For those who think there is money to be made in Latin American real estate, the early returns of a new exchange-traded fund are promising.
Tierra Funds launched the Tierra XP Latin America Real Estate ETF (LARE) in December. The fund tracks the Solactive Latin American Real Estate Index, which comprises 56 stocks listed in the region, primarily in Brazil and Mexico.
The fund is up almost 12% since the start of the year, and has net assets of just under $2.9 million. About half its investments are in real-estate investment trusts, which have holdings in income-producing property like malls and industrial parks, and are required to pay out a periodic dividend. The remainder is concentrated in real-estate operating companies, which are similar to REITs, though they aren’t required to pay a dividend and can invest in a broader range of companies. The fund also invests in an array of other real-estate-focused companies, from construction firms and home builders to related services.
The real-estate market in Brazil has been under pressure due to the recession there, says Jamie Anderson, managing principal of Tierra Funds. Still, he is optimistic, despite the country’s economic travails and the political turmoil surrounding the impeachment of President Dilma Rousseff. Mr. Anderson figures that the economy could turn a corner this year, particularly if the political situation stabilizes, and that there could well be a cut in interest rates, which would benefit the property market.
“Brazil is going to be an unpredictable, challenging environment, but we believe that the broader trend is up, or at least we’re at a point where we’re going to consolidate for a while,” he says.
The fund’s second major focus is Mexico, which has a “very vibrant commercial real-estate industry,” Mr. Anderson says. However, the real-estate market there is similar to the U.S., he says: It’s much more stable than Brazil, “but the returns are going to be lower.” Elsewhere, he sees opportunities in the Andean region, particularly Peru and Colombia.
Mr. Cowan is a writer in London. He can be reached at email@example.com.
One of the newest ETFs to come to market offers first-of-its-kind access to Latin America’s real estate market. The Tierra XP Latin America Real Estate ETF (LARE) tracks an index of Latin American companies that generate the majority of their revenues from real-estate-related ventures. The fund’s underlying index covers four areas: REITs, developers, property owners/operators and companies that provide services to real estate companies and infrastructure developments.
Jamie Anderson, managing partner at Tierra Funds, discusses how LARE works and why adding this type of strategy to your portfolio makes sense.
ETF.com: Tell me a little bit about the portfolio. What do investors own with LARE?
Jamie Anderson: This is the first U.S.-listed ETF product that exclusively focuses on the Latin America real estate asset class. It has 62 components. Approximately 55% of the weights are REIT equities or REIT-comparable equities. The balance are real estate operating companies—residential home developers, service providers, commercial real estate owner operators, etc. We have a fairly robust, diverse set of equities that are represented in this product.
The reference index is the Solactive Latin America Real Estate Index, which we actually created for this product specifically.
One of the goals we set out to achieve was to provide institutional and retail access to the asset class without having to go into illiquid, nontraded, private-equity-type instruments, which, up until this point, was really the only way you were going to get diversified access. Somebody can single-stock-pick with the emergence of listed REITs, especially in Mexico, but they’ll find it’s a challenge to find lower correlation, lower beta and lower volatility without sacrificing yield.
It’s a multifactor approach that takes liquidity, dividend yields and market cap into consideration. It ranks the individual components against the population set and then reranks the entire population. What we end up with is a balance between income and growth.
The index currently has a trailing dividend yield of a little north of 6.5%. I feel really great being able to say the performance year-to-date has been nothing short of phenomenal. Now, we don’t have double-digit returns, but the current net asset value on the product, on a price-return basis, is up 1% year-to-date. The total return is up 2.2%.
And volatility is running roughly comparable to Mexico over the medium term, but it’s about half the volatility of Brazil. To put that into context, Brazil makes up 58% of the weight in the index. So to be running at half the volatility Brazil has shown over the last six-month period—but especially on the year-to-date basis—is a phenomenal advantage for an investor in the product.
ETF.com: From a country exposure, is this really a Brazil/Mexico fund?
Anderson: It’s about 40% Mexico, 58% Brazil and then we have Chile in there. I will say there’s a very strong likelihood Argentina will be included at some point soon.
