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LOOKING SOUTHWARD

Foreign developers, retailers brave tough challenges to enter lucrative Mexican market

BY DEBRA HAZEL

It may be far easier for a foreign company to operate in Mexico today than in the mid-1990s, but it’s still no walk in el parque. The challenges facing business executives going there include labyrinthine zoning laws, unfamiliar leasing practices, expensive real estate and entrenched corruption.

None of that, however, is enough to put off an increasing number of North American and European retailers and developers that are expanding there, lured by a growing market and an ever more stable economy. Costco, Chelsea Property Group, The O’Connor Group and Rockwood Realty Associates are among the U.S.-based companies in the retail business that have headed south of the border in the past dozen years. Costco operates 21 stores in Mexico, The Home Depot 15 and Wal-Mart more than 600.

Inditex, of A Coruña, Spain, operates 53 apparel stores in Mexico — 31 Zara stores and 22 Bershka units. Its Mexico stores generate 7.5 percent of Inditex’s total sales worldwide, according to London-based newspaper The Independent. That’s impressive, given that the company has 530 Zara stores alone in 44 countries. A year after the arrival of Spanish accessories chain Tous in Mexico, it has 14 stores and plans to open more.

Mexico City has a population of 20 million, but only as much retail as the city of Birmingham, Ala.

“The opportunities in Mexico are tremendous,” said Ricardo Zúñiga, director general of Peabody Group, a $1 billion real estate investment fund run jointly by the O’Connor Group development firm and J.P. Morgan Chase.

Equally tremendous are the contrasts with the way business is done back home. Landlords still demand key money — cash the tenant pays up front for the right to open in the center. Large land parcels are scarce in dominant Mexico City. And corruption is still pervasive, despite government attempts to combat it.

“Mexico is a little more like the Wild West,” said Leslie T. Chao, president of Roseland, N.J.-based Chelsea, citing the country’s new-frontier character. “It’s a much more entrepreneurial atmosphere.” Chelsea is co-developing Premium Outlets Punta Norte, an outlet center to the northwest of Mexico City.

This is not the first time developers and retailers have ventured into Mexico. In the early 1990s Simon Property Group and M.G. “Buddy” Herring Jr. announced separate plans to build regional malls. The Simon centers were supposed to introduce Dillard’s and J.C. Penney to the region, with Simon acting as a third-party developer for local owners. The crash of the peso killed those plans mid-decade, though Penney did eventually open six stores in the country nonetheless.

“They were looking for us to provide a new generation of retailers,” said Michael P. McCarty, Simon’s senior vice president of research and corporate communications. “But when the peso devalued, that was the straw that broke the camel’s back.”

Herring, meanwhile, had a contract to develop centers around Sears stores. But when the Mexican economy deteriorated, Sears pulled back on its expansion and eventually sold the stores (though they retained the Sears name), ending Herring’s involvement. He has no plans to return, he told SCT.

Since then, the economy has recovered, helped by the 1994 implementation of NAFTA, additional trade agreements with much of Central America and the European Trade Area, loans from the United States and strict fiscal controls.

Mexico’s trade with the United States and Canada has tripled since 1994, according to the 2002 CIA World Factbook, helping spur the expansion of the country’s middle class. Inflation was 6.5 percent in 2001, down from 150 percent in 1987 and 26 percent in 1995. The government has not devalued the peso since 1994.

“Mexico’s economy is now acting like a mature economy,” said Zuñiga. “It is delinked from Latin America and now more like North America.” Though the U.S. recession slowed Mexico’s growth somewhat, the economy has held up.

“In the retail sector, you’ve seen a remarkable resilience in the Mexican economy and, actually, growth in consumer wealth,” said Joaquin De Monet, managing director of Mexico City-based GE Real Estate Mexico. The company is investing in various forms of real estate, including office, hotel and retail, throughout the country.

Thus, growth-minded U.S. retailers, faced with stagnating comp-store sales at home, have been looking south, where more and more centers are going up that could potentially accommodate them.

Next year Chelsea will open Premium Outlets Punta Norte, an outlet center outside Mexico City, in a joint venture with local developer Sordo Madaleno y Asociados.

“The quality of the centers is more akin to U.S. centers in terms of parking and layout,” said Robert Baer, president of Rockwood Asociados, a division of New York City-based Rockwood Realty that invests in properties in Mexico.

With a population well above 20 million, Mexico City has about the same amount of retail as Birmingham, Ala., which has only about 800,000 inhabitants, notes Simon’s McCarty.

That has led North American retailers and investors to eye Mexico more than ever, continuing a process that began during the 1990s.

Costco entered Mexico in February 1992, with stores similar in size and format to its U.S. models, says Jaime González, Costco senior vice president, Mexico. By 1994 the Issaquah, Wash.-based warehouse club had opened 10 stores around the country and had two more under construction when the financial crisis hit. Nevertheless, those units opened, as did three more in 1995 and yet another in 1997. Costco remains on track to open three to four new stores yearly.

