Brazil: A turning point

Author: | Published: 1 Oct 2011
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Brazil is experiencing a positive economic moment. The decline of the so-called Brazil risk has made Brazil an increasingly secure market, with excellent opportunities and competitive returns in a wide range of sectors. This is particularly true of the real estate market, which was helped in part by the US sub-prime crisis which hastened the tendency for displacement of investment to other national markets.

Due to an economic culture based on years of high inflation and economic instability, Brazil had not encouraged financial leveraging in the real estate market, and the low purchasing power of the majority of the population dampened demand in this segment. Furthermore, the country’s vast territorial extent did not require the creative solutions that lack of space imposes in certain markets. Thus, until recently, Brazil’s property market was relatively underdeveloped, marked by low complexity of transactions and limited diversity of products. However, with the stabilisation of the currency, Brazil’s economic scenario changed to one of solid growth.

As mentioned, the Brazilian property market was not negatively affected by the sub-prime crisis; in fact the exact opposite occurred. Recent legal changes providing greater security for creditors, the creation of more sophisticated investment mechanisms and the need for infrastructure and housing projects have made the time ripe for progress. Foreign investors first sought out real estate opportunities in large metropolitan regions, then expanded to neighbouring cities (especially in the southeast) before turning to look for opportunities elsewhere in the country.

A market ripe for development

Although much foreign investment has been concentrated in the southeast of Brazil, the notorious housing deficit in other regions and the relative shortage of land and associated high prices per square metre in this region have contributed to shift people and investments to other regions, particularly to medium-sized cities.

According to a study by the Institute of Applied Economic Research (Instituto de Pesquisa Econômica Aplicada, or IPEA), a government-sponsored think tank, medium cities – those with populations of between 100,000 and 500,000 – increased their share of national wealth from 26.07% to 27.35% between 2002 and 2005 while the GDP share of large metropolitan regions and cities declined from 43.34% to 41.70%.

This factor has affected the real estate market in various segments. Surveys show that the launch of new residential projects has been surging in regions of the state of São Paulo outside the capital city’s greater metropolitan region, driven by the migration of firms, increased income in medium cities and lack of good land for undertakings in the capital. Another reflection of these trends is the spreading construction of shopping centres throughout Brazil in less populous regions, in cities with more than 150,000 inhabitants, significantly increasing the opportunities for investment in these ventures.

The larger volume of credit available from financial institutions at more palatable interest rates has spurred mortgage lending to people in more varied social segments, enabling a whole new contingent of families to own homes.

The security of these transactions is much improved for all those involved. The enhanced contractual guarantee mechanisms, such as fiduciary assignment (trust deed) established by Law 9,514/1997, now facilitate repossession without requiring a judicial foreclosure process. This has been particularly important given Brazil’s slow courts. In this respect, less protection of borrowers has helped them as a class, since the greater protection of creditors has made banks more willing to lend, and at lower spreads. Finally, the realty market has been greatly favoured by creation of the regime of separate assets and liabilities for real estate development projects. By ring-fencing these undertakings, this regime prevents problems involving one project from affecting a developer’s other projects. (Passage of this law was largely in response to the bankruptcy of a large national property developer.)

Another factor driving the improved housing sector and generating good investment prospects was the creation of the Minha Casa Minha Vida (My House, My Life) programme, by which approximately R$4.6 billion ($2.82 billion) has been earmarked for loans to build low-income housing. This has helped spread development of the real estate market.

Overall, real estate developers, many of them capitalised by foreign investors, have been responding to the expansion of the middle class, the arrival of credit for the lower middle class and new legal mechanisms, with a substantial number of new project launches.

This improved scenario is reflected in the statistics from Caixa Econômica Federal (CEF), a federally-owned savings and loan institution linked to the Finance Ministry, for the first quarter of 2011, during which it signed 226,381 loan agreements, involving R$14.7 billion in housing financing. Comparison with the same period in 2010, when R$14.6 billion was lent, shows maintenance of a good pace of mortgage lending.

First-quarter data also shows that CEF made an average of 3,651 new real estate loans a day, nearly 50% to families with incomes up to 10-times the minimum monthly wage (R$545), worth R$ 7.7 billion. This represents growth of 14.8% in comparison with the first three months of 2010.

In the coming years the Brazilian economy will be further boosted by important events such as the 2014 Word Cup and 2016 Olympics.

Brazilians’ new relationship with real estate investment

The way Brazilians invest their money has also been changing in recent years, because their relationship with credit has also been changing. The increasing income, more accessible credit, and particularly the strengthening of the middle class, have increased the capital available for financial investments, with greater appetite for less conservative instruments.