ETF.com: If you look at a chart, the iShares MSCI Mexico Capped (EWW | B-97) and the iShares MSCI Brazil Capped (EWZ | B-96) are down 15% and 37%, respectively, over the 12-month period. Why would now be a good time to launch this product? Does it really speak to just how uncorrelated these REITs are to the broad equity market in these countries?
Anderson: I think that’s multilayered. The big picture is there’s a clear shift in assets going into emerging markets now. We hit a bottom in the broad EM space back in September/October 2015. Since that period, emerging market currencies have either been range-bound or have been actually appreciating. And that’s on the back of a 2 ½-year period where the trade-weighted U.S. dollar appreciated almost 35%.
The weak-EM/strong-U.S.-dollar/preference-for-development market theme is not new. We’re really into our third year here. But investors are sniffing out a bottoming process and they’re allocating capital.
On a more granular LARE-specific basis, yes, real estate has lower correlations to the local benchmarks, but also to the broader benchmarks. For example, between September 2015 through current day, LARE is 49% correlated to the S&P, and it’s 65% correlated to the iShares MSCI Emerging Markets (EEM | B-100), which is a good, broad benchmark.
Brazil equities, meanwhile are 62% correlated to the S&P and 76% correlated to EEM. Mexico is 79% correlated to the S&P, and 88% correlated to EEM. So you can get lower beta, lower vol, but you’re also getting lower correlation.
Lastly, one of the keys to surviving in the EM space is really to buy assets when they’re cheap. And that’s where we’re at now, especially with real estate. I could run through some big-picture P/E and price-to-sale metrics, but the bottom line is that LARE is cheaper than Brazil, substantially cheaper than Mexico and about 15% cheaper than the broad EEM.
Drilling further into the specific opportunities that are represented by LARE in the real estate segment, we think REITs overall—especially in Mexico—represent a tremendous opportunity. They’re growing revenues year-on-year. They’re in expansion mode. They’re acquiring. They’re well capitalized. They have a very strong investor base driven by the local pension market. Contrast that with developed-market REITs—which are in effect either selling assets or taking on debt to pay dividends.
ETF.com: What’s driving this renaissance in REITs in Latin America? Is it a demographic trend?
Anderson: It’s demographics, and it’s just the slow march of emerging markets in general. It’s all that stuff. In Mexico, there’s been a shift in consumerism that’s just off the charts. There’s a bona fide middle class and a bona fide upper middle class that wasn’t there in the 1990s, and that benefits real estate as well.
Brazil’s funky because it’s a closed economy. At the end of the day, it’s got capital controls. It’s not an easy place to do business. That said, Brazil is a very strong consumer economy. And when things do start to settle down, the power of the Brazilian consumer is quite strong.
It’s very constructive on the real estate front because on the residential side; you’ve got a very strong cultural preference for real estate as a vehicle for long-term savings. And secondly, you’ve got a very entrenched public subsidy program. So this would be kind of like a combination between Fannie Mae and the FHA.
ETF.com: So LARE is basically an income ETF, a growth ETF and a lower-volatility ETF relative to emerging markets. Where does it fit in a portfolio?
Anderson: We’re obviously a new product. We have $2.5 million in AUM. If we set that factor aside right now, I would argue this is not just a complementary ETF, but a potential proxy for emerging markets investment—certainly a potential proxy for Latin America exposure. But it’s clearly a potential complement for somebody who owns one of the big products in the region, or the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB | B-58).
I think complementing real estate with a strong income component in EMB is a really nice way to gain that EM exposure and maintain predictable income—and in fact, enhance that predictable income substantially. But it can also keep the volatility down. Adding LARE would also add growth potential, not just income.
ETF.com: What about the currency exposure here? These are locally listed REITs and securities. Should investors worry about the currency factor in this strategy?
Anderson: No. 1, it would be impractical to try to hedge Brazil, and also Mexico; it would just be prohibitively expensive. But I think, more importantly, we’ve seen the real carnage now. We’re in the third year of this. You wanted to hedge two or three years ago. You don’t necessarily want to hedge now.
