A new focus: Despite housing challenges, the market has been strengthened by liquidity from investment trusts

Reeling from a crisis that left some of the country’s largest home builders in bad shape, the real estate sector is finding ways to grow in other segments. Investment coming through new property trusts is pushing the sector to rally around more profitable markets. The increase in the number of international firms has led to the development of the office segment. The same is happening in industrial real estate, as new production units boost demand for office space and commercial and industrial projects.

HOUSING PLANS: Mexico’s housing sector is still dealing with the consequences of a skewed housing strategy. Over the past two decades government efforts to increase home availability encouraged access to credit. Much impetus was focused on building low-income housing. This was done by trying to support both demand and supply of new homes. Between 2000 and 2012 about 5m low-interest mortgages were given out through the National Workers’ Housing Fund Institute (Instituto del Fondo Nacional de la Vivienda para los Trabajadores, INFONAVIT). Federal authorities also distributed subsidies for down payments to poor families.

Under President Felipe Calderón, the Ésta es tu casa (“This is your home”) programme subsidised 590,000 people with initial payments for a home. Government backing for the industry attracted overseas investment, with foreign bond sales to finance further building. The government distributed subsidies to developers focusing on low-income housing. The bulk of housing construction focused on free-standing homes in semi-rural areas outside major cities, where developers could access cheaper land, helping to limit the final sale price. This allowed them to build large numbers of homes quickly and in a cost-efficient manner. It attracted competition to the sector, and from 2005 to 2007 the number of homebuilders increased from 934 to 1762, according to the 2013 programme from the Mexican Housing Commission (Comision Nacional de Vivienda, CONAVI). The financial crisis negatively affected mortgages approvals. In 2009 alone the number of home loans given by the commercial banking sector declined 35%, while those given out by the INFONAVIT decreased 12%, according to BBVA Bancomer.

Slower home sales led to a reduction in the number of builders, and by 2012, 86.6% of all new homes were being built by three developers: Desarrolladora Homex, Corp. Geo and Urbi Desarrollos Urbanos. “These companies bought a lot of land to develop outside the cities,” Ignacio Gil-Casares, director of operations at Aguirre Newman, told OBG. Large distances from urban centres proved impractical, and owners stopped paying their mortgages and left their homes to look for accommodation closer to the cities. This led to a fall in sales on several of the new developments. Mexico’s major builders were suddenly stuck with large amounts of unused land and empty homes. The failure of outer-city developments finally led to a collapse in main developers’ financial positions. During the first 11 months of 2013 Desarrolladora Homex, Corp. Geo and Urbi Desarrollos Urbanos lost a combined $1.7bn of their market value. Trading in Geo and Urbi stock was suspended by the Mexican stock exchange. According to INFONAVIT, the number of repossessed homes reached 43,853 in mid-2013, double the number in 2011.

PARADIGM CHANGE: Demand for housing remains high, though, with 8.5m new homes required over the next decade, according to a report by the Inter-American Development Bank (IDB). Incentives and subsidies for the housing sector have been gradually adapted to match governmental housing policy. INFONAVIT and Fondo de la Vivienda del Instituto de la Seguridad y Servicios Sociales de los Trabajadores del Estado (FOVISSSTE) are now putting more emphasis on the quality of homes, location and the availability of surrounding infrastructure in their mortgage allocation.

President Enrique Peña Nieto has stated that the government support programmes will focus on building new homes closer to urban centres. Incentives and subsidies in the housing market are directed towards vertical construction, as opposed to the single-home developments that were the norm. “Mexico has always been a place where horizontal building prevailed, and now we are seeing more projects focusing on height construction, which means more people can live in apartment blocks and not live two hours away from work,” Gil-Casares told OBG.

The switch will pose a challenge for some developers. Due to added bureaucracy, low availability of land and the longer construction periods, transferring capacity from constructing individual homes to apartment buildings will require more available capital from builders. The transition might be especially painful for big developers with accumulated land plots in rural areas. A devaluation of the land due to the failed housing strategy has affected the value of the large publicly traded developers’ assets. The focus on inner-city home development might be easier for the smaller developers not tied up with unprofitable land plots.

