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A perfect storm in the cidade maravilhosa

26 Novembro 2012

With Rio’s office space more expensive than midtown New York and demand for retail and residential property boosted by a rapidly growing middle class, the city’s real estate lawyers have never been more in demand. Joe Rowley talks to some of them about the challenges of building in Brazil’s “marvellous city”

Squeezed into a narrow strip of land between the rainforest-clad hills of the Serra do Mar and the Atlantic Ocean, Rio de Janeiro is a city defined by its geography. With available land in short supply, cariocas have traditionally looked to the skies, creating not only the city’s distinctive skyline but also one of the most densely populated regions in Brazil. For real estate lawyers in Brazil’s second-largest city, this has presented its own particular challenges as they have been required to secure scarce land for their clients while navigating tough environmental and planning regulations at a federal and local level.

In recent years, Rio’s highly competitive real estate market has become even more supercharged, with a perfect storm brewing thanks to a booming oil and gas sector, upcoming World Cup and Olympic Games and a middle class that are all creating unprecedented demand for commercial, retail and residential property. Soaring demand has also had an impact on the nature of the legal advice being provided, with a lack of available land increasingly leading legal counsel to confront long-running tax or title disputes, and a raft of sophisticated financing packages requiring lawyers to regularly update their skillset.

Boom time in Rio
A combination of the sharp decline in Rio’s notoriously high homicide rate, thanks to the government’s Favela Pacification Programme, and the healthy economic growth of Brazil’s neighbours has seen growing numbers of international tourists flocking to the cidade maravilhosa, or “marvellous city”. In 2010, Rio saw the highest number of international tourists visit the city in half a decade, while earlier this year the oldest street party at its annual carnival attracted a record-breaking numbers of revellers. With the 2014 World Cup and 2016 Olympic Games expected to attract hundreds of thousands of additional visitors, there are valid concerns about a shortfall in hotel rooms and increased traffic – something Rio’s municipal government is seeking to address by tempting hotel developers to the city and investing in transport infrastructure.

For Canadian real estate company Brookfield, the impact of Rio’s worsening traffic situation has already been felt first hand, with the company planning to move all its operations in the city to a single location in Barra da Tijuca to cut down the time its staff spend travelling between divisions. “We are building our new headquarters in Barra to concentrate all the Rio platforms there, benefiting from having them all together, and because the city has been growing in that direction,” notes Brookfield Brasil general counsel Paulo César Garcia. “Also, mobility in the city is becoming worse and worse, partly due to the increased focus of the city due to the upcoming major events.”

While it may be the charms of Rio’s coastline that continue to draw tourists in ever increasing numbers, in recent years it has been Brazil’s geological make-up below the sea that has helped fuel demand for real estate in the business sector. Following the discovery of vast oil and gas reserves off the coast of Rio in 2006, oil companies have flocked to the city, hoping to secure a piece of the action. Shell, Chevron and BP are among those to have set up offices. “The Olympics and World Cup will only last a few months, but Rio is growing a lot due to the oil and gas industry and infrastructure projects, which are driving the state’s growth and driving up real estate prices,” says Pablo Sorj, a partner in the infrastructure group of Mattos Filho, Veiga Filho, Marrey Jr e Quiroga Advogados.

With commercial property in short supply, in 2011 alone the cost of prime office space in Rio leapt by 47 per cent to US$1,321 per square metre, overtaking midtown New York for the first time as the most expensive city to set up shop in the western hemisphere. In the residential real estate market it is a similar story, with an influx of workers from the oil companies and Brazil’s expanding middle class have contributing to a sharp increase in property prices and rents in the city.

Brazil’s middle class spread
Since 2004, Brazil’s middle class grew by 20 per cent to reach 54 per cent of the population in 2011, according to the Cetelem BGN and Ipsos Research Institute, with Brazil’s President Dilma Rousseff predicting this will grow further to just under two-thirds of the population by 2018. The impact on house prices has been pronounced, with figures from Capital Economics, a consultancy, showing that between January 2008 and July 2012 house prices in Rio jumped by some 140 per cent, leading to fears of a US-style housing bubble that could soon burst.

Brazil’s middle class has had an impact on the retail sector, where a combination of a growing economy, ample consumer credit and an untapped domestic market has led to rapid growth in the number of shopping centres across the country. In recent years, the country’s booming retail sector has unleashed a frenzy of M&A activity, as major players such as Rio de Janeiro-based BR Malls, Canadian-Brazilian joint venture Ancar Ivanhoe and Brazil’s Iguatemi Empresa de Shopping snapped up a host of smaller rivals to gain market share. Further signs of consolidation came with IPOs from shopping mall operators, including Sonae Sierra’s in 2011 and Aliansce’s a year earlier.

