Mexico’s House Party Moves Downtown: An ESG Perspective of Affordable Housing

Published: Saturday, March 29th, 2014 by Lenora

How big is the gap between financial markets and responsible investment in housing? Is it big enough to drive almost $1.5 billion in defaults and nearly $3.5 billion in total lost market value? The turmoil among Mexico’s homebuilders over the past year begs the questions as the market reels from a regulatory shift by the incoming President Pena Nieto in early 2013.

Hundreds of thousands of Mexico’s homes now lie abandoned on the edges of the country’s sprawling cities. Long-simmering complaints by buyers about distant commutes with no public transport, lack of services and promised amenities and rising criminality in these communities dim the prospects for their revival. Mexico’s listed homebuilders are now mired in debt renegotiations and business restructuring in the wake of the President’s move to favor core urban densification as he came into office in 2013.

That regulatory move to bring housing closer to the city undermined an affordable housing business model that had developed hand in hand with government over a decade and a half, an effort that successfully opened up financial access for lower and moderate income working people. Although investors seem to have focused on the headline story about changing regulation, there are less well-understood elements of the mass housing business model in Mexico that drove the its prolonged corrosion, if not its ultimate failure.

A housing model for rapid urbanization. At the outset, Mexico’s housing framework was considered a model of public and private sector collaboration throughout the emerging markets. Investors from the World Bank to rating agencies to major investment managers described the approach as unique, effective and sustainable. The Mexican government supported pension-linked mortgages to lower and moderate income working people through organizations meant to advance housing finance for working people, especially public sector workers. The apex financial institution, Sociedad Hipotecaria Federal (SHF), as well as Infonavit and FOVISSSTE, quasi-public agencies, were vested with the mission to promote financial inclusion for affordable housing.

Government efforts to mitigate risk for housing developers were well-received. Real estate in emerging markets is already a high stakes game because of the high fixed costs, long lead times and shadowy risks around land, permits and construction. Starting in the Vicente Fox administration, developers, homebuilders and construction and engineering companies, among which the now-distressed, large listed builders, like Geo, Urbi and Homex, built their business models on the government’s leadership and these incentives.

On the financing side, the model appeared to be highly successful. While just over 400,000 housing loans were originated in 2000 in Mexico, that number had more than tripled by 2008 to a total of 1.4 million. Government-sponsored loans accounted for more than 60 percent of the total lending volume. In upgrading quasi-public financial intermediaries to streamline and standardize lending, the federal government had a noticeable impact on the lending environment for working class families. Lending became more efficient and lower income borrowers benefited.

Meanwhile, the supply side of the equation was managed in a more laissez-faire fashion. Developers banked low cost land in the peripheries of Mexico’s growing cities, mass producing large-scale housing communities using industrial approaches. As Mexico’s homebuilders’ successes consolidated, market participants emphasized certain positive environmental and social elements:

+ Easing of the urban housing deficit specifically among lower income households

+ Enhanced economic well-being of lower income homebuyers through asset- and wealth-building, increased access to credit and ability to build a formal credit history

+ Industrial manufacturing techniques utilized for increased efficiency and lower materials waste, presumably leading to more rapid provision of housing

+ Improved housing hygiene with better services, less pollution and even some experimentation with energy efficiency

+ Higher security for homebuyer households removed from crime and chaos of urban slum communities

Unfortunately, as the business model seemed to thrive, homebuyers became frustrated with unkept promises by developers, distance from jobs and lack of services. Many communities deteriorated. Renters replaced owners. Crime swept in. Even so, urban planners and thinkers had been shaking their heads in frustration for years, pointing out the model’s shortcomings:

Lack of complementary transportation infrastructure raising the overall cost of living

Distant locations underserved or unserved by businesses and services, like clinics, schools, markets and other social infrastructure

Households disconnected from their families and supportive social networks

Basic infrastructure and services not delivered as promised (e.g. in extreme cases electricity and water but also no maintenance and security)

Poor security and rising criminality in distant, unpoliced communities

Additional environmental burden on Mexico’s cities due to increased commuting and, later, wastage of resources with abandonment

Need for more financial education to help homebuyers understand the financial implications of mortgage finance

Lack of community development to help buyers and, later, renters participate more actively in neighborhood governance

New directions? Long before Pena Nieto’s urban policy break, this model had started to lose its footing with movements toward a new policy starting in 2008. The Sustainable Integrated Urban Developments (DUIS) policy was meant to encourage denser, multifamily housing development and improved access to transport and critical services through tighter regional collaboration of homebuilders and policymakers. More importantly, the DUIS explicitly required developers to show their projects met sustainable planning standards to receive assistance, subsidies and financing. Even so, the DUIS was designed to draw new development out of existing cities and into regional multi-use complexes, away from the revitalization of existing urban communities.

