Mexico's dependency on the US makes it vulnerable to a US-led recession while Brazil can fall back on a strong internal market. Yet both countries will benefit from a growing middle class with money to spend. Stephanie Schwartz-Driver looks at the opportunities this will create
The global economic crisis has not left Latin America unscathed, but its effects have been felt differently from country to country. While Mexico has been at a disadvantage because its economy is linked so strongly to that of the US, other countries, such as Brazil, have not felt the impact so dramatically.
As a broad generalisation, it would be fair to say that many Latin American countries are experienced in dealing with economic crises. However, the nature of the 2009 economic downturn is very different from those that have preceded it.
"This is the first recession that we did not create in-house. This is our first import," says Eduardo Guemez, chief executive officer Mexico, LaSalle Investment Management. This is true not only for Mexico but for other Latin American countries, which have been affected in varying degrees by the global recession rather than by any problems intrinsic to their national economies.
As a result, people throughout the region are hoping for a reasonably rapid recovery without traumatic effects on their economies. "Latin America should be better at weathering this crisis than past crises," says Ariel Amavizca, director and head of risk management, Latin America, for JER Partners, based in Mexico City. "We are not at the epicentre this time."
Amavizca points out that many Latin American countries "have successfully implemented structural reforms that have resulted in real democracies, independent central banks, and healthy levels of international reserves." In addition, financial sectors throughout the region are well capitalised and banks have largely maintained their lending under disciplined credit standards. "This has all helped our economies withstand the storm," he says.
However, Mexico's dependence on the US has made it more vulnerable to an international economic downturn that has been led by the US. Around 80% of Mexico's exports go the US, one of the planks of the country's economic recovery.
"There are several reasons why Mexico has been successful since 1995," says Amavizca. "Nearly all our exports go to the US. Our banking system is in the hands of international banks, including those from the US, and all this has helped to reconstruct the economy. But these are also the reasons why Mexico is now in an uncomfortable position."
Amavizca predicts a "very challenging" period from 2009 through 2010 in Mexico. GDP will continue to contract by around 3-4% (premised on a US contraction of around 2-3%) because industrial production is tied strongly to US consumer demand for Mexican products, such as cars and consumer goods. Furthermore, if oil prices do not recover, Mexico will face additional challenges next year and a further devaluation of the peso that will not be replicated throughout the region.
Yet the long-term outlook is positive, says Manuel Zapata, head of strategy and research for Mexico with LaSalle Investment Management: "The main economic thesis over the long term is that the benefits of Mexico will continue to outweigh its difficulties when the recession is over."
Zapata believes the country will retain its strong position within the US manufacturing market. In addition, Mexico has a large need for institutional-grade real estate and still a relative lack of institutional investors, with significant numbers of family groups as active owners. "The recession has changed the dynamic but the thesis will hold true in the medium to long term," he says.
LaSalle closed its first Mexico real estate fund, the LaSalle Mexico fund, at the end of April. The fund raised $298m (€225m), which, with leverage, represents a total buying power of more than $600m. Since the fund's first close in October 2007, nearly $104m has been drawn down.
Something Mexico can look forward to is a growing domestic market. Since the 1990s, the country has seen the development of a real middle class, creating an internal market for Mexican produced goods. Although overshadowed by massive US consumer spending, this market is a glimmer of light, and one that has not been extinguished by the global recession. "We are not seeing the wipeout of the middle class as we have experienced in previous market downturns," says LaSalle's Guemez.
Remittances have helped sustain the domestic market by putting more pesos in the hands of Mexican consumers. Although remittances from the US in particular have slowed, the devaluation of the peso has moderated the effects of this. And while remittances have declined as much as 12% in some months, on average they are down only 4-5%.
The economic impact of the recession has not been uniform throughout the country, Guemez points out. Most industrial markets, where the effects of the recession are felt most strongly, are near the US border. On the other hand, Mexico City, the largest market and home to 20% of the population, is much more driven by the service sector and has therefore felt less impact.
"In the bigger cities the economies are broadly diversified," says Zapata. "There are a lot of investment opportunities in Mexico City, Monterrey, and even Guadalajara."
While LaSalle is looking cautiously and carefully at industrial, the firm sees opportunities in the Mexican residential sector for both lower and middle class buyers. Although sales have slowed, the supply of new homes has declined further than the demand for them, says Zapata.
In addition, prices are stable and increasing with, or a little above, inflation. Credit is available, although the terms are a little tighter. In residential, the impact of the recession is evident regionally, Zapata says. "In manufacturing-based cities, housing sales are down significantly."
JER is also focusing on residential, says Amavizca, particularly on low-income housing, a sector in which he sees positive demographics in the medium to long term. He points out that there is a need for four to five million more homes. On top of this, government-sponsored mortgage programmes and credit for construction to developers combine to create a positive environment for credit in this sector.
