Brazil Value Talks: Rodrigo Medeiros (DesmistificandoFII)
Multiplied Invested Capital by 2x in 5 Years
Today I have the pleasure of interviewing Brazilian investor Rodrigo Medeiros.
From January 2019 to July 2024 his historic performance will be the envy of anyone.
His portfolio returned more than 112.74% in the period, versus 40.16% for IFIX.
He multiplied the invested capital by 2x investing in Brazilian Real Estate Investment Trusts (REITs)!
This guy knows how to generate real value.
Shall we meet him?
BS: Rodrigo, could you tell us a little about yourself?
RM: My name is Rodrigo Medeiros, and I have been a securities analyst since 2015, when I launched the first independent research service focused on FIIs (Brazilian REITs). I was a federal civil servant for 20 years and decided to resign in 2022 so that I could dedicate myself fully to my investments and my company.
I started investing in the stock market in 2002 and in FIIs in 2009. I launched DesmistificandoFII as a blog in 2013 with the goal of spreading the word about real estate funds. The opportunity to turn this into a service quickly arose, and so I did.
BS: What is your strategy for making money with FIIs?
RM: FIIs are substitutes for direct investments in real estate or in fixed income linked to real estate, and their gain is closely linked to cash generation over time, which is how you will make money. The strategy is simple: buy FIIs that invest in good assets, preferably when they are discounted.
Since FIIs are traded on the stock exchange, they sometimes trade at discounts, making it possible to buy real estate funds that own good properties for prices that you would not be able to buy the properties themselves. By buying FIIs that own good properties, good income will be the consequence. However, investors often invert this equation, looking first at income and forgetting to look at quality, and at some point the price arrives and they lose money.
Therefore, the main strategy needs to be to buy good assets. If you can combine this with discounted assets that generate a good yield, you will be perfect.
BS: What is the advantage of a FII over a good dividend-paying stock, besides the monthly distribution?
RM: What is the advantage of buying a property and renting it to José to set up the bakery on the corner, instead of becoming José's partner?
When José decides to set up the bakery, his goal is to set up a successful business and have a ROE that justifies paying the rent. But, to do so, he takes the risk of not having a satisfactory ROE, of taking a long time to stabilize his profits, and even of having losses to the point of going bankrupt and losing everything.
If you are the owner of the property, you will receive your rent over time and, who knows, the property may increase in value. You will not take on the risks inherent to entrepreneurship. And, if José goes bankrupt, it's no problem, you will lose a few months' rent, you will have some work, but then you can just put in another tenant, without incurring significant losses in assets.
Now we have expanded the size of the property and Mr. José and we now have FIIs and shares of corporations, both traded on the Stock Exchange, and we can even think about Americanas and shopping mall FIIs.
I think the point is the different risks. In one case, you invest in real estate and in the other in a business. In the first case, the gain is limited, but the loss is limited if the property is chosen appropriately. In the second case, the gain is potentially higher, but the risk is that it will be lower.
But of course, if we think about the advantages, FIIs have rules that require them to make large dividend distributions, consolidating them on a monthly basis. This is great for financial planning, and publicly traded companies in Brazil have not yet woken up to a more frequent and regular payment of dividends, as we sometimes see in the US.
BS: What is your process for finding a new FII buy opportunity? What filters do you use?
RM: Over the years, I have come to understand that the best way to find an opportunity on the stock market, whatever it may be, is by monitoring investments historically. The more details you know about the assets, the more you will understand whether or not they are an investment opportunity in the comparative process. If a drop in the price occurs because the asset is in bad condition, or the market does not understand the asset.
For some types of FIIs, such as receivables and FoFs, after you learn about the quality of the assets and understand which ones are “investable”, one of the most interesting filters is the price over the equity value, given the certain absolute nature that the equity value has for these FIIs.
However, for brick FIIs, this indicator is not the best, and can only be an initial filter to deepen your study, if you are a beginner.
