Expansion in Mexico's retail space indicates a healthy market

In 2017 Mexico saw record occupancy in real estate. Despite uncertainty surrounding the potential renegotiation of the North American Free Trade Agreement (NAFTA), import duties imposed by the US in May 2018 and the new presidential administration, the sector is expected to remain strong. Competitiveness as a manufacturing hub and job growth are fuelling a hike in demand for residential properties and retail space. The latter segment has benefitted from 30% growth in sales since 2015, a trend expected to continue over the coming years as demand swells due to population growth, enabled by increased purchasing power and easier access to credit for consumers.

Sector Background

Mexico moved to 10th place on the list of the world’s most populous countries in 2016, overtaking Japan. Among the nine countries with larger populations than Mexico, only the US and Brazil have a similar combination of human development and demographic structure that can generate comparable business opportunities, according to a report by US-based real estate firm Cushman & Wakefield.

The residential housing market continues to grow with the expanding population, but is doing so at a slightly slower pace after a period of turbulence in 2013, when the country’s three largest housing developers collapsed. Subsidies on housing developers and buyers in the affordable housing segment in certain outlying areas of Mexico City contributed to this. Although land values were lower in those locations, the long commuting times and lack of services – including, in some cases, delays in connecting water and electricity – meant many units remained unsold. Policies have changed, with new units built closer to the urban centre and greater emphasis on fully serviced apartment blocks.

Deficit

Although the Ministry for Rural, Territorial and Urban Development reports that the housing deficit was reduced by 30% over the 2012-17 period, demand continues to significantly outpace supply. The distribution of housing styles has shifted since 2012, with the proportion of residential property found in high-rise buildings increasing from 3% that year to 35% in 2017. While housing stock rose by 43% between 2000 and 2014 – the most recent year for which government figures were available – the housing deficit in absolute terms remained stable, at 9.7m units over this period. This translated to a decline, from 37% to 29%, in the housing deficit as a share of total housing stock, demonstrating progress towards addressing this need.

As the government makes headway in this regard, opportunities for successful residential development could come from growth in the industrial and retail segments. The industrial segment, for example, saw record occupancy rates of more than 95% in 2016, and not only in the traditional urban and manufacturing centres. Increased investment in manufacturing is expected to boost demand for industrial and logistics properties, while the subsequent job creation from the expanding manufacturing sector – the main driver of the domestic economy – could also fuel demand for housing. Meanwhile, dozens of major shopping centres slated to open over the 2018-20 period.

Residential

Two key agencies work to support homeowners and address the housing deficit. The state-owned National Workers’ Housing Fund Institute (Instituto del Fondo Nacional de la Vivienda para los Trabajadores, INFONAVIT) is the country’s main mortgage provider. Employers make contributions to INFONAVIT on behalf of their employees, who can use the funds as a down payment on a home.

The Mexican Housing Commission (Comisión Nacional de Vivienda, CONAVI) also runs a subsidised programme known as Esta es Tu Casa (“This is Your Home”) that helps citizens pay a deposit on a new residence and carry out repairs on their homes. However, in the light of fiscal austerity measures imposed after 2015, funds for some of these programmes have been cut.

In March 2018 CONAVI announced changes to its home-buying subsidy programme for low-income families of employees registered with INFONAVIT. Subsidies will now be available for employees earning less than MXN6860 ($371) per month, with the maximum subsidy for house purchases raised from MXN80,300 ($4340) to MXN85,800 ($4640). Meanwhile, the maximum subsidy for house construction has been increased from MXN66,600 ($3600) to MXN71,100 ($3840). The upper bound for house prices qualifying for a subsidy is MXN465,500 ($25,200). In addition, employees either unaffiliated with INFONAVIT or without a social security plan can apply for housing subsidies if they earn less than MXN12,250 ($662) per month. CONAVI also pledged that all new houses will feature energy-saving technology, such as efficient insulation, low-consumption light bulbs and water-saving devices.