The market already shows signs of this new reality: in 2010, the Brazilian Securities Commission (Comissão de Valores Mobiliários, or CVM) granted approval to 39 offerings of shares in real estate investment funds (a vehicle previously little used in the Brazilian capital market) with a record amount of R$9.7 billion offered. Of these, 20 offerings were concluded during the year, for a total of R$3.3 billion, while the others are still in the marketing process.

Of the 20 offerings concluded, a total of R$2.8 billion was effectively placed, to various types of investors. The majority of purchasers in number were individuals, proof of acceptance of the diversification and sophistication of these instruments. Of the volume placed, R$2.2 billion was put up by individuals.

About half the volume of these offerings placed in 2010 went to real estate funds focused on projects for new office buildings, for lease of floor space to first-line companies (Triple A). This type of fund attracted money from around 8,000 individuals, with average investments of approximately R$130,000. In terms of volume, the funds that most attracted individual investors were those with an investment policy of acquiring real estate financial assets.

The average investment of the 700 people who invested in this type of fund was higher, at about R$500,000. With respect to the number of investors, the funds focused on purchasing properties leased under built-to-suit arrangements and commercial properties in general attracted roughly 2,000 individuals each.

The commercial properties invested in by these funds range from office buildings to large stores and units in shopping centres. The average investment in funds specialising in built-to-suit properties was R$90,000 while the average for those focused on investing in other commercial properties was R$60,000. Additionally, but in smaller numbers, individuals also put money in funds specialising in housing projects, industrial buildings or warehouses for distribution of goods. Finally, several funds of funds were established, serving as vehicles to invest in other real estate investment funds.

The numbers show the diversification of the products available and the participation of individual investors in this market (which until fairly recently was virtually nil), as well as still huge unexplored potential.

Acquisition of ownership

As a general rule, in order to be perfected acts involving real estate, including transfer of title and the grant of in rem guarantees, must be formalised by a public deed and be registered at the real estate registry office for the jurisdiction where the property is located.

The formalism and rigour of Brazilian legislation on real estate gives good legal security to transactions. On the other hand, though, this formalism, in a country with a large contingent of citizens with limited purchasing power, generates distortions between the registrations and public records of ownership and the reality on the ground. As a result, many property transmissions are carried out without all the proper registrations.

Many times this regularisation is not possible administratively, and it is necessary to go to court, which generally increases costs and takes many years.

However, the social and economic needs of a country that wants to grow have been prompting a softening of this formalism in specific cases. The need for regularisation of landholding, particularly in shanty towns, as well as the housing deficit, has been forcing an alliance between the archaic civil law and the dynamism of contractual relations to dispense with the requirement for public instruments in some cases.

In these cases, legislation often attributes force of a public deed to private instruments. This is the case with, for example: (i) purchase and sale commitments (conditional sale), assignments, and commitment to assign in transactions involving subdivision of property; (ii) contracts and other instruments issued by state and municipal governments to formalise the transfer, concession or recognition of domain over rural public lands; (iii) trust deeds (fiduciary assignment) to secure real estate financing; and (iv) contracts entered into with entities of the National Habitation System (generally for earmarked lending to low-income people).

In many of these cases, besides eliminating a step, the lack of the need for a public instrument provides significant savings due to the high official fees, reducing the final amount spent by the purchaser and facilitating regularisation of ownership.

Another example of lowering costs occurs in the My House, My Life programme, under which the state and municipal governments can receive benefits from the federal government, such as revenue transfers to offset the revenue forgone by state and local governments’ granting of exemptions on causa mortis and inter vivos transmission tax, as well reduced state value-added tax on construction materials and municipal service tax on construction services.

Recent laws have also been enacted to facilitate regularisation of property records, permitting certain rectifications in the public records that previously needed court approval to be done in the administrative sphere.

Nevertheless, since Brazil is a large country with great cultural diversity, the interpretation and form of applying the legal provisions on property registration tend to be quite heterogeneous. The procedures with public registrars and notaries, and also in the courts, can vary significantly depending on the particularities of each place.

When purchasing property for real estate developments, after the acquisition it is necessary to obtain prior approval from the municipal government and environmental agencies and to obtain connection to public utilities. Although all lower governments are subject to federal legislation, the states and municipalities have autonomy to legislate and regulate these matters within the bounds of the federal rules. This is true of zoning regulations, construction standards and the procedures for approval of projects, for instance.

