The Infrastructure Challenges in Latin America - December 2013

Transcription

1 executive summary Latin American economies require substantial improvement to physical infrastructure to raise potential GDP growth. As macroeconomic stability has been achieved in the largest economies, the public sector now aims to prioritize microeconomic issues. The region s major economies must address inadequacies in the years to come, focusing on the quality of roads, railroads, bridges, airports, and ports. Governments have started to prioritize the urgency of closing the infrastructure gap, by allocating more public resources for infrastructure and pursuing public-private partnerships. Recently, there have been important strides made, with private capital increasingly attracted to investment opportunities in infrastructure projects in the region. JAMESTOWN LATIN AMERICA Real Estate Private Equity Contact: Bret Rosen Managing Director, Research brosen@jamestown-latam.com Rio de Janeiro Bogotá Atlanta New York

2 When one considers the major impediments to faster economic growth in Latin America, inadequate infrastructure is often cited as one of the chief causes mentioned. Here are just a few examples and images of infrastructure constraints that occur throughout Latin America. Transporting a good from the Colombian port city of Barranquilla to the capital of Bogotá, a distance of approximately 1,000 kilometers, can cost more than sending it the 15,000 kilometers from China to Barranquilla. 1 Trucks containing agricultural exports often line up for miles, unable to enter Santos port in São Paulo state of Brazil, as the port is at overcapacity. Isolated communities in Peru are often economically and socially disconnected from the rest of the country because paved roads do not reach these villages. However, there have been important advances in the physical infrastructure of Jamestown Latin America s target countries (Brazil, Colombia, Peru, Mexico, and Chile). Airports, such as Eldorado Airport in Bogotá and Jorge Chavez Airport in Lima, were both recently renovated; indeed Lima s airport has won numerous awards for the quality of its service. 2 The Brazilian government recently privatized a majority stake of several large airports, which should improve service. 3 The interoceanic highway now connects São Paulo state with the western coast of Peru. Governments in Brazil, Colombia, and Peru have committed billions of dollars to infrastructure projects and in many cases are seeking to follow the emerging public-private partnership (PPP) model that has achieved some success, both in the region and internationally, in the past. Furthermore, private capital from abroad has allocated substantial resources recently to solving the infrastructure gap, with private equity firms having dedicated record amounts to infrastructure in the region this year. This paper addresses the issue of infrastructure in Latin America, with a focus on Brazil, Colombia, and Peru. We divide the note into the following sections: 1) arguing that infrastructure is vital to economic development; 2) discussing what Latin America needs to do to improve its physical capital; 3) highlighting what is being accomplished to improve the infrastructure in the various target countries; 4) noting the challenges encountered in addressing the infrastructure deficit. Finally, we describe the potential impact on the real estate market from the infrastructure deficit and initiatives to improve it. To begin, we must define infrastructure for the purposes of our discussion. Definitions vary for describing a country s infrastructure, but typically include roads/ highways, railroads, bridges, ports, airports, and public transport such as subway systems. Additionally, one can include electricity/power generation and quality of telecommunications. There is clearly a high correlation Latin American governments between economic are recognizing development, the necessity of competitiveness, and GDP per capita and the quality of a country s addressing the infrastructure deficit in the region. infrastructure; this correlation is not a perfect one however, as the United States is clearly suffering from infrastructure deficiencies that have been increasingly exposed in recent years. The World Economic Forum s Competitiveness report defines 12 pillars of competitiveness for an economy, with infrastructure listed as one of the most prominent. 1 According to StratFor, a consultancy, it costs US$30 on average to ship a ton of merchandise from the interior of the country to the coast, but half this amount from a Colombian port to Asia. The total cost of exporting a shipping container from Colombia costs on average 20% more than from Argentina for example. 2 Skytrax, a UK based commercial aviation consultancy named Lima s airport the top rated airport in South America in 2012, for the fourth consecutive year. Edward Plaisted, Chairman of Skytrax, stated, A perennial favourite with passengers, other airports in the region must be wondering what they have to do to unseat Lima from this top position. bestairport_samerica.htm 3 In November 2013, two additional stakes in major airports were sold: Rio s Galeao airport, and Belo Horizonte s Confins. R$20.8 billion were raised. Page 2

