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The Problem with Latin America Private Equity Real Estate Gps

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The Problem with Latin America Private Equity Real Estate GPs

Over the last 18 months private equity real estate GPs appear to have missed the mark in the identification and pursuit of investment opportunities throughout the region. During road shows and more public forums, many GPs repeatedly called attention to numerous real estate trends that failed to materialize and grossly underestimated the role of local capital in meeting financing demand. The resulting low rate of new LP investment suggests that the current real estate private equity model is no longer operating ahead of the curve and, consequently, LP investors may experience chronic underinvestment for the duration of the current cycle. Worse yet, as GPs feel the pressure to invest, mistakes will be made in terms of the alignment of interests with local partners and capital investment. LPs are now in the unenviable position of being underinvested, or worse, invested in underperforming assets. This scenario has been further complicated by the fact that the increasingly active role of local capital serves to make the operating structure of GPs more expensive and onerous on a relative basis.

As the real estate capital markets continue to evolve in the Region, more innovative investment products will become available. LP investors deserve a broader selection of investment vehicles than simply private equity or actively managed equity strategies.

Brazil Recap - The Non-Rationalization of Values

By mid-2012 listed Brazilian homebuilders began experiencing a sharp drop in share price. At the time, GPs predicted a "great rationalization" had begun in Brazil real estate prices. But the deep discounts never materialized on the private side. In fact, one of these GP investors is now rumored to be a leading bidder for Gafisa's master planned community division (Alphaville) - and purportedly at a price equivalent to the entire company's market capitalization.

Last year one major GP in the region boldly predicted that, "There will be a need for capital from private funding sources...whenever there's any kind of increased inefficiency or stress in the real estate capital markets, it's harder to get cheap capital." This turned out to be just an axiomatic sales pitch, as it is equally true that a broken clock will read time correctly exactly two times per day. The misread appears to be a combination of timing (duration of future opportunities), but equally misplaced is the over reliance on past experience as a predictor of future performance.

GPs simply miscalculated the strength of the internal capital markets as listed Brazilian homebuilders were in fact distressed but, didn't flock to expensive foreign capital for a solution because they didn't have to. Interestingly, of all listed homebuilders in Brazil, this particular GP's investment in Viver stands out as a severe underperformer - based on public filings, the GP's investment may have unrealized losses of approximately 80%.

Why the disconnect? For one, GPs underestimated the resilience of the local markets and furthermore have misjudged the active role undertaken by both local public (government) and local private entities (internal capital) in supporting real estate investment. As we have seen in Brazil, many developers were able to foresee the pending mini-crisis and reacted proactively by cutting overhead and new launches, and redoubled their focus on selling existing inventory. In addition, the Brazilian government's CAIXA stepped in to provide more credit which has led to a fairly robust turnaround for most listed homebuilders. While homebuilders have not fully recovered, many are up over 100% off their 2012 lows - with no bankruptcies

Mexico Recap - The Increasing Role of Pension Funds and Local Capital

In Brazil, GPs missed the mark by being too pessimistic, but for Mexico the opposite appears to be the case. Last year, few foresaw the depth of losses that homebuilders would experience by 4Q12 - which has resulted in nothing short of a complete bludgeoning of the industry. To add insult to injury, the recently-elected Pena Nieto government has permanently modified the Federal homebuilding policy by reducing horizontal ex-urban financing and, instead, intends to redirect resources to vertical, urban development. This shift is on par with the DOE passing an immediate carbon tax on car manufacturers in the US. The industry is working under a completely new model: the ramifications of which will take time to fully understand but the old homebuilding model is dead in its tracks. The impacts will not only be on operating companies but also on the value of land across the country. We expect to see a reverberation in related commercial retail development as well since much of that was premised on suburban residential expansion.

And the GPs? Here's what a leading Mexico GP said in July 2012, "Mexico has really responded well over the last twelve months." This particular GP was an early investor in Mexico land banking and subsequently monetized much of their residential portfolio via the CKD mechanism. Notably, the GP stated in mid-2012, "We're seeing healthy growth, which is good for real estate." But that is clearly not what happened. More importantly, the Mexican government told the market as much in October 2012 when it announced that it would not increase available mortgage credits under the INFONAVIT program. That one announcement amounted to an immediate sell on the entire sector because after that point, every homebuilder was told that



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