Foreign Investment

Making Money in Mexico

Learn what it takes to do business south of the border.

Editor's note: In March 2004, the CCIM Institute hosted its first-ever trade mission in Monterrey, Mexico, to promote cross-border business opportunities for members. A variety of U.S. and Mexican commercial real estate professionals, including the authors, gathered for two days of presentations, group discussions, and networking. This article highlights Mexico's property markets and key economic and political factors that affect commercial real estate opportunities.

Cross-border real estate transactions are certain to increase as trade agreements, political reforms, and globalization lower the barriers that separate the United States and Mexico. To successfully participate in this promising new market, commercial real estate professionals should educate themselves about Mexico's property sectors and economic and political issues that affect the country's business climate.

Property Market Overview
The following summaries offer a glimpse of Mexico's real estate market's major drivers.

Hospitality. Mexico's hotel market is the most robust in Latin America . Typically properties have been built with foreign capital and about half are leisure-oriented. In 2003, tourism was the country's third-largest source of foreign capital, and Mexico 's beaches and resorts continue to attract foreign tourists, approximately 80 percent of which come from the United States . The tourism industry employs about 6 percent of Mexico's workforce, and foreign investment in luxury hotels, condominiums, and other hospitality-related projects rose 12 percent last year.

Retail. Since 2001, Mexico's consumer spending has risen 5 percent and consumer imports have increased 10 percent to 15 percent due to a strong, stable currency. Large urban populations and solid demographic trends also support a healthy retail sector.

Wal-Mart established a presence in Mexico in the mid-1990s and several other U.S. and international big-box retailers are entering the market, including HEB, Carrefour, Costco, Price-Smart, Home Depot, Sears, J.C. Penney, OfficeMax, and Office Depot, among others.

Industrial. A few large players dominate the distribution and speculative industrial market. Most of the maquiladoras remain near the U.S./Mexico border; however, the industry has been transformed in recent years. Originally formed as Mexico-based manufacturing subsidiaries of U.S. companies, the plants and products now tend to be from Mexican companies. Also, there are no import/export duties for eligible products if the import is temporary. Therefore, once parts are assembled in Mexico into finished goods for export to the United States , only the value added in the assembly process is taxed. The U.S. auto industry is the leading benefactor of maquiladoras followed by durable goods manufacturers.

In addition, logistically prominent industrial parks are emerging away from the border and along Mexico City's outskirts. Mexico City's industrial vacancy rate is currently about 12 percent, a significant improvement over 2000's 18 percent.

Office. While Mexico City is the primary office market, Monterrey and Guadalajara are strong secondary markets. Office properties primarily are owner-occupied, and some sale-leasebacks occur.

As of first-quarter 2004, vacancy was 20 percent in Mexico City, and hovers around 25 percent in Santa Fe, the city's largest submarket. Mexico City's vacancy rate will continue to rise as 3.5 million square feet of office space are added this year. Despite these high vacancy rates, local private investors keep constructing new space, further compounding the problem.

Distressed office property owners soon may provide U.S. investors with some purchasing opportunities at below replacement cost. However, the service sector is a very small part of Mexico's gross domestic product, and the prospects for expansion in the office sector are remote.

Residential. Housing demand is exploding as Mexico's large youth population enters the job market. In 2000, more than half of Mexico's population was under age 24; as this segment ages, 10 million people will be added to the 25- to 50-year-old demographic by 2010.

Affordability is a concern for residential development: Will future employment and income growth be sufficient to allow young families to purchase homes" Financing for home buyers is another issue. Historically, the primary residential mortgage market has been inefficient and government subsidized. Yet, securitization progress is being made, with total property securitizations expected to reach $1 billion this year. However, the Mexican secondary market for residential mortgages is in its infancy, and growth may be constrained due to poor discipline in the primary market.

Two Mexican lenders are opening U.S. branches to allow U.S.- based Mexicans to obtain mortgages for family members still living south of the border. To qualify, borrowers must provide proof of income and a 20 percent down payment to secure five- to 20-year mortgages of $20,000 to $50,000. The loans are made in pesos and generally carry double-digit fixed interest rates.

Mexico lacks professional residential real estate companies and broker training and licensing. Developing these services may improve the market's efficiency over time, but currently tremendous opportunity exists for U.S. real estate professionals to service both sides of the border.

The developer-built housing market also is fragmented. Only eight major companies build more than 2,000 homes per year, leaving opportunities for large U.S. builders looking to expand into Mexico.

To be successful in Mexico's real estate market, investors and brokers must understand the property sectors' nuances and key political and economic hurdles (see sidebar). Other considerations include the unavailability of market data, low reporting standards, and the lack of financial transparency. Market players who navigate these challenges deftly can expect to earn lucrative returns.

