NATAL, BRAZIL—Private equity players have been swarming Brazil for at least a decade. Still, establishing a stake in one of the most attractive BRIC nations is not without its challenges. Just ask Starwood Capital. The Greenwich, CT-based firm has been sizing up the country for some time, looking for an entrée into the market. But finding the right local partner to help navigate Brazil’s business terrain has been an arduous task, says Ryan Hawley, the acquisitions associate who is heading up Starwood Capital’s activities in the country.

By the close of this year Hawley says the firm plans to launch its first office Brazil. Back in March, Starwood closed a $1 billion fund, twice oversubscribed during the process. Now the firm plans to dedicate a hefty portion of that capital to hotel investment in Brazil. What makes Brazil so attractive to Starwood Capital?

Hawley: Brazil looks a lot like the US did after World War II, with a booming growing middle class steadily upping their consumption. Through the financial crisis Brazil has been one of the few countries that’s increased lending instead of pulling back. So that’s very good, especially as it dovetails with the expansion of the middle class.

One anecdote that I thought was interesting: GOL airlines (Brazil’s largest air carrier) recently reported that their number of passengers went up by 26% year over year in the past quarter. They actually broke it down and specifically noted that it was class C customers, who had never flown before that made up the bulk of that growth. As a result, they just announced opening five retail stores in lower-income parts of Sao Paulo to court those first-time travelers. That is going to have a huge impact both on the business and tourism side with so many people traveling for the first time. Okay, so what are the drawbacks to this market?

Hawley: The counterpoint is that the government needs to make some changes in Brazil. The good news is the government is recognizing that necessity. I read an article where the administration noted the need to reign in on the fiscal spending. Obviously, when the economy overheats, if the government doesn’t pullback on spending, often that forces the central bank to raise interest rates. One big challenge for Brazil will be investment. And what you wouldn’t want to happen is a cramping out of the private investment because of high interest rates. China I think spends something like 43% of its GDP on investment; India it’s something like 30%; and Brazil is half of that. Brazil is operating at capacity right now. It needs a lot of investment in logistics facilities, in equipment, in ports. The government needs to make that a major focus and the private sector will respond to that in the appropriate economic climate.

On the hotel side, I find it very interesting learning the culture of Brazil and the perception of Brazil in relation to hotels because it is not positive. I think probably any Brazilian businessman knows somebody who bought a condo hotel and lost money. I know the pension funds lost a lot of money as well. It’s been interpreted at least by some as a statement that the hotel industry is fundamentally too risky and not profitable, which I couldn’t disagree with more. But the interesting thing is I don’t think that there has been an opportunity for the perfect team to come together to really build hotels that are at an international caliber. The big developers that built condo hotels in the 1990s were residential developers. To my knowledge, you have not really seen too many international-caliber hotel investors and international-caliber operators together with somebody who really understands Brazil and Brazilian culture and has that Brazilian expertise. Bringing that together is what we’re trying to do.

We’re in a unique position because we have the largest private equity fund that has ever been raised dedicated to hotels. We also happen to own a hotel manager based in France. And beyond that because Barry Sternlicht, the chairman of the company, ran Starwood Hotels for 10 years, he has a very good relationship with all of the brands across the board. So we’ve got two of the three parts of the puzzle. What we need is—and what we’re working on and think we have some promising leads in that direction, the Brazilian piece. We are very bullish on Natal. Brazil is one of the few countries where during the crisis RevPar went up. And not only that, but it’s going up significantly higher than GDP.

You’ve got Accor, which is probably the biggest chain hotel in Brazil and they’ve got 167 some odd hotels. That’s shocking to people in more developed parts of the world because we’ve got chains that have hundreds or thousands of hotels under one flag. We happen to own seven flags in France where we have probably 600 hotels. So there is a lot of opportunity. I think only 15% of the hotels in Brazil are affiliated with a chain. Only half of that is affiliated with an international chain. So there are huge opportunities. The question is how to bring that together. We are probably primarily focused on taking advantage for the huge internal market in Brazil. We want to focus on the domestic markets in Brazil. Any interest in other property sectors?

Hawley: I won’t speak as much about the other asset classes, not because we don’t have interest. We’ve actually done more work in Brazil in terms of trying to put deals together on the office and industrial side than anything else. You’ve got office vacancy rates that are extremely low in Rio for obvious reasons, topography being one of them. In Sao Paulo as well, the supply situation is relatively benign. In the next few years, the forecast is 150,000 square meters under construction in contrast to the period around 2002-2003 when they were building 300,000 square meters, with a demand environment that was weaker. So I do think that office is a good market. I also think that logistics is a good market because whether it is exporting commodities from Brazil or getting goods that are produced in the South up to the consumers in the Northeast, modernization of logistics will be necessary.

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