We know that a strong dollar is a major theme for the Fed, and for governments around the world. Nobody wants the dollar to get stronger. And frankly, we’re seeing some pretty good indications that global trade—if not already stabilized—is starting to grow again.
The notion that you need to go out and hedge against a decline against the U.S. dollar is probably not a smart money move now. Because what we’ve seen over the last two months is that the strong dollar trade has been exceptionally crowded and it hasn’t been panning out.
ETF.com: What is the biggest risk with this strategy? What could go really south here?
Anderson: Apart from global macro risk, if the process of uncovering corruption in Brazil somehow started to lose steam, and Dilma’s favorability started to climb dramatically—neither of which I see—that would be a risk.
All I see is indication that this thing is marching forward, and it’s a very constructive process for Brazil. If something changed there, I’d be concerned. Brazil needs to have this political purge. And they’re having it.
On the Mexico front, I would watch for any indication that inflation is starting to creep up consistently above expectations, which we haven’t seen. What we’ve seen is a little bit of CPI overheating, and the Mexican central bank responded very rapidly. But inflation in Mexico, given the strength of the consumer, is something to watch.
Why Latin America Is The New Hot Spot For Investors
Investors who feel they’ve been booted out of the U.S. real estate market (and the rest of the developed world for that matter) may want to consider doing the cha cha cha in Latin America. Exchange-traded fund industry newcomer Tierra Funds believes Latin America is the new hot spot for real estate investors.
Tierra Funds rolled out the first ETF investing solely in real estate investment trusts (REITs) and real estate operating companies (REOCs) in that region. Tierra XP Latin America Real Estate ETF (LARE) debuted in December with about $2 million in assets.
James Anderson is the managing principal of Tierra Funds based in Devon, Penn. He explains why real estate investors should venture to Latin America.
Key Growth Areas
Ho: Why did you launch this ETF?
Anderson: A few years ago we predicted that global private equity would be supplanted by local pension capital as the primary source of financing for both real estate development and long-term investment in the asset class. This is exactly what has happened since 2009 and has no end in sight. The Tierra XP Latin America Real Estate ETF (LARE) is simply a response to evolving market conditions in Latin America and a solution for both institutional and individual investors to gain exposure to this key growth sector.
We expect the REIT market to grow significantly over the next five to 10 years as the local capital markets become the go-to place for real estate financing. We designed the multi-factor index around our 20+ years’ experience on the institutional private equity side of the business. In choosing the ETF wrapper, one of our goals was to democratize access and allow the individual investor to invest in a strategy designed for institutions.
My partners and I have been active in the Latin America region since the early 1990s. Apart from being a specialist in the region, we also tried to inject our real estate private equity experience into the product. One of my partners is a Rio de Janeiro-based portfolio manager. My other partner and I began our careers in Mexico City in 1993.
To be honest, the turn toward local public market financing since 2009 is a development we would have never thought possible back in the mid-1990s. But when one steps back, it’s just standard, predictable capital markets evolution.
Ho: What is the investment strategy for your ETF? How do you go about picking the holdings? What are the rules for reconstitution?
Anderson: LARE is a passive product and seeks to track the Solactive Latin America Real Estate Index, which currently has 52 components. Brazil is weighted 58%, Mexico is 39% and Chile is a little less than 3%.
REITs comprise about 55 % of the portfolio with the balance being developers, owners and service providers. This is the growth piece. The index methodology screens more than 150 listed real estate equities in the region and ranks them against the population set based on dividend yield, market cap and liquidity at each quarterly rebalancing.
The index includes most major public real estate owners and operators, developers and real estate services. It’s a diversified and balanced slice of the entire industry.
Rapid Growth Projections
Ho: What catalysts will drive performance in the industry? What are their projected sales and earnings growth?
Anderson: On a trailing basis, LARE trades at 16.6 times earnings as of Jan. 28. We project a 14.8x forward price-to-earnings (P/E) ratio – or about a 10 % discount. Overall, revenue growth is projected to be flat in 2016. But earnings are set to grow 28 %.
