Private investment fuels Mexico construction growth

As the constitutional reforms passed in 2013 start to have an impact on the Mexican economy, construction activity is poised to grow. In recent years many of the most relevant sectors have been characterised by a cautious approach, caused primarily by preoccupations with the last presidential elections as well as the anticipation of regulatory changes across the board. That said, the energy, telecoms and homebuilding sectors are showing a return to a positive investment dynamic. This is reflected through expansion of construction activity in several key areas, such as transport and energy infrastructure, but also in a strong showing of urban building for commercial and housing purposes.

Economic Role

Construction remains a key component of the Mexican economy. In 2014 it was the fourth-most-important sector after manufacturing, commerce and real estate services, and accounted for 8.1% of GDP, according to the Mexican Chamber of Construction (Cámara Mexicana de la Industria de Construcción, CMIC). It also plays an increasingly important role in creating employment. In 2014 the sector was directly responsible for generating 6m jobs and an additional 3m indirectly. This makes it the second-most-important activity in the country in terms of employment after agriculture, and it accounted for 13% of the workforce in February 2015. Besides its contribution to economic growth and job creation, construction activity has a key exponential effect on several other sectors: for each MXN100 ($6.73) spent on construction, MXN45 ($3.03) is earmarked for the acquisition of goods and services incorporated within its value chain. There are currently 18,000 construction companies operating in the country, including domestic and international firms, according to the CMIC.

This has made the sector crucial for growth in Mexico, and an important window into the complex dynamics of the economy. Although the sector expects strong growth in coming years, construction operators are also aware of the potential negative effects of budget cuts. With the price of oil decreasing since mid-2014, the government has announced reductions in spending. Despite limited cancellations of some large-scale transport infrastructure projects, authorities have made it a priority to keep the National Infrastructure Plan 2014-18 on track. Yet some delays linked to a slower release of public funds are expected. The government is also placing greater emphasis on establishing public-private partnerships (PPP) as a way to secure greater financial involvement from the private sector, especially in the case of large transport-oriented infrastructure projects, where private management capabilities and expertise have already proven to be an asset. “The PPP model is the way forward in infrastructure projects, including water, as in all public services-related works, generating savings for private companies already at the bidding process stage,” Hernan Mateus, business development manager of Veolia Mexico, told OBG.

Figures

Total investment in Mexico’s construction sector reached MXN2.2trn ($148.1bn) in 2014, according to the CMIC, of which 75% was accounted for by private investment. The sector has been growing steadily, though its positive cycles have been intertwined with shorter periods of stagnation or recession.

The last negative cycle was in 2013, saddling the sector with a 4.5% drop in activity. This was mostly the result of a slowdown caused by national attention on the presidential election in that year, and to nationwide expectations about changes brought by President Enrique Peña Nieto’s administration to regulations in several key sectors. Negative numbers lasted well into 2014, but as the legislative consequences of important reforms in energy, telecoms and housing became clear, activity surged, and the sector was able to post growth figures of 1.9% by the end of 2014. This was maintained throughout the first semester of 2015, with January to June registering 3.6% growth compared to the first six months of 2014, according to the latest figures by the CMIC. Compound annual growth is expected to reach 3.5% by 2016. “The project pipeline in the construction sector is volatile. This leads to consolidation and stronger competition on price,” Javier Galindo, managing director of contractor Grupo Mazahua, told OBG.

Sector growth patterns over the years have also been influenced by the weight of different segments. In 2014 total sector GDP reached MXN1.3trn ($87.5bn). Of this, 43.8% came from building activity, involving housing as well as offices and other real estate developments. The second-largest segment was transport infrastructure, which accounted for 26.1% of sector GDP in 2014. Construction for hydrocarbons extraction and transport activities constituted the third-largest component, accounting for 10.1% of sector GDP. Construction activity is expected to continue along an upwards trend, driven by significant volumes of private investment going into real estate development in the capital and other cities, and the current government’s aim to implement its ambitious National Infrastructure Plan for the 2014-18 period, valued at MXN7.7trn ($518.2bn).

“Although macroeconomic issues such as a currency depreciation might impact expectations in the short term, public spending on social programmes and increasing private sector interest generated by the reforms are sustaining the market rebound,” Anthony Turner, Latin America regional director at Schindler, told OBG.

Budget Cuts

While public spending has a big role in the sector, especially considering the large-scale infrastructure programme that the authorities are implementing, sector representatives are also expecting that any cuts in government expenditure will be compensated for by increases in private sector investment.

“During the Vicente Fox and Felipe Calderón years, the sector was highly dependent on public financing. This has changed since Mexico started to open strategic areas to investment, meaning that construction activity is today more dependent on the private sector,” José Antonio Hernández Balbuena, manager for economy and financing at the CMIC, told OBG. According to figures released by the chamber, only 25% of annual investment in the construction sector is public.

