Building for growth: Infrastructure development will help alleviate switch in homes policy

Despite Mexico’s dynamism and the size of its economy, the country’s construction industry had a difficult year in 2013. After growing 4% in 2011 and 1.9% in 2012, the accumulated losses for the sector during the first nine months of 2013 amounted to a 4.5% reduction in construction activity. An acceleration of government spending before the end of the year allowed the sector to finish with a more modest reduction of 2% in construction activity. The spending also helped establish an encouraging base for growth for 2014.

The homebuilding sector has been the worst affected, and is having to adapt to a switch in governmental strategy. Linked to the failure of the development of single-home residential clusters outside cities is the shift in demand to vertical housing options within urban areas. How successfully this switch is made by Mexican home builders might determine the manner in which the residential segment evolves in the near future.

The construction sector accounted for 7.6% of Mexico’s GDP in 2013, generating 5.7m direct jobs and 2.8m indirect ones, according to figures from the Mexican Chamber of Construction (Cámara Mexicana de la Industria de Construcción, CMIC). The sector accounts for 15.3% of employment. By comparison, agriculture accounted for 17.6% of employment in the country, but its contribution to GDP is much smaller at 3.1%.

A COMBINED EFFORT: Of the total investment in construction, private investment accounted for 69.3%, while the remaining 30.7% of the sector was made up by public investment, according to 2013 figures from the CMIC. Despite the negative consequences of the 2008 global financial crisis on the country’s construction activity, an alternating balance between private and public investment allowed the sector to sustain a certain level of dynamism in difficult years. Overall, public investment in construction in 2008 grew by an impressive 19%; however, private investment in the same year expanded only 1.1%. By 2009, public investment increased only 4.4%, but the participation of private investment in construction activity had decreased by 10.4%. Yet by 2010 and 2011, the dynamics between private and public investment switched, with private investment into the sector rising by 7.3% in 2011, while the public weight in investment in construction fell by 5.3% over the same year. During 2013 the total investment into the construction sector reached MXN2.1trn ($163.2bn), according to the CMIC.

In what has become a recurrent trend in Mexico, the election of President Enrique Peña Nieto led to changes in government structures, prompting delays in public works and a reduction in spending. This correlation has become the norm, with construction growth accelerating sharply during the final year of a presidential term, slowing down close to the transition, and sometimes becoming negative once the new government takes over. According to figures from the CMIC, construction contracted 3%, 3.6% and 6.9%, respectively, during the first three quarters of 2013, only to accelerate again by 2% during the last three months of the year. The sector remains dependent on public works, which represent 90% of the construction industry, according to a 2014 report by BBVA Bank. Although it is expected that activity on public works will increase significantly over 2014 due to a considerable amount of government spending, the housing market is expected to take longer to fully recover.

Today the construction industry is mainly driven by the private sector. The private sector accounted for up to 70% of construction activity in 2013, while the remaining 30% of the sector is accounted for by public works, according to figures from the CMIC. Because of the construction industry’s link to the larger economy, the government has been trying to strengthen the role of the private sector. Much is expected from the government’s plans to spend MXN1.32trn ($102.56bn) on transport and communications infrastructure under the National Infrastructure Plan 2014-18 (Plan Nacional de Infraestructura, PNI). This will include renovating ports and airports, and building new highways, railways and telecoms infrastructure. Meanwhile, accounting for between 3% and 5% of the 2014 total construction expenditure for the country, according to the CMIC, health, education and tourism construction projects include building new primary care units, institutions of higher secondary education in various states, and the development of tourism infrastructure.

HOUSING PLAN: The outlook for the residential sector is less positive, at least in the short term. At 14.3% of all construction activity in Mexico, home building remains the biggest single segment of the construction industry, according to figures from the CMIC. For over a decade, the industry benefitted from federal programmes to increase hip. A combined total of around 5m low-interest mortgages were issued under the presidencies of Vicente Fox Quesada and Felipe Calderón through the National Workers’ Housing Fund Institute. Coupled with other subsidies, the government mortgage programme made home access easier for poorer families. The strategy also included support for home builders to construct individual homes.

