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Mexican Multifamily: An Opportunity for American Institutional Investors?

The time does not seem ripe for institutional investors in America to enter the multifamily space in Mexico. They have supported previous managers in the country which have not delivered suitable returns. Some failed because they built too expensively and required rentals that aren't, and never were, achievable in the market. Others built appropriately but had bad timing and were impacted by peso weakness. However, the opportunities are present in Mexico multifamily for more nimble investors, not utilizing misaligned and expensive private equity structures, and pursuing smaller deal sizes with realistic assumptions in terms of rentals to be achieved and cost to build and operate in the country. An increasing number of investors are less deterred by holding peso-denominated assets and that's reasonable given the headwinds for Washington DC's currency.

Greystar Multifamily Development in Mexico City
Greystar Multifamily Development in Mexico City
 

Introduction


There are a few trends playing in favor of multifamily investments in Mexico including a growing middle class from nearshoring, more Americans relocating to Mexico, and the remote working fad birthed during the global lockdowns. Institutional investors in America may therefore find themselves being increasingly presented opportunities to invest into the theme. Emerging Real Estate urges a cautionary approach for a variety of reasons, some of which are discussed herein.


Mexico’s latest nearshoring wave may be the biggest yet. It was spurred on by President Donald Trump who, controversially at the time, set America on the path towards reducing reliance on China’s supply chain. The stated goal was, and is, to rebuild the American manufacturing sector and Mexico is benefiting greatly from this geopolitical shift. While NAFTA was a one-sided deal heavily favoring Mexico, the revised USMCA is fairer, and as such encourages more foreign direct investment by American manufacturers and investors. As evidence, the IFC announced a doubling of investment into Mexico in 2024 to $1 billion. According to Bloomberg, foreign direct investment into Mexico has surged nearly 50% in the first quarter of 2023 compared to 2022.


Migration from America to Mexico is trending upward as more Americans move to Mexico or buy vacation properties on its coastline. Forbes suggests that around 1 million Americans live in Mexico and that half of those already own homes in the country. Once a tipping point is reached, Emerging Real Estate predicts the trickle of Americans will turn into a flood. The American migrants are potential renters, and their arrival pushes up property values for all encouraging more Mexicans to rent and at higher rentals than are presently realistic.

American Migration to Mexico in 2022 by State Chart
American Migration to Mexico in 2022 by State (source: Unidad de Politica Migratoria - Boletines Estadísticos

The remote working fad in America is a boon for well-located rental properties in popular digital nomad hubs in Mexico such as Mexico City, Tulum, Playa del Carmen, and Puerto Escondido. We’ve written about Mexico City as being the next “it” city in North America. Remote workers love Mexico City because it offers an attractive time zone, vibrant culture, quick flights to American cities, and their current mobile carrier plans work in Mexico as if they were home. Although many of the remote works living in Mexico aren’t yet established in their careers, they earn in dollars, and don’t mind paying what would be considered premium rentals in Mexico City.

Major American multifamily developers have operated in Mexico, in varying degrees, and they include Greystar, Equity Residential, The Related Group, Tishman Speyer, Hines, Morgan Group, Paladin, Trammell Crow Residential, Lincoln Property Company, Wood Partners, The Lynd Company, Alliance Residential Company, Simpson Housing and more. As American multifamily comes under increasing pressure we expect more to sniff around in Mexico.


Funding of Multifamily in Mexico


A typical multifamily project in Mexico will be funded through a three to four year bank loan, secured on presale agreements from buyers of the individual apartments. Once completed, the apartments are sold, bank loan paid down, and the remainder being the reward for the investors and sponsors. Investors and banks rather like this method of funding projects since capital isn’t tied up for long and the primary risk of presale defaults is not difficult to understand and manage. Trusts are put in place to manage the property, funded by and on behalf of the apartment unit owners.


Relevant implications:

  • Apartments/condos sold through presales will generally be at a lower price than would have otherwise been achieved. This is so because the purchaser is taking a risk that the delivery will occur and that it will match the expectation he has for the project in terms of build quality and other factors. Developers of larger multifamily projects in Mexico will phase the projects and model in higher sales prices for subsequent phases because the purchaser is able to inspect the units in the first phase.

  • Fewer large scale multifamily developments occur due to lack of scalable funding models.

  • There are few professionally managed multifamily developments, with high-quality amenities, available to renters in Mexico.

  • Properties are often mismanaged and neglected given the decentralized ownership.

  • Can be difficult to unify titles and then manages the multifamily project professional as a single owner. Titling in Mexico is challenging and expensive to validate and transfer.


Headwinds for the Asset Class


Some of the headwinds for multifamily in Mexico, for American institutional investor involvement, are unfavorable landlord-tenant laws, funding challenges, preference by Mexicans to own, and low apartment rents.


Landlord-tenant regulations in Mexico are considered to be heavily in favor of the tenant, both in terms of drafting and in terms of how they are interpreted and enforced. Signing a lease with a new tenant is a lengthy undertaking and requires a heap of documents to be signed and layers of protections in place for the landlord aimed at somewhat leveling the playing field. Any professionally managed multifamily development, of any scale, will undoubtedly encounter negative experiences in this regard. Informal mechanisms have been developed by local landlords to handle squatters, but some of these methods wouldn’t be palatable to institutionally funded multifamily projects who would be largely uninterested in informal workarounds.


Local capital is challenging to obtain to expand or improve the property in the future. Interest rates are presently high (11.25% as of March, 2023), with unattractive terms compared to what is achievable in America. Debt is a powerful tool in value creation for real estate developments, but also a risk if over done, and was discussed in a previous Emerging Real Estate newsletter. The dearth of real estate debt availability, on workable terms, also explains why there are relatively few buyers of such properties in the market.


Mexicans prefer to own homes for a variety of reasons. Anecdotal evidence from brokerage firms suggests that 80% of Mexicans would rather own a home/apartment than to rent. Homes in Mexico are affordable, relative to the prices American homebuyers are forced to endure, and the mortgage system is quite mature. Mortgage loan amount totals for the country have consistently grown 7%-8% annually since 2017. Total mortgage values now stand at around $200 billion (i.e., MXN 4 trillion). Over the last two decades mortgage processing fees have recued from 6% to around 3% today. LTVs have risen to 80% - 90% from 65%. And loan terms now are closer to 30 years up from 10-15 years in the past.


Low rent yields characterize multifamily in Mexico, most especially for institutional quality projects. These will tend to cost more to construct, for a variety of reasons, and therefore have further compressed yield than the averages multifamily development in the country. Many of the forces at play which pressure young professionals in America to rent quality properties, rather than purchase, aren’t as present in Mexico. Therefore, multifamily developers will be less likely to find quality long-term renters in Mexico.


A final headwind is that foreign investors aren’t allowed to own property in Mexico along the coast. A 1993 law permitted foreigners to control coastal properties through bank trusts as beneficiaries. However, this system depends on the credibility of Mexico’s banking system and property registry administration.

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