Foreign Investment in Latin American Real Estate: A Comparison of Argentina, Brazil and Mexico by Morgan Deal Bachelor of Business Administration, 1998 University of Iowa and Carlos Rosso Masters in Architecture and Urbanism. 1990 University of Buenos Aires Submitted to the Department of Urban Studies and Planning and the Department of Architecture in Partial Fulfillment of the Requirements for the Degree of Master of Science in Real Estate Development at the Massachusetts Institute of Technology September, 2001 Morgan Deal and Carlos Rosso © 2001 All rights reserved The authors hereby grants to MIT permission to reproduce and to distribute publicly paper and electronic copies of this thesis document in whole or in part. Signature of Author r Department of Urban Studies and Planning August 10, 2001 Signature of Author Department of Architecture August 10, 2001 Certified by William C. Wheaton Professor of Economics, Thesis Supervisor Accepted by William C. Wheaton Chairman, Interdepartmental Degree Program in Real Estate Development Foreign Investment in Latin American Real Estate: A Comparison of Argentina, Brazil and Mexico by MORGAN DEAL and CARLOS ROSSO Submitted to the Department of Urban Studies and Planning, and the Department of Architecture on August 10, 2001 in Partial Fulfillment of the Requirements for the Degree of Master of Science in Real Estate Development Abstract A common misconception is that Latin America is one homogeneous market. In reality each Latin American country has unique characteristics with sectors that collectively span much of the risk/reward spectrum. For example, Mexico is perceived to be highly correlated with the United States while Argentina and Brazil seem less so. On the other hand, the interrelation between these economies is also significant. Economic crises in Mexico, Brazil, and most recently Argentina have had important effects throughout the region. Many real estate investors simply view Latin America as a land of economic trouble. Yet several outsiders are starting or continuing to seek investment opportunities in the region. The purpose of this thesis is to analyze and compare, from the viewpoint of a foreign investor, three major real estate markets in the region: Argentina, Brazil, and Mexico. The paper will attempt to explain how the real estate "game" is played in each country, what the specific risks are for the foreign investor, and how investors are currently seeking to maximize risk-adjusted returns in these markets. Thesis Advisor: William C. Wheaton Title: Professor of Economics 2 Acknowledgements We would like to thank to our respective fianc6s for their support and understanding throughout the project in the past school year. Their support and advice made the difficult times seem bearable. We would like also to thank Professor Wheaton for his guidance during our research. Finally, our special recognition goes to LaSalle Investment Management and particularly Jacques Gordon, International Director - Investment Strategy, for sponsoring the project. Jones Lang LaSalle, through their offices in Buenos Aires, Sao Paulo, Mexico DF and Monterrey, provided valuable operational support, market data and contacts. 3 Table of Contents 1 INTRODUCTION ....................................... 6 2 REGIONAL OVERVIEW ........................................ 9 2. 1 FOREIGN DIRECT INVESTMENT ................................... 10......... 2.2 INTERNATIONAL COMMERCE ................................... 13........... 2.3 CULTURAL CONSIDERATIONS ................................... 16 3 MARKET COMPARISONS ...................................................................................... 21 3.1 BASIC COUNTRY FACTS ................................... 22 3.2 DEMOGRAPHICS AND DOMESTIC WEALTH ......... 22 3.3 POLITICAL STRUCTURE AND CLIMATE ...................... 24 3.4 ECONOMIC INDICATORS AND FORECASTS .26 3.5 REAL ESTATE MARKET FUNDAMENTALS ................... 3...................7................. 3.6 REAL ESTATE STRUCTURAL AND LEGAL ISSUES ..... ........................................ 37 4 FOREIGN INVESTMENT IN LATIN AMERICAN REAL ESTATE ............. 50 4.1 THE FOREIGN RISK PREMIUM ................................. 5...................1...... 4.2 RISKS FOR THE FOREIGN INVESTOR ................................................................................. 57 4.3 STRATEGIES FOR MINIMIZING RISK .................. ......... ............................. 65 4.4 INVESTMENT STRATEGIES AND RECENT ACTIVITY ................................... 70 4.5 OPPORTUNITIES FOR THE FOREIGN INVESTOR . ................................... 81 4.6 INVESTMENT "EXITS ................................... 84......... 5 CONCLUSION ........................................................................................................... 