Mexico City gets premium office space: new developments like Esmeralda III and Torre Libertad show increased investment in intelligent space.

Demand has caught up with supply in Mexico City's office market, according to many area experts. The economy looks favorable for growth, companies are relocating at a high rate and new world-class buildings are set to open in the nation's capital. However, most experts believe large-scale tenants seeking premium office space will need more choices in the next several years.

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"Lower prices since 2001 and a drop in Mexican interest rates contributed to widespread office construction in the city, especially in Santa Fe", said Henry McDonald, senior vice president of CB Richard Ellis in Mexico, to BUSINESS MEXICO. "Corporate real estate decisions are about people productivity. Due to affordable prices in Mexico City, companies can put their people in good working conditions. It makes sense to invest in employee productivity, which is quality office space."

The demand for quality space has attracted significant international investment in new construction for premium buildings.

Several of Mexico City's top real estate investment professionals have reported that multinational companies are demanding corporate offices with international standards, and they have the money to make it happen.

"Foreign companies are a significant component of the overall demand. Plus, international businesses are more selective and request a specific fit to their needs driving up the Class A building market," said head of Corporate Real Estate for HSBC Mexico, Claudio Tanco.

McDonald confirmed the huge amount of investment in new buildings. He said before 1994 there was a lot of foreign interest in building but it went away in 1995, due to the devaluation of the peso. But from 2000, there has been billions of dollars in foreign investment in Mexico City and "the economic climate is good for developers."

Larger investments and higher demand have inspired new state-of-the-art buildings projects to accommodate tenants such as HSBC, which will begin to relocate to a larger building on the corner of Reforma and Rio Tiber in front of the Glorieta del Angel, in January 2006.

Currently, HSBC staff operates in four different buildings so employees are looking forward to being under one roof, a more functional work environment. Plus, the new space complies with HSBC safety standards, including better air quality, ergonomics, technology and water efficiency. Tanco said the office is a more collaborative space improving communications and teamwork by eliminating private offices in favor of open space.

Eye-catching Torre Mayor, another new building on Paseo de la Reforma, contains 73,900 square meters of office space. Reichmann International built Torre Mayor in six years. It is 80% full, but Rick Ricker, director general of Reichmann International Mexico and Torre Mayor, predicts the building's occupancy rate to reach 90% by the first quarter of next year at the latest. Ricker said the building helped raise the level of competition in the Class AAA market and set a new standard for real estate in Mexico City.

"The market now expects Class A products to be equivalent to those in North America and Europe. The Torre Mayor is probably the most efficient and productive space in Latin America, since we have amongst the largest floor plates in town averaging about 1,800 square meters per floor so tenants can locate on the fewest number of floors. The Torre Mayor already finished to each floor everything from elevators to telecommunications, electricity, heating, air conditioning, restrooms, etc. We're not just another pretty face. Being the largest building in town, gives us a lot of economies of scale keeping our operating cost amongst the lowest in town so we can deliver the occupancy costs (security, janitorial services, etc.) at an incredibly cost competitive standpoint. Even though our base rents are not the lowest in Mexico City, our overall occupancy costs are competitive, and we meet all of the Mexican, North American and European codes."

The new options

Torre Mayor is not the only option for companies who seek more office space so their employees can operate on fewer floors, minimizing the cost of copy centers, coffee rooms, etc. Esmeralda III, a luxury office building in Lomas de Chapultepec, is expected to open in September 2005. It contains 40,000 square meters of rentable space, 18,000 of which was already leased to a large insurance company.

Los Atrios in Polanco, between Ejercito Nacional and Moliere, will attract attention when complete. The complex will contain 3 Class A+ office buildings, over 100,000 square meters of office space, a shopping center, restaurants, a cinema and 5-star hotel. It will also include a cutting edge technology used in installations and telecommunications, along with 6,000 indoor parking spots.

Additional projects in the Central Business District (CBD), which include Polanco and Lomas, are Torre Libertad in Colonia Cuauhtemoc, with 10,000 square meters of corporate offices, and Reforma 222, containing 18,750 square meters of office space. When finished, the complex will include a hotel too.

Prices in Mexico City's different areas of the city vary greatly and reflect the trend of new development. Several new buildings along Paseo de la Reforma such as the HSBC tower and Torre Mayor demonstrate a return to the city from the suburbs. Ricker said over the past 3-5 years Mexico, like many great cities in the world, reversed the "flight to the suburbs" trend.

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"Cities realize they can't give away their city centers to crime and deterioration. They need good infrastructure in the way of transportation, people to live downtown, good hotels, restaurants, office space and a civilian workforce. Also, mayor (Andres Manuel) Lopez Obrador has invested pretty heavily over the last 5 years in Mexico City's Centro Historico and the landscaping of Reforma. There is an orientation and it shows up in office demand, that people take pride in their city center", he explained.

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"Reforma has established itself as a quality address again," added McDonald. As such, asking prices by year-end 2004 averaged US$ 27 per square meter per month for Class A & Class A+ commercial properties with a vacancy rate of 6.7% (Cushman & Wakefield). McDonald said the address is desirable, but future building will prove difficult along Reforma due to the aquifer, limited space and poor soil.

Polanco and Lomas are popular with companies too, and asking prices for Class A & Class A+ buildings averaged US$ 23.95 per square meter per month year-end 2004, with a vacancy rate of only 6% (Cushman & Wakefield). Ricker said prices in the CBD vary depending on the size of the tenant, the tenant's credit worthiness, the length of the term of the lease, and whether or not the tenant will pay for his build-out instead of the landlord.

Like Reforma, developers face challenges in Polanco. McDonald said the area is convenient, but there is not much access and the sub-market lacks enough easy land to build on for new projects.