3 According to the report, Extensive and efficient infrastructure is critical for ensuring the effective functioning of the economy and is an important factor in determining the location of economic activity and the kinds of activities that can develop within a country. 4 The report goes on to state that quality infrastructure: 1) reduces the effect of distance between regions; 2) integrates the national market; 3) connects an economy at a low cost to markets in other countries and regions; 4) is a prerequisite for access of less developed communities to core economic activities and services. Efficient modes of transport, whether via rail, highway, or water, enable businesses to get their goods and services to market in a secure and timely manner. Judging the quality of a country s infrastructure can be subjective; the aforementioned World Competitiveness Report ranks 148 countries on the basis Latin American of a number of inputs countries rank low presumed to influence in global surveys the competitiveness that measure of an economy. the quality of infrastructure. Infrastructure is one of the pillars as mentioned above. Unfortunately Latin America does not stack up well compared to the other regions across the globe in terms of infrastructure. Brazil is rated 71st for its infrastructure, Colombia 92nd, and Peru 91st. While this report should not be considered the only means for judging a country s infrastructure, it does add credence to the view that the quality of Latin America s infrastructure falls well short of developed country standards, even possibly Emerging Asia and Europe. Turning to the country rankings, Brazil rates well on air travel capacity and telecommunications, but is rather woeful in most measures of the quality of its physical infrastructure, which is a key component of the custo Brazil, or cost of doing business in the country. As the country s economy has grown impressively over the last two decades, bottlenecks have formed on a large scale, thanks in part to the issues in the table below: Table 1: Brazil country ranking Quality of overall infrastructure 114 Quality of roads 120 Quality of railroad infrastructure 103 Quality of port infrastructure 131 Quality of air transport infrastructure 123 Available airline seats (km/week) 9 Quality of electricity supply 76 Mobile phone subscriptions per capita 45 Fixed telephone lines per capita 52 Overall ranking 71 Similarly, Colombia rates well in terms of availability of air seats, but the ratings highlight the country s poor roads, railroads, and ports. Table 2: colombia Source: World Competitiveness Report, country ranking Quality of overall infrastructure 117 Quality of roads 130 Quality of railroad infrastructure 113 Quality of port infrastructure 110 Quality of air transport infrastructure 96 Available airline seats (km/week) 39 Quality of electricity supply 63 Mobile phone subscriptions per capita 87 Fixed telephone lines per capita 84 Overall ranking 92 Source: World Competitiveness Report, Page 3

4 Meanwhile the rankings in Peru reflect a similar situation: Table 3: peru country ranking Quality of overall infrastructure 101 Quality of roads 98 Quality of railroad infrastructure 102 Quality of port infrastructure 93 Quality of air transport infrastructure 85 Available airline seats (km/week) 40 Quality of electricity supply 73 Mobile phone subscriptions per capita 93 Fixed telephone lines per capita 87 Overall ranking 91 Source: World Competitiveness Report, The World Bank also publishes data on a number of infrastructure-related categories, which allow a further quantitative assessment of how Latin America stacks up versus the rest of the world and its Emerging Market peers. Here is a sampling of statistics: The percent of total roads that are paved in Brazil is 14%, as of This compares to 23% in Chile, 36% for Mexico, and 100% in the UK and USA. Some other Emerging Markets: Turkey (89%), Poland (70%), and Malaysia (80%) display much higher percentages than Latin American countries. 5 For rail lines, Brazil has 29,000 km of tracks, Colombia under 2,000, and Peru slightly above 2,000. In comparison, China (a similar landmass to Brazil) has 66,000 km of tracks, India (with 20% less GDP than Brazil) 64,000 km, while Poland (similar geographic size as Colombia and Peru and 20% larger GDP than Colombia) possesses 20,000 km. In fact Mozambique has more rail track, at 3,100 km than Colombia or Peru. Clearly, Latin America has a major infrastructure deficit, a reflection of decades of underinvestment in the physical capital base of the countries. In prior decades, low levels of public investment were a function of economic underdevelopment, and incapable and inefficient public administrators. When these countries lacked macroeconomic stability, it was impossible to attract meaningful private capital to infrastructure development projects; furthermore, when sovereign balance sheets were overly leveraged, the public sector had limited capability to dedicate resources to the building