By contrast, Pena Nieto emphasized the new government’s support of better located and planned projects to promote core urban multi-family development. He’s pointed to better inter-agency coordination, smart and sustainable urban development, responsible approaches to reducing the country’s housing deficit and dignified housing for all Mexicans. It is still early to determine how that will move forward, but at this writing, the government was reaffirming its fiscal support for improved housing just as creditors of the three major homebuilders are agreeing on restructuring plans.

Lessons for reflection and application. Mexico is certainly not the first nor will it be the last housing crisis in the world. Even so, what lessons can developers, businesses and investors take away to achieve Pena Nieto’s smart, sustainable and responsible housing industry? What does it mean for both Mexico’s own next chapter in affordable housing and the similar developments being launched in rapidly developing urban economies all over the world? “Smart cities” and megaprojects are now ubiquitous.

Without probing the role of business, government and “smart money” in Mexico’s troubles, five lessons in environmental, social and governance (ESG) analysis stand out – lessons that transcend Mexico’s experience to reach the next horizons in this story (e.g. China, Brazil and others):

1. Plan for social and environmental sustainability. Sound urban planning principles are a sine qua non for any large scale development. Planning approaches that support mixed, vibrant and secure places and environmentally sustainable sites can enhance value by bolstering a developer’s reputation for quality. Good planning helps people get to their jobs, provides protection from climate, improves public safety, stimulates civic participation and reduces the risk of new ghettos. This year’s winner of Mexico’s annual housing award, Vinte, offers a window to the future of sustainable affordable housing.

2. Accompany finance with complementary support. Inclusive business models that rely mostly on expanding access to finance creates hazards for borrowers and lending institutions if not combined with appropriate support and information. Financial education, oversight of product quality and consumer protection are necessary complements to mitigate risk for borrowers, lenders and investors.

3. Understand and build for the market segment. Lower income buyers are more vulnerable and sink a substantial proportion of their incomes and wealth into housing. Homebuilders need to design a product that helps solve an economic challenge. Building near jobs and layering in supportive structures for community development is essential.

4. Build for responsible business not regulatory arbitrage. With developing economy governments at all levels exploring new ways of filling housing deficits, regulatory risk is a constant. As markets, knowledge and civic awareness advance, subsidized lending, construction finance, urban planning, sustainability improvements and other interventions may come and go. Right now, the world is swinging back towards smart transport-enabled density and in situ community regeneration.

5. Use transparency as a differentiator. Real estate will have to catch up on governance, transparency and communication, especially where more vulnerable buyers are involved. Affordable housing markets need clear rules and standards for public and private sector collaboration, performance and impact reporting and enforcement mechanisms to build long-term market-driven systems. Investors and buyers need more information about developers’ track record, ongoing performance and community impact.

Where will Mexico’s experience lead next? Other countries – Brazil, India and China, to name only a few – have all embarked on variations on this theme. Commercial homebuilders have yet to recognize their Achilles heel. Homeowners can eventually vote with their feet – more so now in an age of lightning fast communication and unprecedented information sharing.

Even so, the crisis may have created an opening for a new wave of more responsible and sustainable urban business and investment. Social enterprises like Echale a Tu Casa and forward-thinking homebuilders like Vinte can distinguish themselves despite the turbulence in industry and finance. In fact, the vast majority of homes in emerging and developing markets are built by small and medium-sized enterprises. No doubt a new generation of urban leaders can emerge from those ranks.

This article was co-written with Will Von Geldern‘s writing and research support and with several rounds of feedback from Maria Elosua and other advisors. The author acknowledges their contributions with gratitude.