“Cousin Caio” and The Execution of A Deep Value Real Estate Investment Strategy

Cousin Caio has been very, very successful in business at a young age.  He has navigated a tough operating environment and been able to create wealth along Brazil’s growth pattern. Importantly, similar to Uncle Mauricio, he also had a liquidity event in the late 2000s or early in this current decade.  He too sold to a “growth investor.”

Cousin Caio is a hard guy to meet.  He is either at work or with his family.  Perhaps you can meet him if you are a parent at his kid’s school.  Maybe you strike lightning and find him at a quiet lunch spot here in Sao Paulo, usually at a quiet table in the corner discussing business. He is around 40 years old now, give or take a couple of years.

Cousin Caio is nothing but practical.  He has been studying investments since a very young age and, similar to Uncle Mauricio, growing up in an emerging market has had a profound effect on his outlook.  He is very aware of the “mood of the market” and understands the emotive nature of the retail investor and even the institutional investor in emerging markets and his native Brazil.

To avoid this emotive behavior pattern, Cousin Caio reads voraciously about value investing and travels to the USA quite often. Quite frankly, his English is completely fluent and he could be in NYC and be completely comfortable.  Heck, he could have been in my DLJ summer associate pool and no one would have noticed.

Cousin Caio is completely bi-cultural with a slight twist. He has decided to build his fortune in emerging markets and sees the opportunity of a lifetime in 2017 and 2018.  Does it make sense to get to know why?

A Brief History of Cousin Caio – Meeting A Long Lost Friend

If you are a deep value investor, similar to Hachiko trying to find his master, the most famous dog in Japan (see his story here), it is worth your finding the perfect co investment partner.

Cousin Caio set up his first company based on a shift in Brazil.  As Brazilian wealth expanded during the 2000s period, there was the emergence of the professional family office and the trend to outsource money management.  As strange as this may seem to a North American investor, the professionalization of asset management and the emergence of professional family offices is fairly new to Brazil. Hence, the largest asset managers started in the end of 90s to mid 2000 period in Brazil.

Cousin Caio was part of this group.  He succeeded due to hard work, a value investor  orientation, and also he was early in building systems to be successful. Databases, tracking software, hiring the right people, were all key parts of his success in the past and will be critical over the next two years.  There is a significant premium for Cousin Caio’s methodical and process-oriented thinking in a very creative but less process-driven society like Brazil.  This premium for order and process cannot be underestimated.

Cousin Caio and Real Estate

Cousin Caio, no different than Uncle Mauricio, sees real estate as a source of value.  Again, there were only two places to protect cash when he was growing up: overnight and real estate.

Hence, around the year 2006, he started to focus heavily on real estate as a source of value and moved his asset management clients into this space.  It was a very smart move.He sharpened his teeth, executed, built an organization and, similar to Uncle Mauricio, sold to a “growth investor” in the 2010 to 2013 time frame.  Remember that “Pile of Money” we discussed earlier.  However, here Cousin Caio and Uncle Mauricio’s paths diverge, and this is why Cousin Caio is your New Best Friend.

The Couch – Where We Found Cousin Caio Until Early 2016

Unlike our Dear Friend Uncle Mauricio, Cousin Caio could not check out at the beach.  He has a fairly young family, kids in school, and the education system at the beach did not allow him to check out.  One of the reasons he is successful is that he is thoughtful, so briefly, or so he thought, he sat down on the couch in 2013.  He decided around that point, it was better to be liquid and wait.  Of course, he had to manage his newfound liquidity, hit the gym (usually one of Sao Paulo’s very nice private clubs), and he had a key decision to make: when would he get off the couch?  What would his indicators be?

The Indicators

Cousin Caio, while financially able, felt the need for action. He is not made to sit on the couch from forty to sixty years old.  So he came up with a list of indicators.  You’ve gotta love this guy!

Peer Group Behavior – The US EB-5 Investment Visa and the equivalent Portuguese / EU investment visa suddenly became a very popular conversation subject among wealthy Brazilians in 2014 and 2015.  Cousin Caio is a student of people and their behavior. He is acutely aware of both irrational exuberance and end-of-the-world pessimism.  He believes that neither is usually rational. He noted that in 2015 all any of his well-heeled friends discussed was how Brazil was a basket case, was obviously the next Venezuela, and how the government was going to repeat its 1990 mistake and temporarily try to shut down personal bank accounts, and asked when Cousin Caio was leaving.  He listened politely and quietly as Miami became the new Switzerland.  He took notes and observed…

Cost of Corporate Debt – The high cost of corporate debt creates a need for liquidity.  Cousin Caio has watched Selic interest rates go down almost 200 bps since October 2016, but the cost of corporate debt has remained relatively high and / or extremely limited.  The pressure remains and many corporate creditors’ only large source of liquidity remains real estate.  He quietly wrote down a couple of names and some attractive assets that they owned….

REIT Market –  Cousin Caio used the REIT market for some of his income-producing properties as a vehicle to get liquid. However, during the boom he was surprised that people were using a very good tool for providing income for individual investors via access to income-producing real estate as a vehicle for spec commercial and even residential development. He was sure that it would end badly.  Tremendous opportunities would arise. He became pensive thinking about the opportunity. We see a slight smile.

Family Office and Uncle Mauricio Behavior – Similarly, he met with some of his former investors and friends.  People were literally checking out and some, albeit a small group, predicted that Brazil would become a dollarized economy.  He watched his dear Uncle Mauricio pile cash into NTN-Bs (Brazil treasuries making 5.2% real and 10.3% nominal per year) and head to the beach as discussed in our last newsletter.  He noted that the competition for assets was low and getting lower.  He got a little more animated.  The smile grew.

Risk Premium – Gap from NTN-B – Cousin Caio was particularly interested in how far above NTN-B high quality income-producing assets were trading.  He watched the spread expand until he just had to get off the couch with a bucket of cash and start buying.  He only needed one more sign.  He started to put on his shoes.