of roads and ports. More recently, the macro backdrop has changed, and governments can be more active in infrastructure development. Cost of capital for the public and private sector in Latin America has fallen markedly, allowing for deeper and more varied methods of financing infrastructure projects. As Latin American countries have become wealthier, with established middle classes, world class exporters of commodities to Asia, and larger populations, the deficit has become particularly pronounced and the necessity to address the deficiencies has become more urgent. In the cases of Colombia and Peru, there is ample space in future government budgets to dedicate resources Macroeconomic to public investment; stability equates to lower cost of capital Brazil faces a more and flexibility on challenging fiscal the fiscal side to backdrop to direct fund infrastructure more resources to projects. this need. In all cases, financial resources are still limited, which speaks to the need to carry forth with PPPs. The opening paragraph of this note provides some examples of the infrastructure deficit, but the issue 5 Page 4

5 extends beyond some of the interesting anecdotes mentioned there. A casual visitor to any of the region s capitals is of course overwhelmed by traffic congestion, which while obviously annoying, also entails a large economic cost (in terms of lost man hours for the workforce, additional costs of transporting goods, etc.). Traffic jams in cities such as São Paulo, Lima, and Bogotá are legendary. In fact many senior Brazilian business executives hop from meeting to meeting in helicopters rather than face the unpredictable traffic Geographical patterns of São obstacles toward Paulo, which may improving be the only city in infrastructure are substantial. the world where the total amount of traffic congestion, known as lentidao, is almost continuously broadcast on the news and in elevator videos, and can sometimes total into the hundreds of kilometers. 6 While traffic congestion is a symptom of a growing middle class, with access to credit, stable jobs and hence the ability to purchase autos, it is also a result of insufficient public investment in infrastructure and a major detriment to economic productivity in urban areas. Clearly the pace of construction of bridges, subway lines, and highways in a city such as São Paulo has not been sufficient to keep pace with population growth, economic vibrance in recent years, and the number of autos on the road. Beyond the topic of economic costs related to the absence of urban infrastructure, one can also observe the consequences of poor connectivity within countries. Colombia faces massive geographical obstacles, as within its borders there are Andean mountain ranges, dense jungle, and ultimately coastline with the Pacific and Atlantic. For example, it takes 3-4 hours for an item that arrives at Buenaventura port to reach Cali, even though the distance is just 78 miles. Driving from Medellin to Bogotá, the country s two largest, cities separated by 274 miles, takes approximately six hours. In other words, road quality is highly inadequate; decades of internal conflict with the FARC and other guerrilla movements have made it unfeasible to develop much of the country s national transport infrastructure but as the security situation has stabilized, capital is flowing into this area. When economists explain the recent subpar performance of Colombia s manufacturing sector, among the reasons cited along with the appreciation of the peso is that transport infrastructure is inadequate and this inadequacy is highly detrimental to the competitiveness of industry. On the positive side, however, a city such as Barranquilla has seen substantial development in recent years as the city s last two mayors have emphasized infrastructure investment, focused on public roads, facilitating transport, and encouraging trade promotion. The challenges that Peru faces in terms of improving its infrastructure are massive, due in part to the vast socioeconomic divide that exists between the coast and the more remote jungles and sierra regions. Given that nearly half the country s GDP is concentrated in the metropolitan area of Lima, the quality of the country s infrastructure is weighted toward the capital and its immediate surroundings. Similar to Colombia, Peru s geography presents a major obstacle to connecting disparate regions of the country while it also faced security issues in prior decades (namely from the Sendero Luminoso, i.e., Shining Path movement), which made development of large-scale projects in certain parts of the country unfeasible. 6 On November 14, 2013, a record of 309 km in total traffic congestion occurred in São Paulo, as Paulistas headed out of town for a three day weekend. so-paulo-tem-lentido-recorde-com-309-km-de-filas.html Page 5

