MEXICO: An Introduction to Real Estate

MEXICO REAL ESTATE OVERVIEW 

Despite the strong impact of COVID-19 pandemic, the real estate market in Mexico and specifically the industrial and hospitality sectors have remained stable and strong and even with constant growth projected for 2023.

On the other hand, retail centres are slowly recovering as they are viewed in Mexico as entertainment facilities, whereas office buildings are the target of interesting and creative alternatives such as their conversion into co-living spaces, hospitals, and suites.

The government, meanwhile, is directing certain regulations to the promotion of housing development (especially inclusive housing) and renovation or transformation of disused urban centres, seeking to reactivate the Mexican economy (granting tax benefits and facilitating administrative procedures).

Real Estate Entities 

The Mexican real estate industry has evolved rapidly since the creation of FIBRAs and CKDs, both types of vehicles being listed on the Mexican Stock Exchange and the international markets, allowing individual and sophisticated investors to participate with equity in the real estate sector. Furthermore, small developers have become institutionalised players and large international investors have entered the country either through joint ventures with local real estate operators or directly by setting up operations in Mexico.

The traditional real estate business of developing, owning, or holding, and managing assets has migrated to a business of management fees, where developers have placed their properties into FIBRAs and become their property managers and operators, focusing in some respects on the returns from fees charged to the FIBRAs.

CKDs made their entrance into the Mexican market in 2009, providing an investment alternative for qualified players (including Mexican pension funds, i.e. AFOREs, therefore many real estate private equity firms have set up and launched their own CKDs in the capital markets to gain access to AFORE funds) with better risk tolerance (long-term projects with no fixed returns). CKDs are basically securities issued by a trust listed on the Mexican Stock Exchange, with a maximum expiration term to be repaid of no longer than 50 years. CKDs are fully regulated by the Mexican Securities Commission, and can only be subscribed by qualified institutions.

Although a CKD is the perfect vehicle with which to speculate in land bank acquisition and construction, which, once stabilised, may be disposed of to a FIBRA in exchange for a favourable capitalisation rate exit, in some cases funds are utilised to acquire stabilised assets as well.

In 2011, Mexico’s first FIBRA was listed on the Mexican Stock Exchange and today there are more than 14 FIBRAs on the market. A FIBRA consists of a Mexican trust that issues securities (real estate trust securities (CBFIs)) that are placed on the capital markets for general public investment. Regulated by the Mexican Securities Commission, with certain particularities, including that a substantial part of their capital must be invested in rent-generating properties.

Although there is not yet general asset specialisation by all FIBRAs, some of them specialise in certain asset classes. Even though there has been only one merger between FIBRAs so far, in the near future there may be other consolidation of FIBRAs, and more FIBRAs moving to specialise in asset classes.

FIBRAs are definitely the most popular investment vehicle; however, the Mexican real estate market is growing on the Mexican Stock Exchange, with more IPOs of real estate operators over the years.

The challenge for real estate operators in Mexico is the high level of regulation once listed on the stock exchange while also competing with FIBRAs for assets in the market. On the positive side, not being a FIBRA has proven to be a good choice for real estate operators with land bank and development strategies, since they are not restricted to maintaining 70% of their assets on a lease-up mode, giving more flexibility in their construction and land reserve acquisition plans.

Private equity funds have also played an important role in the development of a sophisticated market in Mexico and are becoming increasingly important. Private equity real estate ventures, commonly structured through a managing company and different SPVs or project vehicles, are made in Mexico through investment promotion corporations (SAPIs: legal entities that are set up ready to be listed on the stock exchange, if ultimately an IPO is desired; although they are not transparent vehicles and pay their own taxes, foreign investors may still benefit from international treaties with Mexico and avoid double taxation), limited partnerships or Mexican trusts (set up as pass-through vehicles for tax purposes).

Deal Structures 

Some of the most important aspects to consider in sale and purchase transactions are tax effects for both parties and legacy liabilities that may be transferred to buyers. Usually, sellers would prefer to sell the legal entity holding the assets to avoid triggering payment of deferred tax liabilities, and buyers would most likely choose to buy assets directly into a newly formed SPV, seeking to avoid any previous liabilities.

Real estate transactions in Mexico have increasingly followed the US model and it is now common to see:

• Letters of intent;
• Master purchase agreements with extensive representations and warranties;
• Conditions precedent;
• Execution of closing documents;
• Indemnities with deductibles, baskets and caps; and
• Foreign Corrupt Practices Act clauses.

When a portfolio of properties located in different cities throughout Mexico is the target of an acquisition (multi-jurisdictional deal), flawless notary coordination of the different public registries is required to assure accurate and timely registry duties, information on each property and payment of property transfer taxes. Nowadays most public registries of property and notaries offices are in the process of updating and digitising their data, which will make them faster and friendlier to due diligence and real estate transactions in general.

Antitrust filings and approval of the Mexican Antitrust Commission are necessary in Mexico if the thresholds under the Federal Antitrust Law are met, even if the acquiring party has no participation in the relevant industry and there is no increase in market share from the transaction. Thresholds take into account the purchase price of the transaction with an impact in Mexico, the assets and sales of the target in Mexico, the capital stock involved in Mexico, and the global assets and sales of participants.

Real Estate Financing 

Two traditional commercial real estate lending structures in Mexico are (i) the standard corporate credit transaction used mostly by banks, where a bank performs a market valuation of the assets based on asset class, construction and location, and determines the proceeds of the loan considering such valuation, and a mortgage and a corporate guaranty are requested; and (ii) a non-recourse asset-based loan with a loan-to-value ratio based on the valuation of cash flow coming from rents (present and pro forma considering roll-over and down-time periods in terms of asset class, location, market, competitors and inventory). This type of structure usually targets portfolios that are cross-collateralised under a guarantee trust collateral agreement, and if the assets do not have enough cash flow to cover debt service, the lender cannot ask the borrower to complete payment with resources other than from secured properties.

In addition, new lending structures are being put in place to keep up with the needs of real estate players (mezzanine loans, recourse corporate credits, flexibility to asset guarantee releases and substitutions, and unsecured lending transactions).