The lack of uniformity throughout the country poses a relevant hindrance to the expansion of the market, both for Brazilian investors from other regions of the country and foreign ones. In this particular, partnerships with local parties have shown their importance due to their intimacy with local regulations and procedures.

Restrictions on foreign individuals and companies

The acquisition of rural land by foreigners in Brazil is regulated by Law 5,709 (enacted in 1971). This law establishes a series of limits and restrictions on real estate purchase of real estate by foreign individuals, foreign companies authorised to operate in Brazil and Brazilian companies with foreign majority ownership.

In 1988, with the promulgation of the current Brazilian Constitution, an important discussion arose about the possibility of giving differential treatment to Brazilian companies (those incorporated in Brazil, according to Brazilian law, with headquarters and management in the country). These discussions slowly lost momentum. The position that developed and prevailed until 2010 was that such distinction simply has no constitutional support, so that the restrictions and limits on the acquisition of rural property by Brazilian companies with majority foreign ownership should not apply.

That position was confirmed by the Solicitor General’s Office (Advocacia Geral da União, or AGU) by Legal Opinions 22/1994 and 181/1998. The latter was duly approved by the President and became binding on all entities of the federal public administration.

However, on August 23 2010, a new AGU opinion (Opinion 01/2008) was approved by then President Lula. It not only holds that it is constitutional to apply different limits and restrictions on companies with majority foreign capital, it also extends this to Brazilian companies controlled by foreign capital (such as when foreign individuals and/or legal entities do not hold the majority of the capital but exercise effective control).

A great role in terms of oversight and control of granting (or refusing) registration of real estate transactions covered by Law 5,709/71 is played by the real estate registry offices. As these offices are not part of the federal public administration, the Internal Affairs Office of the National Council of Justice (to which real estate registries are linked) issued a recommendation that they start applying Law 5,709/71, according to the position of AGU Opinion 01/2008, on transactions completed after August 23 2010.

Besides this, with the aim of making Opinion 01/2008 more effective, in March 2011 the AGU issued Notices 110 and 121, by which it requested the National Department of Commercial Registries (which regulates state commercial registry boards, where companies’ incorporation documents are registered) and the Finance Ministry to study ways to restrict indirect acquisition of rural land by foreigners – acquisition carried out by corporate transactions. The AGU also asked the CVM to take measures, among them the issuance of a rule to establish standard clauses and conditions that must be included in instruments or investment agreements intended for trading of securities in exchanges or over-the-counter markets (organised or not), and to refuse permission for trading of securities that do not satisfy the requirements of the referred law.

Although those orientations and opinions do not stop Brazilian companies with majority foreign ownership or control from going to court to challenge the reception of the 1971 law by the 1988 Constitution, from a practical standpoint this would take years to reach final conclusion, and title would be clouded in the interim.

Despite the theoretical possibility of arguing the unconstitutionality of Law 5,709/71, the safest way for foreign companies to purchase or lease rural property, or to acquire the direct or indirect control of a company holding such property, is to satisfy the limits and restrictions of that law and related legislation. In general lines, besides the limits regarding the amount of land owned by foreigners (up to 25% of a municipality), the extent of properties owned by a person or company of the same nationality (up to 40% of the 25% limit per municipality) and the need to use the land for an agricultural or industrial project falling under the company’s stated business purpose, the transaction must be submitted to the National Institute of Settlement and Agrarian Reform (Instituto Nacional de Colonização e Reforma Agrária, or Incra). The real estate registry office may only register the transfer upon proof of approval by Incra.

Nevertheless, even those that decide from a practical or strategic question to follow the requirements of Law 5,709/71, the law’s application has been generating some insoluble questions, at least in the short and medium term. After years of not applying the law, the real estate registries do not have the proper records, for example, to determine compliance with the limits necessary to be able to report that information to Incra for use in the approval process. The need to regulate matters that never were under the remit of these public offices has revealed a void in the registry system. Besides this, the real estate registries do not have the staff or expertise to verify the corporate control of acquiring companies. Likewise, the commercial registries do not have sufficient information about the assets owned by the companies registered with them.

In June 2010, the Brazilian Institute of Real Estate Registrars held a congress to discuss the reflections of these matters and to recommend the procedures that should be adopted by commercial registries, real estate registries and notary public offices in response to the restrictions. It seems that, with rare exceptions, notaries and registrars are simply not prepared to face the question responsibly. The previously mentioned diversity in the application of laws and regulations by real estate registries causes further havoc.

