ECONOMY
Latin America
Only a few months ago, uncertainty regarding the resiliency and the pace of economic recovery hung over the LatAm region. While LatAm economies experienced a rebound from the pandemic-induced contractions in 2020, questions remained as to whether the recovery would be maintained. Much of that uncertainty has dissipated as growth rate projections have been raised again and again. LatAm’s near-term (2023-2026) GDP growth (3.2%) will be the second fastest in the world after Southeast Asia (6.1%).
The LatAm region, like the rest of the global economy, has experienced a sharp rise in inflation as economies have recovered. Now, many LatAm countries have inflation higher than the upper range of their respective inflation targets. Price pressures are expected to be transitory, with inflation rates projected to gradually decline in 2022.
As a major commodities exporter, LatAm disproportionately benefits from commodity gains. The commodity index is up over 86% since last March. Notwithstanding, commodity prices are still 60% below their peak in 2008. Consequently, talk of a commodity super cycle is already heating up. Will this help Latin America? Undoubtedly. But the positive effects are likely to be much less intense than during the last super cycle (2000-2014) due to the rising debt burdens which have now been made much worse by the 2020 pandemic.
LatAm countries missed out on the supply-trade boom from the late 1990s to the mid-2010s following a surge in world trade. However, increased political uncertainty in China has many firms in the United States rethinking their dependence on Chinese factories. Hence, LatAm has another opportunity if it can improve its shipping infrastructure and liberalize its trade policies.
Political discontent, which had been simmering for several years before COVID, has become more widespread. There is a sharp uptick in anti-incumbent and anti-political establishment sentiment throughout the region. In Q4, elections will be held in Argentina and Chile and, in 2022, Brazil and Colombia. Investors have taken note and widened the political risk premiums on LatAm bonds and currencies.
YTD 2021, every major currency in LatAm weakened against the US dollar. A combination of delayed vaccine rollouts, global “risk off” sentiments and regional political risks have at various points throughout the year led to sharp selloffs of LatAm currencies. Over the medium-term, some of the most acute political risks will fade across the region while central banks continue hiking interest rates, allowing for an appreciation in most currencies.
Colombia
Colombia's economy expanded 13.2% y/y in the third quarter of 2021 against market expectations of 12.5%. Q3-2021 was a period in which Colombia consolidated a full reopening and lifted all mobility restrictions. On a sequential basis, the economy grew by a robust 5.7% q/q, showing a strong recovery after the volatile Q2-2021 in which economic activity had the impact of the third COVID-19 wave and a long-lasting nationwide strike.
Colombia’s economy has already reached pre-pandemic levels of activity sooner than expected as the government lifted restrictions as its vaccination plan advanced. Due to growth surprises in Q3, the Central Bank’s recently increased its 2021 (9.8%) and 2022 (4.7%) GDP growth expectations.
October annual headline inflation was 4.6%. Now that headline inflation exceeds the Central Bank’s target range (2%-4%) for the third month in a row, the bank has commenced its rate hike cycle. So far, the Central Bank has raised interest rates 75 bps to 2.50%. The consensus is that the Central Bank will raise rates a further 50bps in 2021 and a further 200 bps in 2022.
Inflation has become a critical issue worldwide. While global supply chain bottlenecks and energy and other commodity price increases are perceived as transitory phenomena, clear signs of stabilization remain elusive. In Colombia, inflation has reflected the impact of international trends, as well as domestic effects, including the disruption generated by nationwide strikes and the effects of normalization of key prices that were frozen during the pandemic. The consensus is that the inflation will end 2021 at 4.9% and 2022 at 3.6%.
In Q3, Colombia’s vaccine rollout gained traction and 62% of the population has now had at least one dose and 43% are fully vaccinated. Colombia has secured enough vaccine doses from Pfizer, AstraZeneca, Moderna and Johnson & Johnson to inoculate 70% of its population in 2021. While COVID cases around the world have stabilized, in Colombia, new daily cases continue to decelerate and are now at levels lower than in the US and Canada.
Colombia’s prospects have greatly improved from the dark days of Spring 2021 when there were widespread demonstrations against an ill-conceived tax reform leading both S&P and Fitch to downgrade Colombia’s credit rating to BB+. In fact, Moody’s recently affirmed Colombia’s rating at Baa2 (two notches above investment grade threshold) and improved the outlook from “negative” to “stable”.