6 The Challenges country by country Brazil Ask any Brazilian economist what is most needed to raise the country s potential GDP growth, and improved infrastructure ranks high on the list of responses. In short, Brazil has invested well short of what is necessary to update and modernize its physical infrastructure, and this has created important bottlenecks that affect all major sectors of the economy. Domestic demand has been strong for years, and combined with incentives provided by the government, has led to a massive surge in car ownership. Yet as any visitor to São Paulo or Rio can attest, traffic congestion has worsened dramatically because the pace of urban infrastructure development, i.e., roads and subways, has not kept pace with the population growth and increased number of cars on the road. Meanwhile as Brazil has become an export powerhouse in recent years, the port capacity has also not kept pace with this growth. Given the large geography of the country, in the best of times it would be a challenge to link the various regions of the country by rail and highway; but, as demand for agricultural products from the hinterland has soared, exporters have encountered greater challenges moving their goods to market. Perhaps the most instructive example of infrastructure deficiencies relates to mining giant Vale, which actually built its own railroad in the northeast region of Brazil to move its iron ore to port rather than relying on government to do so. In a nutshell, for Brazil to burst through the low GDP growth equilibrium that it now experiences, infrastructure improvement is the number one priority; a massive program to improve roads, ports and so on would lift potential GDP, remove bottlenecks, lower the custo Brazil and also reduce inflation. The Financial Times recently published a survey describing some of the challenges that Brazil faces regarding infrastructure. 7 Below are some telling figures and statistics from this report and other sources: The asset stock of Brazil s infrastructure is equal to 16% of GDP versus the global average of 70%, according to a McKinsey study. On an annual basis, Brazil invests just 2% of its GDP in infrastructure which, according to Credit Suisse economists, is half the amount needed to sustain 4% annual GDP growth. In comparison, China invests 13% of GDP in infrastructure, Colombia 6%, and India 5%. São Paulo has a population 40% For years, Brazil s greater than investment in London yet its infrastructure has been inadequate, metro has 1/6 the a prime cause of capacity of that in GDP growth below the UK capital. the regional average On average it in recent years. takes a container ship 21 days to clear Santos port in São Paulo state; in comparison, according to global shipping company Maersk, in Rotterdam it takes just two days. Over the last decade, annual light vehicle sales rose by 2.5x, yet the number of paved roads increased by just half. It is estimated that Brazil has double the dependence on road transport that the United States does, due to its inadequate railroad infrastructure. In fact President Dilma Rousseff, when recently officiating at a railway project in Mato Grosso, stated that Brazil was two centuries behind with regard to building rail networks September 9, September 9, Page 6

7 As the economy has expanded and developed over the past decade, the government has recognized the inadequacy of the current infrastructure. In 2007, the Lula administration launched PAC (Programa de Aceleracao de Crescimento), a program with a four-year budget through 2010 equivalent to R$650 bn. The Rousseff administration followed up with PAC 2, a R$965 bn plan, of which over 1/3 has already been invested. However, according to the Financial Times survey, just R$33 bn of PAC 2 has gone into infrastructure, with a greater focus on energy and housing. Since the initiation of the first PAC program, only R$101 bn has been dedicated to infrastructure, a reflection of the government s inability to properly execute investment plans related to infrastructure. More recently, the government has moved forward with a program intended to allow greater involvement of the private sector in infrastructure development. Its R$133 bn intended concessions program is meant to construct 7,500 km of toll roads and 12,000 km of railroads. Other tenders will also include light rail and bus lines. There have been examples of success so far via the auctions of participation in various airports. In The current 2012, majority stakes administration has in airports in São had some recent Paulo, Campinas, and successes, especially Brasilia were sold the privatization of to private operators several airports. who assumed shares from Infraero. These auctions raised R$24.5 billion in 2012, attracting prominent international bidders. More recently, on November 22nd, control of Rio s international airport and Belo Horizonte s were successfully auctioned. Singapore s Changi Airport Group, which operates, according to some surveys, the highest quality airport in the world in Singapore, paid R$19 billion, (for a 51% stake) or four times the minimum bid, for Rio s Galeao Airport. 9 The Aerobrasil group formed by Brazilian construction company CCR and the operators of the Zurich and Munich airports paid almost R$2 billion for Belo Horizonte s Confins airport, or double the minimum bid for the 30 year concession. 