São Paulo fit-out report - Q2 2018
As Brazil continues to edge out of recession with 2017 growth exceeding expectations, its commercial capital – São Paulo – was the first off-the-line to see the real-estate market stimulated by investment resulting out of controlled inflation, declining interest rates and a stable currency.
2018 should paint a more conservative picture as inventory volume drops and political and economic instability sends cautionary signals into the global marketplace.
2017 market summary
At the close of 2017 the corporate office market boasted a year of constant growth in Brazil and across Latin America. With only Mexico City outgunning São Paulo in any of the recognised indicative metrics. In São Paulo, Q4 saw the fastest growing inventory of all the Latin American capitals, surpassing 4.1m square metres in total, the market remained stable in terms of vacancy and absorption – 20.25% and 44,000m² respectively and over the year net absorption was a shade over 300,000m² again, the highest in LatAm.
At the close of 2017 the corporate office market boasted a year of constant growth in Brazil and across Latin America."
2018 market highlights
Total inventory in São Paulo is expected to increase by a similar volume as in 2017 - around 290,000m² - although there are signs of a slowdown as over half of that inventory was delivered in Q1. Demand appears to be aligned with supply with four of the seven towers delivered in Q1 already leased, according to real estate brokerage firm JLL.
This slow-down is expected to continue into the latter parts of 2018 with only around 56,000m² of inventory expected to be delivered during the coming year.
São Paulo corporate interiors market headlines
The construction market was lukewarm in Q1 as the country continued to come out of recession. Growth and investment have been visible by established multinational clients who have taken advantage of the high-volume of recently delivered AAA inventory and invested in a number of expansion and consolidation projects in the Central Business Districts. Capitalising on attractive rents, associated leasing benefits and perpetuating the ‘buyers’ market. Investors are poised for a shift in Q3 and Q4 as vacancy rates reduce and landlords start to curb discounts and stabilise prices.
Technology companies, investment banking and professional service industries have dominated the landscape, stimulated by ongoing growth in these industries. We have also seen an increase in foreign investment from China and Europe while investment by North American companies remains medium/high and stable.
As the Brazilian currency continues to devalue against the US dollar the São Paulo market begins to look attractive for investors bringing in foreign currency, the longer this trend continues, the more new entrants we could see taking premium rate office space in the city.
Notwithstanding the above, substitute solutions are offsetting the take-up of inventory. The introduction of international companies creating collaborative working environments has given new entrants and start-ups an option to bypass the traditional necessity of investing in fit-out and accelerate their speed to market. So attractive is this model that even established Fortune 500 companies operating in the city are considering this as an viable alternative to expansion or as a way to increase their agility and reduce their risk by housing experimental business units and temporary overspill into the substitute solutions space.
In addition to building costs, location and amenities, companies are paying attention to employee experience and work-life balance with the aim of promoting creativity and raising productivity. This is impacting building choice and design language."
Clients tend to have a shorter term outlook and are slightly more aggressive when they are already established in the country, a more passive cultural influence and historical neglect for enforcing penalties have resulted in an increased appetite for risk. As such, investment in corporate real-estate mirrored the growth trends shown in the economy right up to the end of Q2, 2018 and is only just starting to reduce as clients curb cash reserves, sanction a more conservative level of CAPEX or opt to postpone projects due to uncertainty in the economic and political environment. This slow-down is expected to continue throughout the year.
Market effects on labour
São Paulo is one of the few global commercial capitals to show a small (>6%) surplus in skilled labour.
Labour costs remain lower than the global mean (approximately USD12/hour), but this number is almost double the Latin America average of USD7/hour. Lower labour costs are typical of developing regions and consequently construction sites are often busier and take-up of new technologies and automation by trade contractors is lower. These factors continue to result in inconsistent or reduced quality of workmanship and have a negative effect on the speed and efficiency of execution.
Procurement and construction trends
Tendering conditions have gone from warm at Q4 2017 to cold at Q2 2018 making competition for projects high, reducing cost escalation (4.6% versus 4.1% over the quoted period) and compressing margins. Current data shows contractor preliminaries and margin at 7.3% and 7.4% respectively.
Locally mined and manufactured material prices have remained constant during the first part of 2018 and the value of civil/engineering works contracts are increasing roughly in-line with inflation. The devaluation of the Brazilian Real however has triggered a spike in the cost of imported technological equipment and furniture from the USA as inventory depletes and needs replenishing. In-turn, this is stressing pre-negotiated CAPEX investment and forcing clients to reuse, down-specify and look toward the domestic market for FF&E wherever possible.
Expansion and consolidation projects typically mean an amplified sense of urgency as organisations attempt to mitigate increasingly uncomfortable working conditions caused by growth and overpopulation of offices. 2018 has seen clients table very aggressive deadlines and curtailed project timelines which has resulted in an increase in the adoption of a design & build procurement route, turnkey solutions and single source or negotiated tendering for lower value packages or services.
Risk and forward look
The Presidential election scheduled for October is expected to be the biggest factor putting off potential new entrants investing in Brazil while the devaluation of the Brazilian Real will prolong the trend of established clients postponing projects and suspending real-estate investment unless organisational growth dictates no other option.
On the plus side, this slowdown will play well alongside the drop in delivered inventory predicted for 2019 and should contribute to keeping vacancy levels stable around the 20%/25% mark.
As fewer projects are sanctioned it’s expected that competition will become fiercer and prices or margins will start to come down in an attempt to secure contracts and protect market share.