Investors return as crime levels drop

As crime levels fall and property becomes more institutional, Mexico is again attracting investors. Stephanie Schwartz-Driver reports

One key factor in the growing popularity of Mexican real estate is undoubtedly the launch of Fibras, an investment vehicle similar to a real estate investment trust (REIT). Fibras offer certificates that operate like shares on the Mexican stock exchange. Like REITs, Fibras pay out 95% of their taxable income as dividends to their shareholders. Since Fibras were launched, they have managed to raise more than $4.6bn (€3.5bn) from domestic and international investors – around half the funds sourced from overseas, according to estimates.

Fibras were launched in 2011, but the first, Fibra Uno, had the space to itself until late 2012. The value of its certificates has gone up nearly 130% since it debuted on the stock market. However, it has become more crowded as Fibra Uno has been joined by Fibra Hotel, Fibra Macquarie, Fibra Inn, Terrafina and, most recently, Fibra Shop, which debuted on the stock exchange at the end of July. Fibra Hotel and Fibra Inn focus on the hospitality sector; Fibras Macquarie and Terrafina focus on industrial; Fibra Shop focuses on commercial and infrastructure investment; and Fibra Uno is diversified.

Fibras are not the only real estate–related issues on the stock exchange. There are also CKD certificates, which function much like tradable private equity certificates. There are some 30 CKDs trading on the stock exchange. As a result, there has been around $5bn in issuance overall through Fibras and CKDs.

“This is a huge amount of liquidity,” says Onay Payne, director at Clarion Partners.
Fibras have been a mixed blessing to institutional real estate investors. On the plus side, they have improved transparency in the market, according to Palmer Letzerich, managing director, Hines. “You are able to get your hands on comp data for the first time ever, although it is still from a high-level perspective,” he says. “You still need to dig down to attain quality and detail from the information.”

But Fibras have had a wider impact by bringing more competition – and cap rate compression – to the market. Between 2010 and 2013, cap rates have dropped by around 300bps. “The Fibras are very aggressive acquirers, and they have made some impressive acquisitions,” says Letzerich.

Payne says: “It means there is more competition for deals. As a seller, it’s great; as a buyer it’s more of a challenge. But the strong liquidity in the market means that there is a much more well-defined exit than there was even four or five years ago, for those of us with stabilised product.”

Letzerich adds: “From a development standpoint, we really like the market. It is hard to buy against the Fibras, and as they continue to acquire and international investors return to the market, Mexico still shows upside from a development perspective.”

Beyond the growth of Fibras, the domestic story gets even more compelling. Mexican pension funds are also growing fast. Representing around $165bn in assets at the end of the first quarter of 2013, they have been growing by 15-20% over the past few years. They were not able to invest in real estate, private equity or infrastructure prior to 2007, but now the amounts they can invest are going up as guidelines become more comprehensive.

“They have been a huge source of demand,” Payne says, pointing out that they are estimated to have around $25bn in total capital to invest in real estate as of March 2013 – and they have only invested a small portion of that, around $6-7bn.

Letzerich agrees: ‘The pension funds have gone from zero to 60 in short order, and they are still under-allocated to real estate now that they can invest in alternatives. They have done a great job getting their teams up to speed and they are major drivers in the market.”

At the same time, there is continued international demand for investment in Mexico: 50-70% of Fibra issuance is going to non-Mexican investors, apart from direct investment opportunities.

“The market has become increasingly accessible for foreign as well as domestic investors along with the rise of Fibras and the growth of the CKD market,” says Robert Merck, senior managing director at MetLife Real Estate Investors. “As these financial instruments continue to increase market liquidity, institutional real estate investors will likely look to add even more Mexico real estate exposure.”

Battling a troubled reputation
International investors have long been put off by Mexico’s high crime rate. Drug-related violence has resulted in more than 70,000 deaths since 2007, and much of the violence has been in northern Mexico, where much of the country’s industrial development is located. However, governmental strategies to control drug violence appears to be working. According to figures compiled by the Economist magazine, the murder rate is about 25% lower now than it was at its peak.

“Crime gave Mexico a bad reputation,” says Joseph Sitt of Thor Equities, one of the few private-equity real-estate firms active in Mexico. “It’s not that investors lost money.”
Sitt explains why he decided to invest there: “Our success on three continents is down to running countercyclical, with an overlay of growth. Around nine years ago, we saw Mexico as a great emerging market with a lot of plusses. It’s on the US border so it tends to be a beneficiary of the US economy; labour prices were competitive especially as China’s were going up; it has a lot of energy resources, even though they have not been managed well; and a lot of my own investors thought I was crazy to go there.”

Thor Equities quickly took a strong position in the marketplace, according to Sitt. “It has been easy to find deals but harder to find funding. Now our biggest challenge is convincing global institutions to back us so we can execute everything in our pipeline,” he says. “We need to convince investors that Mexico is not as bad as everyone thinks it is.”