10 One issue that the government has faced with regards to the auction of highway concessions relates to allowing adequate rates of return; to attract private investment, the government faces a tug of war between keeping tariffs low on toll roads and allowing the private sector an ample internal rate of return. One auction in fact attracted no bidders since the government did not allow an IRR deemed sufficient by potentially interested parties. For Brazil to make inroads will require involvement of the private sector and improved implementation from the notoriously bureaucratic public sector. The current PT government has had, at times, a less than amicable relationship with parts of the private sector; but there are signs that the current Administration is looking to provide adequate incentives to encourage more privatesector involvement in infrastructure development. Delays are natural for these types of projects. But on the positive side, as Itau's economic team writes: There is no shortage of investment opportunities. In addition to large sports events such as the World Cup and the Olympic Games, there is the need for infrastructure updates and crude oil exploration in pre-salt fields. Favorable dynamics in government debt create room for increases in public investment. Additionally, equilibrium interest rates are lower than in the past. Hence, investments (as a share of GDP) should increase to about 20% of GDP and the expansion in the 9 The Economist, Taking off at last: Some serious private money for airports and roads, November 30, November 25, Page 7

8 capital stock will likely be the main driver of growth in the next few years. peru Peru s economy has been the region s fastest growing over the last decade, among major economies, despite not due to its infrastructure. A sampling of figures provides some information which highlights the urgency of the matter: According to national statistics agency INEI, 88% of homes in rural zones lack adequate sanitation. Over half of rural homes lack access to clean water. The country s estimated infrastructure needs between amount to US$88 billion, over 1/3 of annual GDP. While for the budget for infrastructure grew 17% on an annualized basis, the country has a history of inefficient execution of public investment. Notably 36% (total of 69 bn soles) of the resources intended for public investment projects between were never utilized according to the Ministry of Economy and Finance. Along with a lack of financial resources until recently, Apoyo Consultoria, a local economic consulting firm, also notes lack of human capital to carry out projects, and inadequate rules and regulations to attract capital. Apoyo recommends that the state moves from providing infrastructure to becoming a purchaser and regulator of infrastructure services while also following the PPP model. 11 However, there are some signs of improvement, as Peru has a long list of infrastructure projects in its pipeline. Apoyo Consultoria provides a list of 17 major projects nine highways, four ports, one airport, and two railroads that are either in phases of construction or on which construction is expected to be initiated within the next couple of years. The total investment required is over US$12 billion for these projects. They include electric trains in Lima that would presumably alleviate congestion in the capital, docks at Callao port near Lima, which would facilitate the transport of minerals, and a Peru s economy has number of highways been fast-growing, that would penetrate despite major the less accessible bottlenecks related regions of the to subpar ports and roads. country. From a real estate perspective, improved capacity at the port of Callao can result in substantial demand for warehouse space and logistics. Over the time period, public investment in infrastructure is estimated to total over US$43 billion, equal to 20% of annual GDP; this compares to US$27 billion in the prior four years. Peru s improving economic track record should help it attract more foreign capital for infrastructure projects under its PPP framework. The country s senior economic officials have held numerous roadshows throughout Europe, the US, and Asia, in recent months, in a bid to further deepen relations with institutional investors. While there are questions about the ability of public officials to carry out these projects, the overall macro backdrop and business environment in Peru looks to be supportive of the attempts to attract private capital into infrastructure projects. Colombia Colombia faces major geographic obstacles to improving its infrastructure. For years, the interior of the country faced security issues, causing the country s major cities to lack the internal transport links that 11 Apoyo Consultora, Cuatro medidas para incentivar el uso iniciativas privadas confinanciadas, September Page 8

