The Secret To Making Money From Beachfront In Brazil
Brazil presents opportunity for both the investor and the second-home-in-the-sun buyer. However, purchasing property in Brazil can be tricky.
The buyer in Brazil has to navigate constant fluctuations of the currency exchange rate between the real and the U.S. dollar. In addition, Brazil imposes exchange controls, meaning you must be careful about how you bring money into the country or you could have trouble when the time comes to take it (and any associated profits) out.
I know investors who tell horror stories about their experiences trying to repatriate funds from Brazil, including one American who tried to enlist the U.S. embassy as an ally in his battle. FYI, the U.S. embassy can’t really help with this kind of thing. This is what your local attorney is for.
Meantime, it’s not uncommon in this country to find developers offering financing with a very low down payment. This presents a great and unique opportunity for leverage; it also creates its own set of risks.
I knew, a few years ago, of a well-publicized launch of a pre-construction project in Fortaleza, on Brazil’s northern coast. Promoters had secured a block of condos with exclusive rights to market them prior to the public launch. The developer agreed to extend a 20% discount to these early buyers and to provide developer financing with only 1% down. The condos were intended to serve the business traveler and tourist market as short-term rentals, with an eye to the anticipated demand created by the 2014 World Cup taking place in Fortaleza. The offer was well-received, and scores of investors participated.
When the official public launch was held for invited local real estate agents, the units were offered at a 5% discount, meaning the early buyers had bought for 15% less than the initial public price. As a result, some investors made good money. Some, though, saw only modest gains, some lost money, all things considered, and many are still holding their units. What’s the difference in the outcomes to date?
The terms of purchase. The cash buyers fared best. The U.S. dollar was relatively strong at the time of purchase (1.95 reais per U.S. dollar), then dropped over the following year, to 1.79 reais per U.S. dollar. Cash buyers who sold their units made 9% on the exchange rate alone, plus approximately 15% on the value of the property. For a buyer selling after one year, those two things compounded to mean a gross gain of more than 25%, before transaction costs.
The complicating factor was the developer financing, for a couple of reasons. First, as buyers taking advantage of the developer financing were paying over time, they were exposed to the dollar’s decline during the finance period. They had bought with a fixed monthly payment of 1,450 reais. Over the course of the following year, this payment increased from US$743 to US$810 per month in dollar terms.
In addition, making time payments anywhere in Brazil exposes you to something called INCC, a government-established inflation adjustment that allows builders to keep up with ongoing increases in the cost of materials and labor during any construction period. In the particular year following purchase in this case, INCC added a total of 5.91%.
Do the math and you understand the problem. The time-payment buyer was left with a total gain (in dollar terms) of just 9.3%, compared with more than 25% for the cash buyer, before subtracting transaction costs, travel expense for visits to the property, etc. Net gains after one year in these cases were modest, in some cases non-existent.
I think this is an important case study because it seems to fly in the face of traditional wisdom to do with how to make money investing in real estate. You make more money with leverage, right?
When buying overseas, as this example shows, this is not always the case, though it’s important to note that things could have turned out differently in our example. Had the dollar strengthened during the period in question, the cash buyer would have suffered, while the time-payment buyer would have watched as his payment went down and his unpaid balance shrunk, in dollar terms.
That’s buying pre-construction on time from a developer in Brazil. A friend, Chris, took a different route entirely when he invested in this country. He shopped on the local market and did quite well with the purchase of a house on the beach. One reason, I’d say, is because he didn’t approach the purchase purely as a profit opportunity. Chris found a comfortable house right on a beach he loved for what he determined to be a greatly undervalued price. He and his wife Janet made the purchase believing they would realize a good financial return if and when they decided to sell; however, more than that, they bought because they’d found a place where they wanted to be.
Chris and Janet invested in a 2,000-square-foot house only 25 feet from the high-tide line on a reef-protected beach for just under US$62,000 (at the exchange rate at the time). The home was located on the causeway-connected island of ItamaracÃ¡, in Northeast Brazil’s state of Pernambuco. Island rental histories indicated that the property could earn in excess of 6% net annual return as a vacation rental on the local Brazilian market. Chris bought with a realistic expectation of capital gain and a realistic backup expectation of cash flow.
It wasn’t long after Chris and Janet moved in, however, before word got out. Other foreigners from the United States, Canada, and the UK started buying up the remaining beachfront properties on the island. As inventory dwindled, prices went up. At the same time, the dollar began to fall against the Brazilian real, making Chris’ property more valuable in dollar terms. After just 10 months, Chris sold his house for 78% more than he’d paid. That’s a gross annualized gain of 93.7%.
Expenses associated with the purchase, the sale, and capital improvements Chris made totaled about US$19,000. Taking that into account, the net gain was almost 47%, and the net annualized return was better than 56%.
A very successful investment experience by anyone’s standards. Part of the success here, as in our pre-construction developer purchase example, is owed to the fact that Chris bought for cash. The fall of the dollar following his purchase worked in his favor. The reais he walked away with after selling bought more dollars back home. Had he financed the purchase, his U.S. dollar payments would have gone up as the dollar weakened.
Chris was also successful because he was on the ground. Prior to buying, he spent time scouting the nooks and crannies of the Brazilian coast. This was how he found the island of Itamaracá. Discovering good local deals is much easier if you’ve got time for firsthand exploring. And firsthand exploring can be a big part of the fun.
Chris’ discovery of Itamaracá was a big deal. Finding an undervalued market with a dwindling inventory takes time and experience, and Chris enjoyed big rewards for his effort in the form of capital appreciation. Chris was also lucky. His capital returns were compounded by a currency gain. This no one can project or predict, and, as with the buyers in Fortaleza, this could have gone the other way. A strengthening dollar could have eroded Chris’ gains, leaving him with more modest profits.
When I asked him about his experience buying and selling in Brazil, though, Chris’ initial response didn’t have anything to do with the profits he’d earned or the currency gain he’d enjoyed. “It was one of the best years my wife and I have spent,” he told me, “living in that house on that beautiful beach. We’ll always remember that time.”
That’s a successful real estate investment overseas.
Continue reading: How To File Form 8938 As An American Abroad