The end of the era? Real estate trusts give up rent-adjusting firm IGP-M; Know what changes the investor

The index general-market price (IGP-M), traditionally known as “rent inflation”, has lost its prominent place in real estate fund rental contracts. The shift to less volatile indices has been a trend and there are those who are betting that the IGP-M’s days in the real estate market are numbered.

Affected by the rise in commodity prices and the devaluation of the Brazilian real, the IGP-M index has risen sharply in the past two years. The index reached 37% in the 12-month period ending in May 2021. Since then, the index has recorded consecutive declines.

The slowdown in recent months is attributed to the stability of the exchange rate and the reversal of the trend in the prices of large commodities, both agricultural and mineral. The index closed 2021 at 17%, down from 23% the year before, but still above the broad CPI (IPCA).

In light of the sharp rise in the IGP-M, real estate funds are increasingly facing the need to re-discuss the correction index for leases. At least five have dealt with this issue in the past two months.

The loss of IGP-M’s space in rent adjustment does not surprise Andre Braz, coordinator of price indices at Fundação Getulio Vargas (FGV), responsible for the index created in 1989. He also recalls that the index was not developed for indexing contracts from the real estate sector.

“IGP-M began to be used because, at the time, there was not much difference with respect to the IPCA, and at the same time, it was measured by an independent institution,” Braz recalls. “Since then, contracts have been copied and pasted and the index has become a standard in this type of contract.”

In Prause’s view, the strong appreciation of IGP-M during the pandemic should serve as a lesson for economic agencies to rethink what is best for their business.

“What we have to think about is the contract methodology under discussion. The IPCA can be good for a tenant whose income is closely correlated with the index. But is it good for the landlord? That is the question the market will have to answer.

With the word, the market

Brick fund managers, who earn income from renting real estate, and “paper” funds, which invest in inflation-indexed fixed income securities, seem to agree that IGP-M’s time in the real estate industry is coming to an end.

“There was a correlation with the IGP-M coming from the past, from a period of hyperinflation, when real estate was traded in dollars. The IGP-M responds better to exchange rate fluctuations,” explains André Catrocchio, Director of Risk Management and Investor Relations at Hectare Capital.

The market needed an inflation of about 30% to understand that it does not make sense to continue indexing the lease or buy-and-sell contract with IGP-M. Since 2020, we have already noticed a significant change in this scenario. Much of today’s operations are indexed to IPCA – something 90/10

André Catrocchio, Director of Risk Management and Investor Relations at Hectare Capital

Among the funds “Brick”, SP Downtown (SPTW11The index exchange confirmed the rental agreement for a property in Badaró, in downtown São Paulo (SP), leased to Atento, a company in the call center area.

Over the next twelve months, the fund will adopt the IPCA instead of the IGP-M, previously stipulated in the contract. According to a statement from the fund to the market, the IGP-M does not reflect the Brazilian reality.

Negotiations for the change to the correction index included an extension of the property lease term, from 2027 to 2030.

x at the bottom of the Earth properties (TEPP11) followed the same line and announced the change from IGP-M to IPCA in three leases in the São Luiz and Torre Sul buildings, both in São Paulo. The tenants Allpark Empreendimentos, Sertrading and Santander Bank participated in the negotiations.

When will the payment in court end?

In other cases, the indexer has not been exchanged in this friendly manner. One example is the travel and tourism agency Agaxtur, which has requested a change of court.

REC Renda Imobiliária tenant (RECT11) until 2025, the company occupies a property of approximately 2,000 square meters in Jardim América, in São Paulo (SP), and is claiming lease modernization by IPCA, not by IGP-M.

According to the FII, the court rejected the urgent request required in the analysis of the case. The Fund promises to take appropriate action with respect to the action proposed by the Tenant.

Children’s Hospital FII (HCRI11) a similar situation to that of REC Renda Imobiliária. Rede D’OR, the hospital’s tenant, requested in court that the rent be adjusted by the IPC (Consumer Price Index), and not returned by the IGP-M. The court granted, on a provisional basis, Rede D’OR’s request.

While the FII Hospital da Crianca is appealing the initial decision, which set the replacement of the readjustment index, the real estate fund sector promotes the debate on a new index that guarantees, in a more efficient way, the needs of owners and tenants.

“I do not know if the IPCA will be dominant because it does not follow 100% of the dynamics of the real estate market either. But between the two, the IBGE index will definitely prevail,” says Catrukio, who also suggests the possibility of an indicator for the sector, as happens with INCC Civil Construction.

What is changing for the investor?

Thinking long-term, José Navikas, investment analyst at Necton, says maintaining the IGP-M will be more interesting to investors.

If you take time series, IGP-M will be most of the time higher than IPCA

Jose Navicas, Nekton Analyst

However, Navikas points out that the indexer’s exchange isn’t necessarily bad news for shareholders. For him, the cases must be analyzed individually and the investor must be familiar with the counterparts involved in the change.

The Necton analyst cites the example of recent negotiations involving Green Towers (GTWR11), the owner of the 138,000 square meter property that is the administrative headquarters of Banco do Brasil, in Brasilia.

At the request of the financial institution, the fund agreed to negotiate a rent adjustment policy. One of the points offered is the IGP-M exchange at a fixed rate of 11.5% per year.

Among the conditions proposed by the fund for this step are to extend the contract and review the termination fine if the tenant abandons the property. The claim was accepted by Banco do Brasil.

The deal was well received by investors The value of Green Towers shares rose 25% in December, the highest increase in the period.

Predictions for 2022

Recent forecasts of economic indicators ease potential investor concerns about the index exchange that real estate funds have negotiated with their tenants.

Navikas expects “over the next few months we expect interest rate increases to continue and we will really start to see more controlled inflation.” In this way, the impact of inflation rates will not be significant, whatever it may be. We should not expect, for 2022, the rent to rise as much as in previous years.”

The outlook favors “paper” funds that hold securities and receivables indexed at a CDI (Certificate of Deposit Interbank) rate, which take advantage of the high base rate of the national economy, Selic, currently at 9.25% per annum – and according to Nekton could reach 11% by the end of 2022.

In our recommended portfolio of real estate funds, we are already exchanging “fiat” money with more inflation-correlated portfolios for more CDI-correlated portfolios, precisely because we are already seeing the movement of higher interest rates and a cooling of inflation.

Jose Navicas, Nekton Analyst

In the case of IGP-M, the biggest slowdown is planned for exactly this year. According to Braz, the prediction is that in May the index will already be close to 10%, which is a result much closer to the IPCA. The trend is expected to continue throughout 2022 and should define a difference of one percentage point between the indicators.

In terms of forecasts, Braz considers the risks of estimating an index such as the IGP-M, given its sensitivity to weather phenomena, exchange rate fluctuations and international prices. “Especially in an election year that can spur exchange rate fluctuations, thus putting pressure on the IGP-M,” he says.