Good Morning!!!!! Yes it actually is 3:30 am as I write this. No, my young daughter is still asleep, I am not mentally ill (or if so I am totally unaware), there was no earthquake in Sao Paulo, and I did not set the alarm for this hour. I simply woke up to share an idea. No more, no less! I cannot control when these deep value investing ideas come to my head and I must put them on paper immediately. Ah, the life of your deep value real estate advisor. It is very, very glamorous 🙂
Objective
This newsletter is based on two actual true stories with “Cousin Caio”- type successful individuals (if you do not know about Cousin Caio, the focus of our last newsletter, please click here). This newsletter will provide a perspective on the distinct advantage that global investors that are not locally based in emerging markets, for example with no large real estate asset management infrastructure in Brazil, have in regards to executing the highest deep-value return investments at this time in the real estate cycle. This is a controversial idea to say the least.
An Example of An Outsider Dominating a Unique Local Market Niche
Sumo Wrestling started in Japan over 1000 years ago. It is Japan’s national sport and a truly great event to attend. Yet there has only been ONE Japanese “Yokozuna,” Grand National Champion, since 1998. This is a staggering statistic given the local nature of Sumo wrestling. One local champion in the local national sport for 20 years. This is like imagining that Michael Jordan was from New Zealand and not the Great State of North Carolina. It is unreal…
In fact, the best Sumo Wrestler of recent memory, pictured above, and perhaps of all time, is the great Hakuho Sho, born as Monkhbatyn Davaajargal in Mongolia. Mongolia!!!! There is likely not a sumo heya (training center) in the whole country.
Hakuho Sho has the longest undefeated streak and won 86 out of 90 bouts in 2009 and 2010. His father, the great Mongolian wrestler Jigjidiin Mönkhbat, actually won Mongolia’s first silver medal. Random facts become big news at 3:50 am.
Now, the reasons for foreigner dominance of Sumo Wrestling? There are several factors including: one, use of advanced techniques such as leg sweeps and lateral movements (you were wondering); two, outmaneuvering and overpowering competition; three, total focus on Sumo as a path to success as they come from outside Japan (Japan is richer now and kids are seeking other avenues to success); four, determination and discipline in a certain niche.
Can an outsider investor not based in Brazil dominate what should be an insider’s game, Deep Value Real Estate. Can your global firm become the “Yokozuna” of Deep Value investing in Brazil in 2017? Keep Hakuho Sho in mind as you read this newsletter.
If interested in learning about Hakuho’s success, please click here.
How to Become A “Yokozuna” of Deep Value Investing in Brazil
So what the #@$% does Sumo Wrestling have to do with Deep Value investing and my NYC or Montreal Large Investor or Large-Scale Family Office having an advantage over a successful large-scale real estate private equity firm based in Sao Paulo? Almost everything…
Answer by Two Cousin Caio-type Individuals to the Question about having a Local Real Estate Private Equity firm as a Co-Investor Partner.
“Joseph (long pause… dead silence), I need to think about it.”
InDev has had two interesting large deep value transactions with Cousin Caio-type individuals and two of our large-scale investor clients. These investors are fantastic and the people InDev deals with are simply great. In a specific case, the investment opportunity was moving fast and, for speed of due diligence, the global investor asked InDev if Cousin Caio would be OK if a local RE PE firm was a co-investor on the trade. The silence on the phone resembled the above picture.
I know the potential local co-investor very well. Again, some of my good friends work at these firms, our kids play together, I hope they still invite me for dinner and this does not change our relationship. Anyway, our local sponsor, after perhaps the longest silence I have experienced on a phone call, said “I need to think about it…” which meant “ #@$% No!”
And that my friend is a great opportunity, a “Hakuho Sho” size opportunity (he is very large, by the way), for a smart overseas-based investor at this time in the cycle.
What Drives the “#@$% No” Answer?
Perhaps now you are starting to see why I woke up at 3:30 am. This is a controversial idea and there are several parts of the story. Let’s first travel to Sacramento, Ontario, the State of Washington, Austin, TX and other homes of large-scale Pension Funds to find out exactly what happened to cause this emotional reaction with our Cousin Caio.
As we all know, these pension funds in Sacramento and other locations are some of the largest and smartest allocators of capital in the world. Most, by design, are not set up to invest directly in real estate projects, nor should they be. In 2006 and 2007, many of these groups opened up to Brazil and the large-scale vertically integrated Brazil real estate private equity market emerged with this capital source. Brazil was a diversification strategy and it makes 110% sense to invest this way from their perspective. In fact, it was quite successful and has been a good run, particularly earlier in the cycle. These large pools of capital were looking for people to manage their capital on a discretionary basis to source opportunities and manage those opportunities.