This is definitely taking place already, according to Hines’s Letzerich. “We have seen a significant uptick in our international partners’ interest. For investors looking for emerging markets exposure in the western hemisphere, most are looking at Mexico or Brazil, since Colombia is still nascent, Peru is not as well-developed from a real estate perspective, and Chile is hard to get scale,” he says. “We are also still seeing a premium on yield for Mexico versus the US, where cap rates are 5-6%, and investors like that. The trick is the currency, but investors are more comfortable with where the currency is and are taking advantage of shorter-term, lower-cost hedging strategies that match near-term cash flows.”

Merck says: “Mexico has represented a good opportunity for some time. In fact, the country is increasingly becoming a strategic part of institutional real estate investment portfolios. There are already many large and sophisticated global payers in the market, and the number is still rising.”

The economic case for investment in Mexico is certainly attractive. Mexico bounced back healthily from the recession, and the outlook over the next five years is positive, according to Oxford Economics, with 4.2% forecast GDP growth from 2013 to 2017, higher than the average of 3% achieved from 2003 to 2008. Mexico’s growth is projected to outpace Brazil’s.

At the same time, the new government of Enrique Pena Nieto has made great progress in its economic reform agenda. “They have put forth a number of pro-business reforms,” says Payne, opening the telecoms monopoly and focusing on education and labour reforms, and promising a continued crackdown on drug-related violence.

With Mexican labour costs comparing favourably to China’s — Mexico is in fact projected to be cheaper than China when adjusted for productivity — the economic picture is bright.

“This all suggests that you will see manufacturing returning to Mexico,” says Payne, “and we are already seeing that in the automotive sector,” where a huge investment in Mexico by carmakers, including Honda, Mazda, and Audi, is already underway. “From an investment perspective, this is very positive, since they will have real estate needs, as will their suppliers.”

The industrial sector is providing a major source of investment opportunities now. Not only are the automobile and avionics industries growing, but an increase in domestic demand, thanks to the growing middle class, is creating demand for logistics. In response, Hines has been looking at distribution to urban centres as well as light industrial, says Letzerich.
Merck adds: “The industrial real estate story in Mexico is very interesting. The Mexico City industrial market is expected to continue to perform well as the city’s local economy improves. At the same time, northern and central markets will benefit from growing investment in maquiladoras (industrial properties operating in free-trade zones). International industrial tenants have been increasing their demand for space in Mexico in response to the improving US economy and rising labour costs in Asia.”

The burgeoning international presence is creating another interesting opportunity, in Merck’s view. “The influx of international firms in Mexico City is driving demand for modern office space and supporting investment in projects aimed at replacing some of the older properties in the main office areas of the city,” he says.

Hines has also noted demand for CBD office. “We are seeing a lot of office absorption,” Letzerich says.

At the same time, demographics and the growth of the Mexican middle class is creating demand for office space. “The growth of the Mexican middle class is a continuing story,” adds Letzerich. “We see this manifesting itself through the growth of financial services and insurance companies, which is driving office demand. As such, we have a value-office programme that is targeting large tenants that need to consolidate in major markets.
Retail remains a growth sector. “The retail sector in urban, close-in suburbs, and resort locations across the country is attractive because of Mexico’s rapidly expanding middle class,” says Merck.

While Clarion is also making industrial plays along the border and in central Mexico, the firm is additionally focused on middle-class retail, which makes up about half its portfolio.
“We have focused more so on non-discretionary spending, with a hypermarket anchor, for example, rather than the traditional US-style mall, which has a different risk profile,” says Payne. Further, she notes: “For the past year we’ve been seeing a number of US retailers coming to Mexico, including H&M and Abercrombie and Fitch. From a developer’s perspective, this represents a growing supply of tenants.”

Thor Equities is taking a different tack when it comes to retail, focusing on moderate-to-upscale retail, as well as hotel and office. The company has funded high-end retail in the resort area of Playa del Carmen, in the Quinta Avenida shopping area, as well as upscale retail and mixed use in Mexico City. But, says Sitt, “we are leaning away from pure residential” (although Thor Equities does partner with GFA, the largest residential investor in Mexico).

One area that is getting less attention than it used to is low-to-middle-class residential housing. The share prices of many public homebuilders have tumbled over the past six months, and the government has cut back on its subsidies for housing. This is despite the fact that a significant housing deficit remains, estimated at housing for around nine million people.

Part of the problem has been that subsidised homebuilders had been putting up units on land far from population or employment centres, meaning that new residents had a commute of several hours to their jobs. It is those homebuilders that own excess land in poor locations that have suffered recently, notes Payne. Regional homebuilders with better-located land reserves can still perform well.

The government has decided to focus on developing housing closer to the cities. “There is an increase in vertical development,” says Payne. “There is potential in for-rent housing, which has not been institutionally managed up to now. Apartment developers that understand the apartment business and can adapt to the demands of Mexico may find good opportunities.”

 

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