On June 2nd, INMSA started to operate in Mexico. It was an opportunity to talk with investors, bankers and experts on Real Estate. During those meetings, one of the most important topics was INMSA´s opinion about Real Estate opportunities.
Below, there is a summary of the conversations held during those days in Mexico between Luis Méndez Trillo (LMT), the local host and a reference in Commercial Real Estate business in the country, and Mariano Capellino (MC), CEO of INMSA.
LMT: Mariano, the recurring question formulated by investors and many reporters was related to the impact of the pandemic on Real Estate investments. What’s your opinion about this? First, let’s talk about the global economy.
MC: Luis, the global crisis of the pandemic reinforced a tendency in the USA and Europe. The interest rates and the fixed income instruments yield became the lowest in history. Of course, there was a reason for that. That situation has remained, even now when both the USA and Europe are recovering from the worst crisis ever. The Federal Reserve insist on keeping rates low and this is also the case in Europe and Japan.
Let´s consider that the USA 10-year Treasury bonds obtained an average 3% yield in 2018 and 2021. In 2020 they fell by 0.89% during the crisis and today they are reaching 1.5%. The equivalent instrument in Spain reached 0.05% during the worst period of the pandemic, its peak in the last 5 years was 1.6% and today it is under 0,50%.
LMT: Those rates are quite below the traditional minimum return on real estate investments in the USA for example.
MC: That´s right. But there are some other key factors that must be considered to understand the current situation. The tax policy in large countries is expansionary and it can be clearly observed in the Real Estate market. In the USA, mortgage loans dropped about one point, from 3.75% to 2,75% thus generating a real estate boom. Many people, who hadn´t had the chance to access private homes, could do it. Or, due to the reduction in monthly payments, many people had the opportunity to move to a better place. Mortgage applications increased 24% and financing reached 80%. Many families changed their original credit to borrow more money or pay lower rates thus reducing their monthly payments.
LMT: A real boom.
MC: Yes. Let´s consider that the household stock in the USA reached its lowest level in decades. Today, less than 2 months are required to sell the stock completely – exactly 1.9 months-. The volume of home sales increased 22% despite Covid. Logically, it generated a surge in prices. It is calculated that the price increment in the residential sector was 11%, situation that had not been experienced since 1968.
LMT: And how did it impact the real estate market?
MC: This reduction in interest rates encouraged large investment funds worldwide to take advantage of it by investing in multifamily and logistics assets in the USA, this impacted their prices and they are currently reaching historic peaks.
LMT: I can see a conclusion here. The USA experienced its boom already and it´s no longer attractive now if you intend to obtain high returns.
MC: Exactly. The right moment to enter was at the beginning of the crisis. Today prices have already reached a point which offer scarce opportunities and, at this moment, entering the market is becoming risky, as we all know that upon the increment of the interest rates, overvalued real estate assets adjust their prices.
LMT: It is a very interesting thing, as we can see that a market such as the American one had few possibilities in 2019 but in 2020 the decrease in interest rates generated a boom. This indicates what you usually say about the cycles of the markets. A market can be very attractive in a certain moment but it can change rapidly and, many times, generate losses if timing is not good.
MC: these are the phases of the market cycles we always mention and which are so important to make investment decisions in Real Estate. This is the key. It must be conducted at the right time. In theory, it is easy, but it requires research and understating the right moment to access, maintain the asset or exit.
LMT: Let´s talk about the USA, where you used to live. Now, you are living in Spain. I imagine there is a reason for that.
MC: (smiling) You have to be where opportunities are. In Europe the pandemic had special characteristics, but the interesting thing is that it hasn´t experienced the situation lived in the USA about which we have been recently discussing. In the USA everything tends to happen faster, both crises and recoveries. The expectations in Europe for 2021 and 2022 is the situation that is currently taking place in the United States. In short, Europe is the opportunity right now as the recovery process has not started yet.
LMT: In your conferences, you always talk about real estate returns. And the popular belief is that rentals are more profitable in rising markets, but it is not exactly like that.
MC: In theory, we can think that in markets under full revaluation process, renting a property can result in successful business. There is a confusion between demand and price, especially in the residential segment where there is little elasticity in rent prices. In this case, the leap in real estate prices in the USA however will not be reflected in rental income, as rents are usually subjected to middle-class’ purchasing power, economic growth, inflation rate and other factors. In this case, with the increment in the prices of the properties, the rental income goes down because at a similar price, there is an implied lower rate obtained. In the case of Europe, and especially in Spain, as the value of the properties has not been recovered yet, the rental income is still attractive until the expected revaluation takes place.
LMT: Interesting. But as you have said recently in Mexico, you believe that the Real Estate returns, in general, are still attractive.
MC: The difference between the income obtained from a rental property and bond yields is still much higher. Historically, the return on real estate was -at most- twice the treasury bond. Today, depending on the country, it yields 4 and 10 times its value. The maximum returns can be obtained in countries such as Spain where no asset revaluation has been produced yet. Rents are still the same but with assets at lower prices.
LMT: But we shouldn´t get confused. Investing in order to obtain 2-digit profitability does not only imply to have a property for rent.
MC: Clearly, investing in Real Estate is much more than simply acquiring a property to be subsequently rented. The basic variables that should be observed in a real estate investment are three: acquiring under the market value, obtaining good rental income and achieving an accelerated recovery / appreciation rate.
Even though we expect the rate of return on a rental property to remain low, we also know that there are 16 trillion US dollars being unprofitable seeking other safe assets and, this is where the real estate market becomes interesting, especially in Europe, particularly in Spain as there will be a strong appreciation. For this reason, we believe that prices will continue rising. With a convenient strategy to find assets under the market value, there are sophisticated Real Estate investments in Europe offering a huge opportunity to achieve 2-digit returns without leverage.
LMT: Mariano, thank you so much for this intense week in Mexico, see you soon in Spain.
MC: We’ll be glad to have you in Spain, and of course Mexican investors as well.
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