Costco has been flexible with its merchandise mix, withdrawing some imported items that became prohibitively expensive after the devaluation. Since then, the free trade agreement with Europe, like the one with the United States, has lowered prices on imports.

J.C. Penney opened its first Mexican store in the mid-’90s, soon following that up with five more. Texas-based grocery chain HEB opened in 1997 in Guadalupe and Monterrey, near the U.S. border. It now has 20 supermarkets in Mexico and plans to open two new stores a year there over the next five years.

Home Depot came in by means of acquisition, buying Total Home, a Mexican home improvement chain, in June 2001 and converting its two units to the Home Depot banner in March 2002. Home Depot also acquired the four-unit Del Norte chain in 2002 and has since built new stores, for a total of 15 in Mexico.

Not surprisingly, the giant among foreign retailers is Wal-Mart, which entered Mexico through a 1991 joint venture with Cifra (operator of Bodega Aurrera, Suburbia and Superama stores) to open a Sam’s Club. After acquiring its joint venture partners in 1997, Wal-Mart de Mexico has grown to more than 600 units in 58 cities, including Sam’s Clubs, Wal-Mart Supercenters, Superama supermarkets, Bodega self-service discount stores and Vips restaurants.

Wal-Mart has begun dominating retail in Mexico much as it does in the United States. The chain introduced its everyday low pricing strategy in 1999, and the resulting pressure has forced competitors, including Mexican supermarket chain Gigante, to trim their own prices. Wal-Mart de Mexico increased its revenues 13 percent to $10.2 billion last year, even though the Mexican retail market shrunk by 1.8 percent, according to Forbes. Wal-Mart sales in Mexico now comprise 26 percent of its total non-U.S. sales, a performance second only to its results in Britain, the magazine reports.

Photo: Associated Press

Wal-Mart, which entered Mexico in 1991, now operates more than 600 stores in 58 cities, including Sam’s Club, Wal-Mart Supercenters and other brands.

But such expansion does not come without difficulty for these chains. Permitting remains difficult. Chelsea is targeting an October 2004 opening for Premium Outlets Punta Norte, a joint venture with local developer Sordo Madaleno y Asociados. Originally, it planned to have the center open this year.

“Things do take longer, even with a good local partner,” Chao said. “Because the rules are not as well developed, there is uncertainty on how long it takes to do things.”

Chao says the 200,000-square-foot Punta Norte will probably be about 90 percent leased at opening. The tenant mix will include a combination of Mexican retailers and names more familiar in the United States and Canada, though he declined to name names.

But U.S. retailers must also contend with the fact that Mexico City is as notable for its lack of available land as for being one of the world’s most densely populated urban areas.

“It is very congested and land is very expensive,” said Pedro A. Azcué, president of Jones Lang LaSalle Latin America, Mexico City. And much of the city is inaccessible by subway, which reduces even further the number of viable areas in which to build.

Zoning has become stricter too, says Costco’s González. Faced with these restrictions, developers and retailers are redeveloping auto dealerships and other existing retail sites to get needed space, just as some are doing in the United States.

Some things are getting easier, though. Increasingly, leases are being negotiated in pesos, not dollars, making deals more attractive to foreign tenants. Demands for key money are abating to a degree, too. Until recently, Mexican developers had little to no access to long-term financing, so those fees helped pay for the cost of construction. But the practice is diminishing as GE Real Estate, The O’Connor Group and other financial companies have begun investing in retail properties. It remains prevalent in Mexico City, however, retailers’ most desired market. “In the top shopping centers, it’s pretty firm, and it’s not going away,” Azcué said.

But major U.S. retailers, more accustomed to being paid tenant improvement fees by the landlord, might balk at these fees even there, according to Simon’s McCarty. “If you think you’re going to get Gap or The Limited to pay key money, forget it.”

On the corruption front, meanwhile, the government has pledged to battle bribery by officials, and it is against U.S. law for companies to pay bribes to overseas officials, in any case.

“I can’t say it’s been taken out 100 percent,” Azcué said. “But the major companies such as Wal-Mart have very strict codes. They forbid their employees to pay one dime in bribes, and they still sell millions of dollars in goods.” Investors, increasingly looking to Mexico, are providing financing vehicles that never existed before.

“As the peso stabilizes, you have percentage rents,” said Baer of Rockwood Asociados. “And yields — around 14 percent — are compelling, compared to U.S. cap rates.” Mexican banks, too, are providing financing now.

Despite improvements to the business environment, though, it remains too tough for some. Competition forced French hypermarket Auchan, which had five units in Mexico City and one in Puebla, to sell the stores to Mexican operator Controladora Comercial Mexicana in February. Auchan has no plans to revisit the region, says spokeswoman Emmanuelle Ferrari.

That may not be true for Simon.

Pointing to the company’s successful centers in Texas border towns Brownsville and El Paso, McCarty said, “We would, if the right opportunity were present, look again at Mexico.”

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