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U.S. DEVELOPERS, STORES, EAGER TO REAP MEXICO’S GROWING CONSUMER MARKET

BY ANNA ROBATON

A decade after an economic meltdown in Mexico led foreign retailers and shopping center developers to shelve or scale back ambitious expansion plans, foreign investors have again set their sights on the country’s nascent retail real estate sector.

U.S. shopping center giant Kimco Realty Corp. and real estate mogul Sam Zell’s Equity International Properties are among those set to spend hundreds of millions in coming years for portfolios of malls and shopping centers — which until recently were developed largely by Mexico’s big retailers, conglomerates, architectural firms and entrepreneurs.

“There is a huge inflow of money and developers of retail scouting the market for good opportunities,” said Ricardo Zúñiga, a principal and director general for Mexico with O’Connor Capital Partners, a New York City-based real estate investment firm founded by industry veteran Jeremiah W. O’Connor.

The firm has joined up with a subsidiary of Consorcio Ara, one of Mexico’s biggest affordable-housing builders, to develop a portfolio of about 10 malls and shopping centers during the next several years. This includes a project now under construction in Ecatepec de Morelos, one of the largest cities in the state of Mexico. The project has two components: a fashion-oriented regional mall and a neighboring power center.

O’Connor and other foreign investors, many of them backed by big U.S. pension funds, started to trickle into Mexico in the mid-to-late-1990s, when the nation’s economy began to improve. Many concentrated first on industrial, office and housing before turning their attention in recent years to the retail sector.

Downscale development
But unlike the foreign developers that early on hatched ill-fated plans to build malls serving the country’s wealthiest citizens, many of today’s builders are targeting two groups that are significantly larger and still relatively underserved: low-income consumers and the country’s burgeoning middle class (see charts).

For anchors, developers are turning to a lineup of foreign big-box retailers and fast-growing Mexican chains, from hypermarket operator Soriana to theater chain Cinepolis. Among this market’s biggest foreign retailers are HEB, The Home Depot, OfficeMax and Wal-Mart.

“The up market is smaller in Mexico compared to the United States,” said Frank Badillo, global program manager at Columbus, Ohio-based consulting firm Retail Forward. “It is more a niche market focused on a handful of cities, primarily Mexico City and large regional cities such as Guadalajara and Monterrey. The growth has been in the mid-to-lower-income markets that provide opportunities for mass retailers like Wal-Mart.”

Though poorer Mexicans have enjoyed more access to affordable credit and mortgages in recent years, they are still served mostly by independent merchants. With a population of nearly 105 million, Mexico has roughly 1 square foot of retail space per capita, compared with about 20 square feet in the United States. The pace of development is briskest in the northern half of the country, especially in those areas nearest the U.S. border and in the big inland cities, such as Mexico City.

“You see informal retail popping up all over the place because the need is there, but it is not being serviced,” said Zúñiga, who works out of O’Connor’s Mexico City office. Through the Ecatepec project, called Las Americas, O’Connor is targeting a trade area with no existing regional mall and a largely low-income population of about 2 million. The project’s regional mall anchors will be Cinepolis, a Fiesta Inn hotel, department stores El Puerto de Liverpool, Sanborns and Sears, and a unit of Belgium-based junior department store C&A. Wal-Mart and Sam’s Club will anchor the power center portion.

O’Connor and its partner, Promotora y Desarrolladora de Centros Comerciales, have committed $100 million in equity capital to the 50-50 venture, which, combined with debt, should allow them to develop about $250 million in assets. The focus is on hypermarket-anchored community centers, with the exception of the mall under way in Ecatepec.

Because of the relatively low level of retail development, said Zúñiga, “you drive through some communities and see that on every block one or two houses have converted their living rooms into small convenience, liquor or meat stores.”

Not only is Mexico relatively underdeveloped, it also has a sizable population of young people, which means the workforce is likely to keep growing, along with the demand for housing. In 2000 more than half the population was 24 or younger, compared with 37 percent in the United States, according to Retail Forward (see chart).

“It appears as though the average age is coming right into a sweet spot, and you have more people entering the workforce with the ability to borrow more and more money,” said Joaquin de Monet, managing director of GE Real Estate’s operations in Mexico.

GE Real Estate, which has a $1.7 billion portfolio of loans and equity investments in Mexico, has been active in the market since 1993, the year before the peso devaluation threw the country into economic turmoil.

Since then, interest rates, which topped 100 percent following the devaluation, have fallen, thanks in part to foreign investments in the banking sector. Inflation, about 4 percent last year, dropped too, giving consumers more purchasing power. In addition, the creation in 1995 of Sociedad Hipotecaria Federal, Mexico’s equivalent of Fannie Mae, has given more low-income citizens access to mortgages, helping to fuel a housing boom in some urban areas.

The country’s economic strides led GE Real Estate, whose initial investments were tied to the export-manufacturing sector, to expand to include retail in 1998. The firm focused initially on providing loans to developers, but later broadened its activities to include equity investing through a joint venture with Kimco to acquire and develop grocery-anchored centers. So far the venture has bought three properties and expects to close on an additional five by year-end. The partnership intends to amass a portfolio of 15 to 20 properties with a total capitalization of $300 million by the end of next year, according to de Monet.

