Bar Stool Wisdom from São Paulo

“One cannot overestimate the importance of that hotel bar,” says veteran journalist Mort Rosenblum in his handbook for foreign correspondents, Little Bunch of Madmen: Elements of Global Reporting.

The basic idea is that local intelligence has a remarkable tendency to collect in little pools in hotel bars where travelers and locals mix. You can learn a lot on a bar stool talking to a local or even chatting with another traveler just blowing through who you might not get otherwise.

(The title, by the way, comes from a line by H.R. Knickerbocker, a renowned Hearst correspondent from the 1930s, who wrote: “Whenever you find hundreds of thousands of sane people trying to get out of a place and a little bunch of madmen struggling to get in, you know the latter are newspapermen.” I think this applies equally well to those hard-boiled — and successful — investors who love and seek out lonely or forlorn markets.)

I’d amend Rosenblum’s advice to include the airport lounge bar. I was sitting in one in São Paulo, waiting for my long overnight flight back to New York. It was crowded, as everything in São Paulo seems to be. I ordered another Caipirinha, and this Brazilian guy sat on the one empty stool next to me.

We got to talking, and eventually it came out that I was an investor hunting around for ideas in South America.

“You should invest in real estate,” he told me.

“In Brazil?” I said.

“[Expletive] no!” he said. “In the US. Brazil is expensive. Everything is expensive in Brazil.”

I told him he might be the first Brazilian I met who wasn’t gung-ho about putting money in Brazil.

“The problem with Brazil is that it is good, but then it goes very bad. It has always been this way. When it is good, you put your money somewhere else before it goes bad again. Now it is good,” he said. “The problem with Brazil is the Brazilians,” he added with a chuckle.

“I’ve heard that joke before, but it was about Argentina and the Argentines.”

He laughed. “Well, for them, it is true!”

He told me he was with a group buying apartments in New York. They are good buys, he says. He gave me some figures about what his group owns, but since I had a head full of Caipirinhas and it was nearly 11:00 at night, I had no desire to pull out pen and paper and start taking notes. We talked for a while longer, and then our flight began boarding. We exchanged cards and wished each other well.

Of course, now I can’t find his card. But it doesn’t matter. The story highlights an interesting point: For overseas buyers, US real estate is cheap. This influx of foreign capital helps boost the prices of US real estate, providing almost a floor on valuations.

Recently, I chatted with the co-manager of a Florida real estate fund. He made the same point. There’s been a flood of South American investors looking for second homes and investor properties. In some markets, this is more pronounced than others, of course. The Brazilians, for instance, aren’t buying property in Detroit. But in Miami, yes. I remember reading reports last year about how more than half of all condo sales were to foreign buyers. And for newly built condos, that figure jumped to 90%.

I could be wrong about this, but my gut tells me most Americans still think US property is headed lower. Or at a minimum, they think it is dead money. Investors have a tendency to look behind them. They tend to shun what’s done poorly in the recent past.

There have been some surveys with results in this direction. This from the Real Estate Economy Watch reporting on a survey of US homeowners: “The five-year-long real estate depression has taken such a toll on homeowners that they fear falling values four times more than fires, and they are twice as likely to monitor local prices than their own cholesterol levels.”

Yet even in commercial property, you can get better deals in the US than in comparable markets abroad. In New York, you can get yields on commercial property twice what you could get on comparable property in London (non-distressed). As a result, the money is starting to flow back to the US. This from the Wall Street Journal:

European investors bought $1.6 billion worth of real estate in the US in 2011, more than double the $700 million they invested in 2010, according to data from Jones Lang LaSalle. While the figure is still far below the $8.4 billion bought in 2007, it shows activity is picking up.

It’s an interesting dynamic that sometimes gets overlooked. It also seems to put a floor on high-quality US real estate in big cities where such foreign money might look to park some cash — New York City, Miami, Chicago, Los Angeles and the like.

There is still a lot to do in cleaning up the wreck of the epic bubble. According to the real estate firm HFF, banks have $3-plus trillion of commercial real estate debt on their books:

Banks have approximately $2 trillion of core commercial real estate loans on their books: CMBS [collateralized mortgage-backed securities] account for $1 trillion, and life companies are approximately $300 billion of direct loans maturing throughout the coming decade.

This mountain of maturing property loans will require a lot of refinancing. Given the huge bubble that created this debt, much of this loan pool will also require additional equity. In other words, borrowers are going to have to come up with more money to roll over or refinance the debt. This is the opportunity for investors — Brazilian or otherwise.

Because of those maturing loan pressures, pricing for new investors who want to put money in is not bad. Nobody is stealing properties these days, at least not many of them. There is a lot of competition hunting around US real estate right now. But good values are not hard to find, depending on the market and property type.

I’ve surveyed a number of the larger deals. With interest rates so low, borrowers are locking up 10-year notes on commercial property for 4.7-5.8%. If you want a shorter term, you can get even lower rates. Healthcare Properties did a three-year deal last year at 2.7%. And I’ve seen plenty of five-year notes at 3.6% and 3.7%. It’s a once-in-a-lifetime chance to own property at über-low financing costs.

Property owners on current rents can earn cash-on-cash yields of 6.5% to as much as 11%, depending on the property type, quality and location. That’s better than what you can earn in other assets taking similar risks. And at the end of the day, you own a tangible asset that central bankers can’t print. In fact, money printing probably aids you in the long run, as it eats away at the value of your debt and raises the replacement cost of building your asset (discouraging competitors). Plus, your rental rates will rise over time.

Remember that real estate is cyclical. We just had a huge bubble that peaked in 2007. We had a very painful bust that found its bottom sometime in 2009. We are now in the gradual recovery phase. Investors have begun the long process of refurbishing property, recapitalizing it and refinancing it.

There is still more to do, and there are still good values out there in US real estate. If you don’t see it, you’re too close to it. Just talk to someone in Brazil.

Chris Mayer,
for The Daily Reckoning

The Daily Reckoning