RCA Insights

Chasing Higher Yields in Mexico Is No Risk-Free Endeavor

By on July 12th, 2017

The lure of comparatively high yield investments in Mexico may compel some U.S. and Canadian investors to seek acquisitions there as cap rates in their home countries hover at record lows. Make no mistake, there are great reasons to be involved in Mexican commercial real estate, but chasing yield is not as risk-free or easy as one may hope.

How big is the yield opportunity? Into Q1’17 cap rates for commercial properties sold in Mexico averaged 8.8%. This cap rate was 240 bps higher than commercial cap rates in the U.S and 260 bps higher than those in Canada. Even an extra 100 bps might seem attractive to investors in today’s environment but the embedded risks are different.

Inflation in Mexico was running at 5.3% for the year to Q1’17, data published by the OECD shows, while inflation in the U.S. and Canada is in the low-2% range. As a result, yields on 10yr government bonds are far higher in Mexico than in its northern neighbors. In Q1’17 10yr benchmark bonds for Mexico averaged 7% versus 2.5% for the U.S. and 1.6% for Canada.

1707 Costello Mexico main SSC-01

In some sense, investors in Mexican real estate are paying more dearly, then, for their investments. In Mexico spreads over the “risk-free” rate of government bonds are less than 200 bps versus a 460 bps spread on offer in the U.S. and 390 bps in Canada.

Lack of available commercial real estate supply in Mexico is also an issue. Mexico was in some turmoil in 2008, when RCA started covering the country, as the drug war eroded investor confidence. Volume for transactions priced $10m and greater totaled less than $1b per year until 2011. Transaction activity returned with the introduction of the FIBRA structure and waning of the drug war, and hit a peak of $6.8b in 2013. In the 12 months to Q1’17, deal volume was down to $3.0b.

Whether deal volume for the year is $1b or $10b it is also simply difficult to find attractive investments in Mexico without deep, long-standing relationships. The best-of-the-best assets in the country are concentrated in the hands of investors with little interest in selling amid higher inflation and economic uncertainty. Deal volume in Canada, which has a population less than a third that of Mexico’s 127m, is far more liquid. In the 12 months to Q1’17 Canadian volume stood at $21.3b, some seven times the size of Mexico’s transaction market.

That large Mexican population is a compelling reason to continue focusing on the country, however. There is significant retail consumption potential as economic liberalization marches onward and helps boost the middle class. Commercial real estate investments today have both a current high yield and upside potential despite the economic risks.

Jim Costello

Jim Costello

Senior Vice President

Jim Costello has worked in the CRE space on issues of urban economics since 1990, including a 20-year stint at Torto Wheaton Research. Jim expanded the reach of the Torto Wheaton Research team developing forecasts of global market fundamentals. He also developed approaches to pair the forecast results with frameworks to answer investor questions on asset values and relative investment opportunities.

In the aftermath of the Global Financial Crisis, Jim provided advice to the Treasury Department and helped educate these professionals on commercial real estate performance. Jim is a member of the Commercial Board of Governors of the Mortgage Bankers Administration, where he helps policy makers understand the commercial real estate industry.

Jim is expanding the capabilities of the Real Capital Analytics team on issues of real estate market dynamics. Jim has a master’s degree in economics and is a member of the Counselors of Real Estate.