Investing in the Mexico Hotel Market, Outlook & Opportunities

Hospitality Investment Opportunities in Mexico

Yadira: Good morning, everyone and thank you for joining us today. We are here to discuss topics that are challenging for the Tourism and Hospitality sector but that at the same time can present great opportunities for the growth of new market niches. Where diversification and adaptability may be key in the coming years.

I would like to start with Patricio. Patricio: What trends are you seeing in the market and what differentiates the winners from the laggards during this phase of the recovery?

Patricio del Portillo:

Thank you, Yadira, the current market can be divided into subsectors depending on geographic location, size, category, and type of asset. Starting with business hotels, I can tell you that it is the most affected sub-sector, first due to structural issues such as oversupply and uncertainty, as in the case of the Bajío, where in 5 years almost 100 hotels were built, or political issues such as in the Mexican Southeast where the business has proven to be dependent on oil, so that Veracruz, Tabasco, and Campeche have low occupancies.

In the main and secondary markets, business hotels have been recovering, reaching occupancies above 40% due convention tourism market and traditional vacation patterns. Contrary to this, we have seen a sustained growth in AirBnB occupancies in Mexico City with markets such as Polanco, Roma and Condesa with occupancies close to 80% and rates above USD$200. As for border markets, Tijuana for example, they held up the best are running at levels consistent with 2017 and 2018.

In the Leisure Tourism market, the big losers have been the All-Inclusive hotels given their great dependence on the volume of tourism and the closures and caps imposed by local governments. The opposite is true for the boutique and luxury hotels which have had their best months since opening.

The three main markets have had very different behaviors. Cancun/ Riviera Maya has seen a considerable increase in the number of tourist arrivals, but not in rate growth. Puerto Vallarta has had an increase in local tourism arrivals, and the Riviera Nayarit has had a growth mainly in its rates, given that the resorts in this submarket have positioned themselves in the luxury segment.

But the biggest winner of all has been Los Cabos, where growth in demand and rates has been unprecedented, as well as the desire for 2nd home ownership. Last year, the sales of residential tourism product reached almost USD$600 million and it is expected to double this year, to an all time high.

Yadira: When we look ahead, the pandemic, inflation, and supply chain disruptions have led to an uneven and fragile recovery in certain areas. Tim: What do you think are the biggest challenges facing an investor in the hotel sector today what best practices are you sharing with your clients?

Tim Gifford, Managing Director, Capital Advisors, Latin America:

The biggest challenge for hotel investors today is the travel restrictions imposed by government authorities due to COVID. There is a direct correlation between the pace of the recovery, and the level of governmental restrictions throughout the region. Mexico is a region where we see the Sun & Sand theme strongly at play. For example, Cabo, Vallarta, Cancun and La Riviera, are benefitting from higher end travel by those that typically want to vacation and are more limited based on restrictions. We expect Mexico to continue to benefit from these travel patterns given their compelling resort offerings and few governmental restrictions.

The second biggest risks are politics and travelers’ perception of safety. We have not seen increased headlines dampen demand; however, it is impossible to say if trends would be even stronger without these types of incidents in markets like Cancun and Tulum.

Another topic that we hear debated in the market these days is inflation. In general, inflation is not a major concern for hotel investors in Mexico and less so in assets with revenues mainly in USD. Keep in mind that they will be collecting revenues in Dollars and at least some portion of their expenses will be in Pesos. International capital is focused on the EBITDA growth in these markets and seeking opportunities to deploy capital.

Finally, one question that remains is the cadence of the recovery in business travel. We have yet to see significant pick up in the large city center business hotels, and we are watching these trends closely.

Yadira: Patricio, who are the new entrants in the market and what are the new rules for example, in contracts that we are seeing in the sector?

Patricio's answer:

That's right Yadira, this pandemic has produced a major shift in demand, with a savvy traveler who is willing to pay higher rates and stay longer in exchange for better experiences. What does this mean? It means that the average tourist is looking for more than a great room, which they already take for granted, but also for extraordinary food and beverage offerings and entertainment.

They are no longer willing to let hotels charge for outdated Wi-Fi and tasteless buffets. They want to walk into their room and find something that's different from all the rooms they've stayed in in the past. They are always looking for a differentiator to help them with their Instagram moment.

This has led hotel companies to evolve by paying more attention to their luxury and lifestyle products and offering unique and elevated experiences to guests as well as top of the line technology.

For investors it has also been an important change, as thing something we never would have thought possible has happened. So, investors are reviewing the clauses of the contracts in greater detail and looking for alternatives, such as guaranteed minimum rents, lease contracts, participation of the operators in the investment, preferential returns, and compensation frameworks that are more closely tied to profitability.

According to the latest figures from the World Tourism Organization for 3Q 2021, Mexico had experienced the most modest declines in tourist arrivals relative to relative to 2019 (along with Turkey). In fact, Mexico essentially matched its 2019 tourism levels thanks to longer stays fueled by remote Work and Digital Nomads.

