Investing in a Brazilian Favela, a COVID-19 success story

[Aaron B.]

I invest in real estate for fun, but it turns out I am pretty good at it. I have stopped investing in the USA and started investing internationally, but everyone single one of my properties performs. Part luck, part education, part experience, and taking risks.

This is a crazy story of where I broke all the rules and still managed to come out with a good investment. Almost a decade ago I sat next to a guy on an airplane between Texas to California and he told me about his business as a "slum lord". He owned and managed properties ranging from Section 8 housing to project housing in "ghettos" from Compton to Oakland. He told me that they were the best tenants because they always pay their rent on time and they do the maintenance themselves. The reasoning made sense. I decided that one day I would diversify my portfolio with some properties as this guy had. Fast forward to 2018.

Background Context

1. At the time I had bought a property in a favela in Brazil, I had never even been to Brazil
2. I was visiting Rio de Janeiro for the annual Carnaval celebration in 2018 and bought on a whim
3. I had no experience with properties in a Class C or D in the USA, and not abroad
4. I knew very little about investing in Brazil and didn't begin to research until I arrived
5. Within 2-weeks I had spent about $400 with a local attorney to expedite and acquire the necessary tax registration number (CPF) to buy property
6. Favelas are appreciating faster than luxury property in Rio de Janeiro, rent is inflating relatively fast for all property types. This is a result of the economic downturn after the corruption crackdown years ago: Odebrecht corruption scandal,m Petrobras scandal, & Operation Car Wash. These crackdowns have made Brazil safer in many respects. You can watch documentaries/shows on Netflix and YouTube about it.

The Property

1. Cost: 65,000 BRL (for the "best" house in the area)
   Construction: New in 2018
   
2. Class: D (USA approximation) in a favela (sometimes called shantytowns by foreigners)
3. Location: Best area in Maré, Rio de Janeiro, Brazil
4. Monthly Rent (Net): 700 BRL (increasing to 750 BRL for 2020) 
5. Utilities (Monthly): $0
6. Internet (Monthly): $0
7. Maintenance Costs (Annual): $0
8. Annual Property Tax: $0
9. Annual Income Tax: $0
10. Property Management: $0

It considerably beats the 1% Rule since there is no mortgage or cost of ownership. It's pretty ridiculous.

Additional Upside

Favelas are built as stackable housing. They are designed as brick rectangles. Subsequent apartment additions are about half the cost of the initial investment.

For another 30,000 BRL (~$6,200) I can have a second apartment on top of the first one. It would be identical and rent for the same amount in 2020 of 750 BRL. This would considerably boost the return on investment as follows:
Initial investment = 65,000 BRL (750 BRL rent), 2nd story apartment = 30,000 BRL (750 BRL rent). Total Cash Invested = 95,000 BRL; 1,500 BRL monthly rent. 

That pushes the investment up to a 1.5% net monthly return. However, it gets way better. The USD to BRL exchange rate right now is 33% higher than it was in 2018. What that means is my cost to add the additional apartment on top and double the rent only costs me 67% of the construction cost (30,000 BRL) because I am converting USD to BRL right now in this economic downturn of COVID-19. That changes my investment numbers to the following: 20,100 BRL to double the rent for a total cash investment of 86,000 BRL equivalent, with a 1,500 BRL/month rent. That brings the investment up to a 1.7% net monthly return from mid-2020 onwards. 

In terms of dollars, we are talking about <$24,000 invested for a 2-story apartment that is earning a net monthly rent of $300. Now compare that to many of the investments in the United States in Class A-C properties where $24,000 is invested as a downpayment, and if it is a good deal it may earn $300/month net. My investment risk was relatively small in terms of dollars, but risky in a foreign that I knew little about and had nobody or lessons to learn from. It worked out in my favor. I don't know if I'd invest there because I believe in heavy diversification. I have invested in other countries in totally different property types, but those deserve their posts.

Lessons Learned

I chose this favela because it was one of the safest and has clean water. It is a calm neighborhood with relatively lower levels of crime compared to other favelas.

There is no concept of property management at all. Tenants must take care of everything, this is the culture and community way. The house has had several bad roof leaks during heavy rain and the tenant simply tells me about it, but then they pay to have it fixed. The tenant had one attempted break-in and had to replace the broken door and windows, but the robbery failed. Again, no action required on my part, no concept of home insurance. Tenants take care of their homes and take pride in them because they are hard to acquire. Favela tenants tend to stay for life, which is amazing. Once you find that good family tenant, they aren't going anywhere.