9 exist in most other countries. Meanwhile geographical barriers add to the complexity. Colombian territory includes the Andes mountain range, dense jungle, and inaccessible coastlines. According to a recent survey of the Colombian economy by the Financial Times, Luis Carlos Villegas, the head of the national industry group, likens the infrastructure deficit to a 10%-15% tax on business. While the Colombian The current Santos administration is dedicating increased resources government has been investing only 0.6% of GDP in transport and communications, to infrastructure, this percentage is especially roads and rising and the level highways. of execution of infrastructure projects is showing some signs of improvement. According to the Agencia Nacional de Infraestructura, between investment in infrastructure should reach 1.2% of GDP by the public sector alone. While 3 trillion pesos were invested in infrastructure in 2010, it is expected that up to 9 trillion will be dedicated to infrastructure investment this year overall. The country s infrastructure plan focuses first on highways as roads account for 80% of internal transportation in Colombia. According to the Ministry of Transportation, the next generation program to develop highways would add 8,000 km of roads, 1,200 of which would be two-laned. A four-lane road from Bogotá to Buenaventura, which will cost US$4 bn is a highlight of this plan. Another top priority is connecting Medellin directly to Pacific and Caribbean ports. As these highways are constructed, the government estimates a 1%-2% direct and indirect influence on GDP over the rest of the decade, with potential growth likely to increase from 4.6% currently to 5.3% by 2024 as a result. 12 With the improved highway network, according to official sources, the estimated time to transport items from Bogotá to Medellin would be reduced by 28%, while from Bogotá to Cali there would be a 27% improvement, 26% from Cartagena to Bogotá, and 33% from Cali to Cartagena. 13 Vehicle transport costs between cities would fall between 16%-30%. Currently the government is looking to move forward with these concessions in the next few months. Aside from the planned improvements to roads, there are also expectations that the country s minimal railroad system will be expanded. The government s plan includes railroads from Bogotá to the Caribbean coast, theoretically linking the economic center of the country with the main ports serving the United States at Barranquilla and Santa Marta (and a function of the accompanying free trade agreement between the two countries). Overall the government aims to invest US$100 bn in infrastructure by 2021, and as Luis Fernando Andrade, director of Agencia Nacional de Infraestructura says, Nowhere else in the world is there such an ambitious program. 14 Fortunately as the security situation improves, the government can divert resources away from defense toward more productive uses such as capital projects. In addition, there is a focus on improving the infrastructure along the country s rivers. Semama magazine recently described plans to invest 2.1 trillion pesos, or around US$1.1 billion in new ports along the Magdalena River, Colombia s most important, as well as on maintenance of canals and on dredging of them. River transport in Colombia can be a more efficient method of transporting 12 At a seminar around the IMF meetings in Washington in October 2013, Finance Minister Mauricio Cardenas also mentioned that potential GDP for Colombia could increase by 0.7% per annum if certain infrastructure projects were realized. 13 The aforementioned FT survey quotes a truck driver who states that the 410 km between Bogotá and Cali can take 14 hours, on one of the better routes provides information on the country s infrastructure plans. Page 9

10 goods, given the aforementioned challenges that the country s geography presents. Semana reports that it costs US$3,200 to move a container from the center of the country to the Atlantic ports, but just US$1,800 if transported by the Magdalena River. A concession will be auctioned, via a PPP format with the national government, local governments, and state oil firm Ecopetrol to make these improvements. Investment in ports is also a prime focus for the Caribbean coastal cities of Cartagena, Santa Marta, and Barranquilla, thanks to the emergence of the free trade agreement with the United States. For example, the port capacity at Cartagena is expected to double by 2017, to move 5 million containers per year, thanks to expansion plans. Investors in the industrial space are already expressing growing demand for warehouses to attend to this increase port capacity. Additionally, the government is looking to privatize assets as a way of financing infrastructure development. In the first half of 2014, the government intends to sell-off its participation in utility firm Isagen, which is expected to raise US$2.6 billion. The proceeds of the sale would then be transferred to the National Fund for Infrastructure Development (FONDES), a vehicle which can then spend the proceeds on infrastructure without negatively impacting the central government s fiscal position. 