So what we have is a basket of diversified real estate companies that, in aggregate, have cleaned up their balance sheets over the last three years and are growing earnings in a flat sales growth environment. There is tremendous built-in operating leverage when overall growth picks up.
Notably, it’s important to mention projected revenue growth for Mexican REITs is 21% , which comprises 23% of the overall weights.
LARE is a regional product with exposure to Brazil, Mexico and Chile (which are tracked by iShares MSCI Brazil ETF (EWZ), iShares MSCI Mexico ETF (EWW) and iShares MSCI Chile ETF (ECH), respectively.)
Growth catalysts differ by country. Brazil, for example, is entering its third year of recession. Forward performance is largely dependent on improvements in the overall economy, which we think are underway. Since the market is a discounting mechanism, which prices in future earnings, investors are starting to put money to work there on expectations that Brazil’s economy will bottom during 2016 if it has not already.
In the second half of 2015, Brazil’s current account surplus grew to more than a 5% rate, cutting the current account deficit in half compared to 2014. Brazil’s gross domestic product (GDP) in 2016 is projected to fall 2.5%. However, this is an improvement compared to the 3.7% contraction in 2015.
The central bank has aggressively raised interest rates in the face of high inflation, which was brought in large part by transportation and fuel price increases last year. Real estate and assets, in general, are very discounted, with real estate trading close to half of book value.
An investor in LARE can have access to Brazil REITs with unleveraged yields of 10% to 15%, trading at a 40% discount to book value and a forward seven times P/E. That is dirt cheap for commercial real estate with stabilized lease cash flows.
Mexico and Chile continue to be favored by foreign investors. Mexico tracks the U.S. economy very closely and is going through a real estate renaissance fueled by low-interest rates, stable growth, low inflation and a growing middle class. The rise of local pension capital will also continue to be a major driver of real estate development.
On the downside, Mexico is not cheap. Its benchmark index trades at an approximate 20% premium to the S&P 500 (SPY). But it is growing faster than the U.S. However, Mexico REITs are quite attractively priced, trading at 14 times trailing earnings with a projected 13.5 times earnings on a forward basis, or a 25% discount to the Mexico benchmark (iShares MSCI Mexico ETF (EWW)).
If we step back, Brazil is a discount, get-paid-to-wait story. And Mexico is a GARP (growth at a reasonable price) story. By combining Brazil’s high yield with Mexico’s growth, an investor has the best of both worlds inside the convenience of the ETF structure.
Broadly speaking, demographics favor real estate across the board in both Mexico and Brazil, including residential, commercial office, retail and industrial. There is a long runway regarding housing needs, retail, industrial, etc. That isn’t going to slow for many years.
The real determinant in the short run is macro conditions. Economic growth can reignite just as quickly as it drops off. We have witnessed this phenomenon many times. The key is to buy into assets when they are cheap.
Ho: How do their current valuations compare to historical and the S&P 500 (SPY)?
Anderson: Long-term comparisons between the S&P 500 (SPY) and public real estate are difficult since many companies in LARE have only been publicly traded since 2010. LARE began trading publicly in December 2015. But we do have live index data back to September 2015 and two years’ of third-party back testing.
The major impact over the last two years on index performance was currency. And this has been a global emerging market theme. Brazil’s currency has declined more than 35% and Mexico’s is down about 30% (against the U.S. dollar).
In 2014, Brazil REITs were trading at 15x to 17x trailing P/E vs. 10x currently. Mexico REITs are a harder comparison since many of them went public throughout the last three years. But regarding price to book value, Mexican REITs currently trade at 0.9x book value, which is more than 30% below where they debuted on public markets. The attractiveness of the discounts, we feel, is one of the most compelling aspects of LARE.
Ho: What is the historic performance of the underlying strategy or index?
Anderson: Regarding performance since September 2015, which was the period just after the sharp August sell-off, LARE has outperformed not only the Brazil and Mexico benchmarks (iShares MSCI Brazil ETF (EWZ) and iShares MSCI Mexico ETF (EWW)) but also the global emerging markets benchmark (iShares MSCI Emerging Markets ETF (EEM). Notably, LARE exhibits much lower volatility than Brazil (EWZ) and very similar volatility to Mexico (EWW) and the global emerging market benchmark.