“These developers bought large amounts of land to develop. But they bought too far away from the main cities, and discovered that people were not willing to go that far due to the long commute,” Ignacio GilCasares, director of operations at Aguirre Newman, a Spanish real estate consultancy operating in Mexico, told OBG. People started to move away, and by the time Enrique Peña Nieto took office, there were an estimated 300,000 abandoned homes in the country.

As a result, government policy is now focusing on vertical construction to make better use of land closer to urban centres. This switch in housing strategy is driven by demand, but adapting to the new trend might be challenging for some of Mexico’s homebuilders mainly because building apartments complexes requires more available capital than what is needed to build individual units. According to the Inter-American Development Bank, 8.5m homes will be required over the next 12 years if Mexico is to solve its housing shortage. According to the CMIC, $104bn will need to be invested in new homes in the 2014-18 period alone.

The transition to a new housing model remains unresolved and numerous homebuilders have filed for bankruptcy and large developers have defaulted on their debt. The government has agreed to help homebuilders affected by the situation. However, the effects of the crisis in the housing market have put a damper on near-term developments. According to BBVA Bank, “The peaks in real estate building of the past decade was an exception, and the market is now converging at a more stable level, so the construction of new housing will continue to see an adjustment.” More investment has flowed into real estate due to regulatory changes allowing pension funds to direct funds into the real estate sector. “The real estate sector was deeply affected by the 2008 world economic crisis, but the approval of a package of measures by the government which allowed pension funds to invest in infrastructure and commercial real estate projects, has transformed the investment climate in Mexico,” Rodolfo Balmaceda, commercial director of Corporación Inmobiliaria Vesta, told OBG.

INDUSTRIAL: Despite the troubles, the non-residential building sector has managed to expand. Much foreign investment in industrial construction has gone into the auto industry, with several manufacturers expanding operations. Japanese carmaker Honda has started production at its recently built $800m plant in Celaya, and is investing $470m in an additional production unit to make transmissions. Volkswagen Audi also started construction of a new $1.3bn factory in 2013.

In early 2014 Nestlé announced its intention to spend $1bn to build two new factories, and expand an existing cereal processing unit. The investment will include a pet-food factory in Guanajuato and another unit in Jalisco, to produce baby food. Beverage and food manufacturer PepsiCo also plans to expand capacity over the next five years by building new manufacturing lines.

HIGHWAYS: The need to connect new manufacturing investments with import and export markets, as well as improve on existent infrastructure, is pushing construction activity towards the transport sector, which is set to receive MXN1.32bn ($102.5bn) over the 2014-18 period. Some MXN386.3bn ($30bn) of this will go into road renovation and expansion. The second-largest recipient of investment will be the railway network, which is set to receive investment of MXN98.1bn ($7.6bn) for rehabilitation and the building of rail lines, especially for new passenger links. Mexico’s Pacific and Atlantic seaports will also get a revamp, with the total budget for renovation and construction efforts expected to reach MXN62.4bn ($4.8bn). The nation’s airports will get MXN35bn ($2.7bn).

The authorities have announced the modernisation and construction of 5410 km of highways. The Ministry of Transport and Communications has said it will launch $2bn worth of road project tenders during 2014. One of the main roads to start construction in 2014 is the $211m Siglo XXI highway, which will help connect the Pacific coast to the Gulf of Mexico by linking the states of Puebla and Morelos to the Autopista del Sol and the Mexico-to-Veracruz highways.

The project to build the 62-km, four-lane road was awarded in December 2013 to a consortium of Mexican firms Pinfra and Grupo Bursátil Mexicano, and the Spanish construction group Aldesa. Construction of an elevated section of the highway connecting Puebla and Mexico City is set to cost about $1.1bn, according to the CMIC. Also expected to be tendered in 2014 is the expansion of the Jerez-Tlatlengo-Guadalajara highway, at a cost of $1.1bn.

SEA, RAIL & AIR: Additionally, port renovation is set to receive government funding over the coming years. Long under discussion has been a plan to expand the Veracruz port on the Gulf of Mexico, which is likely to start in 2014. The MXN25bn ($1.9bn) project is bound to attract attention from international companies.