CONAVI will loan MXN12bn ($932.4m) in 2014 under the Ésta es tu casa programme to allow low-income home buyers to afford their initial payments. The new subsidies will be directed towards home development in urban areas. Since September 2013 the FOVISSSTE has been giving out new credit lines to state workers to invest in renovation of dilapidated homes.

Other programmes will help shore up support for the sector. The IDB is currently financing a MXN84m ($6.5m) programme to enable an estimated 80,000 public employees to obtain access to finance for housing improvements and new construction on land already owned by the client. The financing will be allocated through the Fondo Económico para el Desarrollo Empresarial (Economic Enterprise Development Fund), which will receive government workers’ loan repayments through payroll deductions. This is set to reduce credit risk and lower transaction costs.

LUXURY RESIDENTIAL: Problems in the low-income housing sector are not expected to affect other segments of the market. The mid-range and high-end housing segments remain dynamic, especially in major urban centres. In Mexico City specific residential neighbourhoods such as Polanco and Condesa have remained active, because they are high-end, coveted areas well served in terms of amenities. “The luxury market does very well. There is 1.5% of the population who is very rich. This means that there are 1m-2m people who can buy luxury homes. In Mexico City the market has not felt a slowdown,” said Gil-Casares.

Prices in residential real estate, as in other segments of the market, are pressured by low availability of land in major cities, for which average prices have increased by 10-15% in the past two years. Middle-market units in the capital will sell for $125,000-300,000 depending on the location. In the most sought-after neighbourhoods luxury apartments sell for $4500 per sq metre for units without any type of finishing save electricity and pipe installation. The selling price can go up to as much as $8000-9000 per sq metre with finishing.

Growth in the residential real estate sector, especially for the mid-range and high-end market, is set to be determined by mortgage availability, which still represents a sizeable part of home financing.

MORTGAGES: The home mortgage market in Mexico is divided between private and public providers. INFONAVIT still accounts for most workers’ mortgage loans, although a smaller number are also given out by FOVISSSTE, which oversees home credit allocation for federal government workers. Over recent years there has been an increase in the amount of mortgages provided from private providers much to the detriment of public institutions. Mortgages given out by banks and limited objective financial corporations, which are non-banking financial institutions, increased from 27.3% of all mortgagees in 2010 to 38.7% in 2013. Over the same period, the proportion of total mortgages given out by INFONAVIT decreased from 52.5% to 47.1%, and the share of FOVISSSTE mortgages was reduced from 20% to 14.2% of total mortgages.

Medium- and high-income earners generally access bank financing. In fact, despite having the largest number of individual mortgages, around 84%, home financing for lower-income buyers in Mexico represents less than half of total credit, according to 2012 figures on home loan allocation compiled by BBVA Bancomer.

Expensive financing has mainly affected medium-income earners, who are not eligible for low-interest mortgages or government subsidies, but might not have enough cash to pay upfront. However, this is changing. Mexico’s improved macroeconomic performance and increased competition between banks have allowed for reductions in the cost of borrowing. “Average mortgage rates offered by banks have decreased from over 11% to almost 10%, and some products offer interest rates below 9%,” according to a BBVA Bancomer report published in early 2014. There has also been an increase in payment deadlines, although the percentage of the total cost of a property covered by bank mortgages has remained stable in recent years, ranging from 70% to 90%. Housing institutes have also been directing more credit financing towards home improvement and reducing demand for new home building. In 2013 more than 40% of all loans given out by INFONAVIT were for renovation of existing residences.

INTRODUCING REITS: On the non-residential real estate side of the market, growth is coming from new products. The recently introduced real estate investment trust (REITs), referred to as a Fideicomiso de Infraestructura y Bienes Raíces (FIBRAS) in Spanish, has been impacting the real estate sector by attracting a wave of new investment. REITs allow for the management of real estate portfolios, by issuing real estate certificates to investors. Funding from REITs can also be used to buy existing property portfolios.

