Juan Francisco Torres Landa
Hogan Lovells
View from the Top

Bubble Concern Form in Real Estate

Tue, 11/01/2016 - 16:19

Q: What is your view of the real estate industry in Mexico?

A: There is rising concern that a bubble is forming in the real estate market due to an oversupply of properties. By 2017, Mexico City will have about 2 million square meters available for office space. That is a lot of space that will need to be allocated somehow. The real problem with the industry is that economic expectations will not be met and the excess supply will hurt prices. There will be some readjustment to the targets for rental rates. Whether developers take the hit or not and how that will affect their finances is the question.

At the same time, there are other areas where space is in demand, such as industrial parks. Several industries are attracting new manufacturing plants, increasing the demand for industrial space, such as the automotive industry in San Luis Potosi, Guanajuato, Aguascalientes, Sonora and Puebla among others. We provide assistance to these types of developments in many areas, particularly in the Bajio region. These regions are experiencing growth they had not seen in 10 years. Some areas that were near saturation have not expanded quickly, thus creating opportunities for other areas to develop and absorb the excess demand. I do not think this trend is going to stop in the near future.

Q: What problems are industrial park developers encountering with the authorities regarding infrastructure?

A: It is a real challenge in the sense that the budget for 2017 is being reduced significantly. That automatically means the resources allocated either federally or locally to build additional roads, railway tracks, airports or port facilities will not be enough and the planned infrastructure will not be completed in the near future. If some of these parks are relying on this additional construction they need to rethink their strategy. If there are plans to set up a new industrial park, reliance on public sector improvement of the current infrastructure should be a low priority issue.

Q: How is growth from the influx of industries impacting infrastructure?

A: There are four states that are absorbing a lot of growth: Queretaro, Guanajuato, Aguascalientes and San Luis Potosi. You already can see there is a little bit of saturation in both urban areas and with highways. With few exceptions, highways have not been modified or improved in years or even decades. The improvements that have been implemented have not been consistent with the additional demand for roads and other infrastructure. If these additional infrastructure needs are not fulfilled, we will hit a dead end where we cannot move products efficiently. In spite of budgetary restrictions, careful thinking is required to ensure that industrial sectors, such as automotive, are not harmed.

Q: What are the pros and cons of special trade zones or bonded warehouses?

A: Special trade zones or bonded warehouses are specific locations where you can take immediate delivery of products thate are already in the country and that upon release, and not before, must pay taxes for imports. It is a little bit of a financial advantage because companies can have Just-in-Time (JIT) delivery without having to pay tariffs. For industries such as automotive or aerospace, immediate delivery is critical and suppliers are heavily sanctioned if they miss a delivery by a minute. These types of bonded warehouses or free trade zones allow the JIT structure to work.

Operating these types of bonded warehouses is somewhat problematic due to the needed bookkeeping and governmental reporting. From a government standpoint, they do not like having less control over what they can charge at customs for merchandise that stays in the country. If the government waves duties on merchandise because it is going to a bonded warehouse in the middle of the country, the expectation is that the warehouse will keep a methodic and accurate record of what is received and what leaves the premises.

For industrial parks to implement these, they need to have a significant volume of trade and a sufficient number of customers who require bonded warehouses. Sometimes these free trade zones are not exactly within an industrial park but within a region that encompasses several industrial parks and facilities. This is more common than having one for a particular site. We have seen that in many cases specialized companies operate these warehouses and not the industrial parks. This arrangement is more efficient because industrial parks deal with their own needs and additional services are best handled by experts in the area.

Q: What other challenges are faced by industrial real estate developers?

A: Water is probably one of the most important hurdles companies face everywhere and industrial parks are no exception. There are very strict requirements regarding sourcing, treatment and discharge of water and its effluents. No industrial park can ignore these obligations. Industrial parks need to have state of the art technology and full legal standing regarding water rights and volume. An industrial park that is not up to speed in this area will end up disappearing. If an industrial park wants to host companies that are large water users, the concern will be supply availability. Most of the country is now subject to not new volumes being authorized, but rather the transfer of existing volumes in concessions in good standing in the area held by third parties

The same is true with respect to electricity. Industrial parks are forced to install a power supply distribution grid within the facilities, which they have to build and connect to the national grid operated by CENACE. The problem is that once industrial parks build their installations, they have to donate them to CFE. That is the condition for electricity supply.

Railroads are also critical factors for an industrial park’s viability. I do not know of any successful industrial park that does not have any connection with a railroad. Basically, all significant customers in an industrial park require rail links. Companies cannot move all their products by road because it is not cost efficient.

If you look at a national map of highways, powerlines and railroad lines, it is somewhat simple to see where are the hot spots for industrial parks. The Bajio region is an example where highways, rail lines and powerlines intersect, so industrial parks are located within a reasonable distance of the three. That is why certain regions have several industrial parks.

Q: What is your view on the instruments,like FIBRAS, that are being used to grow the real estate market?

A: In Mexico, we have had this discussion for several years, based on US style REITs. Due to a lack of understanding and regulatory hurdles, such as tax concerns, these options were delayed for many years. Fortunately, that changed and we are seeing incredible growth. This is an area where the first comers have received greater benefits. They were able to secure better properties, better locations and more surface area.

The growth we will see in the country in the coming years regarding properties funded through these special vehicles will not be as significant as that which we have seen in previous years. It is a competitive market and the initial distribution or allocation of properties is basically done. Growth will be more limited and may have to be strategically based on new developments and new areas that are demanding real estate due to some industrial need. I think the initial momentum we saw of almost endless growth has nearly come to an end. But it was important for the country to generate these instruments, which have allowed the entry of foreign capital.

Still, there are some clouds on the horizon regarding exchange rate and even electoral risks. Funds that have come to the country expect returns in dollars and the initial returns will be difficult to match in the coming years. This will have an overall impact on a FIBRAs' portfolio and yield capabilities.

Industrial Park, FINSA