When Tom Shapiro, president of GoldenTree InSite Partners, a global real estate investment firm, boarded a 10 p.m. flight from New York City to Sao Paulo recently, he glanced around the cabin and was startled to discover that the flight was full of familiar faces. It struck him that the lucrative investment deals available in Brazil, South America's most populous country with 190 million people, were no longer an international secret.

“I saw pretty much every head of every major investment fund on the plane. It was unbelievable. Everybody seemed to be on it,” Shapiro recalls with a laugh.

His New York-based firm has sunk $75 million into real estate projects in Brazil, mainly in Sao Paulo, a bustling financial hub of 11 million people, and GoldenTree plans to shell out another $100 million with its Brazilian partner over the next four years to build condo, office and hotel towers.

Brazil's undulating, 4,650-mile coastline, its dwindling Amazon rainforest and the vibrant carnival of Rio de Janeiro have long beckoned tourists. But for years, economic crises left foreign investors afraid to gamble on the country's commercial real estate market.

In 2001 and 2002, Brazil's currency(the Real) was sharply devalued. And in 2005, interest rates reached a scorching 19.75%. The gap between rich and poor formed a chasm, with the rich comprising 20% of the population and the poor making up the remaining 80%.

Now, however, Brazil ranks among the world's top 10 economies, and the surprising stability and growth that followed the ascent of former union leader and leftist Workers Party chief Luiz Inácio Lula da Silva to the presidency in 2003 has convinced legions of investors that this is the moment to consummate deals in the Portugese-speaking nation.

Considering that competitive emerging markets like Russia, China and India also are drawing investors, what makes Brazil so popular? “It's a great growth region that's on this side of the world where there is plenty of development,” says Pete Culliney, director of global research for New York-based research firm Real Capital Analytics. Brazil's rebounding economy and growing middle class have fostered development, as has a more business-friendly environment than in some Latin American countries with leftist governments, he says.

A money monsoon

Brazil's strength as an emerging market is evident on many fronts:

  • Commercial real estate transactions in Brazil involving a foreign buyer or seller rose from $143 million in the first six months of 2006 to $2.2 billion in the first half of 2007, a 15-fold increase, according to real estate services firm Jones Lang LaSalle.

  • Over the next three years, Cleveland-based Developers Diversified Realty, which ranks fourth on NREI's top shopping center owners list and owns and manages 155 million sq. ft. of retail space, plans to double its $150 million retail investment in Brazil. It will grow through third-party acquisitions and new developments, says Richard Brown, executive vice president international of the REIT, which has over 735 retail properties.

  • Wal-Mart has become a power player in Brazil, after spending about $757 million to buy Sonae SGPS retail operations from Portugese owner Modelo Continente in late 2005. With the deal, Wal-Mart nabbed 140 outlets in Brazil that are expected to generate annual revenue of about $1.4 billion, according to business reports.

  • Hines has completed nine South American projects with more than 2.9 million sq. ft. of office, hotel and industrial properties, and is developing another seven projects with 3.8 million sq. ft. In Sao Paulo, current projects include Interlagos, a residential complex with 12 towers of 18 stories each.

  • Sao Paulo's office market was so strong in the second quarter of 2007 that the vacancy rate in the Jardins submarket dropped to a record low 3%, reports CB Richard Ellis. The city's general market vacancy rate was 9.9%, a decline of 1.1% from the previous quarter. A 40% increase in absorption in the first half of 2007 over the same period in 2006 helped lower the vacancy rates, says CBRE.

The middle class emerges

Re-elected in 2006, Lula's fiscally conservative policies have bolstered the economy and strengthened the middle class. Brazil's economy expanded 5.4% in the second quarter of 2007, and a survey by Brazil's Central Bank predicts that GDP will rise 4.7% overall for 2007. Meanwhile, social programs like Bolsa Familia, for which the World Bank offered aid, have lifted 36 million Brazilians out of poverty and into the lower middle class.

The new middle class, with its labor force of 96 million, has ignited consumer spending on goods from refrigerators to mobile phones, DVD recorders and automobiles, and cracked open the residential sales market. Developers can scarcely keep up with the demand for new shopping centers, condo towers, single-family homes, and office buildings throughout Brazil.

“We are doing a lot of transactions, mostly for international investors. Over the past 20 to 24 months, we received almost $20 billion in investments just for the real estate market. For the Brazilian market in 2007, we will hit the number of $32 billion coming into our country. It's unbelievable,” says Celina Antunes, CEO of Cushman & Wakefield for Central and South America. The firm manages a 70 million sq. ft. portfolio of South American properties valued at 10 million Reais.