15 Eventually funds raised from potential sales of the government s stake in Ecopetrol could also fund FONDES. According to a recent Global Source report, FONDES will become a crucial vehicle to support the success of the upcoming wave of road infrastructure projects to be developed through public-private partnerships, better known as the 4G program ; the main goal of the 4G initiative is to give Colombia a set of strategic highways through which trucks will be able to travel at a speed of at least 60 km/h. On top of funding from FONDES, private capital will be invested alongside, via debt and equity, from the firms that win bidding processes, as part of a PPP model. Final thoughts and impact on the real estate market For Latin American economies to increase their level of productivity and potential GDP growth, lifting the quality and quantity of infrastructure is a necessity. Inadequate infrastructure has become a political issue too, as the recent protests in Brazil showed. The next half decade will be crucial as governments have drawn up proposals for improving infrastructure; whether private sector concessionaires will provide the capital remains to be seen. Furthermore, efficient public administration Positive strides are is mandatory for these being made, but investments take projects to be carried years to mature and out in a timely and impact economic transparent manner. outcomes. There is a long path ahead. Logistics costs as a percentage of GDP for the region dwarf those in other major economies: for Peru 32%, Brazil 26%, Colombia 23%, Mexico 20%, and Chile 18% compared to 10% for the United States and 9% in the OECD. The upside for the region is that if even semi-adequate infrastructure can be established, the potential returns over the long run can be huge in economic terms. Despite the mixed outlook on infrastructure, there are impressive achievements occurring. For example, Rio de Janeiro s landscape is changing, in anticipation of the World Cup and Olympics. Specifically, the city accounts for over R$2 billion of funds earmarked for urban transport from the government s credit line for World Cup 15 Escobar, Andres and Veronica Navas. Global Source Partners Monthly Report. Boring Race, Known Outcomes. Section titled Selling assets to build new ones, December 2, Financial Times, Rio s Olympic deadline forces transport upgrades, September 10, Page 10

11 transport projects. 16 The state government is investing R$8.5 billion to double the capacity of underground rail that connects Barra, which will host the Olympic village, with the rest of the city. The city of Rio has dedicated another R$5.6 billion to an express bus system which will connect disparate areas such as the Galeao airport with Barra and Santa Cruz. In Lima, the city government is also in the midst of an ambitious infrastructure development plan. One new metro line is slated to be completed in 2014, with other additions to Metro Linea 2 scheduled for Additionally, the city Infrastructure has embarked on the improvements can construction of five literally change the new lines of electric face of certain cities trains, totaling 130 and shift trends of demand for real estate km of track, according to certain areas. to Consorcio Tren Eletronico. 17 A number of new highways are under construction, many under the PPP format, intended to ease the city s notorious congestion as estimates show that the number of autos in the Lima metro area will reach 1 million by 2017, double the level of One major project is the Via Parque Rimac requiring US$700 million dollars of investment connecting the port area of Callao with Javier Prado, one of the major thoroughfares in the central city. While the track record of infrastructure improvements in Latin America is poor, and skeptics can point to years of failed attempts to improve roads, ports, airports, etc., the next half decade will be particularly telling, to determine if the region s major economies reverse years of disappointment in this area. One can point to a number of ways to measure infrastructure improvements, ranging from increased public investment to GDP, growing capacity of airports, larger percentages of paved roads versus total roads, more kilometers of rail lines, and increased numbers of subway lines. For the real estate investor in Latin America, closing the infrastructure deficit has important ramifications both macro and micro. On the macro side, clearly if infrastructure improvements are realized, potential GDP growth will increase. Substantial improvements to these countries capital stock would raise potential GDP by 1% per year according to the estimates of various economists. Higher GDP of course means more productive businesses, more demand for labor, additional job creation, and higher standards of living; these all positively impact real estate demand. Since these countries are starting from a low base, even marginal improvements to infrastructure can have outsized benefits for economic activity and hence demand for real estate. Improved business competitiveness and productivity, all things equal, should boost real wages. On the micro side, greater connectivity within cities would also result. Better urban transport can enable people to live further away from their jobs. For example, in São Paulo there is great demand for finance professionals to live near Faria Lima, the financial district. If there was a better urban transport network, this could allow finance professionals to live further away and hence the trends of demand for real estate could shift as a result. Urban plans and zoning could be potentially adjusted, and the idea of suburbs would develop further. If urban infrastructure could be improved, we would expect lower price differentials between locations with proximity to the central business district and more dispersed locations. For example in São Paulo, prices of residences near the central business district can command prices 2x-3x those located 10 kilometers away due to the massive challenges of public transport and 17 Apoyo Consultoria, Inversiones en Transporte en Lima, December Page 11