After recovering slightly, the COP weakened mid-2021 following the credit downgrades. YTD 2021, the COP devalued 9.8% vs USD and 12.3% vs CAD (CAD appreciated 2.8% vs USD). While considered an undervalued currency, the COP is not expected to recover until after the 2022 elections.
In September, Colombia passed a new tax reform. For investors, the main measures are the increase of the corporate income tax rate from 30% to 35%. Overall, this is a watered-down tax reform, but one which is politically palatable.
President Duque’s continuing political struggles are likely to benefit his most important opponent, Gustavo Petro, in next year’s presidential election. While Petro is the clear frontrunner on the left, the picture is far fuzzier in the center and on the right, where dozens of potential candidates are vying for position. However, Petro’s leftist stance and rhetoric are regarded as radical among moderate voters.
Overall, the Colombia real estate market continues to demonstrate resiliency in 2021 and we expect that to continue going forward. The market has been disciplined and has avoided overbuilding. We do not see Colombia real estate succumbing as much to some of the macro trends impacting real estate in the developed world such as work-from-home and e-commerce. Furthermore, Colombia’s real estate yields may once again be attractive as they have not been compressed as much as those in the developed world.
RESIDENTIAL MARKET
For 2021, national residential sales are expected to hit a record 220,000 units, up 25% from 2020. This remarkable industry wide success is attributed to an increase in government subsidies (# of VIS subsidies plus introduction of new No-VIS subsidies), lower mortgage rates and higher demand. While still at record levels, the surge of sales that began in September 2020 may be leveling off at a more sustainable level ~15% higher than pre-COVID. YTD sales are up 39% (admittedly from a low baseline in 2020) with nearly all markets up. By holding back on new launches, the available offer has decreased by 14% and the finished inventory by 37% compared to pre-COVID.
However, due to the introduction of longer term 36-month installment payment periods for purchasers, accelerated sales have not resulted in accelerated deliveries and the resultant payment of development fees and profits. As such, the 2021 completion shortfall of 69,000 (sales of 220,000 less completions of 151,000) follows a 2020 shortfall of 65,000 and will take several years to correct itself.
When allocating its limited resources, the government considered aid to the residential sector a foundational tool to stimulate the economy because of the industry’s particularly high multiplier effect on employment. Sales should remain high as long as the government maintains its subsidy programs though too much of a good thing will create conditions of pull-forward demand that could impact sales in 2022 and 2023.
Prices of VIS (low income) housing increases annually with minimum wage (approximately CPI + 1.5%). Non-VIS prices have been increasing at a slightly higher rate. Profitability is expected to stay constant as higher development costs, due to higher steel and materials costs, are offset by a 200bps reduction in interest rates and shorter construction loan durations.
RETAIL MARKET
Colombia's retail sales advanced 15.3% in September of 2021. This advance represents an advance over pre-pandemic retail sales and follows a year of strong retail sales growth. Similarly, consumer confidence has nearly recovered to pre-pandemic levels. Nearly all stores, restaurants, theatres, gyms and amenities have reopened.
There is evidence of a strong pipeline of brands waiting to re-enter the market once mall traffic returns to normal. Consequently, rental rates and vacancies should recover quickly in the best malls while some older malls may become obsolete.
Contrary to North America where shopping centers serve an essentially utilitarian function, modern Colombian retail malls have in fact become part of the social fabric that serves a community function much like the old town squares used to decades ago. Expect resiliency from this asset class.
Most retail tenants have long-term leases with contractual annual rent escalations (>CPI).
OFFICE MARKET
For 2021, most office tenants continue paying their contractual rent whether or not they are using the space with the exception of some street front retail and coworking space. While tenants are contemplating shedding space to accommodate work-from-home, in practice most tenants are simply delaying major leasing decisions
In 2020, the Bogota Class A vacancy rate increased to 14% and has further increased to 17.5% by mid-2021. Market rental rates have decreased 8.5% but renewal rental rates are staying at previous levels. Renewals, usually 90-100% are now 80%-90% and for shorter terms. All tenants are asking for shorter leases (2-3 years) or additional concessions for signing longer leases (5 years). Fortunately, the production of new space for delivery in 2021-2023 was already at historic lows before COVID. The office market is expected to recover by 2024.
In terms of property valuations, discount rates and cap rates have remained relatively constant. However, appraisers’ market and renewal assumptions have been reduced. Consequently, YTD appraisals have increased an average of only 3%, slightly below inflation.
Most office tenants have long-term leases with contractual annual rent escalations (>CPI).
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