Ghetto chic for guests at Brazil's World Cup

With the World Cup approaching, Dale Smith made a bet on Rio de Janeiro. The New Zealander purchased a ramshackle building atop a hillside favela, or shantytown, that was only recently reclaimed from drug gangs, and began remodeling it into a boutique hostel set to open in time for the tournament.

Mr. Smith reckons that a surge in hotel demand, and a shortage of supply in Brazil's second-largest city, will send soccer fans to his hilltop hostel. He also hopes that adventurous visitors will seek out an “authentic” Brazilian experience, set inside the shantytown’s maze of alleyways, surrounded by pounding samba beats and a tinge of lawlessness.

“This is a bit more than I would have taken on without these events coming on,” says Smith, standing on the fourth-floor of his building as construction workers hammer around him. “But we know there’s a housing shortage in Rio.”

Rio de Janeiro’s hotels are almost fully booked during the World Cup, projected to attract 600,000 international visitors and 3 million domestic travelers. It is spurring demand for alternatives such as apartment sublets, as well as a rush to open new hotels and hostels ahead of the month-long tournament that starts June 12. The official booking website hotels.fifa.com lists only three Rio hotels with full availability, while Brazilian travel agency Matuete states on its website that “hotels in Rio de Janeiro are sold out.”

This shortage is creating opportunity for investors like Smith to build visitor accommodations or sublet apartment rentals. But as tourism heats up, the demand is also fueling what some call an unsustainable real estate bubble that is displacing locals, whitewashing local culture, and undermines urban planning.

Meeting the climbing demand

Much of the housing demand is due to Rio’s inability to keep pace with a surge in visitors. Between 2009 and 2013, Rio was the world’s 16th fastest-growing destination city for foreign visitors, seeing 59.6 percent growth, according to Mastercard.

“There’s already a culture here of renting out your apartment for New Years Eve and Carnival,” says Georges Ethuin, a Parisian who recently started an informal brokerage firm in Rio. “Renting out short-term is legal here, whereas in New York it’s illegal and in Paris it’s complicated…. You just need authorization from the owner.”

Mr. Ethuin says he gets about 50 rental inquires a day, mainly from foreigners researching prices. The rush for World Cup accommodations is already causing a pricing war in all 12 Brazilian host cities, with hotel rooms jumping up to six times the normal price, according to Brazil’s tourism agency. President Dilma Rousseff set up a committee in October to monitor price gouging. However, apartment sublets fall into a grey area, since they do not technically align with any "fair" market price. 

Rio, which will host the World Cup final, is projected to charge higher prices than in Johannesburg in 2010 or in Berlin in 2006. The city's average hotel room costs $247 per night, according to Brazil’s tourism board, not far behind New York's average asking price of $281. 

Ethuin’s entrepreneurial approach to bridging the housing gap in Rio was to set up his own brokerage for locals to sublet their apartments during the World Cup at mark-ups three to four times their normal rent. He collects a 20 percent commission, the subletter collects several months’ rent, and the renter gets a cheaper deal than staying in one of Rio’s pricey hotels.

Locals are also getting into the swing. Paulo Quindere, a Brazilian real estate agent, says he is renting dozens of sublets during the World Cup, including a five-bedroom oceanfront house in Ipanema at a price of $4,075 per night. The renter is an American socialite, he says. 

On average, apartments in Ipanema will rent for $700 per night during the World Cup, compared to $230 a night normally, according to Ethuin, who has already rented out four apartments for the World Cup and has another 30 sublets pending.

“Most people who come to Rio want to know one thing: How close am I to the beach,” says Ethuin. “They don’t necessarily care about an authentic experience. They want to see the beach.”

'Wild west'

Meanwhile atop Cantagalo favela, Smith aims to please the more adventurous visitor at his nine-room Tiki Hostel.  

His hostel is located near the end of a steep cobblestone street that winds uphill from a starting point only blocks from the famed Ipanema beaches, where land prices are soaring. Smith paid about $50 per square foot, whereas real estate in Ipanema sells for up to $780 per square foot.

Smith says he paid about $100,000 for the four-story building a year ago, and he expects to invest another $200,000 to reinforce the structure, install proper drainage and piping, and add a fifth story and rooftop bar. Smith is employing all locals, including a graffiti artist known as ACME, so that he pumps money directly into the community.

Smith paid a “real estate fee” to the favela association for help in connecting him with the sellers, and agreed to donate about $850 a month to a non-profit rugby development program, which he helped found.

That’s all earned him a lot of goodwill in a battle-scarred community wary of outsiders.

“I was happy for Dale to build here because he has social projects here, he’s invested here,” says Luiz Bezerra do Nascimento, a lifetime resident and the favela president since 2000, adding that he has turned away other potential buyers. “I sometimes tell people it’s not a good fit.”

Mr. Bezerra says the community is changing quickly since a police-enforced pacification in 2009 that pushed out the controlling drug gangs. The government is now providing social services under a $21.4 million investment scheme.

“People who invest here, they’ll make money,” he says. “The new generation doesn’t want to get involved in drugs, that culture is dying.”

New businesses are opening, such as Casa Keleta Construction Materials, which is the sole hardware shop in the favela and a supplier of Smith's cement. “I knew the amount of construction was increasing, I saw it happening,” says Ezequiel Januario, the shop manager of the family company. “Big companies don’t deliver up here, and we can deliver directly to houses.”

Smith admits there are risks to his project. Fast-rising real estate prices have many speculating of a Brazilian housing bubble, among them Robert Schiller, an economist who predicted the collapse of the US housing market. A small gang and drug presence still exists in the favela, where most homes and infrastructure have been built ad-hoc.

“We’re going from a Wild West situation to bringing the community up to speed with sewage, trash, building codes,” he says. “We’re in a grey zone at the moment. I’m trying to do something that would be approved by the city. And from a social point of view, I hope it is something the community would also approve of.”