12 traffic. The same phenomenon occurs in Lima where prices in San Isidro and Miraflores have appreciated dramatically, in direct correlation with the increase in traffic congestion in that city. Thus far, these urban agglomerations have centered around the business and financial centers and extended outward; aside from Santiago and Buenos Aires, where public transport is generally better than the rest of the region, we have yet to see true suburbs emerge in major Latin American urban areas. In the United States, we see that cities with good urban connectivity tend to exhibit smaller price gaps between central business locations and suburbs. This is not to suggest that all suburbs of a city such as New York exhibit prices similar to Manhattan. But for example, Greenwich, CT which has a train that connects professionals to Grand Central Station in New York in under 45 minutes has an average home price of $1.1 million (versus $1.6 million for an average dwelling in Manhattan). 18 Vienna, VA is connected to Washington DC by that city s metro line. The average home in Vienna sells for $865,000, compared to $480,000 in the nation s capital, and $1.2 million in Georgetown, the ritziest neighborhood of Washington. If infrastructure remains sub-standard, we can also identify some impacts. As mentioned, traffic congestion in major Latin American capitals is a major urban issue, due in part to inadequate highways, roads, and public transportation. If we see continued inability to improve subways, roads, and other urban transport, there will be even stronger demand from urban professionals to live near their places of work, especially in a city such as São Paulo. As mentioned above, those who work in the financial center of Faria Lima tend to prefer to live near their office, to avoid long commute times. This has pushed up the value of property in neighborhoods with close proximity to Faria Lima. Indeed homes in the southwest region of the city, near the financial and business districts of Faria Lima, Avenida Paulista, and Berrini tend to be priced 40%-50% above the city s average, partially for their proximity to the workplace, and this trend could be exacerbated further if urban transport is not improved enough to meet demand. We see similar trends emerging in cities such as Bogotá and Lima; prices in higher end areas such as Rosales in Bogotá and San Isidro in Lima have outperformed the city average thanks to their close proximity to the central business districts in each city; if infrastructure constraints are aggravated we would expect this gap to widen. Another trend that has evolved in São Paulo is the increased demand for microapartments, as young, urban professionals sacrifice space these units are typically square meters for the ability to walk to work, hence Given poor avoiding extremely standards of urban transport, residents long commute of certain cities pay times. A series of large premiums for microapartments proximity to offices. has emerged near the Avenida Paulista business center. Lack of infrastructure, and the resulting traffic congestion, also impact zoning regulations. In São Paulo, specifically, the current mayor has pushed in the direction of fewer high density projects that are not in close proximity to public transport. Furthermore, as new transport nodes are being developed over time, the city s urban plan will allow for higher density projects that are near these points. Consequently, there may be fewer new developments in the future in areas without immediate access to public transportation, while more supply can be expected in zones that are located near 18 Based on figures provided by Zillow.com. Page 12

13 subways, bus lines, and other transportation. This concept has been implemented in a number of cities across the globe, such as Los Angeles, where new high density development zones are placed around transport hubs. Table 4: Planned infrastructure improvements to Rio de Janeiro Transport mode From/to % of work complete cost (R$ mn) budget executed (R$ mn) Trans Oeste BRT (express bus) Jardim Oceanico / Santa Cruz Trans Carioca BRT (express bus) Barra / Deodoro 70 1, Trans Olimpica BRT (express bus) Int'l Airport / Ipanema 0.5 1, Trans Brasil BRT (express bus) Santos Dumont Airport / Santa Cruz 0 1,500 0 VLT Light rail Downtown area 0 1,164 0 Line 4 Metro Connects to line 1 at Ipanema 32 8,500 2,600 Source: Rio Negocios, Rio Municipal Secretary. Rio Page 13