In this class, each type will have a different dynamic. In terms of logistics, you will look a lot at the cap rate generated by the assets, the duration of the contracts, and the diversification of the tenants. For shopping malls, you will look at the cap rate, but also at the history of NOI growth and its future potential. You will also look at a possible moat. For corporate buildings, you will first look at the location and potential improvement in rental values and at what stage of the cycle we are in.
It is certainly not a “game” of setting up a filter and making a choice.
BS: How do you value a FII?
RM: In my opinion, the best way to value a FII is its discounted cash flow, and the discount rate needs to consider the difference in the previous items for each sector. A sector, or a fund, with a greater capacity to pass on inflation to its contracts, needs to have a different discount rate than one that may not have this facility.
BS: How do you like to build your FII portfolio, considering the number of FIIs, sectors and concentration?
RM: I don't have a rule for the number of FIIs. Obviously, you won't set up 70 FIIs and create an IFIX, but the number will depend on the strategy adopted and the size of the FIIs you will invest. Anyone who invests two logistics FIIs with assets above R$1 billion is already well diversified, but anyone who invests two with assets of R$300 million is not and will need more FIIs.
The important thing for me is to have a balance between the sectors as a whole and, in the receivables FIIs section, to have smaller stakes in a larger number of FIIs.
A large part of the profit of the FIIs comes from their cash flow, so having diversification among the various sectors will protect the constancy of this cash flow.
BS: How long do you keep a FII in your portfolio on average?
RM: There is no standard for this. I follow everything that comes out about the FII market every day. If an opportunity to trade arises, it is done. If something arises that poses a future risk that could make me uncomfortable, the asset is removed.
BS: Do you believe that graphical analysis, together with fundamental analysis, can help with buying and selling points for FIIs?
RM: Graphical analysis doesn't make sense for FIIs. I don't like graphical analysis for stocks, even though it was my first step in this universe. But it doesn't make sense for FIIs, because there is no liquidity.
BS: What are your favorite sectors in FIIs? And which ones do you avoid? Why?
RM: I really like the shopping mall and urban income sectors, because of the greater adaptability that these assets have. As I said, FIIs are a substitute for direct real estate investment, that is, earning from rent and the appreciation of the property. To earn from rent, I need to rent, but tenants come and go. Sectors that are important today may not be in the future. Therefore, being adaptable will allow me to better rent my asset, and shopping malls and urban income provide that.
There is no sector that I don't like or avoid. I look at them all. I believe that the most difficult sector to exist in the FII universe is residential. FIIs are very much based on income generation, and the return on residential properties usually comes from the appreciation of the asset and its eventual sale, and this is not something that is part of the investor culture yet.
BS: What is your opinion on single-asset FIIs?
RM: It is a fund like any other, but with a smaller number of properties, or to be more precise, one property. Many people are afraid of single-asset funds, but the problem lies in single-tenant funds. The latter is something you need to be very careful about. A single-asset fund with 70 tenants is not a problem in itself.
In general, single-asset funds are also passive funds. I think these are an excellent diversification option, as they provide a certain level of protection against managerial errors that we cannot foresee, in addition to enabling income growth without being so dependent on reinvestment. However, they are not a fund for every investor. They are among the funds with the highest gains and the highest losses, so investors need to be a little more advanced in their analytical skills.
BS: The vast majority of FIIs with a longer history do not show an increase in net equity over time. Is it worth buying one of these FIIs to receive, say, a 10% per year cap rate net of income tax, in your opinion?
RM: What happened in the last 10 years does not mean what will happen in the next 10 years. I see a lot of confusion on the internet when people look at FII charts comparing the last 10 years and want to plot what will happen in the next 10 years. Since 2014, Brazil's GDP has barely grown and we have been through one of the biggest crises in the real estate sector ever seen. When it seemed like things would improve, the pandemic came along and “knocked the improvement out of the water”.
A FII invests in real estate and, if the real estate has not appreciated, if the rents have not appreciated, there is no way you will have gained net equity within the FIIs. At that moment, many investors will say “oh, but I bought an apartment 3 years ago and made a lot of money”. Of course, but if you asked someone in 2018 who had bought an apartment in 2012, there would be a high probability that this property would have depreciated, or not appreciated at all.