The capital went to a very small handful (less than five, by my count) of successful fund managers on the ground here in Brazil. Again, very close friends of mine that I respect. Some of these firms started out executing programmatic JVs, sometimes more than one JV in the same geography. Some of their chosen JV partners were successful. Others were not and were kicked out from their projects and the investor took over. The investor itself became a vertically integrated operator with full asset management capability.
Currently, some of the most successful of these firms only really work with local sponsors when they invest in residential development. Why? The small ticket size of residential and the delivery of the units at the time of completion are not activities that have economies of scale. The best local private equity firms are in themselves fully integrated real estate operators. So they should get the best deep value investment opportunities, correct?
Ah, Global Investor Friend, have you already forgotten about Hakuho Sho?!?!? Let’s Not Jump to Assumptions! Time to Review What Really Happens on the Ground Floor
So Cousin Caio is radically different from these real estate private equity firms. He is not an allocator of capital as much as an entrepreneur seeking opportunity. He is not constantly investing in the real estate market and does not have a US$500M to US$1B equity under management fee to support his overhead. When the market peaks, Cousin Caio sells his company and only enters the market again when it makes sense.
Importantly, as Cousin Caio has made many local high-network investors a lot of money, these are his core investors, his contact base relationships with large-scale Brazilian wealth are much much deeper than the private equity funds’. Cousin Caio is the go-to guy for many of the top Brazilians at this time in the sector. He is a peer, a friend, an insider, and he has made the individuals that are the target sellers or know the target sellers a pile of money. He is part of the club.
How Does Distress Really Happen – The Private Club Membership
Image: This is a private club, a virtual paradise, in the middle of the urban jungle of São Paulo.
Distress in emerging markets, at least among the top asset owners, is not something that is advertised. It is very subtle. The world in emerging markets is much smaller. In fact, most of a foreign investor’s activity in a country like Brazil will either take place or originate in four to five neighborhoods in São Paulo and two to three neighborhoods in Rio. It is an extremely small world.
Often this world gathers on weekends in these wonderful paradises pictured above. The entry prices are high but many people are members for generations, and it is particularly likely that any distressed seller is at the wealth level to be a member and to have been for generations. You can bet that he or she does not want everyone at the club to know that he or she is in distress. It is a nice place isn’t it? By the way, will you support my membership after we close the current transaction that we are working on? Please!?
Avoiding Sharks – Ouch!!!!! – Not Meeting People on Faria Lima Ave.
The last thing a successful owner of assets wants is to talk to someone about his situation outside of a small universe. He or she is only temporarily cash constrained and a large vertically integrated real estate private equity fund (whose managing director may also be a member, though a new member and not an old timer second or third generation like our seller!) is someone who the seller sees as a competitor, someone playing with someone else’s money, distinctly not part of the club. Not to be trusted. He tries to call a close group of potential buyers and not advertise his problem. He wants discretion and speed above all else. Advertising that you are bleeding is a way to feed sharks. These successful individuals who suddenly have liquidity challenges are not walking down to Faria Lima Ave., the Wall Street of São Paulo, and saying can you lend a fellow a hand?
What is Going through a Distressed Seller’s Mind When Temporarily Under Distress with a need to sell assets and Trying to Avoid Gossip at the Club
Do No Harm – How can I sell this to an entity that is either not competition or at least a friendly source of capital? My objective is to get back in the real estate business as I fix my liquidity position. The last thing I want to do is significantly strengthen a core competitor. How can I sell this to someone with cash who is not in a dominant position already in the market?
Discretion – How can I have as absolute few people in Brazil know I am selling this asset? I do not want a Tombstone in the local paper saying I was a seller now when I should be a buyer. At all costs, I want to avoid calling the business development office at a larger real estate private equity firm. I want to desperately avoid dealing with brokers of all types. I want to have quiet conversations with peers and move fast. The last thing I want to deal with is a local investment committee etc.
A Person not A Firm – While I need the cash rapidly, my situation is complex. It is helpful if the seller can quickly understand my situation and make a decision fast. My interaction needs to be with a decision maker, at all costs, not a group.
