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Sun and profit: investing and developing in Mexico.

What image does the word "Mexico" conjure in your imagination? Sunny beaches, bright skies, and blue oceans? Or high inflation and economic upheaval?

If Mexico still raises the specter of economic instability, you probably have not been following the news about Mexico closely. Inflation dropped dramatically from a high of 160 percent per annum in 1987 to 18.5 percent by late 1991. That's eight times lower than the 1987 figure. Further, economists believe that the Mexican government will be able to force inflation lower this year--to about 12 percent.

And, consider this: While, in 1992, the American economy was growing at the sluggish annualized rate of about 2 percent, the Mexican economy has been accelerating at the rate of approximately 3 percent.

A new economy

Economists now consider Mexico's economic reform a model for other Latin American countries. The country's Harvard-trained president, Carlos Salinas de Gortari, in office since December of 1988, has radically restructured almost every element of his nation's economy.

Last year, the Bush administration initialed the North American Free Trade Agreement (NAFTA), a treaty that will create a vast common market among the United States, Mexico, and Canada, surpassing the European Community in combined population and gross national product.

The goals are gradual but comprehensive elimination of trade barriers among the countries, resolution of trade disputes, establishment of formal dispute-settlement procedures, and protection of intellectual property rights.

While the Mexicans might be unsure of what Bill Clinton's new administration will mean to NAFTA, Clinton has said that he would endorse the agreement if it is accompanied by additional accords and legislation meant to protect the environment, jobs, and the U.S. economy. Most observers expect Congress to accept a free-trade agreement with Mexico in one form or another.

New foreign business regulations

With or without NAFTA, however, the Mexican government has said it is committed to opening the Mexican economy and has acknowledged that foreign investment will be the cornerstone of Mexico's economic revival. The Salinas government has abandoned Mexico's old hostility to foreign investment in favor of encouraging foreign ownership of businesses and property.

In 1989, the Salinas administration promulgated new regulations removing the barriers to foreign ownership of most businesses--including real estate development and real property management.

Under the old regulations, a foreigner generally was unable to engage in commercial enterprises without a Mexican partner. Worse, in most cases the foreigner would have been permitted to own only up to 49 percent of such an enterprise, with a Mexican partner owning the majority. Special permission from the National Commission on Foreign Investment would have allowed the foreigner to own a greater percentage, but it could never be certain of a Commission decision in its favor.

New regulations have changed much of that. The development, real estate, tourism, and property management businesses are, practically speaking, now accessible to foreign businesses.

For example, under the new regulations a foreign business may own up to 100 percent of such interests without a permit from the Mexican government, provided that certain criteria are met. Among them, the original investment may not exceed $100 million in fixed assets and may not be located in Mexico City, Guadalajara, or Monterrey.

In addition, while the automatic approval rules described above will not apply to foreign businesses established in those three areas, a foreigner may own up to 100 percent of a proposed business with a permit from the NFIC and the Ministry of Commerce and Industrial Development. The agencies have been fairly relaxed in granting such permits since the beginning of the Salinas administration.

Equally important, President Salinas has forced the Mexican bureaucracies to respond to applications from foreign investors quickly. After an application for a permit, the NFIC and the Ministry of Commerce have up to ten business days to request any items missing from the original application. If they make no request, the application will be deemed complete. At this point, the administrator must make a decision within 45 business days or the application will be approved automatically.

The 1989 regulations also have made ownership of real property in Mexico much more attractive.

The fideicomiso

The Mexican Constitution, adopted in 1917 after a revolution that was promoted in part by anger at foreign intervention in Mexico's economy, included tough foreign investment rules. Its Article 27 states: "Under no circumstances may a foreigner acquire direct dominion over land and water located within 100 kilometers (64 miles) of Mexico's borders and 50 kilometers (34 miles) of Mexico's coasts."

Practically speaking, this meant that no foreigner could own any of Mexico's choicest real estate--that located along its coasts and borders.

Today, the problem for the foreigner interested in investing in or developing any coastal or border areas--such as the resort and recreational developers and the industrial developers active along the U.S. border--is that Article 27 still forbids outright foreign ownership of these choice properties.

However, in 1973 Mexico's legislature created an official loophole in the ban by authorizing a foreign entity to obtain the beneficial use of Mexican real property within the prohibited zones by means of a Mexican bank trust, or fideicomiso.

