Real Estate: A Refuge Against Volatility and a Shield from Inflation
Towards the end of 2016 and the start of 2017, a series of events seriously exacerbated financial volatility and caused inflationary pressure on our country – on the one hand, the referendum that prompted the United Kingdom’s withdrawal from the European Union (#Brexit), and the election of Donald Trump as the 45 th President of the United States (@realDonaldTrump); and locally, Mexico’s recent liberalization of gasoline prices (#gasolinazo), and the extradition of drug kingpin Joaquín Archivaldo Guzmán Loera (El “Chapo” Guzman) to the US – just to cite a few.
This context spurred significant volatility in the exchange rate between the peso and the US dollar, bringing our currency to a parity of $21.70 pesos per dollar on January 20, 2017 (the day President Trump took the oath of office). If we analyze exchange rate volatility patterns since 1994 (the year when the North American Free Trade Agreement, NAFTA, came into effect), the parity we are experiencing today comes out as one of the highest in the country’s recent history.
Separately, this scenario of high volatility and the increased exchange rate parity, triggered an upward adjustment of the Banco de México’s reference rate, which in turn, brought our target rate to levels we had not seen since 2009.
Perhaps one of the most impacting components in economic, political, and social terms for the country, was the liberalization of gasoline prices on January 1, 2017. This measure originated an increase in the sales price of hydrocarbon fuels (#gasolinazo) which spiked the average price from January 1 through February 3, 2017 to the following levels: Magna gasoline, $15.99 per liter; Premium gasoline, $17.79 per liter; and diesel, $17.05 per liter.
All of the uncertainty caused by international issues, sustained raises in exchange rates and interest rates, and the hike in gasoline prices, triggered an increase of Mexico’s inflation rates, closing 2016 above the goal set by the Banco de México (+/- 3%) at a 3.36%; a rate we had not seen since the first quarter of 2014.
objectives that include a strong commitment towards commercial openness, border security, market diversification, respect to human rights, and to fighting organized crime. As such, and given this general context of high volatility and inflationary pressure, real estate becomes a refuge and the safeguard it has historically represented.
Since the creation of Real Estate Investment Trusts (in Spanish known as FIBRAs), the return on real estate investments has been higher than returns reflected in the stock market and have come in above Banxico reference rates and annualized inflation in Mexico.
Over the period from 2011 to 2016, the FIBRA Total Return Index in the Mexican Stock Exchange (BMV) was 22% as compared to the Total Return Index of the Mexican market, which was 7%. During the same period, Banxico reference rates neared 4% and inflation remained below 3%.
In 2015, FIBRAs and practically the entire capital category of the BMV underwent a complicated year, resulting primarily from the increase of interest rates in the US and the international economic slowdown; this in turn caused FIBRA Total Return Indexes to move towards negative grounds (-6%) compared to the positive Total Return Index of the stock market (1.5%).
By 2016, FIBRAs had achieved better performance than stocks, and towards the end of Q1 2016, they reflected a better Total Return Index of 9% v. 7.4% in the stock market.
The real estate market is maintaining upwards growth practically on all fronts, because despite announcements regarding the cancellation of investments by US automakers (Ford, GM), other markets such as Japan (Toyota, Nissan) and Germany (VW, BMW) have in fact ratified and increased investments in Mexico. This has helped to maintain growth rates in the industrial segment, particularly in the country’s central region, including Mexico City, Estado de Mexico, and Puebla, as well as in the Bajío Corridor, that covers the states of Querétaro, Guanajuato, San Luis Potosí, and Aguascalientes.
On another front, the exchange rate depreciation puts pressure on leases, especially in the AAA corporate offices segment of the Mexico City and Monterrey markets. This situation will call for solid communication, as well as mitigation measures on behalf of property managers to negotiate with tenants and to avoid pressuring possible flight from these locations, given that securing decreases in rent or even contract renegotiations into pesos will be very difficult.
On the other hand, the relative competitiveness of the peso against the dollar will benefit the tourism sector (ironically, tourism traveling from the US) both in the beaches and business segments, and for this reason, we expect a consolidation and an increase in hotel room construction for properties located throughout the country’s tourist destinations and industrial corridors. Two segments that have grown significantly over the past few years – and that will maintain their momentum in the short run, despite being sensitive to levels of consumption and to increasing interest rates, are the residential and the retail segments, which will require distinct follow up without losing sight of the levels of sales absorption in residential and occupancy rates in retail.
An undeniable and consistent fact in the real estate market is that returns are long term, and short term junctures have an impact on valuations, however, generally speaking, the market has the capability to sustain them and maintain committed rates of return on projects.
To retain the level of performance of real estate projects in times of uncertainty, it is important to rely on a group of xperths and specialists with market intelligence and who recognize the way that critical variables behave in each of the real estate segments; experts who know how to interpret and make assertive decisions based on the insight provided by experience.
For more than 15 years, at Xpertha Capital we have specialized in offering our clients training, counseling, development, and management services to support them with their real estate investments, fully understanding that property related decisions are the foundation of estate planning.
We are passionate about what we do and know the potential offered by our people and our country. Recent developments are an unexpected challenge for Mexico, however, we are fully convinced that times of crisis are essential to spur change and help societies move ahead, as Albert Einstein said, “in times of crisis, only imagination is more important than knowledge”, and today, that is what Mexicrequires.
*The authors are Managing Partners at Xpertha Capital, a real estate firm that provides training, counseling, management, and investment services for private equity funds in value added projects, with an understanding that our client’s real estate decisions are the foundation of their estate planning. (www.xpertha.com).
By Adriana M. Guillén Tarragó and Jorge A. Castañares Moreno *