top. My condo fees and property taxes are fixed costs.

• Tax
• Rental management fees
• Condo fees
• Property taxes

Finally, my spreadsheet spits out my expected yield, and the property either meets my criteria…or it doesn’t. 

Most importantly…

You have choices about the type of rental you buy. For example you could buy an office unit and sign a 10 year lease and make the tenant responsible for all maintenance and fit out. You do nothing other than collect your checks. Or, you could buy a short-term rental unit that you manage yourself. 

When picking the type of rental property you want to buy, the most important question you need to ask is how much work you want to take on. This is the starting point and you go from here…

For most of us the answer is somewhere between no work at all, or as little as possible.

That means we need to match the rental property and its location to the amount of work we want to take on. And we need to make sure that we can find the help we need locally to implement our strategy.

In Fortaleza, on Brazil’s northeast coast, I bought pre-construction condos that I plan to make available for rental once they are complete. I can go with short- or long-term rental. I have a choice of rental management companies. These companies manage hundreds of condos. They know this business and their prices are competitive.

I won’t have to go from store to store buying furnishings, either. There are companies that will sell me a furniture pack, which they then assemble. I’ll pay a bit more than I’d like to pay but the convenience is worth it.

In other places there isn’t this infrastructure.

Ronan McMahon

P.S. I’m currently getting ready to offer those condos I bought pre-construction in downtown Fortaleza three years ago for rent. RETA members, look for my note on the analysis I’m undertaking to decide on furnishings, rental managers and the market I will target. If you’re not a RETA member, you can find out more here. 

 

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