Sweet Home Floripa, Florianópolis, Brazil

The image of Brazil as a rapidly-growing world economy is now familiar to any investor interested in the world economy.  As a BRIC nation, Brazil has gained the reputation as a fast-moving, dynamic economy as rich in opportunities in the financial world as it is in mineral resources, agricultural land, and tourism.  According to the International Monetary Fund,  Brazil will close 2011 ranked as the 7^th largest economy in the world by GDP, just ahead of England. 

http://en.wikipedia.org/wiki/List_of_countries_by_future_GDP_(PPP)_estimates

That ranking put Brazil ahead of such economic heavyweights Italy, France, and Spain.  Many predict that Brazil will even surpass Russia and Germany (currently ranked just ahead of Brazil) at some point in the not-so distant future in terms of GDP.  Best of all, Brazil’s rise has been dramatic and rapid, with the last ten years showing impressive gains across a broad cross-section of economic areas.  There is little reason to believe that this trend won’t continue into the future.

With such an enticing profile of growth, progress, and prosperity it’s tempting to imagine that these advances have been uniform–or at least similar– for all Brazilians.  Is this really the case, however?  Or is Brazil, like many countries, large and small, subject to wide economic gaps by region or even by state?  And if so, where are these disparities and how great are these economic divides?  Most importantly, where does Santa Catarina fit into this picture?

A graphic that appeared in the Economist shows the extreme disparity in regions, especially between the small states of the northeast and the wealthy, southern states.  While there are some obvious problems in comparing individual Brazilian states with whole countries, the chart gives a picture of how disparate GDPs are in Brazil.  The small northeastern state of Alagoas, for example, has a GDP comparable to that of Afghanistan.  On the other end of the scale is the prosperous state of São Paulo, whose GDP is equal to that of the entire nation of Poland.   

http://www.economist.com/content/compare-cabana?fsrc=nlw%7Cnewe%7C09-05-11%7Cnew_on_the_economist

The rise of the Florianópolis real estate market is an astonishing success story. A brief  history of the real estate market in Florianópolis is sufficient to put this story into a global perspective and show why Florianópolis is fundamentally different from other comparable real estate markets around the world.

For centuries after the Portuguese first arrived in Brazil in 1500 Santa Catarina remained a distant province disconnected from the commercial and political centers of Rio de Janeiro, Bahia, and later, São Paulo.   Attempts to integrate the state into the 19^th century nation were rebuffed by the citizens of Santa Catarina.  Plans to build roads connecting the region to São Paulo were vigorously opposed and finally defeated.  The state of Santa Catarina remained largely self-contained through the passage of the years.  The economy of the island revolved around fishing and whaling.  No one really wanted to hasten the pace of life.   Even as late as 1960 there were no major roads directly linking Florianópolis with the interior of the state.

As a result, property prices on the island of Santa Catarina remained remarkably low until very recently.  Consider that in the 1940’s beach front property in Campeche was bartered for meat at Carnival time.  The land was so cheap that you couldn’t buy parcels of less than 50,000 square meters.  Things began to change in the 1970’s when the BR101 was built.  The highway made access to Florianópolis much easier and people from São Paulo began to arrive.  They found property prices dirt cheap, the cost of living low, the island as beautiful a place as one could ever hope to find, and the surfing top notch.  Paulistas began to buy land from the fisherman.  Argentines and Uruguayans came, too.

These more sophisticated newcomers bought large parcels of land, legalized them, and then divided them up into individual plots.  This is what happened, for example, in Novo Campeche.  What had been farm land with a nebulous—even questionable title—became a community of completely legal, subdivided lots.  Each plot had an escritura publica, a publically recognized title that allowed buyers to ensure legal ownership.

As soon as property titles became common on the island, prices began to increase 100% per year—year after year.  Developers arrived to build luxury houses and modern apartment buildings.