LARE price return (PR) and LARE total return (TR), despite having a 58% Brazil weighting, dramatically outperformed the Brazil benchmark, iShares MSCI Brazil ETF (EWZ). The Index has a trailing yield of approximately 7.2%, as of Jan. 27, which is a pretty compelling get-paid-to-wait proposition.
Ho: How do you expect your ETF to perform over a bull and bear market cycle?
Anderson: We’ve been involved in the Latin America real estate industry for almost 25 years. We’ve been through multiple cycles, including the 1994 Tequila Crisis, the 1998 Asia Crisis and the 2003 Brazil Crisis.
Real estate, next to cash, is a sweet spot for local investors and tends to act as a safe-haven asset. We believe this is one of the reasons why real estate equities are less volatile than overall equities.
Anecdotally, you could have purchased new Class A office space during the depths of the Mexico Tequila Crisis in 1995 for about $100 per square foot. Today, Class A office space trades at around $400 per square foot. This is over a period where the Mexican peso lost more than 80% of its value versus the U.S. dollar. In nominal terms, that’s more than 700% appreciation.
For the long-term investor, real estate should provide a cushion against volatility while paying an attractive dividend. In bull periods, real estate is a natural beneficiary of stronger capital investment and growth. But the trade-off is you aren’t going to get the same rip higher when everyone decides that EM is the place to be. That said, minimizing losses is one of the key determinants in long-run asset appreciation.
Ho: Why should investors invest in your ETF? What purpose would it serve in their portfolios?
LARE is an ideal complement or proxy for emerging markets exposure that may provide a substantially more attractive current dividend yield with broad exposure to all economic sectors – consumer, industrial and commercial. We also think LARE is a compelling addition to an income portfolio overall.
For example, LARE, alongside the iShares JP Morgan USD Emerging Markets Bond ETF (EMB), would add material income plus growth potential at roughly the same volatility. Many consider real estate to be a bond-like asset with some of the growth potential of a traditional equity.
Finally, emerging markets real estate (Guggenheim Emerging Markets Real Estate ETF (EMRE), contrasted with developed markets (iShares International Developed Real Estate ETF (IFGL), is growing operating cash flow. Developed market real estate (IFGL) in general is either selling assets or borrowing to pay dividends. Payout ratios among some of the leading U.S. REITs are well above 100 %. Latin America REITs have payout ratios of roughly 60 %.
Ho: What are the investment risks that investors should consider?
Anderson: Investors should always consult with their financial advisor prior to making investment decisions as well as read an investment’s literature. Ours is available at www.tierrafunds.com. Major risks in our opinion, are a continuation of the U.S. dollar strengthening and a deterioration of economic fundamentals in Brazil.
The trade weighted dollar has rallied about 30% since 2014. Being long U.S. dollars is now a very crowded trade. In fact, since the Federal Reserve hiked interest rates in December, the dollar has actually stabilized, which suggests we may have seen the brunt of dollar strengthening – a little bit of buy the rumor, sell the news.
Given the impact of the stronger dollar, I can also imagine the Fed holding off on further rate hikes for at least the first half of 2016, if not longer.
On the Brazil front, we are really starting to see constructive signs that the economy is stabilizing. The main issues are their current account deficit and inflation. 2016 is projected to have the first annual surplus since 2014.
Inflation remains hot but many believe it is set to stabilize and drop as we get further into 2016 and government controlled price increases last year were a major contributor to the spike in the indicator. Since Brazil’s central bank began hiking interest rates two years ago, they are actually much closer to a cut in rates which should spark a rally in assets across the board.
Most have heard something about the political mess and the potential for President Dilma Rousseff to be impeached. While we are somewhat agnostic as to whether or not Rousseff survives her full term, we are increasingly convinced that this political paralysis can actually play into investors’ hands if we continue to see improvements on the economic front. A hobbled leader has little hope of pushing an agenda.
Also, don’t lose sight of the tectonic shift in the country’s desire to cleanse the political system of corruption. It is a major change in tolerance for what has been problematic for way too many years.