Update on the Fortaleza Market

Monday, March 08, 2010

Dear Reader,

You know that I’m bullish on Fortaleza.

Brazil is booming and is now an investment grade middle class country. As soon as Brazilians can afford to, they want to visit the beaches around Fortaleza. Fortaleza is Brazil’s #1 domestic tourism destination, hosting 3 million Brazilian tourists in 2008.

Soccer’s Confederations Cup comes here in 2013 followed by the World Cup the following year. 9.8 billion reais ($5.38 billion) will be spent in the state of Ceara (Fortaleza is the capital of Ceara) improving infrastructure and tourism amenities in the lead up to 2014.

There’s oil offshore—bringing revenues and high-paying jobs.

Best of all, there is a hotel and condo shortage in the area where visitors want to stay. There is practically no more development land. This is where I have been investing for the last 20 months.

The best way to maximize your return on investment in this market is to buy pre-construction condos with a low down payment (1%) and monthly payments of 1% during the build period. This is the type of deal offered to members of Real Estate Trend Alert.

Twenty months ago, when I started investing here I set out my strategy for my personal investments. I told members of Real Estate Trend Alert about my plans. As investors, we need a clearly planned exit strategy and a clear view of who the ultimate end user for our property will be.

The strategy I set out is as follows. I took profits from pre-construction investments in Panama and ring fenced them to use for pre-construction investments in Fortaleza. I’m only interested in low-money-down deals that are competitively priced and with at least a three-year build period.

My goal is to have accumulated a portfolio of income-generating rental properties in the city of Fortaleza in three to four years. I’ll continue to buy more units than I expect to ultimately hold. This means I expect to do some flipping along the way to help fund other purchases or to pay outstanding debt on purchased units. However, at no point will I have to flip to make payments. I’ll have a cushion at all times. Flipping is for replenishing the pot, not paying the bills.

The best time to flip units will be in the months coming up to completion or when you get the keys. I’ve made sure I’ll have the resources to carry the units I buy to this point. Given current interest rates, when developers offer financing I will keep my debt levels as low as possible. If I enjoy the levels of capital appreciation I expect, my units will be debt-free, as debt payments will be made from profits on sold units.

While developer financing is expensive, the high cost of capital is one of the reasons that rental yields can be high. I expect to net 15% yields on completion of the city units I have purchased. A great yield if your unit is debt-free…not so exciting if you are paying 1% per month on the outstanding balance on your condo while also repaying the principal.

The units I have purchased are in prime locations and will have broad rental appeal to businesspeople visiting the city: oil executives, young professionals, vacationers, and retirees from southern Brazil, Europe, or North America. While choosing a location with broad appeal, I also have to bear in mind that although lots of people would like to rent a 250-square-meter condo right on the ocean, the market will be extremely limited and rental yields much lower than you can command on smaller units.

The units that I bought offer the prospect of capital appreciation. I got in early at pre-release pricing, with the pick of the best units while paying less than other buyers. The units are located in prime areas and the developers have an established track record.

I expect to see a strong resale market for these units…the same groups that will rent here will also be interested in buying. The same logic applies…you need to aim to appeal to as many market segments as possible.

There have been no major pre-releases over the past five months. A new mayor in Fortaleza replaced most of the permitting officials and set out to review pending approvals. This has given the market a breather.

Get ready though. The backlog is being cleared. This has taken longer than I had hoped, but developers and officials now seem confident we’ll be back to business as usual by the second quarter of this year. Real Estate Trend Alert members will be getting in early at special member pricing and terms…and we’ll be back on the road to Fortaleza.

In particular, I’m excited about a project that’s taken much longer than first expected to get through all the hurdles. That’s the nature of the beast. Local elections and new officials are beyond our control.

Once this site is developed, the focus of development will move to the Praia du Futuro area of the city. The best beach in the city is here. The “big boys” (local and from the south) have snapped up land banks here. A major project is ready to go. Again, it’s just awaiting sign off.

These delays have been frustrating. Thing is: It’s better for the medium term prospects for the market that development is considered and balanced. I think that’s what we are going to get…which is good for those of us invested or planning to invest here.

Ronan McMahon

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