Cushman & Wakefield recently brokered the sale of the former Bank of Boston tower in Sao Paulo, a 22-story trophy that sold for nearly $180 million to Hines, which owns and develops Class-A office buildings internationally, and has an agreement with the California Public Employees' Retirement System.

Cushman fielded 14 proposals for the property, says an amazed Antunes. “Two years ago, we wouldn't have sold that building.” No single investor could have afforded to spend so much for a lone property, she says.

“We are not dependent on the U.S. anymore,” Antunes says. Brazil has been unscathed by the subprime mortgage crisis in the U.S. “In the past, every time we had a crisis in a neighboring country or in the U.S., it would affect us immediately.” As evidence of Brazil's health, Antunes points to this year's expected trade surplus of $44 billion.

‘Phenomenal’ returns

There are other indications of strength. In just two years, since 2005, Brazil's decreased economic risk and lower interest rates have led to a 60% increase in foreign direct investment, according to CB Richard Ellis.

And in September, the Central Bank of Brazil lowered its benchmark Selic interest rate, the main measure of the marginal cost of funds in Brazil, to 11.25%, a significant drop from the nearly 20% rate in 2005. In mid-October, Brazilian economists lowered their estimate of the country's 2007 inflation rate to 3.91% from more than 4% in earlier surveys this year, according to Dow Jones.

High yields have lured many investors to Brazil. Shapiro of GoldenTree says his investments have been rewarded with an internal rate of return of about 25% on an unleveraged basis.

In the retail sector, returns slipped from about 17% a few years ago to about 12%, Antunes says. “On the residential side, we are not talking about long-term investment, we are talking about the development and sale of the property. So the returns are phenomenal. I cannot even tell the number because it's huge — way above 30% or 40%.”

After the September 11, 2001 terror attacks in the United States, the office market went into a slump; vacancy rates soared and developers stopped building. But a few years ago, as Brazil's economy picked up, a shortage developed in the office sector, and developers resumed activity.

Rents jumped 25% from 2005 to 2006 and 28% from 2006 to 2007, as tenants snapped up Class-A space. In Rio de Janeiro, firms that couldn't find quality space in the CBD moved out to Barra da Tijuca, a new seaside business district, according to Cushman & Wakefield.

There is a consensus that returns can be high. “We can see yields in Brazil that are greater than we can achieve in the United States today,” says Brown of Developers Diversified. The shopping center developer entered a joint venture agreement in October 2006 with Sonae Sierra Brazil, a subsidiary of developer Sonae Sierra, based in Portugal, to build retail developments in Brazil.

Shakeout in shopping centers

Brown and a handful of peers are busy consolidating the shopping center industry in Brazil, buying out minority partners and small investors. In particular, they are targeting Brazilian pension funds that bought into the retail market but now are required by the government to downsize or sell off their real estate holdings to protect pensioners' funds.

Meanwhile, California pension funds and companies like Microsoft and Google are buying so much land in Brazil that the government may impose restrictions on foreign investments, says Culliney of Real Capital Analytics.

RCA, which tracks deals of $2.5 million and higher, officially projects sales of commercial real estate buildings in Brazil at about $2 billion this year.

But Culliney's sources indicate that the actual value of deals could be far higher, and U.S. investment alone could total nearly $4 billion this year. In emerging markets like Brazil, reliable figures are hard to come by, he adds.

In addition to the American buyers, European and Asian buyers are also drawn to Brazil. Spanish and Portugese groups are snapping up resort land in the northern regions of Bahia and Ceara. In overall investment, the Netherlands was second to the U.S. with nearly $3.4 billion, according to Real Capital Analytics.

Reassuring investors

Brazil's relatively strong democratic government and its stable relations with neighbors add to an aura of stability, as does the observation that it poses no nuclear threat. The United States is Brazil's leading trade partner, providing Brazil with 21% of the goods it imports, according to the CIA. The Brazilian government's ability to knock inflation below 4% contributed to lower interest rates and strengthening of the Real.

“It's been the strongest-performing currency in the world in 2007,” says Alexander Kazan, a Latin America strategist at Bear Stearns in New York. Over the past few years, Brazil's lower interest rates helped stimulate consumer credit, he says, and consumer lending has been growing by about 30% to 35% annually.