This all occurs due to the real estate market cycle. If you believe that real estate will only be able to generate a cap rate gain of 10% per year in the next 10 years, it doesn't seem to make sense for someone to take out a loan of 8% + IPCA to build a project, as we see happening. This would lead to a reduction in projects and would trigger a series of events that would make the cycle adjust and real estate would appreciate again.
Obviously, the equation is not that simple and linear, but what I mean is that, when investing in a brick FII, your goal is to have the return on investment and seek a return derived from the appreciation of the properties, as we see with some FIIs already selling a new batch of properties with IRR above 15% per year.
Of course, the lack of growth in net assets is not due to this alone, but to several factors, such as inefficient management or extremely active management. Inefficient management pays a lot for real estate, makes bad issues, buys bad properties, etc., which hinders or even reduces the net assets of the funds.
Extremely active management, on the other hand, rotates more properties, seeking new opportunities in the market. The more the assets are rotated, the more constant they will tend to be, due to the rules that permeate FIIs. But of course, there needs to be a compensation with high returns at times.
So, if you compare brick FIIs with investments in similar properties, commercial, logistics and even shopping malls, you will see that it is worth it, as long as you know how to choose and do not enter at times when everyone is euphoric about buying, as we will see again at some point.
BS: How do you see the misalignment of interests that occurs in the vast majority of FIIs, since the managers are not the largest shareholders?
RM: To me, this does not indicate a misalignment of interests. The managers do not need to be the largest shareholders, or even be shareholders, to have or not alignment. The problem is that FIIs are funds, a product of the financial market, and the manager's business depends on the fund growing so that he can earn more money. In recent years, many managers understood that they would earn more money if they grew their funds (and therefore their management company) quickly and then sold the management company. This led to the huge misalignment of interests in several funds.
I thought it was terrible and I made and still make several criticisms. Social networks try to portray FIIs as something miraculous, or the last big thing in the package, and sometimes they try to portray them as the villains. Ultimately, it is all just marketing pieces to sell a product.
I understand that FIIs are excellent options for replacing direct investment in real estate or fixed income (receivables FIIs), but there are many conflicts of interest and many people interested in generating fees for the financial market, and investors need to be aware of this.
Therefore, my suggestion is for investors to be careful. Investing is not as simple as they try to convince you, although it is possible to simplify it.
BS: Why are corporate slab FIIs avoided by many investors?
RM: The crisis of the last 10 years. We entered 2012 with great optimism about Brazil, with many corporate buildings being built, as they would have high demand and rents. However, in 2013, we entered a major crisis in the country, causing our GDP to not grow for many years. A weak economy reduces demand for these properties. With reduced demand and increasing supply, since I can't stop a corporate slab construction in the middle, rents fall and vacancies increase. This lowers the profitability of the funds. In 2019, we believed that there would be an improvement, but the pandemic and home office came along and we had to go back to work.
That's why I believe investors avoid this sector, they look to the past and believe that everything will repeat itself.
BS: What is your opinion on the Plug & Play thesis that has been seen in some corporate slab funds?
RM: The Plug & Play thesis began with Prof. Dr. João da Rocha Lima Júnior in FIIs and has proven to be extremely efficient in reducing vacancy time. Vacancy in real estate means reduced earnings. I have found it excellent, but it needs to be well applied, since furniture has a high level of deterioration over time and the rules of FIIs make it difficult to generate cash to replace it. So far, it has been well applied.
BS: What do you think about hospital and educational FIIs?
RM: We have few FIIs and only a more advanced and diversified investor should consider having funds that rent properties for these sectors. These are sectors that have great legal protection for their lease contracts and this can be a bit of a problem in the long term. There are indeed some opportunities, but they are always more complex funds.
BS: What do you think is the biggest investment opportunity in FIIs today? Could you briefly explain the case?