"Polanco and Lomas are the most desirable areas for companies, but Santa Fe appeals more to firms with back office employees who do not have to travel a lot during the day, especially in the banking sector," explained McDonald.

Rents in Santa Fe are significantly less than in the CBD because there is more supply. The area attracts developers for its space, cheap land and high-grade soil. Last year, Class A & Class A+ rental asking prices averaged US$21.30, and the vacancy rate was 27.4% (Cushman & Wakefield). "Popular since 1992, a cost of a building in Santa Fe this year is about 30% less than downtown, about US$ 16-17 per square meter per month," offered McDonald.

Ricker agreed, "In Santa Fe, you're seeing anywhere from US$ 6-8 per square meter per month less because of the oversupply and competition. However, sophisticated tenants compare the base rent (2/3 of a tenant's cost) against services some buildings may or may not supply. In some cases, it may be cheaper to pay a higher base rent because upfront tenant concessions are included so the overall occupancy cost is cheaper."

Base rents are inexpensive compared to the CBD, but there are infrastructure challenges in Santa Fe for new projects, warned Ricker. He said the area lacks enough water supply and electricity making it hard to get a building permit. Plus, traffic is poor resulting in long and difficult commutes.

There are more intelligent buildings in Mexico City today than a few years ago, but the tenant/landlord relationship is changing. Since prices stabilized in 2005 and the oversupply in the office market is in decline, landlords offer fewer perks to new tenants compared to last year.

"Our view is that rents have stabilized ... the big difference is in the form of concessions. There really are not upfront landlord concessions the way there was in 2003 and 2004. By that, I mean free rent, generous tenant finish build-out, furniture allowances and those sorts of things," explained Ricker.

Time to build again?

Currently, Mexico City has 1-2 years of office supply, and is no longer overbuilt. Ricker said this indicates a healthy office market since it takes a minimum of 2 years for a developer to buy the land and build out the space. The vacancy rate is falling too.

Global real estate firm Cushman & Wakefield gauged that Mexico City's general office vacancy rate in 2004 was 18%, a decrease compared to 2003, and estimates 17 buildings are under construction in the district adding roughly 323,000 square meters to the office inventory within the next 2 years.

McDonald said of the 8 million square meters of office space existing in Mexico City, only 3 million square meters is "quality space," the more modern and efficient buildings larger companies seek. The vacancy rate of this quality space was 16% at the end of June 2005, less than 2004.

In general, the vacancy rate in Mexico City is approaching 18-20%, said Ricker, but not all of it will be leased so the rate is really lower. "A lot of Mexico's inventory, probably as high as 10%, is functionally obsolete. There are Class A and Class B buildings built as recently as ten to fifteen years ago that are structurally sound and architecturally look pleasing, but they don't have enough parking, telecommunications, air conditioning or electricity. They can't ever lease more than 60% of the building because 60% of the building takes up 100% of the parking, all of the air conditioning, etc. That sort of functional obsolescence builds into the market a vacancy rate of at least 10% that you have to understand about the Mexico City class AAA office market. There is enough supply to take care of demand."

In a business climate where vacancy rates are falling, corporations are upgrading their spaces, and billions are being invested in Mexico City, is this the time for developers to build new high-end projects? Most area experts support building because larger companies are running out of quality choices.

"There is a huge amount of money interested in investing in Mexico right now and not enough product to accommodate the need, which is why we think it's time to build. It takes roughly 2.5 years to complete a building so it is a great time for new development," McDonald opined.

He said medium and large-sized clients are running out of options in popular business areas of town including Polanco, Lomas, Periferico, Reforma and Insurgentes. According to McDonald, there are 8-10 quality Class A buildings available in the CBD for medium-sized clients (needing 2,000 square meters of contiguous space) and three viable options in the same area for large-scale tenants (needing at least 10,000 square meters) today.

Ricker agreed that mid-size and larger tenants lack an abundance of choices for quality office space, but he does not think it is time to build. "2004 was a record year in leasing and that trend has continued in 2005 so that supply, especially in the Class AAA product, had been greatly diminished. The competition is such that there is not the oversupply. There has not been continued construction. Therefore, prices have stabilized. But it is not a good time to build because there is still a lot of vacant space out in Santa Fe so the smaller tenants still have a lot of choices. Since there is still a lot of supply in Santa Fe, it is difficult for a developer to put together a meaningful project."

Like McDonald, Mario Navarro, senior director at Cushman & Wakefield Mexico, said it is "definitely time" to build Class A and A+ office space since the market right now has a profusion of money. Santa Fe is getting absorbed and the United States economy is starting to heat up so Navarro expects to see more projects as early as September, good news for companies looking to relocate.

HSBC Mexico's Tanco concurred with McDonald and Navarro. "I believe we have enough in the market of standard products in the commercial corridor. What we're lacking are those more oriented toward a specific type of plan. In our case, we (HSBC) knew we had some options in the market but none of them were really of the quality and functionality we were looking for. Eventually, that may happen to other companies. I believe it is time to build more Class A buildings, those that are really well-planned with a good functionality and put them in a place where you have the right infrastructure because in Mexico we have some infrastructure problems such as energy, water and transportation."

As Mexico City's vibrant office market continues to induce companies to move into updated and enlarged office space, numerous hot projects are in the pipeline to meet the demand. Experts predict that with large-scale tenants needing room to grow, there will be additional attractive opportunities in the commercial real estate sector for investors and developers in the near future.

Total Occupation Cost

US$/ year, per square meter

Bogota             US$180
Colombia
Santiago           US$235
Chile
Buenos Aires       US$253
Argentina
Sao Paulo          US$284
Brazil
Mexico City        US$379
Mexico

Source: CB Richard Ellis, Global Market Rents, January 2005

Note: Table made from bar graph.