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Mexico is a sizeable country by many accounts. For starters, it is the largest economy in Latin America – the loosely defined geographic/cultural region that includes all Western Hemisphere countries south of the Rio Grande. Its population recently broke the 100 million mark, and its capital, Mexico City, was a teeming urban centre long before the Spaniards arrived there five centuries ago.
However, people often forget that Mexico is just as much a part of North America as it is Latin America. The country’s economic ties with its neighbors to the north got a boost with the enactment of the North American Free Trade Agreement (NAFTA) in 1994. The agreement, which came amid a national push for greater economic openness, has been an important driver of the liberalisation of the Mexican economy over the past decade.
NAFTA, beyond being a trade agreement, represented a shift in mentality that helped strengthen Mexico’s ties with its more affluent northern neighbours. And though the country’s per capita GDP has yet to reach levels seen in the US and Canada, the agreement has wrought some notable changes. First, Mexico’s economy has decoupled from economies in Central and South America, and today moves more in tandem with that of the US. At the same time, fiscal discipline and low inflation levels have helped the country gain respect among foreign investors, who have poured record amounts of capital into Mexico. Now, foreign companies not only see Mexico as a conveniently located platform for exporting to the NAFTA region, but also as a stable destination for their capital and operations.
Stronger economic fundamentals have not only contributed to growth in foreign investment, but also to greater availability of financing. These were catalysts for the development of the four property sectors discussed in this article.
The transformation of Mexico’s industrial sector began in northern Mexico, where the rapid establishment of export-oriented manufacturing facilities along the Mexico-US border increased significantly after NAFTA. It is true that since the 1960s foreign manufacturers had been drawn to Mexico by low labour costs and its proximity to the US, but the pace of foreign inflows quickened with the advent of NAFTA.
Local and foreign real estate investors, attracted by (mainly) US firms paying rents in US dollars, property quality often on par with that found in more developed markets, and lease contracts with strong guarantees, have been eager to put their money in Mexican industrial properties. These investors initially included private firms only, but the investor landscape grew quickly and now includes institutional investors such as pension funds and US real estate investment trusts.
As opposed to the typical investor seeking a secure asset to anchor its capital through volatile times, the industrial property investor of today is more concerned with liquidity. Income streams are more important than long-term appreciation and the availability of permanent debt at competitive rates has given way to creative financial structures. An increased flow of capital to industrial property markets, added to an overall drop in interest rates, has brought cap rates down. Though the differential between industrial property cap rates in Mexico and those in the US is smaller than ever, higher return expectations for Mexico make Mexican industrial properties an attractive investment.
Mexico’s manufacturing boom of the late 1990s eventually spilled over into other sectors. Office markets, for instance, were influenced both directly and indirectly. Simply put, companies investing in Mexico (now not only in manufacturing, but also in supporting sectors such as financial services and consulting) created the demand for office space. This newfound need for quality office space drove an improvement in the quality of construction, introduced more innovative architecture and produced increasingly competitive infrastructure. In addition, new office sub-markets, particularly in Mexico City, began to emerge with the greater push to develop office properties.
At the same time, wealth created in some booming manufacturing sectors propelled another wave of development as entrepreneurs assembled investment clubs and built office buildings. Here, status played as much of a role as fundamentals. Further, more available financing made leverage possible, thus supporting more development.
The end result is not surprising, given the economic slowdown of the early 2000s in the US and the resulting downturn in Mexico: plummeting demand together with heavy supply caused property values to fall. Since then, however, a drop in new construction activity, the return to economic expansion and the resulting growth in office demand could spell recovery for the oversupply-stricken office market. The question is whether developers will maintain a balance between actual demand and new construction, now that demand is again picking up and players are still by and large high net worth private local investors.

In Mexico, housing is almost exclusively for-sale, as the country still lacks an institutional market necessary to develop rental properties. In addition to the country’s large deficit of new housing, a young and rapidly growing population supports demand. In Mexico’s sprawling cities, housing infrastructure is often owner-constructed and therefore of poor quality. This lack of quality housing supply has opened the door for the country’s major developers which, by producing in volume, provide higher-quality and more affordable homes than the traditionally owner-constructed units.
The missing component in Mexico’s housing market has always been financing (both for construction and mortgages). Yet over the last five years, government-backed large-scale financing programmes have changed the housing landscape. Annual new homes sold with mortgage financing jumped from 280,000 in 2000 to 530,000 in 2004, and are expected to increase further this year. Even so, production of housing in Mexico is still short of potential demand, which is estimated to be in the neighbourhood of 800,000 homes per year.
Large homebuilders have benefited from growth in financing and have taken steps to gain greater access to available financing sources. Six of the country’s main homebuilders have gone public in the last decade, which is noteworthy considering Mexico’s shallow capital markets. Going forward, housing developers hope the main supply drivers will remain in place, to provide the essential fuel for the sector to keep pace with demand.
Favourable economic conditions have had a positive effect on Mexican retail, which is currently experiencing sales growth of more than 10% annually. Financial institutions have recognised this trend and are enlarging their consumer loan portfolios accordingly.
Retail operations in Mexico have a less sophisticated tenant base than that of other property types. Satellite stores in traditional shopping malls have weak financials, and national retail chains are rare. As for anchor tenants, Mexico has a solid list of well-capitalised department stores. This strength, however, comes with a catch for future development – department stores have traditionally monopolised brands and often prevent shopping malls from housing satellite stores they consider to be direct competition.
Demographics, improving income per capita and relatively low retail penetration have gradually attracted institutional investors who are eyeing opportunities to bring new retail formats to Mexico. Interestingly, the growth in retail is also motivating the development of new distribution facilities, thus providing diversification for industrial real estate investors.
Mexico’s real estate investment landscape has visibly changed in the last few years. The rate of change in real estate markets has been dictated by profound transformations in the country, while the binding force behind these advances has been stability. This has affected everything from spurring demand to allowing all kinds of debt financing to flourish.
The market is now in a position to gain access to new sources of capital. New investment may soon arrive from within Mexico’s borders via the recently regulated local version of US real estate investment trusts. Investment also continues to arrive from abroad: global investment funds already hold significant holdings in all of the previously mentioned property sectors, as well as in the country’s hotel sector. From a real estate market perspective, Mexico today resembles more and more its North American neighbours.
Paulo Gomex is director of research for Pramerica REI – Latin America

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