Under the fideicomiso provision, a Mexican bank serves as the trustee and legal owner of a property. The foreigner is named as the beneficiary of the trust and, as such, has the exclusive right to the use and control of the property. Although the law limits the fideicomiso to a thirty-year term, the beneficial interest can be sold to another party at any time during the term and can be encumbered as security for a debt just like any other personal property interest.

In addition, President Salinas' 1989 regulations now made the fideicomiso more appealing, allowing them to be issued automatically for almost any commercial use.

The Salinas regulations also allow a right that earlier foreign investors had longed for: the fideicomiso term, while still limited to thirty years, is automatically renewable. Now, the Foreign Ministry must issue a new trust permit effective for a new term of thirty years if an application is filed within the allotted time period.

There is more good news for investors looking for real property investment in the major urban centers of Mexico--Mexico City, Guadalajara, and Monterrey: If the project is to be located in an area outside of the prohibited zone, including these cities, a foreign corporation can set up a wholly-owned Mexican subsidiary, which, in turn, can own the real property directly without a fideicomiso arrangement and without a permit from the Foreign Ministry.

(Foreign individuals and corporations wishing to obtain fideicomiso interests in real property in Baja California and foreign individuals who wish to acquire direct title to real property outside the prohibited zone still must obtain permits, but the permits are relatively easy to obtain.)

The Mexico City office market

Mexico City is the hub of nearly all political and economic activity in Mexico, and is home to offices of nearly every major governmental agency and many large multi-national corporations. Mexico City's population has been estimated at more than 19 million people--about 20 percent of the country's total population. It is the largest city in the western hemisphere and a remarkable business center.

Mexico City is the bellwether for other urban centers, including Guadalajara, Monterrey, and Tijuana. However, until now, it offered little room for foreign office-ownership and property management. The reason is that, like almost every other major element in the economic puzzle, these urban office markets have seen enormous mismatching of supply and demand.

The wild economic ride of high inflation, incredibly high interest rates, punitive income taxes, and real property transfer taxes--plus the government's huge foreign debt burden--meant that the few Class-A office buildings constructed in Mexico City were financed from the developer's own funds or through very short-term financing. Permanent lending for such facilities was almost non-existent, prompting developers to sell their projects as soon as possible.

In addition, because transfer taxes were prohibitively high, few investors were interested in purchasing and leasing these facilities. Individual office suites were sold off like condominiums to the owner/user. Because there were few tenants in these projects and the owner/user tended to manage the space themselves, there was little room for commercial office management of the type that Americans are used to.

All of this means that demand for such office space is intense. One observer has estimated the vacancy factor for commercial office projects in Mexico City today at less than 4 percent.

And, every one of the major impediments to investing in an office project in Mexico City has been removed over the last few years: inflation has substantially moderated, interest rates have fallen, foreign investment is being invited into Mexico, the government has forced a reduction in real property transfer taxes, and income taxes are now competitive with those of the major industrialized economies.

The pent-up demand for office space, coupled with the expected explosion of demand occasioned by NAFTA, indicates that Mexico City will see a surge in Class-A office projects for lease, and the other urban centers are expected to follow. All of this should cause a boom for office managers.

New opportunities

Foreign businesses have long thought that Mexico was a risky place to do business, primarily because government policies inhibited foreign investment and contributed to economic instability. But today, the Mexican government is sensitive to the needs of foreign investors and has taken dramatic steps to offer them political and economic security.

More liberalization is expected to result from the free-trade agreement, but many businesspeople are not waiting. While Mexico is still a challenging place in which to do business, these businesspeople feel that the opportunities outweigh the challenges.

David G. Ellsworth is a senior partner in the Los Angeles office of the firm of Morgan, Lewis & Bockius and is co-chair of its Real Estate Section. For over 10 years, he has represented private resort developers active in Mexico and the official real estate development and finance agency of the Mexican government.

Michael D. Capaldi is an associate with Morgan, Lewis & Bockius' Newport Beach, Calif., office. He specializes in international real property development.
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Author:Ellsworth, David G.; Capaldi, Michael D.
Publication:Journal of Property Management
Date:Jan 1, 1993
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