While residential construction remains strongest in metropolitan areas and close to manufacturing centres, housing developments in other cities are increasingly attracting investment. “Tijuana, Mérida and Aguascalientes have seen growth in new housing construction, while the expansion of the housing market is spurring investment in retail complexes as consumer demand grows,” Jesús Ramón Orozco de la Fuente, director-general of real estate appraisal firm Tinsa, told OBG.

The average price of houses with guaranteed mortgages increased by 7.37% year-on-year in the last quarter of 2017, according to the federal mortgage society, Sociedad Hipotecaria Federal. The full-year growth for 2017 was somewhat lower, at 6.11%, and the average price for a house that year was MXN756,000 ($40,900).

This rise in prices took place despite decelerating GDP growth of 1.8% during the fourth quarter of 2017. For the full year, the inflation rate was 6.77%, and mortgage rates increased by 0.13 percentage points to around 11%. The purchase price of existing – as opposed to new – property also registered a 6.08% upturn to MXN756,000 ($40,900), and these accounted for 48.1% of all property purchases, a 5.7 percentage point increase over 2016. However, the 2017 earthquakes are projected to see house purchases decline by 25% in the near term, according to real estate portal Lamudi. The earthquakes have also caused a shift in awareness among homebuyers, with prices in some of the worst-hit areas expected to ease as demand cools.

Retail

Some 50 shopping centres are expected to open across Mexico in 2018, adding 1.8m sq metres to domestic retail space. Among these are five malls in Mexico City, one of which – the 1.1m sq metre Parque Antenas – will include a fairground. Such growth is a sign of the continuing trend of shopping centres being seen as recreational centres. “This pattern is also partly the result of sustained insecurity in various Mexican states,” Carlos Pantoja, leading partner in construction, hotels and real estate at Deloitte in Mexico City, told OBG. “Such issues have led to an increase in mall attendance, as such complexes are considered a safe space for shoppers and families to spend their leisure time.”

Pantoja also highlighted that there is a retail real estate boom occurring in 25 Mexican cities as the country attracts international brands. Part of the draw is the cost of operating, with the average price per sq metre of domestic retail space 10 times less than in the US. While growth of retail space is expected to continue as a result of these competitive prices, some cities will likely see market saturation eventually.

Furthermore, retail growth is likely to remain robust outside of major urban areas. “Mexico is a country with many out-of-town shopping centres,” Eugenio Garza, CEO of car park operator Central Estacionamiento, told OBG. “The majority of the population does not look to shop in the centre of large cities, because they are not easy to access.” This tendency also means that a substantial market for car park operation can be tapped. “For all shopping malls, the construction of a car park with sufficient capacity is vital to ensure current and future demand,” Garza continued. “Thankfully in Mexico City, this is now legislated for, obliging developers of all buildings to take it into account.”

Expanding Market

The year 2018 is set to see twice as much new retail space delivered in Mexico City as in 2017, according to local consultancy firm MAC Arquitectos. Thor Urbana is a Mexico City-based real estate investor and developer actively engaged in developing nearly 1m sq metres in six cities, with three shopping centres and one hotel slated to open in 2018. The company raised MXN2.5bn ($135m) in February 2018 through the issue of development capital certificates and structured equity securities from trust funds on the Mexican Stock Exchange, which it plans to channel into retail, mixed-use and hotel developments.

With current retail space totalling 19.5 sq metres per 1000 inhabitants, compared to more than 10 times that amount in the US, according to JLL, a US-based real estate brokerage firm, there is significant scope for such expansion. Another factor driving domestic shopping centre construction is the relatively low penetration rate of e-commerce compared to other, more mature markets. This is due to lower bankarisation and credit card usage, coupled with a distrust of both online purchases and their secure delivery.

Industrial

The fundamentals of the industrial segment are sound: demand has been very strong, outpacing supply, with record-high occupation rates of more than 95% in 2016 and early 2017, although performance is cyclical. Areas with the largest land scarcity – like Mexico City and Tijuana, where industrial occupation is around 97% – have the highest relative demand. While this rate is somewhat lower, at 92%, in rural areas like Ciudad Juárez and Monterrey, this has not been a cause for concern for many stakeholders, who perceive security as the main impediment to further growth.

