Brazil’s credit rating downgrade brings even more challenges to the real estate market

Leitura de 7min

What is the impact of Brazil’s risk reclassification on the real estate market?

October 8, 2015

Brazil no doubt is experiencing a delicate political and economic moment that poses challenges for everyone: governments, large and small business owners, and households. The recent announcement of Brazil’s credit rating downgrade from “investment grade” to “junk grade” by Standard & Poor’s, one of the big three credit rating agencies, presents an additional element of concern to the country.
Analysts see hard times ahead for Brazil, with no recovery in sight before 2017. What will we do until then? What are the consequences for the real estate market? We have invited JLL’s Transactions directors André Rosa and Roberto Patiño to make an analysis of the impact of Brazil’s credit rating downgrade on the real estate market. Read below.

What are the consequences of losing the investment grade status for Brazil?

André Rosa – First, we have to say that the credit rating agencies just reflect the conditions of the country. Losing the investment grade status is one of the consequences of the governmental economic policy, an increasingly gigantic government machine, and the poor management of the public accounts which led to an increase in the primary deficit, not to mention the problems of misappropriation of funds. That is, a complex backdrop. Even so, as a recent Financial Times article shows, Brazil is ahead of other countries, such as Mexico, because of its respect for institutions, what is very important.

How would you analyze the downgrade of our credit rating from the “good payer” status that we took so long to earn?

André Rosa – Actually, Standard & Poor’s (S&P) downgraded Brazil’s credit rating to junk status in September. S&P was the first to do it. In August, Moody’s had already cut Brazil’s credit rating to near-junk status. The detail is that Moody’s rated the country’s outlook as “stable” and said that it intends to revise the rating by the second half of 2016. With this, attentions are all turned to the expected revision by Fitch. A great responsibility falls to this agency. Brazil’s rating by Fitch, which is now two notches above junk status, may even not fall to junk status, but anyway it’s very likely that it will fall at least one notch. What would make a difference, then, is the outlook on the rating, which, if negative, will be read by the market as a strong indication that Brazil will be subject to increasing borrowing costs.

What are the possible scenarios after Fitch’s credit rating announcement?

André Rosa – If it falls one notch with a stable outlook, it’s the best scenario. But if the rating falls two notches or even one notch with a negative outlook, it will trigger an outflow of investment funds from the country. Some funds have rules determining them to withdraw from junk markets at any price – and the deadline for doing so is tight. The outflow of foreign investment affects the value of the currency, pushes up interest rates and borrowing costs, and makes it difficult to obtain funding for investment. In a way, this movement has been occurring for six months now; so much so that the stock market did not fall after S&P’s announcement. The investment markets had already been anticipating this trend toward Brazil’s risk deterioration.

What are the consequences for the real estate market?

André Rosa – We expect an asset sale movement, but the lack of liquidity forces repricing. It will be very costly to keep a nonoperating property. Even if at a lower price, selling is a good strategy (for owners) to raise funds, which at this time are precious and scarce, and, in the bargain, cease to bear expenses like IPTU (property tax) and maintenance fees, which are likely to rise with inflation. There can be also sales of operating assets linked to a lease contract (sale & leaseback). We also expect an increasing number of companies interested in valuing their assets. Another way of reducing costs is by streamlining and consolidating assets. Occupancy rationalization may free up some of them for sale or leasing. New issues are expected as it becomes more difficult for companies to raise funding for new projects. It remains to be seen whether the government’s thirst for financial resources will allow corporate bonds to raise money at rates consistent with the financing of projects.

In the Brazilian market landscape of lack of liquidity and crisis, who would be interested in buying vacant properties now?

Roberto Patiño – The downward trend in prices and an appreciated dollar make the acquisition of real properties in Brazil very interesting for foreign investors. We estimate that real estate prices have fallen by 60% since 2014, on account of the currency depreciation, interest rate increases and rising vacancy rates. There are investors who like to buy during periods of crisis and there are sovereign wealth funds that can afford the risk of doing so.

Is there a sector that will be more affected by the crisis or it affects every industry?

Roberto Patiño – The crisis affects the whole economy. Retail, which was so favored in recent years, is likely to suffer significantly now, and consequently so do the shopping mall and street store sectors. We’ve had the worst Mother’s Day and Father’s Day sales in 2015. The waiting lists to rent space in prime shopping malls have vanished. Rather, in recent months, we’ve seen lease renegotiations in shopping malls and store chain expansion plans being revised. Consumers are already tightening their belts and reducing and postponing purchases.

How can JLL help clients at this moment?

André Rosa – We continue advising companies that this is a good time for what we call flight to quality, that is, moving to more modern, more efficient and better quality space at a low cost. This is because of the large volume of new construction being delivered to the market and also because of the high vacancy rate, causing rents to fall. To those willing to stay at the same location, we can advise on lease renegotiation, which can benefit both the tenant with a lower rent and the landlord with a longer lease term. We can help rationalize assets and provide property valuations to support strategic decisions of companies and owners.

Graphic: Gary Yim /