Elías Camhaji
Co-Managing Partner
View from the Top

Finance Factors in Real Estate Development

Wed, 11/01/2017 - 11:42

Q: Why did ZKC decide to focus on Mexico City’s commercial market?

A: We have been in the market for 15 years and we have worked on all types of developments, from tourism and retail to housing and mixed use. Since 2009, we have focused mainly in Mexico City and something that we have learned is that real estate in Mexico is a local game. The more local markets you know, the greater the competitive advantage you have. We used to invest in secondary cities and tourism areas, where some projects were successful and some were not, especially during the recession in the US. Tourism investments may enjoy high returns but they are also the most volatile, especially when the economy slows down or there is a crisis. The commercial subsector presents an interesting challenge. The average national GLA remains low in comparison to not only the North American average, but also to that in Latin America. This means that there are many opportunities to grow but the cost of land is extremely high and building only commercial developments is no longer viable. Mixed-use developments have become more popular as developers seek to get the highest returns from the land acquired. An increase in land and commodity prices, along with the depreciation of the peso, has greatly impacted the overall price of construction.

Q: What are the main factors that will determine the performance of Mexico’s real estate sector?

A: This year, there will be two main factors that will impact the Mexican real estate industry. One factor is the US presidential election, which has created a great deal of volatility in the market and overall uncertainty in the industry. This caused, at least temporarily, a decrease in investment and a lower number of transactions in terms of sales and rents. Secondly, real estate is extremely vulnerable to rising interest rates. In 2017, Banxico raised interest rates four times, taking them from 5.75 percent in December 2016 to 7 percent in June 2017. Analysts expect another hike, to end the year on 7.25 percent. Developers must be careful because financing will become more expensive, as will the various financial instruments available for real estate. Mortgages have not been impacted thanks to the banks absorbing those hikes so far but ultimately, they will have to be passed on to the end user.

Q: What are the real estate trends developers will follow in the coming years?

A: We continue seeing a solid real estate segment and with many flagship projects being developed. The trends shaping the industry are verticalization, urbanization and mixed use, as well as an increase in quality and square meters of new developments. There are some subsectors that are doing better than others. There is an excess supply of office space in Mexico with more than 3 million m2 under construction. The demand has been solid but it may begin to deaccelerate as a response to a more cautious private and public sector. It is a subsector where companies must be careful and be aware that the most highly leveraged projects will be more challenging to complete. Once lease prices stabilize, it will continue being attractive thanks to the growing demographics that are driving demand. Bank loans and debt issuance will become more expensive in the next year. Companies will have to accept debt with higher rates. The decrease in VAT return application rates that prevailed in the last few years is no longer sustainable, so VAT return applications will probably rise. There will also likely be an increase in capitalization rates, which may force some subsectors to reach double digits.

Q: What types of problems can developers run into when constructing in urban spaces?

A: Most developments have a positive impact on their surroundings. They bring diversity in services and space, along with capital gains to existing developments. There have been instances where neighbors try to gain personal benefits from the development of a real estate project, looking for legal mechanisms that could position entire communities against construction. These situations can increase the level of legal uncertainty in a project. If there is indirect or direct damage made to surrounding properties, it is responsibility of the developer to repair the damage.