Because they are listed financial instruments, REITs have been able to attract funds from abroad into real estate, and have been outperforming other instruments on the stock market. Capital from institutional investors from the US and Europe has been flowing to the Mexican real estate sector through the REITs. Some of them invest in property, while others focus on specific segments, such as industrial real estate or in hotels.

Changes to financial regulations in 2009, which allowed Mexican pension funds to place funds in a broader spectrum of investment vehicles, contributed to the quick expansion of REITs. They also enjoy fiscal benefits, as investors are not subject to taxes on dividends. The first REIT to be listed on the Mexican stock exchange was Fibra UNO, which joined in 2011, and has been focusing on commercial and industrial real estate, as well as mixed-used development projects. A variety of other REITs started to appear in 2012, such as FibraHotel and fibra inn, which invest in the hospitality sector. Two other trusts, Terrafina and Macquarie Mexican REIT, have specialised in industrial real estate. Confidence in the ability of REITs to galvanise the market rose in mid-2013 through one of the largest real estate deals in Mexico. Fibra UNO bought the commercial real estate portfolio of Mexico Retail Properties Group (MRP) for $1.8bn. The acquisition included 49 commercial properties in Mexico, which will now be managed under the Fibra Uno portfolio. “In Mexico the real estate sector was originally under-funded, but today sourcing finance is no longer a problem,” Juan Guichard, CEO of Mexican banking group Invex, told OBG.

FIBRAs have poured new investment into the sector, especially towards the commercial and industrial segments. Besides Fibra Uno’s acquisition of MRP’s commercial real estate portfolio, other transactions show the impact that FIBRAs are having. Commercial real estate, which has an average return of 8%, has accounted for 60% of real estate transactions through FIBRAs in 2013, according to Aguirre Newman.

COMMERCIAL: This brought liquidity into the market, encouraging new commercial developments. In 2013 some $2.1bn was spent on buying commercial properties by REITs. Much of it was raised in a single transaction between Fibra UNO and MRP. However, it made commercial real estate the most sought-after type of property for investment. Commercial real estate has followed an upwards trend in Mexico for more than a decade, especially in the three largest cities, Mexico City, Guadalajara and Monterrey. According to “Retail Insight Mexico 2013”, a report published by CBRE Global Research and Consulting, a real estate consulting firm, the combined gross leasable area (GLA) for the main cities was 6.8m sq metres in 2013.

The capital city has the biggest offer of commercial space, with around 4.5m sq metres of GLA. Competition is increasing, with six new shopping malls expected to open in 2014 and adding more than 206,000 sq metres to the city’s commercial stock. Rent prices in Mexico City depend on the specific commercial area. For the large multi-storey shopping malls, monthly rents per sq metre are $40-60. For smaller ground-level shopping areas, rents vary between $20 and $40 per sq metre per month. In Guadalajara, average monthly rents range between $35 and $55 per sq metre in the large shopping malls and between $15 and $35 per sq metre per month in the smaller retail areas. For Monterrey, prices ranged from $30 to $90 per sq metre in malls and $15 to $40 per sq metre in smaller retail areas.

INDUSTRIAL: Mexico’s advantages as a manufacturing location have boosted the industrial real estate offer, both by government institutions and private developers. According to figures from the investment promotion agency ProMéxico, there are a total of 200 industrial parks in the country.

Much new investment has been channelled through REITs, attracting institutional investors because of its long-term contracts, which offer more predictable returns than commercial or office real estate. Some of these have been changing hands. Fibra Uno acquired a portfolio of 34 industrial properties from FINSA, Walton Street Capital and AIG for $372m. It also bought the Tepozotlan industrial complex for $38.6m. Meanwhile, Fibra Terrafina paid $600m to Kymco Realty to buy a portfolio of 87 industrial properties.