89 BIBLIOGRAPHY................................................................................................................... 91 4 Tables TABLE 2.1: FOREIGN DIRECT INVESTMENT ................................ ................................................ 10 TABLE 2.2: TRADE PARTNERS ......... ...................................................................................... 14 TABLE 3.1: EIU FORECASTS ......... .................... ..................................................................... 36 TABLE 4.1: COUNTRY RISK PREMIUMS ....................................................................................... 56 Fiures FIGURE 2.1: FOREIGN DIRECT INVESTMENT ......... ............. ..................... ............................ 1 FIGURE 3.1: URBAN UNEMPLOYMENT ........................................................................................ 27 FIGURE 3.2: GROSS DOMESTIC PRODUCT ................................................................................... 28 FIGURE 3.3 ARGENTINE STOCK MARKET .................................................................................... 29 FIGURE 3.4: ARGENTINE CURRENCY .......................................................................................... 30 FIGURE 3.5: BRAZILIAN STOCK MARKET .................................................................................... 31 FIGURE 3.6: BRAZILIAN CURRENCY ......... ... ............................................................................. 32 FIGURE 3.7: MEXICAN CURRENCY ............................................................................................. 34 FIGURE 3.8: M EXICAN STOCK MARKET .......... ........................................................................ 35 FIGURE 3.9: SELF-FINANCING SCHEMES ..................................................................................... 43 FIGURE 3.10: SELF-FINANCING SCHEMES (CONT.) ...................................................................... 44 FIGURE 3.11: FIDEICOMISOS ...................................................................................................... 47 FIGURE 4.1: RISK PREMIUMS ..................................................................................................... 53 FIGURE 4.2: EFFECTS OF DEVALUATION: NOMINAL AND REAL ................................................... 64 5 I INTRODUCTION A common misconception is that Latin America is one homogeneous market. In reality each Latin American country has unique characteristics with sectors that collectively span much of the risk/reward spectrum. For example, Mexico is perceived to be highly correlated with the United States while Argentina and Brazil seem less so. On the other hand, the interrelation between these economies is also significant. Mexico, Brazil, and most recently Argentina have experienced economic crises with far reaching effects. In December 1994, the devaluation of the Mexican peso provoked a sell-off of bonds throughout the region. In January 1999, the devaluation of the Brazilian Real was a major blow to Argentina's exports as well as the incomes of Argentine real estate companies with Brazilian interests (i.e. IRSA). Currently, Argentina is suffering from a three year recession, a growing budget deficit, and political uncertainty. The effects of a default on its foreign debt could have a disproportionate impact on global markets because its debt makes up about one-fifth of the supply of widely traded emerging-market bonds'. "Although Mexico is a safer haven for investors, it can't be fully insulated from what's happening in Argentina," said Thierry Wizman, global emerging markets strategist at Bear Stearns2. As evidenced by the effects on US capital markets of Russia's 1998 default, it is perceivable that a default by Argentina could have far reaching affects. Capital markets are now "truly global - inextricably linked and interrelated," as mentioned by Ric Lewis of Curzon Global Partners.37 Wall Street Journal, July 16, 2001 2Wall Street Journal, July 19, 2001 6 Many investors see Latin America as a sea of economic trouble. Yet several outsiders are starting or continuing to seek investment opportunities in the region. The purpose of this thesis is to analyze and compare, from the viewpoint of a foreign investor, three major markets in this region: Argentina, Brazil, and Mexico. The paper will attempt to explain how the real estate "game" is played in each country, what the specific risks are for the foreign investor, and how investors are currently seeking to maximize risk-adjusted returns in these markets. This thesis describes the real estate markets in Argentina, Brazil and Mexico both from the perspective of the local environment and the potential for