Currently under way is the building of a new $900m container terminal in the Lázaro Cárdenas Port, awarded to APM Terminals. At the same time, in the northern state of Sonora, works are ongoing on the MXN7.2bn ($559.4m) modernisation of the Guaymas Port. Also planned are series of investments in the Gulf ports of Matamoros, Tampico and Altamira, where expansion and modernisation work is set to cost some $454m.

Mexico’s railway network will also see construction and renovation projects, with the government announcing in 2013 plans to tender rail projects totalling $7.4bn during 2014. A new $3.3bn passenger train will run the 237 km between Mexico City and Querétaro. Another interurban connection, between Mexico City and Toluca, 47 km away, is expected to cost $2.9bn. Both of these are set to be tendered during the first half of 2014.

The MXN35bn ($2.7bn) set to be invested in airport upgrades does not include the construction of a new airport for Mexico City. The project has been under discussion for some time and was included in former President Calderón’s infrastructure development plans but was never carried out. The government is yet to clarify whether it will be an expansion of the existing airport or a new airport altogether in a different location. It is estimated that the expansion of Mexico City’s Benito Juárez International Airport would cost $5bn.

Recently confirmed was the renovation plan by airport operator ASUR to develop the Veracruz and Cancún airports. A MXN4.9bn (380.7m) investment will expand Cancún airport’s terminal 3 and build a fourth terminal by 2016. The Veracruz airport will receive a total of MXN1.1bn ($85.5m) to double capacity before 2018. Smaller renovation work is also scheduled for airports in Cozumel, Oaxaca, Villahermosa, Mérida and Huatulco, which are also operated by ASUR The nation’s telecommunications infrastructure will also be modernised under the PNI, with MXN700bn ($54.4bn) allocated for the development of telecommunications infrastructure. The plan is to expand network coverage, encourage competition, and ensure that the telecommunications and broadcast reform bill signed into law by the president in June 2013 is implemented in a timely and effective manner.

ENERGY PROJECTS: According to a list of the top 500 industrial and construction projects in the country compiled by the CMIC, state-owned oil and gas company Petróleos Mexicanos (Pemex) accounts for a total of 166. In addition to various offshore and onshore field developments, Pemex is working on pipeline construction projects, in addition to other enterprises.

Plans to build up to 10 nuclear reactors were scrapped in 2011, with the Mexican government focusing instead on the construction of gas-powered thermo-electric plants. The change in strategy was due to a loss of confidence in nuclear power after the Fukushima power plant disaster in 2011. It was then reinforced by natural gas discoveries, prompting Pemex to positively revise the country’s natural gas reserves.

This development, coupled with liberalisation of the sector, which will allow private firms to invest in refineries and pipelines to transport hydrocarbons, enhances the need for new infrastructure.

The planned $10bn bicentennial refinery was announced in 2008, but so far only initial basic infrastructure has been initiated. Pemex has yet to announce whether work on the new refinery will resume.

Meanwhile, in early 2014 Spanish firm Iberdrola won a contract to build a 300-MW natural gas combined-cycle power plant in the state of Baja California. The project is estimated to cost $270m, and construction is scheduled to start in April 2014. Commercial operation of the plant should begin in mid-2016, and the contract includes a 25-year purchase agreement with the Mexican Federal Electricity Commission.

In Pesquería, Nuevo León state an agreement between energy and steel multinational Techint, energy contractors Tecpetrol International and steel pipe producer Tenaris has been signed, paving the way for a $1bn gas-fuelled power plant. The plant will have a capacity of 850-900 MW and supply electricity to Technit’s production units in Mexico.

The power plant will be 48% owned by Technit, while Tecpetrol and Tenaris will have 30% and 22%, respectively. The plan awaits the final approval of Mexico’s new energy bill, which should allow for energy producers to sell energy directly to end-users, without having to go through Comisión Federal de Electricidad, the state-owned utility, as required under current legislation.