“The reforms carried out during the Enrique Peña Nieto administration have been successful, which could lead to great transformations. However, we will not see those benefits until the medium term,” Luis Gutiérrez Guajardo, president of real estate investment trust Prologis Latin America, told OBG. “One of the challenges facing the new government is to increase security. Rising expenses to mitigate insecurity lead to elevated costs for companies operating in Mexico, which reduces their competitiveness. There was uncertainty regarding the 2018 Mexican presidential elections, but the market is healthy.” While the election of US President Donald Trump provoked uncertainty and a pause in the supply pipeline in some areas, that appears to have dissipated.

Sez Development

In what could be another fillip for the industrial real estate segment, in the first quarter of 2018 Mexico’s Federal Authority for the Development of Special Economic Zones (Autoridad Federal para el Desarrollo de las Zonas Económicas Especiales, AFDZEE) announced the approval of seven special economic zones (SEZs) coming into operation in 2018. The zones are located in the states of Chiapas; Veracruz, close to the Pacific port of Lázaro Cárdenas; Michoacán, near the port of Salina Cruz; Oaxaca; Campeche; Hidalgo; Tabasco; and Yucatán. These zones will focus on petrochemicals, agro-industry, manufacturing, energy and technological innovation, and the automotive sector. The creation of the SEZs responds to increasing investor interest, with AFDZEE having received $6.5bn in expressions of interest since applications were opened at the beginning of 2018. This is spurred by incentives, including tax breaks, stimulus funding and a special Customs regime, with the temporary import of foreign goods used for productive economic activities exempt from trade duties for the first five years of operations.

Regionally, the Bajío, the automotive manufacturing centre, has seen industrial real estate growth outpace the 6% sector average. This area is especially oriented towards receiving new entrants, Pantoja told OBG. However, this concentration of industry and manufacturing in clusters – such as in Querétaro, Jalisco and Baja California, where growth is also strong – means that some regions, such as the south-east and Yucatán peninsula, remain outside the growth trend.

This is also due to Mexico focusing on expansion of existing infrastructure, such as ports, Gerardo Gutiérrez Candiani, director of the AFDZEE, told OBG. SEZs focus on established, sustainable foundations rather than aiming to transplant growth, bolstering the existing economies of those regions. Their expansion is based on a 20- to 30-year vision of infrastructure development. “The zones will develop the natural vocations of each area, increasing the attractiveness of Mexico as an investment destination” Gutiérrez Candiani said.

Office

As a result of the earthquakes in September 2017, Mexico City’s office segment saw a significant shift from class-B to class-A properties – the latter being the highest-quality buildings in a given market area. This was also a consequence of increasing pressure on companies to provide improved workplaces with not only innovative technology and design, but also greater security, representatives of CBRE México told local press in October 2017.

While the quakes caused office rental and sales instability, they also fuelled demand for more luxury workspaces by up to 40% in the months following the disasters, the Mexican Chamber of Construction (Cámara Mexicana de la Industria de la Construcción, CMIC) told local press in 2018. Demand increased by 30-40% for office space in the Santa Fé, Reforma, Insurgentes Sur corridor and Periférico Lomas areas. Meanwhile, Insurgentes Centro and Condesa, two areas in close proximity that suffered major damage in the earthquakes, saw office demand ease. The CMIC estimated that around 30% of the more than 3m buildings damaged in the city were zoned as office space.

Despite the destruction and spurred by demand for better-quality space, 2017 saw positive sector indicators, and the capital city’s office market remains stable, according to Cushman & Wakefield’s fourth quarter 2017 report, with the vacancy rate down 20 basis points year-on-year to 10.5%, even with more than 300,000 sq metres of office space added. The city’s central business district experienced healthy absorption, to 6.1% above the average over the 2013-17 period.

Developers continue to trust in the potential expansion of demand, with 1.3m sq metres in the construction pipeline at the end of 2017, according to Cushman & Wakefield. This is 7.5% below the average over the 2013-17 period, as developers take note of a possible short-run moderation in tenant activity and curb their offer expansion. Regardless of a gloomier start-of-year outlook, when general elections were looming, Mexico’s fundamentals are those of an expanding market with solid demographics and a sustained improvement in governance. The higher-risk, higher-return equation is likely to reward, according to Cushman & Wakefield.