In 2003, as the Brazilian economy faltered and the real plunged to below 4.00 against the dollar,  Americans and Europeans began to arrive and snap up cheap deals, furthering the cycle.  By 2011 land that had been nearly worthless in the 1970’s is now worth $100 per square meter and above.  Larger plots, formerly used for cattle grazing and horse farming, is now worth tens of millions.

In the last twenty years the real estate market in Florianópolis has realized spectacular gains.  Many have rightfully asked whether such a trend can continue.  Or will Florianópolis succumb to the losses that have devastated property markets in such places as Miami or Marbella?

In Miami losses in the real estate market have been astonishing.  In 2008, at the height of the crisis, high rise projects that were started during the boom of 2003-2007 were left unfinished as buyers dumped their deposits and ran for the exits.  Property prices in South Florida have seen a staggering drop of 50%–and more in some cases.  Prices have now leveled off, but sales are once again beginning to drop, according to the most recent S&P Case-Schiller Index figures.  This new decline may herald even lower prices, especially if the world economy stumbles again.

Marbella, whose beautiful beach real estate market crackled during the boom, are now being sold off at steep discounts by the banks.  As Europe’s troubles continue, one might expect prices there to continue to plummet.

But what of Florianópolis, where property values enjoyed price rises that were steeper than those in the US or Spain?  Did these prices fall as steeply as their counterparts?  No, they did not.  While sales did slow in 2008, prices have not dropped.  In fact, they have only continued to rise and will continue to rise.  Why is this?

There are two main reasons, both of which stem back into Florianópolis’s past as a secluded, remote island in a distant part of Brazil.

First of all, Florianópolis is an island and so real estate is a very finite resource.  As the old saying goes, you can’t make any more of it.  Furthermore, people in Florianópolis have seen the prices of their properties go up dramatically each year and bank on yearly gains of 10-20%.  These are modest increases, they maintain, since earlier gains were dramatically higher.   If sellers on the island of Florianópolis don’t receive what they want, they just don’t sell.  Therefore it is not uncommon for a property which does not sell one year to go up in price the next and the next.  Like the fishermen of the sleepy island town of bygone years, the residents of Florianópolis are content to wait until they catch the big fish. If that fish doesn’t bite, they don’t sell.  This point of view has kept prices going up and up and up in Florianópolis.

The second reason is that the vast majority of real estate in Florianópolis was bought with cash.  Few properties in Florianópolis have been seized by the banks because they weren’t bought with untenable mortgages.  They are owned outright.  So there are no big-discount sales going on in Florianópolis as are now extremely common in Miami or Marbella and many, many other places around the world today.  Consequently, don’t expect to find any cut-rate foreclosed houses in Florianópolis.

One way of looking at this situation is to assume that this is the moment to buy in those badly beaten down markets.  After all, now is the moment to buy cheap in Miami or Marbella.  This is a perfectly reasonable way to think.  But it is not without risk.  There is no telling how long it will take real estate markets in those places to recover.  For example, though selling has picked up in Miami in the last three months, that selling is at a significant discount as compared to 2010.  In other words, prices continue to fall.  Moreover, last month selling dropped off again signaling more bad times ahead.

In such an environment, property purchases that will hold their value against a relentless downward trend may offer a real advantage.  At the same time, even after dramatic price drops in Miami and Marbella, Florianópolis real estate remains below what you can expect to pay for a luxury property in those places, even when bought from the bank at a steep discount. 

Meanwhile, swimming against world currents, Florianópolis property prices just continue to rise.  Here, the beaches remain as pristine as in long-ago times and the way of life is deeply tranquil when compared to Miami or Europe.  While there is no guarantee that prices on the island will not fall, it’s unlikely.  For those who already own a slice of Floripa just won’t sell until they catch their big fish.

Since 2003, when Brazil’s economy and currency last hit bottom, there have been few cloudy days. Sure, there was a bit of a downpour in  2008 after the Lehman Brother’s panic.  The real dropped precipitously, commerce slowed, and real estate investment froze.  But after that brief deluge, sunny skies quickly returned.  As a consequence,  Brazil’s reputation as investment-worthy nation with the economic oomph to come back from true adversity was greatly reinforced. Since then Brazil has gained investment grade status in world financial markets.

