NAFTA: what does it mean for RE investment?

What difference will the passage of NAFTA make? What opportunities will there be for US investors and related service professions?

First of all, let's be clear on what NAFTA means and what it does. It is a tariff reduction bill, which reduces tariffs between US, Canada and Mexico to almost zero over a 10-15 year period. There will be different impacts on Canada and Mexico.

Canada is a developed nation of 20 million people, with income levels very close to our own. The country is currently in recession, and generally over-developed with real estate in most major markets. There are likely to be minimal impacts or new opportunities for U.S. investors.

Mexico presents a somewhat more positive story for American investors, but with some risks. Mexico is a relatively poor nation of some 80-90 million people, but with a rapidly growing middle class. Passage of NAFTA should accelerate growth of this middle class, with attendant opportunities for purveyors of American services and products.

Opportunities and impacts will differ, by product or land use type, and by area of the country. Let's examine the specifics.

* Mexico City will emerge as the dominant financial center, and be the most attractive office market.

* Border industry - (the so-called, maquiladora plants) - will lose their special advantages, as industry throughout Mexico, not just at the border, can take advantage of US/Mexico trade.

* Hotel development is somewhat old news. American hotel chains have been active in Mexico for years, and are well represented in all the major commercial and resort areas.

* Industrial and warehousing - There should be good opportunities throughout the country.

* Residential development presents possible opportunities for American mass producers, who have innovative technology but have not been able to apply it in the US because of local ordinances, work rules, or other irritants.

* Retail - American shopping centers and other retail developers should find many opportunities as the Mexican middle class expands. Mexico City now has the world's largest Wal-Mart. Other chains will follow.

Who's in the game to date?

American developers have not waited for the passage of NAFTA to begin their expanded operations in Mexico. New American venturers will see many familiar faces in Mexican real estate.

In retail, Hahn Co. has formed a joint venture for development with Groupo Gusta. Melvin Simon Associates has formed a joint venture with Groupo ICA, which will bring such American retailers as Penney's and Dillard's to Mexico. And last but not lent, QVC, the home shopping channel, has announced that its second operation outside the US will be in Mexico (the first was in Britain). And so, as Bell Atlantic upgrades the Mexican telecommunications system, the Mexican shopper will be served with America's latest in shop-at-home convenience.

In the industrial and warehouse area, both the Koll/Cushman joint venture and Trammell Crow have established themselves as players. They had previous experience as developers for the maquiladora market. Keep in mind, however, that the Mexican distribution system will start from scratch in the era of "just in time" warehousing. This may mean, as it has in the US, fewer and larger facilities, bypassing the need for the many smaller facilities that were developed in the US through the 1970s and 1980s.

Office developers of all nationalities have been active in Mexico in recent years, building more space in Mexico City in the last two years than was constructed in the previous 25 years. Just in the past few months, rents have started to come down, by as much as 15-20 percent in some instances. Even with these declines, however, rents remain well above US levels. Vacancy rates are also increasing, as hints of over-building begin to appear. Historically, vacancy rates have been less than one percent. Observers now report that they have increased to 13 percent, and could increase to 20 percent in 1995 - even with NAFTA approval. Office demand from American financial services firms could absorb some of this excess supply - how much, remains open to question. The last office boom in Mexico City was brought to an end by the 1985 earthquake, which tightened supply by obsoleting much existing space instantly.

Design and service firms, such as RTKL, Skidmore Owings and Merrill, and Frank Gehry Associates are also active in Mexico, on front end activity associated with infrastructure projects. Like many of the American developers now active in Mexico, they are both pulled by opportunity in Mexico and pushed by lack of opportunity at home.

Finally, the Soros/Reichmann team has signed on as developers of a portion of the multi-use Santa Fe new town, nine miles west of Mexico City. They will not be the only developers there, but they will have a major piece of the project. Local comment on the project is mixed. Positive comment speaks to its visionary, 21st Century character of the project. Less positive commentators describe it as an image project of the Mexico City government, to show that "everything's up to date in Mexico City," and say that, even with heavy subsidies, it's way ahead of the market.

Proceed With Caution

Finally, some cautions for the American investor.

Focus will be important. Provide a unique service or product, and you will be more likely to succeed. Try to be all things to all people, and you'll likely fail.

Bring equity money. Sorry, Mexico is not the wished-for Shangri-La, where banks make 90 percent loans. In fact, equity requirements may be higher for Mexican than for American projects. The financing of buildings totally with cash is much more common in Mexico than in the U.S.

Realize that many other experienced players are already in. Mexico is not an amateur's game. Americans, most notably but not exclusively from southern California, Arizona, and Texas, have been playing here for years, have joint ventures and other relationships in place, and know the local politics and markets in great detail. This is particularly important in such a developing market, where much of the data will be unpublished, at least for the next few years.

Understand that NAFTA represents a gradual speed-up of the inter-linking between the US and Mexico, not a quick fix that makes everybody instantly rich. Investors must be prepared to hang in for the long run, and be flexible in the face of inevitable surprises.

Be aware that Mexico is not just Mexico City. Better opportunities may be found in the less picked-over areas of the nation's 30 states. However there, the need to understand local markets and politics will be even more critical.

Watch for the results of the November 1994 Mexican presidential elections. Nations undergoing rapid change don't always do it smoothly (witness former Russia and eastern Europe); expect some fits and starts, and possible nationalistic resistance to "the invasion of the gringos."

(Mr. Peterson recently was named Chairman of the Advisory, Committee of AFIRE, the Washington, D.C - based Association of Foreign Investors in U.S. Real Estate. AFIRE, formed in 1988, is a professional association of major foreign institutions which haw all interest in laws, regulations and economic trends affecting U.S. real estate markets.)