Diogo Canteras

Having emerged strengthened from the global financial crisis, Brazil — in contrast with the current international economic climate — offers excellent investment opportunities, especially in the hospitality industry.

Brazil is a large economy with a highly favorable medium and long-term outlook, and in fact now may be a unique moment of opportunity in the country's history. It is also true, however, that Brazil has some very peculiar characteristics and that doing business in the country is not easy. In this context, we aim in this article to clarify broadly the specificities of the Brazilian hotel market and its current situation, and then discuss investment opportunities.

The Director of Development of a large international hotel chain once told me that he did not have a hard time doing business in any other country in Latin America, but that in Brazil was difficult.

Brazil is geographically distant from all of the other large economies of the world. Its language is Portuguese, and even among businesspeople few speak English fluently. In addition, for more than 15 years, from the mid 70s to the early 90s, the country closed its economy, adopting a policy of self-sufficiency.

These factors of isolation, together with the fact that Brazil is a relatively large economy, created the typical conditions for the development of a unique business culture. As a result, doing business in Brazil always requires a lot of study and patience.

Charles MacKay, in his 1841 book "Extraordinary Popular Delusions & the Madness of Crowds," very rightly affirmed: "...Men think in herds; ...they go mad in herds, while they only recover their senses slowly, and one by one." Making money with hotels in Brazil is very easy, mainly because the performance of the hotels is highly predictable, but it is fundamental to know the market, to be patient, and, most of all, to question the "herd."

THE BRAZILIAN ECONOMY, THE 2014 WORLD CUP, AND THE 2016 OLYMPICS

It is true that the Brazilian economy has improved considerably in recent years and that its outlook is very positive. In relative terms, however, it continues to be much smaller than that of the major world economic powers. Brazil's GDP is a bit over 10% of that of the United States, and the Brazilian hotel industry, given the specific characteristics of the country, does not exceed 5% of that of the U.S.

There is no doubt that the 2014 World Cup, which will be held in 12 Brazilian cities, and the 2016 Olympics in Rio de Janeiro will be very positive for Brazil. For the hotel industry, however, what truly matters is the legacy that will be left by these events: the "day after," or the extent to which Brazil will be capable of taking advantage of the events to permanently increase the country's hotel demand. Investing in a hotel just because there will be a lack of rooms for people to sleep in during the World Cup or during the Olympics would be foolish. What will become of the hotel afterwards?

CONSTRUCT NEW HOTELS OR INVEST IN THE EXISTING SUPPLY?

Many Brazilian cities still suffer from an oversupply of condo-hotels, which to this day causes Brazil to have among the lowest average room rates in the world. These rates cause new projects to be economically unfeasible in the great majority of Brazilian cities. The following chart shows the process of market recovery of the city of São Paulo, indicating when, on average, various investment opportunities will arise.

In the chart, we can see that for the past several years (since 2006) the great investment opportunity has been the purchase of existing hotel properties. More recently (since 2009), investing in the renovation and remodeling of hotels has also begun to make sense. The construction of new hotels should become viable only within a few years, when the average room rate of the city reaches a level similar to that before the oversupply of condo-hotels.

This same process of recovery is taking place in all of the other destinations affected by the condo-hotel oversupply, which is to say the majority of large Brazilian cities. What varies is the stage in which each city currently finds itself. This does not mean that any new project in Brazil in the next few years will be unfeasible, but it does mean that its implementation will require great care and precise studies.

BRAZIL AND ITS LEISURE TOURISM MARKET

Understanding the dynamic of the Brazilian leisure tourism market is fundamental to making any investment decision.

As Brazil is far from the world's main feeder markets for tourism, it is not possible to count much on foreign tourists. In the past 10 years, the flow of external demand has remained stagnant at around 5 million visitors per year. With the current exchange rate (1 US$ = 1.70 R$), it cannot be expected that this flow will increase much, given the increased relative cost of the Brazilian tourism product.

Thus, Brazilian hotel products in general, and those of leisure in particular, are essentially focused on the Brazilian market. In fact, given the current exchange rate, Brazil is an exporter of market (or, with regard to the flow of capital, we are importers of foreign tourism products). It is estimated that approximately 2.5 million Brazilian residents travel to the United States and Europe each year.