For Monterrey, the country’s second-largest city, corporate prospects are bright, with an expanding construction pipeline – particularly of mixed-use developments – and an increase in office-based employment driving growth in the number of transactions, taking advantage of competitive rents. “Office demand across Mexico has been buoyed as a result of a shift among employees from agriculture to services,” Pantoja told OBG. “Meanwhile, factors such as the energy reform – which is working to boost economic growth by ending the 75-year-long state monopoly over the hydrocarbons sector – are bringing new companies to Mexico. These are setting up shop close to oil and gas, and electricity generation, facilities, fuelling office demand.”

Tourism

Tourism is also seeing solid growth: the country had 39.3m arrivals in 2017, up from 35.1m in 2016, according to the Ministry of Tourism. At 7.1% in 2017, the sector’s contribution to GDP was the highest in the Americas and double the OECD average, according to the World Travel & Tourism Council. Investment in hotels has traditionally been strong, making it a robust part of the real estate portfolio, and 2017 saw an increase in hotel investment in Riviera Maya, Nuevo Vallarta and Los Cabos, with the latter expecting five hotel openings adding around 4700 rooms by 2021.

However, growing tourism arrivals highlight the need for an increase in supporting infrastructure, representing an opportunity for investors. “There is a need for more investment in transport infrastructure, but the coming years should also see an increase in construction spending and the entry of new players,” Pantoja told OBG. While the government has taken significant steps to attract more tourists, security will need to be a top priority for the new administration, leading to an improvement in the country’s image abroad as a safe destination, for both tourists and investors.

Uncertainty

The year 2017 had ups and downs for real estate: investor uncertainty arose, provoked by US President Donald Trump’s decision to renegotiate NAFTA and the resulting barriers to trade, and the outcome of the July 1 presidential elections. Despite this, industry players remain optimistic regarding sector performance in the medium term as resolutions to these issues begin to come into view.

However, 2018 may see a brief pause in real estate investment as developers await clarity regarding the new government’s plans, according to De la Fuente. “It’s a year of challenges, but nobody is talking about a crisis,” he told OBG. “There is a strong retail real estate market that has been robust for several years. This is the result of not only local capital, but also strong support of foreign investors. Unless there is a catastrophic event, we don’t see investment being affected.”

He also highlighted growing interest in banks to enter the market for mortgage and credit for construction programmes. Although inflation and the cost of credit have risen, Mexico has not seen a dramatic reduction in investment – another sign of the sector’s resilience. The probability is high that housing policy will be changed by the new government, but De la Fuente warned against overreactions by investors and other market players. “Mexico must stop entering into panic mode at the end of every presidential administration. The market is mature enough for that now,” he told OBG.

Government efforts to create a reliable regulatory framework could help assuage investors’ fears. “Mexico’s regulatory framework can often be a burden for foreign investors new to the market,” Alan Cruz Porchini, director of federal real estate administration at the government’s real estate entity, the Institute of Administration and Evaluation of National Assets, told OBG. “It is important that it maintains streamlining as a top priority, whether it be in rights of way, permission or the simplification of land registry procedures. Furthermore, many government entities have been adopting a one-stop-shop initiative, which allows for more flexible business activities, as well as better market access for both local and foreign investors.”

Outlook

Somewhat slower economic growth and reduced housing demand in areas most acutely affected by the 2017 earthquakes could pose some challenges for real estate, but certain segments are set to drive further expansion. In particular, with substantial increases in retail space and tourism anticipated in the near term, the opening of new SEZs and continued high demand for office space, real estate is set to remain a robust contributor to the economy.

The expanding population is also driving continued growth in housing demand, as the housing shortage remains above 25%. These factors are all solid indicators of a market that is far from saturated, demonstrating substantial opportunities for investment and growth.

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The Report: Mexico 2018

Construction & Real Estate chapter from The Report: Mexico 2018

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