Although there is a lack of financing generally for commercial real estate projects, the one exception is grocery and core retail neighbourhood centres, linked to lower and middle income housing developments.
Similarly, although the retail sector has been hit hard by the recession, some big companies, such as Wal-Mart, continue to expand. Guemez at LaSalle points out that it is the smaller retailers, especially ‘mom and pop' type shops, that are at a complete standstill.
In spite of the recession, LaSalle has not implemented a major shift in strategy. Rather, it has become "more opportunistic", Guemez suggests. "We were formerly development-focused, but now we are looking at some acquisitions. And we are clearly on the lookout for distressed seller opportunities that allow us to leverage this specific moment in time."
JER is also on the lookout for distressed deals - either good projects with an inadequate financial structure, which the bank or developer has stopped financing, or good assets owned by an international operator that wants to divest its Mexican portfolio at a discount. In brief, "good assets under distressed situations", says Amavizca.
"The most aggressive bets were in the second-home market, and now most projects in distress are related to second-home projects," he says. "The best opportunities today are ongoing projects with good fundamentals but that are in need of financial support, as opposed to greenfield developments."
Mexico's office market, concentrated in Mexico City, presents the greatest challenge, Amavizca says. "Some office projects, for example, will get absorbed now in twice the time you would have thought," he predicts.
Two categories of distress are unlikely in Mexico. Land is not in distress because no financing was available to buy land. In addition, banks are not in the position of trying to foreclose on highly levered assets. Generally loan-to-value was 50-70% at most on stabilised and core assets and banks did not make aggressive construction loans. Developers were required to put in equity and show significant pre-sales or pre-leasing.
Currently, distressed opportunities across the board seem to be few and far between, says Guemez. "Certain groups are rumoured to have liquidity issues, but they have yet to come to the institutional market," he says. "Groups are trying to hold on, ride out the storm or work with their current investors. They know that all the institutional capital out there is increasing their requirements and looking for bargains."
JER, as befits a pan-regional fund, is looking beyond Mexico for opportunities. "We see Brazil with better opportunities," says Amavizca. "Brazil is a country where we can still do greenfield development." JER is also looking at Peru and Colombia opportunistically, he adds.
JER has had an office in Brazil since May 2008. The company was poised to make its first investment in September 2008 but decided to wait because of economic volatility, says Roberto Perroni, director and head of JER Partners' Brazil office. In Brazil, as in other Latin American countries, JER seeks joint venture partners, and the economic crisis has helped JER to get better terms and conditions with local partners.
In 2006-07, many real estate companies in Brazil went public, promising their investors highly ambitious goals. They started buying up land very quickly, when prices were high. Having spent so much on land, they are now having problems with working capital.
"When we started, the real estate companies were in good health and were very demanding," says Perroni. "Today they are more flexible. Some have 50-80% of residential units pre-sold, and we can get in, with no premium."
Brazil is riding out the global recession with a measure of stability. It is not export-dependent, it benefits from significant internal demand, and inflation is under control. As of February 2009, Brazil had a $2bn positive trade balance. Interest rates are still high, at around 11.25%, leaving the government room to manoeuvre.
The biggest problem Brazil faces is unemployment, which has risen to around 8%. However, some 30,000 new jobs were created in March.
"I'm very optimistic about the economy in Brazil," says Perroni. "In the past, we've had many economic crises here. Companies are very flexible and can alter strategies quickly."
Brazil benefits from a growing middle class. Over the past five years, it is estimated that some 20 million people have moved into the middle class.
This new middle class has spending power. People are shopping in Brazil and buying homes. "We believe this middle class is sustainable," says Perroni.
As a result, the residential sector represents a good opportunity, with inventory in São Paolo lower in 2009 than it was in 2008, and financing still available for those who want to buy. Maximum financing for individuals is around 80%, and the banks have stringent lending criteria and will finance house buying only for living in, and not for investment. In low-income housing there is a shortage of around seven million units. The government is working to resolve this by releasing additional financing as working capital lines to construction companies and reducing the tax on industrial materials.
The retail sector also looks promising. Perroni points out that retail sales were up 6% in January 2009 year on year, despite the economic crisis "Opportunities are good in residential but may be even better in retail." In retail, JER targets cities with populations of between 500,000 and one million, where financing is available from the government development bank.
Even the office sector may offer some opportunities, he says. "The market is still strong." Vacancy rates are around 5%. These are low historically - especially compared with the 20% seen in 2005 - but rising. Although JER is not looking at the office sector currently, because of the rising vacancy rate, Perroni acknowledges that there may be opportunistic possibilities in certain neighbourhoods.
One sector JER avoids is hospitality. "We don't do it," Perroni says. "There is not a good history of selling hotels here, even when they are running with strong occupancy."