Foreign investment and the Brazilian real estate market.

[FIGURE 3 OMITTED]

The investment in this portfolio, kept for 20 years, would present an annual income rate as shown in Figure 3.

In the event that an investor decides to sell his FII shares on the secondary market, at the scenario price, and [i]--the ten-prototype building portfolio is set up in 20 months, [ii]--it takes 5 months to structure and register the share sale in the CVM and [iii]--the share sale is liquidated in 12 months; we will have more favorable indicators concerning investment quality. Using the parameters of the referential scenario, the annual rate of return on investment would be 19.67% for an investment cycle of 37 months, with the break-even point in the 33rd (thirty-third) month. Although these assumptions may appear somewhat unrealistic due to the nonexistence of a secondary market for FII shares in Brazil, we think it is important to show what the rate of return would be for the investor if it were possible to sell the shares and exit the investment in a shorter period.

5. INVESTMENT QUALITY, IN US DOLLARS

As we mentioned before, the Brazilian capital market does not offer hedging mechanisms at acceptable costs for medium and long-term investments. Moreover, along with the high cost of setting up the hedging mechanisms that do exist, they suffer heavy taxation which increases the costs even further, and neither are they totally safe, bringing with them a certain amount of risk. Consequently, any real estate investment in Brazil would be subject to risks resulting from the exchange rate.

We have demonstrated that the attractiveness rates perceived in the Brazilian market for foreign investors in prime office buildings are significantly higher than are those in their home markets, Chua (1999). Even so, foreign investors should compare the margins of profit obtained from doing business in a developed economy with those that the Brazilian market feasibly offers to evaluate the risk/benefit quotient.

As long as the exchange rate variation remains linked to the rate of inflation as measured by the IGP-M the rates of return expressed in US dollars will be the same as those mentioned in item 4. This can serve as strategy to remain in the portfolio for the 20-year cycle or for setting up the portfolio and liquidating the FII share positions before the cycle has ended.

[FIGURE 4 OMITTED]

Nonetheless, according to the scenario parameters described in Table 3, in the event the exchange rate is no longer linked to the IGP-M variation, the rates of return will drop to the levels indicated in Table 5.

A permanent detachment from the exchange rate, as we described in Table 3, indicates annual income will trend in a downward-sloping curve during the 20 years of the operational cycle, fulfilling the strategy of remaining in the portfolio (Figure 4).

6. DISTURBANCE IMPACT-RISK ANALYSIS

By simulating the portfolio behavior to market risks, along with the inflation rate and operational management cost fluctuations, we can build measurable lab samples with a certain degree of reliability. As mentioned before, these bands of quality indicators or confidence levels indicate the degree of risk for investing in such Brazilian real estate portfolios.

Concerning foreign investments, which are unprotected from exchange hedging, we must still analyze the contingent severance from the exchange rate with respect to the inflation variations of Brazilian currency.

The simulations can lead to the production of different lab samples suitable for analysis from these risks, which in turn allow us to present, in Table 6, how the rate of return indicator fluctuates.

Now, we record the expected financial return, keeping in line with the two border strategies for making foreign investments: [I]-exiting as early as possible through the sale of the FII shares after the portfolio has been set up or [II]--exiting later, at the end of the 20-year operational cycle.

The rates of return with behavior disturbances show border positions (in Table 6 we show the average reliance interval taken from laboratory samples) with a certain detachment, but significantly above the hurdle rate perceived in the Brazilian market, and surely, much higher than the rates that you can receive from the American REIT market, used as benchmark.

Following strategy 11, maintaining the investment for the 20-year operational cycle, the annual income behaves according to the patterns in Table 7.

7. COMPARATIVE ANALYSIS

In Figure 5 we show the parameters found in this analysis and the average performance demonstrated by the NAREIT (2007), equivalent to the annual dividend yield received by Office Equity REITs in the 1999-2007 (until August) cycle. Using this cycle as a reference we can see that the average income of Office Equity-REITs has fallen. Therefore, instead of taking the average income curve as a reference, we chose two references, the average annual income cycle and the rate of return for investors who entered and exited their positions within the cycle, thus creating a more aggressive image. That resulted in an average annual nominal income in U.S. dollars of 6.70%5 and the rate of return, 6.37% observe the Figure 5.

[FIGURE 5 OMITTED]

An investment, in U.S. dollars exchanged for Brazilian reais, in an FII with a triple A office-building portfolio in the Sao Paulo real estate market, even with the exchange rate unprotected by the IGP-M and the devaluation of the dollar, still yields an annual income and rate of return on investment that far exceeds those found in the U.S. market. We have not taken under consideration whether or not, with the detachment, the investor would consider this investment and the risks that come with it, worthwhile. That, in view of the Brazilian risk index and the risks associated with the migration of funds from a developed economy to a developing one. This includes taxation and aspects concerning liquidity. The obvious reward, in the event of an affirmative response to this question, is an FII and its average profitability against that of the American Equity REITs, presented in Table 8.

8. CONCLUSION

The objective has been to visualize the amount of foreign interest there might be for investing in the Brazilian real estate market. To do this we have compared indicators taken from behaviour assessment of an FII prototype in the Brazilian market with those of Equity REITs in the United States.

According to our analysis, there are two basic opportunities for foreign investment in the Brazilian real estate sector: [I]--Strategy I--an intermediate-term investment and [II]--Strategy II, staying in the investment for a long (20 years) operational cycle, while earning revenue. There is yet, a third alternative, where the investor can remain on the alert for an opportunity to exit later, before the projected end of cycle. This can occur when the exchange rate variables and the referential interest rate permit financial results above that of the income generated by the portfolio.

In even more aggressive scenarios, in the segment we analyzed, investment opportunities in the Brazilian real estate market outperform equivalent investments in the U.S. market. Hostile factors include a strong persistent devaluation of the U.S. dollar, exchange rate detachment from the IGP-M variations and disturbances in income generation. In addition, further exemplifying this investment opportunity, we even adopted a 300-point margin for the Brazilian-risk index and still the Brazilian FIIs outperformed Equity REITs in each case scenario.

The income fluctuations, displayed in Table 8, should be understood as the most depressed hypothesis (6), with a 7.64% annual yield in the FII against 6.70% from the Office Equity REIT-USA, and a 7.38% rate of return for investments in the FII against 6.39% obtained from Office REITs, as we see in Table 8. Even within these limits, there is a competitive advantage in the Brazilian market compared to that in the U.S., using the investment in an Office Equity REIT as benchmark.

Received 27 April 2007; accepted 10 March 2008

REFERENCES

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