Of an existing stock of 50.5m sq metres in Mexico, some 31.5m are located in the northern region, which is home to the majority of its manufacturing capacity. Land leases depend on the region, but the average countrywide price is $4.25 per sq metre per month, according to a 2013 report by Jones Lang LaSalle. In the central region, which includes Mexico, Toluca and Puebla, the average lease rate is $4.72 per sq metre per month, while land in Mexico City was the highest nationwide at $5.52 per sq metre per month. According to figures from Aguirre Newman, the average returns on industrial real estate are 8.4%. Interest in industrial real estate is set to continue rising, as the country attracts more production capacity.

MORE OFFICE SPACE: Several prominent construction projects in the city are showing the rise of the business districts and increasing competition for office space development in some of Mexico City’s neighbourhoods. Investors are taking note: the average rate of return for investment in office space real estate is 9.3%, according to 2013 figures from Aguirre Newman. Rising demand is strengthened by relocations, as a number of business headquarters have been moved to more central areas of the city in an attempt to avoid congestion and increase proximity to restaurants and other amenities. Paseo de la Reforma, one of the city’s vital thoroughfares, has become a coveted place for office space. “Paseo de la Reforma is becoming Mexico’s financial district,” Gil-Casares told OBG. “There are more services available there, as well as better public transport, which makes things easier for commuting.” The rising demand for office space in Paseo de la Reforma has been met with new supply. Between 2008 and the end of 2014 the amount of office space in the area is expected to increase from 280,000 sq metres to 585,000 sq metres, according to figures from Aguirre Newman. Rental prices for office space in the Reforma area are $27-35 per sq metre per month.

Other popular areas include Polanco and Lomas de las Palmas, where high-end malls and office space developments have attracted interest. Total office space is expected to reach 1.5m sq metres in 2014, rising from 800,000 sq metres in 2008. “Polanco is an interesting market, where demand for office space is high, but available product is limited,” said Gil-Casares. Insurgentes, one of the capital’s central avenues, is also attracting new office space development.

According to Jorge Gamboa de Buen, CEO of the Danhos Group, a real estate developer, there are 200,000-300,000 sq metres of office space entering the Mexico City market every year. This move towards a centralisation of business activities in a few neighbourhoods is reducing average rents in some of the more peripheral neighbourhoods. In Santa Fé, from where several companies are relocating, average office monthly rents are currently around $21 per sq metre.

Gil-Casares estimates that AAA office space in Mexico City totals 5m sq metres. However, new space over the next three to five years will increase the market offer by 500,000-1m sq metres. Other prominent cities in the country, such as Guadalajara and Monterrey, are also seeing an increase in competition as new office space developments enter the market.

REGULATION: Much development is supported by the rising value of REITs. The trusts do not pay corporate tax, as long as they distribute 95% of taxable income to investors, through dividends, as required by law. This has been part of their allure. However, some governance issues have arisen. Under the current law, for example, FIBRAs need to be managed by outside firms and management fees can thus vary greatly.

Some investors have expressed concern that being managed by outside companies might lead to conflicts of interest between the management companies and the investment decisions, according to media reports. Strengthening governance rules for FIBRAs would help increase the market’s confidence in these instruments in the long term. This would encourage continued and likely increased investment into the industrial, commercial and office real estate segments.

A change in real estate law might soon impact the residential sector specifically, as legislators will decide on a measure to allow foreigners to own real estate within 50 km of the coastline, which has been banned in the constitution for more than a century. The change, passed by the lower house of Congress but awaiting Senate approval, might open up Mexico’s shores to new development, especially as a vacation-home destination for neighbouring markets (see analysis).

OUTLOOK: Sector growth will depend on how well developers adapt to the focus on vertical construction. But, as the failure of the previous model has shown, vertical construction will be more in tune with sustained development of the housing sector, as well as homeowners’ demands for proximity to cities. Continued growth in mortgages will have a positive impact on the residential segment but this will also depend on economic stability keeping interest rates competitive.

Despite bringing dynamism to the sector, the number of new REITs may peak. It is still expected, however, that demand for office, industrial and commercial space will continue to sustain the real estate sector.