While Brazil’s forecast GDP growth this year is 1.5 per cent, the lowest since 2009, Ancar Ivanhoe general counsel Fernanda Tavernari says the shopping centre market in Rio remains “very active” and competition between the major players continues to be “very strained”. Brookfield’s Garcia echoes this view, noting that the government’s consecutive interest rate cuts may help boost demand for new retail outlets by making saving less attractive for consumers and increasing consumption. “There have been a lot of shopping centres built in Rio, São Paulo and other cities in Brazil, but there is room to grow due to the upwards mobility and increasing consumer spending power,” he says.

Protecting the beauty
Developers scrabbling to meet this demand must navigate a complex regulatory framework. With tourists drawn in equal measure to Rio’s natural attractions and its man-made ones, one challenge cited by the city’s real estate lawyers is meeting the government’s tough environmental regulations for new projects. With much of Rio’s prime real estate situated on the coast, lawyers note that obtaining regulatory approval in these areas can prove to be a lengthier process as coastal developments tend to be subject to greater regulation at state level and may require an environmental impact assessment. This becomes further complicated if additional approvals are required, or if there are any long-running disputes relating to land title. “The main legal challenges we experience are related to finding the appropriate site, with clean and regular titles and getting all the approvals,” explains Barbosa Müssnich & Aragão partner Cristiana Moreira, who points to the many unresolved land title disputes across Brazil.

“Because of the growing real estate market we have also seen a huge increase in the price of the land, so if you have a property with clean property titles it will probably have a very high price.”

With suitable land for building in short supply or subject to strict environmental regulation, operators in the retail sector increasingly opt for M&A-led growth to rapidly gain market share. In August, this strategy saw Ancar Ivanhoe close its 11th investment in Brazil to snap up a majority stake in the Boulevard Shopping Rio, located in the city’s North Zone, from Iguatemi, as the Brazilian shopping centre operator sought to raise capital to invest in further projects of its own. Tavernari explains that with many shopping centres remaining in the hands of individual families or small companies, M&A-led growth may prove a viable strategy for some time to come and could prove less risky than seeking to acquire a greenfield site.

“Sometimes buying land from someone who has outstanding titles or tax increases the risk of litigation,” she explains, noting that in the past three years the company has had to increase its in-house legal team by two lawyers to deal with real estate issues related not just to greenfield projects, but also expansion works and renovation. “Local shopping centres are a welcome investment for local government, especially in small cities and neighbourhoods they want to develop,” she says, but adds that sometimes this involves negotiating with the municipal government on a range of issues, such as traffic flow and sanitation. “If we think there will be a problem with the land, issues with water, contamination of the land or if it is situated too close to any gas stations, then we don’t buy,” she concludes.

Financing space
Strong growth across Rio’s residential, commercial and retail areas over the past decade has translated into increasing sophistication in the financing options available to fund projects. For residential projects in particular, one of the most common structures involves the pre-sale of a number of units during the construction phase of the project. As Barbosa Müssnich’s Moreira explains, however, this structure is often only used to finance between 20 and 40 per cent of the overall cost of the project, with the remaining balance paid either with the real estate developer’s own resources or through financing from a financial institution under the Sistema de Financiamento Imobiliário, or SFI. Closely regulated by federal law, the lenders in this arrangement usually take the land lot as guarantee for the investment.

While these two structures remain the most used in Brazil, Campos Mello Advogados partner Fabio Mello notes an increasing trend for financing to be raised through the capital markets. This is generally achieved in two ways: either through private equity funds (FIP) or real estate investment funds (FII). As both structures are supervised by Brazil’s securities regulator, the CVM, Mello notes that they tend to have high levels of governance and tax benefits that make them particularly attractive to foreign investors. “People saw the opportunity and most of the players and financial institutions are looking for those types of structures,” he says.

Following the government’s creation of tax incentives in 2004, FIIs have been a “rising star” of real estate financing, according to Siqueira Castro Advogados partner Rossana Fernandes Duarte. Boosted by successive cuts to the interest rate by Brazil’s Central Bank over the past couple of years, the number of FIIs has grown from 63 in 2005 to 167 by the end of September this year. Investment in these funds has also boomed, from US$1.2 billion to US$15.8 billion over the same period, according to the CVM. Duarte says the popularity of FIIs was brought home in October when advising clients in the purchase of shares in a recently created private fund. “By the time I contacted the fund’s manager, just a few days after its creation, I was informed all shares had been already purchased,” she says. “Therefore, there was no interest on the fund’s part to present the prospectus to new investors. This shows how this market is stimulated.”

Stimulating supply and managing demand
Looking to increase supply in the market and put the brakes on the city’s soaring real estate prices, Rio’s municipal government has introduced a series of measures aimed at encouraging property developers to invest. Among these is a so-called “Olympics package”, which offers special urban planning rules in certain areas of the city and tax benefits in the acquisition and operation of hotels aimed at boosting the number of hotel rooms ahead of the World Cup and Olympic Games. In 2010, Hyatt became the first hotel operator to make use of this package for its construction of a new 408 room luxury hotel, while earlier this year Hilton Worldwide announced plans to open its first hotel in the city. At a federal level BNDES, the Brazilian development bank, has also made available a 2 billion reais (US$983 million) credit line to encourage sustainable development by offering favourable conditions to projects that promote energy efficiency and minimise their impact on the environment.