New Hyde Park, N.Y.-based Kimco brings its strong connections with U.S. tenants to the partnership, but the firm is no stranger to Mexico. The firm’s vice chairman and chief investment officer, David B. Henry, oversaw investments in Mexico as investment chief of GE Real Estate before joining Kimco in 2001.

Kimco has also hired Richard M. Ellwood, the longtime head of HEB’s real estate development operations in Mexico, who is now helping Kimco find acquisition and development opportunities.

“Virtually 50 percent of retail sales are done through the smaller independent shops,” said de Monet. “There is still plenty of room to grow with in-fill locations, taking business away from the informal street vendor.”

The commercial real estate business in Mexico is no morning stroll, however. Most foreign players are emphasizing development rather than acquisition, because of the scant supply of newer, high-quality centers. Historically, shopping center developers raised construction funds by selling off small-shop space in their centers to tenants, resulting in fragmented ownership and poor management. But land can be hard to acquire, too; demographic information may be scarce or unreliable, and the development process is often lengthy.

Gotta have friends
“A lot of people who control land in Mexico are not leveraged,” said Andrew Strenk, president of Tustin, Calif.-based Strategic Planning Concepts International, which helps retailers and developers create positioning strategies for Mexico and the U.S. areas bordering it. (His firm has done work for both Kimco and O’Connor.)

“Whether they do a deal doesn’t always depend on the financials of the deal,” Strenk said. “It may depend on whether they like you or not. They might sell you the land at a reasonable price, or there is no deal at all, no matter what the price. This has been a hard bridge for Americans to cross.”

What’s more, though more foreign retailers are expected to enter the market, the existing pool of strong shopping center tenants remains relatively meager, especially when it comes to small-shop specialty retailers. And the continued expansion of Wal-Mart de Mexico, which came to the country in 1991 through a joint venture with Mexican retailing giant Cifra, is expected to result in a shakeout among locals, including leading mass-market retailers Controladora Comercial Mexicana (better known as Comerci), Grupo Gigante and Soriana.

The three are fighting back by forming a joint-purchasing company that will allow them to cut costs and negotiate better prices with suppliers. But Comerci and Gigante, hindered by a lack of money for investment, have already lost ground to Wal-Mart, which has been able to add stores more quickly, a Retail Forward study says.

According to published reports, Wal-Mart de Mexico plans to spend nearly $700 million through next year to build new stores and restaurants. It already has about 650 units in 64 cities nationwide.

“A lot of the local players have been hampered in their investment plans,” said Retail Forward’s Badillo. “They have been hurt by the stiff competition that Wal-Mart has presented, and their expansion plans tend to be a lot more meager than Wal-Mart’s.”

Despite the hurdles, foreign investors in retail real estate are determined to amass sizable portfolios. Some, like O’Connor, are relying on local joint venture partners to help them overcome challenges inherent to Mexico, including land access and site selection.

O’Connor was drawn to Consorcio Ara in part because over time Consorcio Ara has carved out parcels within its housing developments that are already zoned for commercial use. In addition, since Consorcio Ara often helps buyers apply for mortgages, it has a strong understanding of many low-income markets where big-box retailers are likely to flourish, Zúñiga says.

“Seventy percent of the population of Mexico, which we have neglected for 20 years, is emerging as a consumer at this point in time,” Zúñiga said. “But developing in these communities is not simple, because knowledge about them is opaque. Ara provided [that] to the joint venture.”

Plus side of the minus side
Indeed, some foreign investors say they like Mexico precisely because the difficulties involved in building there are likely to keep it from becoming overbuilt anytime soon.

“One of the reasons we love Mexico is the barriers to entry,” said Gary Garrabrant, CEO of Equity International, the privately held international real estate arm of Sam Zell’s Chicago-based Equity Group Investments. “What that does is limit the competition.”

Equity International has been active in Mexico’s real estate sector for the past six years, helping to attract big U.S. institutional investors such as the Washington State Investment Board, which alongside Equity International invested $250 million in a Mexican industrial property company in 2002.

This year Equity International announced its first retail-related investment, a $42 million commitment to Mexico Retail Properties, which was founded in 2001 by Denver-based Black Creek Group, a privately held real estate investment company. Mexico Retail has an office in Mexico City and plans to invest $100 million a year in the next five years to develop U.S.-style power centers in urban areas. Its first project, called Plaza Panamerican, is under construction on a 32-acre site in Juarez, one of the 50 largest cities in Mexico. Costco and Home Depot will anchor the first phase, which is slated for completion next spring.

Of course, the outlook for retail real estate also hinges on whether Mexico continues to make economic and political strides. Its economy has experienced relatively slow growth recently, and its manufacturing sector faces strong competition from China and other parts of Asia. There has also been some backlash in recent years against the North American Free Trade Agreement, which has accelerated U.S. imports. But many are optimistic.

“Mexico has had its ups and downs,” said Retail Forward’s Badillo. “But it is steadily on pace to a more stable, developed economy. That will bode well for retailers there.”