Operator vs Private Equity – To get a transaction done, it is important that the buyer understand the intrinsic value of the asset. It is an asset that has been undermanaged based on my distressed situation. Sure, I understand the valuation must be at the current distressed cash flow, but I still need a person that has an operational orientation because this asset has substantial latent value. In fact, without this understanding I am unsure if the trade can happen.
MidSize Deals – I have multiple assets. Some are large, and some are small. I need a buyer who may see value and be willing to work put together the portfolio. Taking mid-sized deals and piecing the portfolio together is how I would think, and I want a buyer who thinks the same way.
This emotion above is very real and is why the business development office of the large-scale vertically integrated firm in Brazil often does not see this prime-time distress. They are seen as the competitor, and sometimes mortal enemy, to both the distressed seller and to Cousin Caio.
A call to one of these local real estate private equity firms is seen as going to market and quite honestly is The Last call a high profile distressed owner of high quality assets will make. Interestingly, this aversion to selling to the large vertically integrated local firms exists even among some of the same “Private Equity Firms” that are exiting their portfolios at this time in the cycle. There is no call by these firms to A Large Broker saying, “Please tell the entire world that I am a seller when I should be a buyer at this time in the cycle!!!!!” Everything in deep value tends to trade quietly.
And Cousin Caio, Our Co-Investment Partner, What Does He Think?
Local Competition – Why would I show my best deals to a vertically integrated competitor. That would be foolish
Cannibalization of Market – These local real estate private equity firms have multiple local partners. If they invest with me, they may also invest in my competition on a regular basis. I am just not comfortable with that scenario.
Been There, Done That – When I was first starting, perhaps I would have gone this direction, but I am a proven operator and quite honestly know as much and perhaps more about how to execute than some individuals in these firms.The value add, at least at my current experience level, is limited.
Decision-Making Process – I do not have time for the multiple meetings and people justifying their jobs that take away from my executing the business plan. I know what to do, I am willing to put up 10% of the cash which is more than these characters…I do not need the hassle.
InDev Capital – There is this niche real estate advisory firm that helps me access large-scale capital that seeks a local partner to execute a deep value investment strategy. Hmm.. this is a better option. InDev Capital appears to be the tallest midget in the room and I like their newsletters.
So, Yokuzuna (Large-Scale Global Investor) – Be Large and Take Charge!!!!!
What are the Specific Investment Opportunities?
Specific Successful Asset Owners that are under Situational Distress – The Quiet Sales that are taking place currently. Be aware that some of the transactions have hair on them but Cousin Caio can help you navigate through the weeds to discover value. A Sweet Spot for our Hero! Click Here for Additional Information on the Situational Distressed Seller Opportunity.
2. Data Center Segment – Capital is scarce and demand is large. Cousin Caio is working diligently in this sector and almost ready to launch. You can reach out immediately to InDev and have a 15-minute chat about Cousin Caio’s activity in this sector.. Click Here for Additional Information on the Data Center BTS opportunity.
3. Senior Housing – Similar to Data Centers, strong demand and a unique niche with zero large-scale players in Brazil. Cousin Caio is seeking a strategic partner and LP investor as he will not go alone in this space. Click Here to Learn more about this strong core demand sector with limited supply.
4. Sale Lease Back Portfolio – The Forward Yield Curve Trade is happening with a recent interest rate reduction of 2% in 4 months. However, there are still high quality credits where transactions can underwrite to a 20%+ unlevered nominal IRR. Cousin Caio spends a lot of time on this activity. Please click here to learn more about a trade that is moving forward rapidly by clicking here.
5. Niche Specialty Logistics – Refrigerated Warehouse and special purpose logistics is on Cousin Caio’s radar currently. There is strong demand and limited supply based on this sector’s exclusively build-to-suit development pattern. Find out why cold storage can make hot cash by clicking here.
6. Developer Re-Start Finance – Sao Paulo is not Arizona when it comes to housing. What this means is that there is a certain level of core demand. Cousin Caio is looking at this sector based on the significant need for capital and the ability to structure attractive transactions with low downside and huge upside. Learn more about how the lack of liquidity of developers turns into high equity multiples by clicking here.
Next Steps
If you are a large global investor ready to start the process of investing in a deep value orientation, let’s get on the phone and set up a call. If you are still studying the market, we stand ready to help you ramp up with various Custom Research Services. Finally, if you are in Sao Paulo, please look me up. If you are serious, I will even invite Cousin Caio to join us for one of his rare focused lunches 🙂
Good Morning!!!!!!
Joseph W. Williams
CEO & Founder InDev Capital