Now we are seeing rain clouds gathering on the world economic horizon once again.  Those interested in investing in or moving to Brazil should ask themselves whether this might not be the time to start planning to take advantage of the problems in distant economies and buy into Brazil at a discount.

Last week the real dropped to its lowest levels in seven weeks, R1.86—an 8.5% drop for the year.  Bloomberg went so far as to report that it could drop to 2.40 before the adjustment was over.  Referring to the uncertain global economic scenario Hideaki Iha, a currency trader at Fair Corretora de Cambio e Valores said that, “The situation in the global market is ugly.  With the danger out there, nobody wants to buy the real.”

At the same time Brazil has reported a dramatic economic slowdown.  The economy expanded at the slowest pace in two and a half years last quarter.  In response, the government has vowed to bring interest rates down.   Analysts expect that the policy makers could cut the COPOM by as much as 75 basis points at their next meeting, signaling the government’s anxiousness to stimulate the economy.  Guido Mantega, Brazil’s finance minister told reporters that the government will do “everything possible” to reduce the cost of credit and spur the economy.

It’s clear that this situation will continue, and possibly worsen, until the European debt crisis, Chinese manufacturing slowdown, and the American deficit problems are realistically addressed.  Is this unfavorable scenario a window of opportunity opening for those who hope to invest or live in Brazil?

One approach would be to consider that this is not a good moment to invest.  Brazil is economically vulnerable and who is to say that it is not on the verge of an extended period of economic decline?  That could be the case, especially if China, now Brazil’s largest trading partner, goes into a period of dramatically slower growth.  If that happens Brazil’s export revenues—from such commodities as soy beans and iron ore—would drop and the Brazilian economy would suffer.  That’s because commodity exports now account for nearly 12% of Brazil’s GDP, according to the national statistics agency.

On the other hand, this may be one of those rare windows of opportunity to buy into Brazil at a discount.  Since 2003 there have been only two or three such windows of time when foreign investors could get into Brazil at 20% or more slashed off the usual price.  All such windows have been short-lived.  After the Lehman’s collapse, for example, the real dropped precipitously from 1.56 against the dollar to 2.40.  The Bovespa stood above 70,000 in May of 2008 but plummeted to below 30,000 late in the same year.  But by January of 2010 the Bovespa was up over 70,000 again.  In other words, a 100% gain was not at all unusual during that 15 month period for those who had the courage and foresight to buy at the bottom. 

The same was true of the real.  While it took longer to fully recover, it rose consistently until it reached the 1.56 level and even went a little beyond early this year.  For larger investors, the drop in interest rates might bring Brazilian rates into line with other developing countries for the first time and increase consumer and corporate lending alike.

Are we on the edge of another Brazilian precipice?  Many analysts think we are.  If so, bold investors will be looking to take advantage of a solid overall Brazilian economic scenario that goes into a temporary decline.  While there’s never any guarantee that the past will repeat itself and any drop in Brazilian currency or stocks may not be followed by a dramatic recovery this time round, it might be worth considering the gains that could be made if it does. 

For those who are looking for a way to move to Brazil and get into the dance of Brazilian life, get ready.  In the next year the window of opportunity might once again open to purchase beautiful Brazilian property at a steep discount, minimize moving costs and other expenses, and lessen the threshold of investment required for an investors’ visa.  Such opportunities have appeared only rarely in the period since 2003.  Only time will tell, but the window might be about to slide open once again.

To answer this question I spoke recently to Wilson Souza of the asset management firm, Somma Investimentos, based here in Florianópolis.  Somma is a heavyweight among Florianópolis investment firms, controlling R$1.4 billion (USD$800 million) in assets, which range from pension fund holdings to real estate. Read the rest of this entry »