Shapiro, of GoldenTree, who spent 17 years at Tishman Speyer, another Latin American contender, prefers Brazil to other emerging Latin, East European and Asian markets in part because construction costs are indexed to inflation. New bankruptcy laws also make it easier for creditors to recoup their assets.

Shapiro's strategy led him to Brazil ahead of many competitors and old acquaintances. He gets calls from a number of newcomers to Brazil, asking his advice in dealing with government rules. He plans to keep flying to Sao Paulo; he's in it for the long haul, not for a quick turnover.

He thinks about that night on the plane, spotting all the familiar faces. What did that tell him — the moment he realized his competitors had discovered the potential returns of Sao Paulo, Rio, and Brazil's smaller cities?

“It says to me that I'm talking too much to the press,” the investor says with a rueful laugh. “I should just stop.”

Denise Kalette is senior associate editor.

Brazilians want malls, and they want them now

Shopping center development in Brazil is hotter than the equatorial sun beating down on a cocoa pod. In little more than a decade, the number of major malls in Brazil has sprouted from fewer than 150 to 346, according to the Brazilian shopping center industry group ABRASCE. The current total includes 13 projects under construction as Brazil's healthy economy gives consumers purchasing power.

Brazilians want stuff — cell phones, shoes, blue jeans, washing machines and other household goods. More than 200 million visitors frequent the malls each month, browsing in 54,000 satellite and anchor stores, or taking in a movie at one of more than 1,300 theaters. The shopping experience mirrors that of North America, as crowds gravitate to the mall for recreation, socializing and shopping.

“In 2007 we had a huge boom in the retail market. It received a lot of money from overseas — Europe, Canada, the United States. All the big players in the shopping center industry came to Brazil,” says Celina Antunes, CEO of Cushman & Wakefield for Central and South America. Those players include Developers Diversified Realty, a Cleveland-based shopping center REIT, and Sonae Sierra, its partner in Brazil. Sonae Sierra is headquartered in Portugal.

Several foreign investors have partnered with the six or so leading firms dominating Brazil's retail sector, and together they've garnered a 20% market share of all shopping centers, Antunes says. She forecasts a swift rise in the number of new malls throughout the country. Developers ventured far from Sao Paulo and Rio de Janeiro when they picked sites for half the new projects, she says.

In partnership with Sonae Sierra Brazil, Developers Diversified plans to build a $75 million, 464,000 sq. ft. mall in Brazil's only free-trade zone, in Manaus, Brazil's eighth largest city. More than 1.1 million people live within a 15-minute drive of the mall set to open next year.

Brazil is vastly undersupplied with retail space, says Richard Brown, executive vice president international for Developers Diversified. Parque Dom Pedro, near Sao Paulo, a 1.3 million sq. ft. mall in which DDR invested in 2006, is 98% occupied.

Retail tenants are seeing their businesses grow and expand, so for investors the opportunities are limitless, says Brown. Compared with other westernized economies, he says, Brazil is still very much in its infancy.
— Denise Kalette

Red flags alert global investors to possible risk

In Brazil, as in other emerging economies, investors are wary of a number of potential risks. Inflation could rise again, and interest rates could spike, as they have in the past. Drug-related crimes in neighboring countries could spill across Brazil's borders to a greater degree than they do now.

Scandals that singed some members of Congress and government officials in President Luiz Inácio Lula da Silva's administration could pose further problems, undermining confidence in the government.

“The whole political scene is one risk,” as in other emerging markets, says Steve Collins, managing director of Jones Lang LaSalle's international capital group. “What happens if they have another currency problem?”

Infrastructure problems, too, cannot be ignored. Two airline disasters that occurred in September 2006 and July 2007, killing approximately 350 people, called into question the adequacy of runways, radar equipment, air traffic controller staffing, and the airline industry's ability to keep pace with Brazil's growth.

The government plans to build a new airport in Sao Paulo. For global investors, reliable and safe air travel is a critical component of making a suitable investment decision on behalf of a client.

Analysts also foresee potential problems with Brazil's energy supply, predicting up to a 32% chance of blackouts within five years if the economy grows too fast. Analysts generally consider the threshold for rapid growth to be 4.8% per year, and the government has forecast a growth rate of 5% annually.

Political relations with energy-rich Bolivia, which nationalized the local operation of Petrobras, Brazil's state-owned oil-and-gas company last year, are also of concern, according to a report by The Economist.
— Denise Kalette