Brazilian Real Estate is a Buy

Someone once said that if LA threw up on New York, it would resemble São Paulo. That’s an imaginative way to describe the sprawling Brazilian metropolis. São Paulo is a bustling, congested city of 11 million people, with another 9 million in the suburbs. Greater São Paulo ranks as the third largest urban area in the world, according to the United Nations, after only Tokyo and Mexico City.

For many, it’s an ugly city, but I loved it right away. While gloom and doom hover over the economies of the US and Europe, it is impossible to maintain a sense of pessimism in São Paulo – or even in Brazil, for that matter. It’s a showcase for the kind of changes sweeping over the emerging markets.

São Paulo had a humble beginning. Jesuits founded it on the banks of the little Tietê River in the 16th century. It was for hundreds of years an insignificant settlement. Even as late as the 1870s, it had only 26,000 inhabitants, cobbled around narrow streets.

But it would go on to put up perhaps the greatest population growth curve of any major city in human experience (as the Fernand Braudel Institute maintains). A great coffee boom in the 19th century was the kindle that sparked São Paulo’s growth. By the 1890s, the population tripled. And today, there are 20 million people in greater São Paulo.

The state of São Paulo has 45 million people and makes up nearly a third of Brazil’s economic output. Half of the country’s tax base is here. If it were its own economy, the state of São Paulo would be the second largest in South America – behind only Brazil and ahead of Argentina and Colombia. It is also home to Brazil’s stock market, the fourth largest in the world by market cap.

São Paulo did not grow up slowly around a center, as did the cities of Europe. Rather, it grew hastily and in an improvised manner. You can see the consequences of that process today. Traffic is horrendous. It can take more than an hour to move only a handful of blocks. The subway system is not up to the task of serving the entire city. And record car sales overwhelm the construction of new roads.

There is also an acute housing shortage, which is where an interesting investment opportunity lies. There are a lot of ways to show the data on housing. One common way to measure housing shortages is to look at how many families have three people per bedroom. This measure shows about 13% of families live in substandard housing. Expressed as a number of units, Brazil needs nearly 6 million new homes.

That’s really not surprising when you think of the swelling ranks of the middle class. Millions of people have become consumers in the last decade. Housing has not yet caught up with that demand. By some estimates, Brazil needs to build about 1.6 million homes every year just to keep up with new families entering the market.

In São Paulo, you can also see the shortage in the price of homes. New construction often takes three years. People now taking delivery for housing units bought three years ago find that the value of their dwelling doubled. A recent edition of The Daily Reckoning provided an illuminating contrast between São Paulo’s housing market and that of the United States.

Existing Home Sales in Sao Paulo, Brazil

Clearly, the São Paulo housing market is in the midst of a boom. All that frothiness has some people worried about a housing bubble. Brazil’s mortgage market, too, is in hyper-growth mode. Take a look at the total loans to homebuilders and buyers.

Lending to Brazilian Homebuyers

It looks impressive, but the starting base was very low. Brazil’s home lending market is still only a fraction of that found in other Latin American countries, such as Mexico or Chile. Brazilians also have much more equity invested in their homes. Typically, loan-to-value is 70-75%.

Eventually, supply will catch up with demand, and maybe even exceed it. Then you’ll have a correction. But that day seems years away.

The best and easiest way to cash in on Brazil’s housing boom (other than to buy a property directly) is to buy Gafisa, which trades on the NYSE under the ticker GFA. It is the only Brazilian real estate company trading on the NYSE.

Gafisa has built and sold nearly 1,000 developments and more than 11 million square meters of housing in its 55-year run. Traditionally focused on the high-end market, Gafisa recently bought Tenda to tackle the low end of the housing market.

The stock looks cheap at $16.80 per share, which is only 11 times next year’s earnings guess. That’s not much for a company that looks to grow at least 20% annually for the next several years. Sales are up eightfold since 2005. Sam Zell, the US real estate mogul, bought his first shares then. Though he sold some recently, he still owns 6% of the company.

Replacement value is about R$5.6 billion, or $3.3 billion at the current exchange rate of 1.69 reais to US$1. The current market cap is $3.5 billion. I’d be more interested in buying the stock below replacement value (about $15.40 per share). Perhaps we’ll get that price on a correction.

Gafisa has a good track record, nationally recognized brand names and a strong balance sheet. It looks like a good speculation on the long-term demand for housing in Brazil. I have not officially recommended the stock to my subscribers, but the housing story in Brazil is a very compelling one.


Chris Mayer
for The Daily Reckoning

The Daily Reckoning