DISTRIBUTION: Energy distribution is set to receive a boost. A plan to create a $4.8bn natural gas distribution system in northern Mexico will include the construction of a 2214-km gas pipeline through the states of Sinaloa and Sonora and also connect to Chihuahua in order to supply factories with energy feedstock. Los Ramones, a $2.5bn, 1000-km gas pipeline linking the US with El Bajío, is also in the works, with phase I expected to be operational by the end of 2014. Mexico and Guatemala have agreed to build a gas pipeline between the two countries. The 600-km structure is budgeted at $1.2bn and will connect Salina Cruz on the Mexican side with Escuintla in Guatemala and allowing Mexico to sell natural gas to its southern neighbour. Pemex will build the 420 km on Mexican territory.

Renewable energy projects are attracting investment as the country aims to increase clean energy output. In late 2013 construction work started on the $196m Dominica wind farm. The 100-MW unit is being built by US-based Enel Green Power, which has signed two power-purchase agreements worth a total of $485m to sell output to Banamex and Delphi Automotive.

The water sector, which is overseen by the National Water Commission, is an important part of the government’s public-private partnership (PPP) strategy. The sector is set to receive up to MXN415bn ($32.2bn) over the next five years. A project to deliver water from the Panuco River to Monterrey and 16 other cities in the region is under way. Estimated to cost some $1.5bn, the project involves the building of an aqueduct between Tampaón and Cerro Prieto as well as upgrading the existing link between Cerro Prieto and Monterrey.

In early 2013 the Inter-American Development Bank approved a $450m loan to be directed at improving access to drinking water in 5000 poor communities across Mexico’s rural areas. The loan is targeted at communities where water and sanitation infrastructure reaches less than 20% of the population, and is part of a total budget of $562.5m, the rest of which will be financed by the government.

ACCESSING FINANCE: High interest rates have limited growth options for small and medium-sized construction companies. Mexico’s banks have traditionally shied away from financing the sector or offered high-interest loans, which has made project execution financially unattractive. This is in part due to existing financial regulations, which underline the importance of collateral as part of the financing structure, and not so much the feasibility of a project. This has left Mexican construction companies vulnerable to competition from foreign players, which can access financing from abroad, through international financial institutions or state backing from their own countries. Financing in the US, for example, can generally be obtained with an interest rate of 5-6%, which is significantly lower than the average interest rates of 11-12% offered by local banks.

“Mexican construction companies are at a disadvantage compared to international companies due to their financial arrangements. The only option to win tenders is to create consortia or to act as subcontractors for foreign companies,” José Maiz García, director-general of construction firm Maiz Mier, told OBG. Equity securities are also an important means for raising capital.

REGULATIONS: Accessing finance might become easier with the new PPP law. For years, the structuring of construction projects involving private and public entities in Mexico was completing using regulations with a more general purpose. In 2012, at the end of President Calderon’s presidential term, Mexican legislators approved a new PPP law. Details of the bill were published in late 2013, and have been received with enthusiasm by private operators due to a clear definition of rights and obligations of parties as well as more flexibility for contract changes. The law will be a key tool for the government to attract private investment for its infrastructure plans (see analysis). Accounting laws are set to be standardised across all states, which will allow for the federal government to have a better grasp of which funds are being allocated and spent across the country. Foreign investment in the real estate and construction sector will also be spurred by the law to ease foreign ownership of real estate. In 2013 the lower house of Congress voted against the rules preventing foreigners from owning property within 50 km of coastal areas and 100 km from international borders. A constitutional amendment is now awaiting approval by the Senate (see Real Estate analysis).

OUTLOOK: The construction sector remains an important part of the economy, and increased government spending is set to create a host of new opportunities for companies operating in it. Existing projects will inject a fair amount of dynamism into the sector for years to come. However, economic stability and a clear legal framework will be essential if Mexico is to attract more private investment. Domestic financing for construction companies is set to improve, not only through governmental programmes, but also as access to the commercial banking sector becomes more affordable. The CMIC estimates that an economic rebound, driven by reforms and public investment, might allow the construction sector to grow at a rate above 5% annually until 2017, and at 4.7% a year from 2018 to 2022.