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More U.S. commercial real estate investors looking to Mexico for value

Low cap rates and high real estate prices in the United States are proving to be a boon to Mexico, where real estate investors from the United States are snapping up Mexican properties.

Venerable U.S. financiers, including Wall Street firms and life insurance companies, are working with their real estate investor colleagues to finance deals. CBRE Melody, the real estate investment banking arm of CB Richard Ellis (NYSE: CBG), is currently financing resort projects in Cabo San Lucas, Ixtapa and Manzanillo.

"Ten years ago, U.S. financing for commercial real estate in Mexico was rare," said Mark McGovern and Wayne Paulus, directors for Melody in San Diego. "Now, a handful of U.S. lenders are financing projects south of the border, ranging from industrial properties to resorts."

Financing has been one of the major impediments to investing in Mexican property in the past. Changes in legislation and stabilization of the peso have made U.S. investors feel more secure, but the process is still much different from what investors are accustomed to in the United States.

Though Mexico's political situation is far more stable than in years past, unexpected changes in elected posts and real estate policy are still a greater risk in Mexico than in the United States. Accordingly, foreign investors should consider political risk insurance for their Mexican properties at the time of closing.

This coverage insures against the taking of an asset by a foreign government without prompt, adequate and reasonable compensation.

Title insurance for Mexican real estate purchases became much more available and improved when Stewart Title began to issue policies for this market 10 years ago through Stewart Title Guarantee de Mexico. Now, First American (NYSE: FAF) and Commonwealth (Nasdaq: CWBS) also provide title insurance.

"The title insurance policies from these companies for Mexican property are very secure," said Rich Kwasny, a broker for CB Richard Ellis who specializes in cross border real estate.

Another factor encouraging U.S. investment in Mexican properties is the health of the peso.

Recently, the peso has performed very well, a marked departure from the downturn of 1994 and 1995. Market factors contributing to the strength of the peso include increased exports, low interest rates, availability of cheap labor, ties to the U.S. economy and an inflow of funds from a rise in the price of international commodities, including oil.

"Resort investments are somewhat insulated against peso fluctuation anyway," said Paulus. "Eighty percent or more of the income at Mexican resorts typically comes from American dollars."

In addition, most industrial leases are dollar-based.

"It all comes down to the strength of the deal," Paulus said. "We may accept pesos instead of dollars. Some of the factors in this decision include loan to value ratio and tenant strength."

McGovern added that a lender might also require a lock box form of payment, where all of the investment income goes directly to the lender, who then returns the surplus money to the borrower.

Another scenario has the financier executing a lease directly with the real estate investor's tenant and collecting all lease payments for 10 years. At the end of that time, the investor owns the property free and clear and can then execute leases directly with tenants.

Typical loan to value ratios from U.S. lenders for Mexican real estate purchases, says McGovern, range from 60 percent to 70 percent for industrial and 50 percent to 55 percent for resorts, though he says resorts are trending up.

Typical loan to value ratios required by Mexican financial institutions hover around 50 percent or less.

Despite the unfamiliar nuances of investing in Mexican real estate and the corresponding and costly lawyers' fees to structure the deals, the yields are too good to pass up.

"I estimate the yields to be two to three percent more in Mexico than in the U.S.," said McGovern.

Capitalization rates in the United States have been increasing steadily and investors are looking for a new frontier. McGovern estimated cap rates for industrial projects in Mexico to be three percent to four percent higher than in the United States.

"Fifteen years ago, very few manufacturing companies were willing to buy real estate in Mexico for their manufacturing operations," said Rob Hixson, a broker with CB Richard Ellis specializing in cross border transactions. "But now, there is so much money in the U.S. real estate market that investors are willing to consider Mexico on a broader scale."

Kwasny agrees and adds that investors are also more likely to buy in Mexico because of the Mexican people themselves.

"Mexico has stepped up its competency, productivity, credibility, work ethic and skills," he said.

Several infrastructure projects planned for the future in the Baja California region of Mexico will also likely boost interest from U.S. investors.

The government has proposed to build one or more bridges across Baja, from the Pacific Ocean to the Sea of Cortez, facilitating travel.

"This would open up areas along the Sea of Cortez to resort development, especially," said McGovern.

Another important proposal involves building a major seaport south of Ensenada. The seaport would increase cross border trade, traffic and infrastructure needs, including warehouses and other support buildings and facilities.

In order for a U.S. company to own real estate in Mexico however, it must first become a Mexican company. Accordingly, taxes are paid to the Mexican government, not the U.S. government.

It is interesting to note that deeds of trust are not used in Mexico. Commercial properties are typically secured by a guarantee trust. The collateral is assigned to the trust, which is managed by a third-party trustee; the lender is the first beneficiary.

For a variety of reasons, including navigation of foreign governmental policies, some of the major U.S. investors choose instead to partner with or buy a stake in a Mexican real estate investment company. As a result, these local Mexican investment companies have gone from having five to 10 projects in their portfolio to 20 to 40 projects.

"Either way, it is very important to have a fully integrated team that will surround the client and lender with proven professionals and experts on both sides of the border in order to protect and enhance the client and their investment," said Paulus.

Whitelaw is principal of Whitelaw Marketing.

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