As a reflection of the success of both initiatives, earlier this year BNDES announced it was doubling its programme’s budget and extended the deadline for applications to meet significant demand in the hotel sector. Campos Mello’s Mello, who advised Hyatt on its deal, says that while the initiatives have proved a great success, the procedural requirements imposed by BNDES often makes obtaining financing a time-consuming process. “The credit line has been effective, but it is not so easy [to obtain] as it requires a lot of effort from both the hotel and us,” he explains. “The main issue is that it is a very new credit line, so BNDES and a lot of hotel companies are still trying to work it out. It is still a work in progress.”

In a bid to open up unused space on the outskirts of the city, Rio’s government is overseeing a US$2.7 billion transport infrastructure programme, which will see the city’s subway system extended and the creation of four new “bus rapid transit corridors” ahead of the World Cup and Olympic Games. While aimed at improving connectivity with Barra de Tijuca, where many of the Olympic events will be held, and easing congestion in Rio’s clogged city centre, the measures have also opened up new areas for development and increased demand for real estate advice. “The path we are following is correct as it is good for those events and all that is being done during the Games should be something that remains afterwards,” opines Trench, Rossi e Watanabe Advogados (associated with Baker & McKenzie) partner João Francisco Regos.

Since 2009 this strategy has been further boosted by the government’s Porto Maravilha project, which aims to regenerate some 1 million square metres of derelict land on the waterfront and will feature a mix of commercial, residential and retail units. Like the Olympic package, the project offers a series of incentives to encourage real estate developments, including favourable municipal tax rates and legislation to permit increased density, allowing taller buildings to be constructed.

With the municipal government and real estate developers increasingly looking further afield for available space, Mattos Filho’s Sorj says investing in “mass transportation that works” will become key to maintaining the cohesiveness of the city and remaining attractive to investors. In the private sector, real estate developers are increasingly looking towards intelligent design to influence how cariocas live, work and interact with their environment. One such development is Union Square in Barra de Tijuca, which will feature a mix of residential, commercial and retail units and is based on the concept of blending where you live and where you work to keep residents out of their cars.

For existing real estate, in 2002 Brazil’s federal government introduced the Brazilian Civil Code to consider land title issues on a case-by-case basis, in an effort to increase clarity in the system and to better regulate the transfer and ownership of real estate. Together with an existing public registers law, which allows residents to check real estate property for outstanding liens or incongruences, lawyers say the regulation has helped make buying real estate more straightforward. For existing real estate, in 2002, Brazil’s federal government introduced the Brazilian Civil Code to consider land title issues on a case-by-case basis in an effort to increase clarity in the system and better regulate the transfer and ownership of real estate. For Campos Mello’s Mello, however, the continued absence of initiatives such as title insurance, as well as lengthy delays in acquiring necessary licences and approvals, means that getting a new project off the ground can still take up to three years from start to finish, and with the World Cup taking place in 2014, time is not a luxury developers can afford.

Stuttering growth?
For many of Rio’s real estate lawyers, it is developments in the wider economy that hold the greatest concern. With Brazil expected to end 2012 with economic growth of just 1.5 per cent – a far cry from the 7.5 per cent rate of two years earlier – the faltering growth rate has knocked the confidence of buyers, lenders and developers alike, contributing to the lowest volume of mortgage lending in two-and-a-half years.

While Rio’s booming oil and gas sector, upcoming sporting events and rising tourist numbers have largely cushioned the city from the full force of this slow down, Gustavo Padilha, name partner at real estate boutique Gustavo Padilha Advogados Associados, notes that 2012 did see a dip in the number of real estate projects being launched compared with previous peaks, but predicts this will prove temporary. “We had a big boom here from 2008 until 2011 and I think 2012 is a period in which companies have decided to reorganise and restructure some departments,” he explains. “These companies are still selling units and I think they are just running down their stock.”

The notion of a collapse in Rio’s real estate market is also rejected by Couto Silva Advogados partner Alexandre Couto Silva, who says the combination of the stability of Brazil’s economy and the possibility of returns on real estate investments that remain “better than in the US” are continuing to draw in international investors. “There are other people who are saying that maybe there is a bubble in the market, but people who say that haven’t really analysed the figures,” he says. “Brazil has a housing deficit and a latent demand for middle-class real estate, which makes the market attractive to investors. We have a deficit in the market and the middle class are looking to buy new homes. Prices are going up and we need more housing.”

Ultimately for Barbosa Müssnich’s Moreira, the continued health of Rio’s real estate sector will depend on a combination of public and private initiatives. “We are living in a very good moment in Brazil and especially in real estate market, not only because of the increase of the population, but also because of the initiatives of the government to promote access to the housing market,” she says. “There are also a lot of opportunities and I am very confident and optimistic about the real estate sector over the next five to six years.” There is little sign that Rio’s storm will blow over any time soon.

Fonte: Latin Lawyer