I had a property manager at first that I paid about $10/month for the first few months, however, I realized I didn't need them anymore once I had recognized the tenant could handle the property (i.e. the attempted break-in and roof leaks) and nothing was required of me. The property manager was a father/son who had their own business in the favela managing properties and had been there for at least 2 generations. Everyone knew them and that was a good thing.

Favelas have a different sense of community, justice, security, ride-sharing, etc. I hung out in the favela before buying the property. I shopped, I ate, I walked, I rode on the back of local motorcycle taxis, in community van transportation with no doors or air conditioning, etc. People don't mess with each other unless they want problems in their community. That being said, it was surprisingly safe.

Being that it is a favela, there are no property taxes or utility costs. The houses are wired up into the power lines and tenants buy their water and collect it in these giant rain buckets. There is no property insurance.

I checked on the tenant today and they informed me they are going to spend 3,000 BRL to upgrade the roof because it keeps leaking during heavy rain. Right now Brazil is experiencing heavy rains and flooding. They got 3 quotes and will take care of it. Awesome!

The purchase process in the favela was an adrenaline-filled adventure, to say the least.

Last but not least, photos!

New construction. Believe it or not, it is the nicest house in the favela. Notice the wires above the front door? That is the free electricity.

The kitchen before being furnished.

The kitchen and living room area looking from the kitchen towards the living room.

The rooftop and clean water system. This is where the second identical apartment is being built, and the water tanks will be moved onto the new rooftop.

The only bathroom. It was a small efficient electric tankless water heater.

The bedroom

The bedroom has enough space to fit a bunk bed for 2 kids + a bed for the mother. There is a large standing close along the left wall but it is out of view.

[Felipe Lois Affini]

Hi @Aaron B., and fellow BP friends,

I am really amazed by your post.

I am from Brazil and, although I have been several times to Rio de Janeiro I don't live there (I'm in São Paulo).

Before I give my thoughts about your investment I would like to give general data about Brazil (and its real estate market):

Yes, it is a great time for foreigners to invest in Brazil. A couple of reasons (some you have mentioned already):

- our currency is under-evaluated (to US dollar). It's due to our (local) recession that came after the impeachment of our former president (Dilma Roussef) and was aggravated by COVID19. Besides that, our stock market faced the biggest loss among stock markets around the world. So all this together led to BRL (Brazilian Real) lost a lot of value.

- After several years of Operation Car Wash (that dismantled one of the largest corruption schemes in history), our legal/compliance system improved a lot. This led to better laws and practices and a safer environment for international investments.

- although we had a huge increase in real estate prices in the last 6 years we still see opportunities in our market. Brazilian Companies lost investment power and US Dollar and Euro are really strong (for now) making foreign capital buy more here.

That said, I would like to ask you some questions that remained unanswered by your posts (or I may have passed through the answers. If I did I'm sorry):

- What type of contract did you sign when you bought this property? 

- It is not clear if you signed a lease agreement with your tenants. Did you?

- I believe you don't have an "Escritura de Compra e Venda" or a "Matrícula de Registro de Imóvel" (translating that to English it would be a formal deed. Here in Brazil we have this figure - Cartório de Registro de Imóveis (it is like a mix of a public notary with a title company. It´s a delegation of public power to a person that is, then, responsible for the register, maintenance and any modification of real estate transaction records. You cannot chose the one you want. It´s determined by the location of the property). Do you have one of these documents?

About investing in favelas: 

For me, this wouldn't be my first option due to the risks involved. Mainly because, legally, you probably don't own this real estate you paid for (your answers for the questions above could determine that). 

Favela are a risk due, too, the existence of 3 figures (all heavily armed and - imagine that - not trustful): The Police, The Militia and the Drug Cartels (this last fighting each other now and then). The pacification was heavily applied (and advertised) from 2013 on because of World Cup (2014) and the Olympic Games (2016). During the largest event in the year - Carnival - that is special operations in place to maintain the city as safe as possible (it includes non-aggression deals between police and drug cartels). It´s true that the situation is better than 5-10 years ago but this is a problem not solved yet. 

So that is a very unstable situation because all 3 parts in this equation want to see their power prevail. This often led to conflicts (you can go to youtube or google to see how it goes).

So as you already invested and are getting paid (and I really agree in the part you say that is reliable and honest people that live there because they have no option) I would recommend you to be extra careful and keep track of this first investment and the local situation before jumping in other deals.

These are just my thoughts and the most important: If I can help you in any way (Legal or non-legal question) just let me know.