The following figure shows a comparison of the level of attractiveness of each tourism product and its average daily price per person:

There is a strong correlation between level of attractiveness and price, but there is an imbalance introduced by the current exchange rate, which strongly benefits dollarized products. In this way, trips abroad, even more so, cruise trips on the Brazilian Coast, end up becoming more competitive and gaining market share, while the resorts in Northeast Brazil as well as other domestic hotel products are negatively affected and lose guests.

In the case of cruise ships, this benefit has caused the number of room nights to increase from 139,000 in the 2003-2004 season to more than 500,000 in the most recent season (2008-2009), representing an average annual increase greater than 20% over the past five years. This number of room nights is the equivalent of 2,000 hotel rooms at 70% occupancy for one year.

The Brazilian leisure tourism market has grown, fueled by the improvement in the economy and by the growth of the middle class. However, this increase has benefitted mainly foreign tourism products, by virtue of the better attractiveness-price relationship offered by the dollarized products.

In any case, due to this growth in the Brazilian leisure tourism market, there seems to be a good opportunity for a domestic tourism product of high attractiveness and low price that would benefit from the demand that is currently almost exclusive to the cruise and resort market. The structuring of a product with these characteristics, however, is not trivial.

HOTEL INVESTMENT OPTIONS IN BRAZIL

The aforementioned considerations allow us to have a general view of the Brazilian hotel market and its peculiarities, whether in the urban hotel segment or the leisure segment. The investment opportunities are a direct consequence of these market conditions. Specifically, some of the current options in Brazil are:

  1. Acquisition of existing hospitality assets that are already operating in cities affected by the oversupply of condo-hotels. These assets can be hotels, condo-hotels, or even hotel companies. They tend to gain value with the recovery of the markets;
  2. Investment in renovation and market repositioning of hotels and condo-hotels, mainly in view of the resources that are being negotiated by the Ministry of Tourism together with the BNDES (Brazilian Social Economic Development Bank) for this purpose;
  3. Clearly, a combination of the two previous options makes sense. In other words, buying existing hospitality assets in order to renovate them and reposition them in the market;
  4. In some specific markets and in some market niches, mainly in the economy segment, it is worth considering the construction of new hotels. Overall, however, of every 10 projects analyzed by HVS in recent months, 7 are still economically nonviable;
  5. The development of leisure products of high attractiveness and low cost for the middle class, in the same market as cruises and resorts, may be an interesting opportunity;
  6. Finally, the development of products for Brazilians in neighboring countries — such as Argentina and, mainly, Paraguay — that can benefit from the strong Brazilian Real may also be an interesting investment option and may work as a complementary investment strategy.

For all of the options, the initial observations of this article apply: Brazil is a country that has its own business culture and that presents good opportunities.

In Brazil there are investors who, after putting a great deal of money into their hotel, find that their property is worth only a fraction of what was invested. There are pension funds that suffer millions in operational losses each month at their resorts. At the same time, however, there are profitable resorts that consistently make money each year and hotel investment funds that gain more than 25% in value per year for their shareholders. The opportunities are there; taking advantage of them requires a deep understanding of the market and "doing one's homework" with diligence.

Diogo Canteras is Managing Director of HVS in Brazil and professor of Hotel and Real Estate Development Projects in FGV University. Email: [email protected]

About Diogo Canteras | Diogo Canteras, the managing director for HVS in Brazil, has more than 20 years experience in the national and international hospitality industry. He is also professor of hotel development at Fundação Getúlio Vargas (FGV), a highly regarded business school in Latin America. Having focused the greater part of his professional life to the development of hospitality properties, Diogo Canteras has become one of the most respected specialists in the structuring of business opportunities in Brazil. This has enabled HVS to establish some very successful partnerships with its international clients in Brazil to develop low risk and high return opportunities in Hotel and Resort Business.

About HVS

HVS is the world's leading consulting and valuation services organization focused on the hotel, restaurant, shared ownership, gaming, and leisure industries. Established in 1980, the company performs more than 4,500 assignments per year for virtually every major industry participant. HVS principals are regarded as the leading professionals in their respective regions of the globe. Through a worldwide network of over 50 offices staffed by 300 experienced industry professionals, HVS provides an unparalleled range of complementary services for the hospitality industry. For further information regarding our expertise and specifics about our services, please visit www.hvs.com.