According to early 2015 calculations by the CMIC, the government expects to cut MXN124bn ($8.35bn) from the 2015 budget, which will involve an MXN18bn ($1.2bn) cut in investment. This has not translated into a spur of cancellations for infrastructure projects, although two railway projects have been affected. The 250-km Transpeninsular Railway line that was planned for the Yucatán Peninsula has been cancelled due to financial constraints. Predicted to involve both private and public funding, the project was budgeted at a total MXN17.9bn ($1.2bn). The contract to build another major railway project, the MXN59bn ($3.97bn) Mexico City to Querétaro line, was also cancelled.

Yet these examples do not point to a large-scale scrapping of infrastructure plans. It is more likely that projects will suffer execution delays because of a slower disbursement of federal government financing. “There is a slowing down of financing. Instead of the government allocating, say, MXN20m ($1.35m) for a project, it releases MXN15m ($1m), allowing the project to start, and the expenditure to be slightly reduced in the short-term,” Hernández Balbuena told OBG.

Housing

Instability has affected Mexico’s housing policies in recent years, but a change of government direction seems to be putting the segment back on track. Housing activity is a key component of the sector, representing 40% of all real estate construction. Average investment in housing across the country’s 32 states had reached MXN9.2bn ($619.2m) in 2014, according to the CMIC, with the Mexico City Metropolitan Area and the states of Nuevo León, Mexico and Jalisco accounting for the majority of housing investment.

Construction of new homes has been a priority for successive governments. This has been mostly done by a two-way support system, where the government helped homebuyers access low-cost mortgages, while also providing homebuilders with subsidies. However, homebuilders have focused large amounts of capital in acquiring land and constructing homes on the outskirts of Mexico City, which meant homeowners were forced to commute back and forth to the city in order to work or study. This led to many homes being abandoned or remaining unsold, as owners chose to remain closer to the centre, leaving some companies with a considerable number of unmarketable assets. Some homebuilders, such as Geo, Urbi and Homex, were consequentially left in dire financial straits.

A switch in policy implemented by the government has seen housing construction return to the central area of Mexico City. “The home developers negotiated with the banks, making the banks part owners of all those home assets that had been abandoned. In turn, the banks now finance the building of new homes in other more sought-after areas of the city, and with the profits of these new homes, the developers pay back the banks,” Hernández Balbuena told OBG.

Authorities are hoping that overhauling housing policies will accelerate construction of new homes across the country (see analysis). Besides positively responding to some of the problems caused by the recent housing sector crisis, the new policy will also help to bring more building efficiency to the housing segment; it will do this by focusing on existing urban areas which already have the infrastructure to provide water and electricity. Mexico’s housing deficit is estimated at 15.3m homes, of which around 3m need to be rebuilt, and the remaining properties are in need of maintenance or extension work. Housing is certain to remain a relevant segment of sector activity, as the Mexican government aims to reduce the deficit by increasing the number of homes per hectare from 92.42 in 2013 to 100 by 2018.

Transport Infrastructure

Besides improving housing developments, the government is keen to enhance transport and logistics operations by investing heavily in road links. Increasing competitiveness by linking ports and manufacturing areas has become critical, especially with foreign direct investment into manufacturing and services set to rise in the near future. The Ministry of Communications and Transportation (Secretaría de Comunicaciones y Transportes, SCT) expects to spend $3.5bn on highway projects in 2015, both for ongoing projects and for new tenders expected to be put out over the year. Some tenders for road projects have nonetheless been delayed due to cuts in the SCT’s budget. Over 2015, transport projects will have to absorb a MXN4.1bn ($275.9m) expenditure reduction, according to the CMIC.

One recently tendered project was the 83-km road section linking Las Varas to Bucerias in Puerto Vallarta, which is set to cost up to MXN7bn ($471.1m). The project was originally suggested by Mexican company Impulsora del Desarollo y el Empleo en América Latina (IDEAL), under the unsolicited bid regime included within the current PPP law. In June 2015, authorities launched a PPP tender for the construction and operation of the La Raza-Indios Verdes-Santa Clara highway overpass in Mexico City, with investment expected to reach $65m.

Improvement projects are also under way in the area of urban transport infrastructure. The MXN5.7bn ($383.6m) construction of Monterrey’s third metro line is already in progress and scheduled to be finalised by the end of 2015. Extension plans for four of the 12 lines of Mexico City’s metro system are also set to be launched during 2015, with the SCT expecting the four projects to cost up to MXN36bn ($2.42bn).

Port expansion has also become a critical way to support the growth in commerce flows. The SCT expects MXN70bn ($4.71bn) to be spent over the current presidential term on a total of 25 projects. Most of the investment, however, will go to expansion projects taking place at the ports of Veracruz, Coatzacoalcos, Lázaro Cárdenas, Tuxpan Mazatlán, Guyamas and Manzanillo.

