If Selic goes up, how much can real estate funds suffer?


Hello, welcome to our Sunday chat about Aposentadoria FIRE® (Financial Independence, Retire Early).

Has the 2% Selic numbered days?

This is a question that is heard (despite the social distance) at lunch tables throughout Faria Lima.

There are good arguments for both sides, but I am interested in a second derivative of this discussion: the impacts on real estate funds.

If it goes up, how big is the scolding?

From the start…

2020 is the official year of the “impossible” in the financial markets.

We hit the post in March, and we almost had three circuit breakers on the same day (saved by the Federal Reserve in the 45th minute).

We have seen oil futures contracts being traded below zero, with losses of 300% from pre-pandemic levels.

Many professional investors didn’t even know it was possible.

Now, we have the Selic Treasury being marked to the market at a discount, that is, presenting negative daily profitability.

The last time this happened, as my colleague Ana Westphalen found out, was 18 years ago.

Elaboration: Empiricus

This discount from the Selic Treasury has a raison d’être: with the ratio between Brazilian debt and GDP hitting 100%, the Selic at 2% per year does not offer an adequate return to investors, given the high level of risk.

For this reason, the market started to “demand” the premium, buying post-fixed bonds only at a discount, given the Central Bank’s insistence on not offering longer bonds (at higher rates).

And speaking of the longer titles …

I wanted to join this discussion because I have seen a lot of misinformation about real estate funds.

They are umbilically linked to interest, that is true. But it is necessary to be very calm when proclaiming its end if the Selic rises again soon.

The higher the interest rates, the less attractive the FIIs’ rental income (its yield) will be.

It is always a relative question.

But, today’s Selic is not the right variable for you to put these two investments into perspective.

This happens due to the following: since real estate funds are real assets and their profitability comes mainly from rental contracts, it has a “duration” (yes, in quotes).

In other words: the real estate fund is more like a medium-term government bond, plus a risk premium, than the Treasury Selic.

This happens because – in a slab fund, for example – the contracts are indexed to inflation and have a term generally of 5 years.

In addition, even though the renewal of rental contracts is not guaranteed, we do not usually zero out a property’s cash flows at the end of the contract; we always assume its longevity, at average values, a kind of “optimal” vacancy level in the long run.

Therefore, what interests us when we think about the battle between Selic and FIIs, is the longer interest, with maturity in 5, or even 10 years, depending on the profile and type of assets of the real estate fund.

And how are short and medium-term interest rates peaking?

If the Central Bank was successful in lowering the Selic rate by 2% per year, at historic lows, that same success did not materialize to the same degree for longer maturities.

In the chart below, I compile the last three years of history of Brazilian future interest, one year ahead and five years ahead.

Source: Koyfin

Today, the market prices interest at practically 3% per year in 12 months (blue line), and about 6.36% in 5 years (yellow line).

Also notice how the distance between the blue and yellow lines has been increasing since the beginning of 2020.

In other words, while the BC managed to drop short-term interest rates, the market did not accept the terms for the medium term, fearful of the huge range of fiscal risks that lie ahead.

As the interest rates that matter when looking at real estate funds are those of medium and long term, it seems to me that FIIs today have a much better risk and return ratio than short fixed-rate bonds, maturing in 2022 and 2023, for example.

And here, I speak both of government bonds and of their alternatives in the private market, like CDBs of medium-sized banks.

Of course, the FIIs will suffer if the interest curve is steep, but this impact tends to be better absorbed (read as “less suffering”) in medium-term maturities than in short-term ones.

In addition, if we have a stronger fiscal adjustment in 2021 capable of flattening the difference between short and medium-term interest rates, FIIs tend to benefit a lot.

I consider real estate funds to be an excellent asset class. One of the important pieces to achieve your early retirement is to choose sources of income generation. No wonder, we made a selection of three real estate funds for members of the Empiricus FIRE®. I leave here the way for you to release your free tasting for seven days, without obligation.


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