With the country receiving foreign investments in virtually all segments, the attempt to apply a law enacted in 1971 does not appear to be the best way to address the question. The market as a whole, while continuing to function through solutions attempting to safeguard positions, anxiously awaits the outcome of this debate so as to resolve the impasses this has brought to a vitally important market.

Built-to-suit leases and the judiciary

In terms of the advance and maturity of the Brazilian real estate market, the growing use of built-to-suit arrangements is an important indicator of the more sophisticated mechanisms available in the commercial property market. These arrangements cover buildings constructed specifically for a single tenant, and for this reason the lease agreement has particular characteristics, generally covering a long term and calling for pre-established monthly rent and other charges, subject to well-defined inflation adjustment clauses. The aim is to provide a steady and reliable cash flow to remunerate the owner for use of the property and to amortise the construction outlays.

In short, because these leases are tailored to the specific needs of a single tenant, the contractual relationship must assure return of the investment, based on the certainty that the monthly revenue stream will not suddenly fall and that in the event of early termination, the liquidated damages will be sufficient to make up for the lost rent.

This type of contract rests on a series of legal and financial developments and serves as the basis for various funding transactions in the property market.

In Brazil, typical leases for residential or commercial purposes are regulated by the Tenancy Law, which if applied strictly to built-to-suit leases could undermine all the contractual features discussed above. For this reason, the majority doctrine, in line with market practice, has taken the position that these are atypical contracts that cannot be tightly bound to the rules applicable to regular lease agreements because the purpose of a built-to-suit lease is essentially different from a common one.

In the absence of specific legislation and of judicial decisions supporting the legal doctrine on the atypical nature of built-to-suit agreements, the market has been experiencing a degree of uncertainty. A recent decision by the São Paulo State Court of Appeal, in a suit filed by a lessee seeking to lower the rent based on the argument it was excessive in relation to the market value, went some way to reducing this unease.

This question is extremely relevant because under a built-to-suit lease the rent is set so as to reimburse the lessor for the investments made to build installations tailored specifically for the tenant’s activities. This generally costs more than would otherwise be the case, so the rent is usually higher than under a typical lease. However, the appellate panel held that the revision of this type of agreement would cause contractual imbalance and generate losses for the lessor and legal insecurity for all interested parties.

Though the final outcome is still uncertain, the decision was a step in the right direction and demonstrated the sensitivity of the judges to the needs of the rapidly developing market.

Brazilian real estate legislation and practice are extensive, in flux and interpreted in varied ways by the courts. The local customs and practices also often influence the applicability of the general rules in each case. Despite these particular features, Brazil’s economic situation is promising for real estate investments of the most varied types, from purchasing individual properties to investing in real estate funds.

About the author

Cristiane Mamprin de Castro Guerra specialises in corporate law, M&A, joint venture structuring and commercial agreements, as well as real estate law. She is one of the founding partners of Lobo & de Rizzo Advogados and head of its real estate practice. Mamprin assists clients on both real estate acquisitions and in the process of funding, as well as sale and leaseback transactions, built-to-suit agreements, leasehold advisory, real estate receivables securitisation and other real estate transactions. She has also advised US, European and domestic corporations in Brazil and other South American jurisdictions.

She holds an MBA in Economic and Corporate Law form Getúlio Vargas Foundation and a postgraduate degree in US Law from New York University. She is a member of the Commission on Interns and Bar Examinations for the Brazilian Bar Association and a frequent speaker at real estate seminars throughout the country.

Contact information

Cristiane Mamprin de Castro Guerra
Lobo & de Rizzo Advogados

Av. Brigadeiro Faria Lima, 3.900, 3º andar - Itaim Bibi
04538 132 - São Paulo - SP - Brazil

t: +55 [11] 3702 7000
f: +55 [11] 3702 7001

About the author

Fernando Semerdjian is an associate lawyer of Lobo & de Rizzo’s real estate team. Before joining the firm, he worked as a consultant of real estate registry offices and notary public throughout the country by providing opinions and analysis regarding titles submitted for registration. Semerdjian assists national and foreign clients in real estate matters, including real estate acquisitions, sale and leaseback transactions, built-to-suit and real estate development projects. He holds a postgraduate degree in Registry and Notary Law focused on Real Estate Law from Escola Paulista de Direito. He specialises in Real Estate Law at Escola Paulista da Magistratura.


Contact information

Fernando Semerdjian
Lobo & de Rizzo Advogados

Av. Brigadeiro Faria Lima, 3.900, 3º andar - Itaim Bibi
04538 132 - São Paulo - SP - Brazil

t: +55 [11] 3702 7000
f: +55 [11] 3702 7001




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