One of the most important transport projects planned for the near future is the building of Mexico City’s new international airport, with a projected cost of up to $9.2bn. The project is being financed through public debt and passenger charges from the current airport. “The next step will be to tender different parts of the project, such as the runways, terminal and other infrastructure. These tenders are expected by the end of 2015,” Francisco Ibáñez Cortina, lead partner for capital financing and infrastructure projects at PwC Mé xico, told OBG. One challenging aspect of the project relates to the necessary water studies, because of the risks associated with the soil at the new airport’s location. More airport renovation projects might emerge, as the government is considering privatising at least some of the 18 airports that remain under government management through the para-statal Aeropuertos y Servicios Auxiliares (ASA). The move could bring new private investment to a host of regional airports.

Energy

Alongside transport, energy infrastructure has become an important segment for investment. Although oil prices are in the midst of a low-price period, the government expects the industry to continue to play a major role in the national economy over the long term. With sector reforms expected to attract major private investment into oil and gas exploration, authorities are aiming to revamp pipelines, platforms and other vital components of sector infrastructure. Within the country’s National Infrastructure Programme 2014-18, 53% of planned expenditure will go towards the energy sector, expected to total MXN3.9trn ($262.5bn), according to figures reported by the CMIC.

A number of these energy projects have begun to be commissioned. In early 2015 the Spanish firm Abengoa was awarded a tender to build the Central Norte III thermoelectric power plant. It is expected to cost $1.5bn, and under the contract signed with Mexican authorities, the contractor will be responsible for the building and operation of the 925-MW unit for 25 years. Also awarded in early 2015 was the $380m project to build the Chicoasen II hydropower plant, which will have a production capacity of 240 MW. The winning consortium is made up of the Chinese company Sinohydro and Mexico-based Omega Construcciones.

Another recently awarded energy project is the construction of the 615-MW Valle de Mexico II combined-cycle power plant, a project that is expected to cost $425m and be running by late 2017. The winning bid came from a consortium made up of Cobra Instalaciones y Servicios and Initec Energia, both Spanish, and Mexican partner Avanzia Instalaciones.

In May 2015 the Federal Electricity Commission (Comisión Federal de Electricidad, or CFE) announced that the country would spend up to $16.6bn over the coming years. This will primarily be channelled towards sizeable projects, such as six combined-cycle gas power plants, 14 renewable energy projects and 14 planned pipeline projects. Pipeline projects alone will allow for the addition of an extra 1647 km of pipeline networks between 2014 and 2018, according to figures by CFE. The state company is extending its network in order to increase gas commercialisation, linking its distribution network between the state of Chihuahua and Texas, in the US. Investment in the northern natural gas network over the four-year period is planned to reach $2.2bn, through five different pipeline sections.

PPP On The Rise

With such a large-scale infrastructure programme in its sights, the government is hoping for more private sector participation. This will not only reduce the amount of financing needed from the state, but it will also allow for project structuring and execution know-how from private firms. Much of this will be done through the country’s PPP law, which was approved in 2012 and is gradually becoming a central part of infrastructure development efforts in the country. Road construction and operation in particular has benefitted from the application of the PPP model, with several highways in the country now privately operated by consortiums which include foreign partners (see Transport chapter) as well as domestic firms.

Banobras, the state-owned development bank, is an important partner in financing infrastructure projects, accounting for up to 45% of projects currently being developed in Mexico, and with a strong presence in the road sector. “The role of Banobras is vital in the development of infrastructure in Mexico. Besides financing a large amount of projects, it acts as a seal of approval,” Rolando Montero Casillas, CEO at Powercem Mexico, told OBG. Banobras has been encouraging a large number of private firms to adopt the PPP framework as a way to participate in infrastructure development efforts.

Differing types of cooperation agreements between state and private partners are being introduced to renew infrastructure in the energy sector. Under regulations established by the energy reform bill, state energy company Petróleos Mexicanos (PEMEX) has been establishing partnership agreements that allow the company to renovate refineries, pipeline networks and exploration platforms. Under the energy reform rules, and because they are strategic companies, PEMEX and CFE can define their own contracting dispositions and make them more flexible.

Outlook

Construction activity has returned to a period of growth after recovering from the negative impact felt over 2013 and first half of 2014; this trend is in line with the normal economic cycles the sector has witnessed over the past several years.

More importantly, the comeback is also a reflection of a renewed level of confidence, following a more sophisticated understanding of what impact the current reforms being implemented are expected to have on sector trends in both the medium and long term.

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The Report: Mexico 2015

Construction & Real Estate chapter from The Report: Mexico 2015

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