Resources

The following resources provided additional information on real estate investment in Mexico.

"Comparative Analysis Between U.S. and Mexican Commercial Real Estate Transactions (With Tax Considerations Commentary)," by Patrick W. Martin, in Law and Business Review of the Americas, Fall 2001.

"Legal and Practical Issues Involved with Maquiladora Financing," by Sandra L. Shippey and Patrick W. Martin, Law and Business Review of the Americas, Winter/Spring 2002.

"Prerequisites for a Successful Secondary Mortgage Market: The Role of the Primary Mortgage Market," by Michael J. Lea, Housing Finance International 15, Dec. 2000.

"Understanding Real Estate in Mexico," by Mitch Creekmore, Texas Realtor, May 2001.

Bryan L. Goddard, CCIM, and Donald P. Guarino, CCIM

Bryan L. Goddard, CCIM, is senior appraiser and Donald P. Guarino, CCIM, is director of applied research at Aegon USA Realty Advisors in Cedar Rapids, Iowa. Contact them at (319) 896-6932 or BGoddard@Aegonusa.com and (319) 369-2508 or DGuarino@Aegonusa.com. Understanding Mexico\'s Economy and Politics Numerous economic and political factors affect Mexico\'s commercial property markets. Following are key issues to consider when conducting business. Economic Shifts. Mexico currently is transitioning from a protectionist Latin economy to a North American and global economy. However, the population\'s livelihood continues to depend heavily on remittances from relatives in the United States , the commercial/manufacturing trade, and illicit activities. Generally, Mexico\'s economic transformation is premised on some key fundamentals, including inflation below 5 percent, a stable peso, investor confidence, global orientation, and rapid middle-class growth. Prospects for future expansion of Mexico\'s real estate sector hinge on continued investor confidence and the predictability of such underlying economic fundamentals. Macroeconomic stability also directly impacts real estate exit strategies because it drives Mexican investment demand, fund supply, required returns, and investment time horizons. Banking. Historically, Mexico\'s banking system has been weak and undercapitalized. In 1982, all banks were nationalized; then 10 years later, 18 government-owned banks were re-privatized. Spanish, U.S. , and Canadian interests now own 98 percent of Mexico\'s banks, with the largest six controlling 85 percent of total assets. Foreign banks earn huge profits in Mexico and face resentment and political pressure. The country is concerned that banks are not extending sufficient credit to small and mid-sized business customers. As a result, the government is developing new regulations and higher fees. National Politics. A major power shift occurred in 2000 when former Coca-Cola executive Vincente Fox was elected president, unseating the opposing incumbent party after 71 consecutive years in power. Mexico\'s traditionally powerful executive branch has dominated national politics. However, presidential power was diluted in 1997 with the rise of opposing parties in the country\'s congress. Therefore, the pace of reform has slowed, and there is a risk that future elections could produce leaders who reject the North American Free Trade Agreement. Border Issues. Security concerns after Sept. 11, 2001 , slowed U.S./Mexico trade advances, but in June 2004 the U.S. Supreme Court gave the White House the green light to open U.S. roads to Mexican trucks. This ruling ends a dispute that has festered since NAFTA was signed in 1994. However, new proposals from the U.S. Department of Homeland Security could hinder this trade progress. Local Politics. Mexico has 31 states and a federal district, which is located in downtown Mexico City . Decentralization is pushing more decisions to these states and local governments. Real estate development and investment are impacted strongly by local political issues, including licensing, zoning, and environmental regulations. In addition, red tape and corruption risks are significant at the local level since each state\'s pace and reform direction are different. Courts. Mexico\'s judicial system is exceptionally slow and unpredictable when compared with the U.S. legal process. Foreign investors are wary of frivolous litigation, corrupt judges, and the capriciousness of the law. For instance, evictions and foreclosures can be very lengthy as the courts tend to favor tenants and borrowers. In some cases, it may require two to five years to complete an eviction or foreclosure. Judicial reform is necessary to help clarify rules, and courts need greater consistency in interpreting contracts and applying the law. Conferring with competent legal counsel is advisable when working on a transaction in Mexico . Tax Reform. Marginal rates are high, but collections are low due to rampant tax evasion and arbitrary loopholes. In fact, Mexico \'s tax collection rate is among the lowest in its peer group. The country\'s future competitiveness hinges on taxes for investment in physical infrastructure and human capital. Windfall from privatizations and high oil prices has delayed a tax crisis thus far, but tax reform is needed soon because few opportunities for privatization remain. Without sufficient tax revenue, political pressure may build for some form of re-nationalization or expropriation to generate revenue.

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