Yadira: Tim, how do you see the appetite for investment and M&A in Mexico in terms of most active regions and type of players or transactions are most active? Where do you see the future hotel investment market coming from?

Tim's Answer:

Thank you, Yadira, we see strong appetite from international investors for existing assets first and foremost with a focus on Sun & Sand resorts. These assets are leading the recovery and in a number of cases have actually surpassed 2019’s pre-pandemic levels. Cabo, Vallarta, Punta Mita and the Riviera in general are markets with strong international investor interest, along with the Caribbean side from Cancun to Tulum.

We have done capital raises in the US for investors interested in investing these markets and repositioning assets to be more amenity rich and lifestyle and experience focused. Investors are also focused on brands, or regional brands, that are well-known in the segment. The acquisition, repositioning and rebranding of Sun & Sand assets is much more prevalent than new development these days and we expect this trend to continue in 2022.

Although we have yet to see meaningful interest in traditional city center business hotels, we are seeing increased interest in hotels located close to regional logistics and manufacturing hubs, particularly in the northern parts of Mexico where the rates are frequently tied to the dollar and fundamentals have recovered and, in some cases, surpassed pre-pandemic levels.

Another area where we are seeing investor interest is short-term rental type assets (AirBnB). These are homes or buildings where a portion of the units are designed as short-term rentals and are put into rental pools. We expect this to be a theme as we continue into 2022.

Finally, despite significant appetite for distressed assets by foreign institutional investors, we have yet to see many of these assets come to market. So, the two areas where we don’t expect many transactions in 2022 are distressed assets and new construction.

Yadira: Patricio, there has been a lot of talk about FIBRA consolidations. What are your thoughts on the potential for growth and M&A going forward?

Patricio's Answer: As for the largest hotel FIBRAs in the country, I can tell you that the market is undergoing a major transformation. FIBRAs are reinventing themselves by focusing on specific market niches such a luxury or Sun & Sand locations. In some cases, partnering with foreign funds and operators.

At the same time, we are seeing more and more participation and investment by Mexican Family Offices, who are investing directly or along-side international funds, in the Mexican hotel acquisitions and development.

Yadira: Tim, how are you seeing the hotel financing, refinancing and development market in Mexico?

Tim's Answer: Yadira, great question and just to circle back if I can for a moment on Patricio’s comments related to the FIBRA market. Over the last year, many have traded below replacement cost or NAV and this has impacted transaction levels in the sense that some investors have lower appetite for direct investment when they can potentially purchase the same exposure and upside through a FIBRA trading at a discount.

With respect to financing, over the last year Mexico most of the refinancing and covenant waivers have been relationship based. Lenders have been willing to work with owners to extend their terms and increase flexibility in the wake of the pandemic. As the segments we mentioned earlier have recovered, we have seen additional interest in extending credit and lending on behalf of banks and various lenders. What we still have not seen is significant interest in financing for construction and new development.

Yadira: Let’s take a moment and take a few questions from the audience.

1.  Should we consider Tulum a continuation of the Riviera Maya? Do you consider Tulum a luxury hotel market? How do you see Tulum developing as a destination?

Patricio: From my perspective, we shouldn’t consider Tulum to be an extension of the Riviera Maya largely because the Riviera Maya has positioned itself primarily as an All-Inclusive market, with the exception of a few areas like Mayakoba. Tulum on the other hand has distinguished itself as a market with a large number of small, boutique, lifestyle properties. In addition, Tulum can be separated into to markets, Tulum beach, and the city center. The city center has seen the greatest growth and that is where you see the lifestyle properties opening. We expect the trend of renovations and conversions to continue and expect to see more international lifestyle brands like Soho House penetrating the market. Security is also a key priority for the market.

2.  Tim what are your thoughts on Mexico City, which historically had been more business transient driving but has evolved into a leading cultural destination as well. How should we think about the growth in that market with respect to travel and where are investors most focused?

Our view is that we will see a rebound in the gateway cities such as Mexico City, Guadalajara, Monterrey. We also believe that the trend toward lifestyle and boutique hotels with differentiated décor and experiences will continue to unfold and we expect to see continued interest in hybrid condo-hotel, mixed use, and amenity-rich facilities.

3.  What is your outlook for the transaction market in urban hotels and do you expect to see assets trading hands at meaningful discounts?

Patricio: In a tertiary submarket, it is possible to find hotels on the market at a discount, but in a prime location, that isn’t likely. There is a lot of money on the sidelines look for investment opportunities just like in the US, and trophy assets and prime locations are trading hands at premiums to pre-pandemic levels. As a result, if there are prime assets that trade hands this year, it will be at a premium, not a discount, or there could be portfolios where patient investors can generate a meaningful return by buying early in the recovery and holding the assets over the cycle.

Tim: I believe we are likely to see more activity on the part of investors in 2022 than we saw in 2021. We will likely see refinancing and direct investments and we are generally more optimistic on the outlook for the deployment of both domestic and international capital.