Real Estate Investment in Mexico

September 2009 REAL ESTATE UPDATE Real Estate Investment in Mexico INTRODUCTION As neighbors and partners in the North American Free Trade Agreement (NAFTA), the U.S. and Mexico share a broad and expanding trade relationship. Since the implementation of NAFTA, trade between Mexico and the U.S. has tripled. Up to 1 million Americans currently live in Mexico and more than 18,000 companies with U.S. investment have operations in Mexico. In fact, the U.S. accounts for 47 percent of all foreign investment in Mexico. With gross domestic product growth of 3 percent in 2007 and 2.05 percent in 2008 (compared to 2.2 percent in the U.S. in 2007 and 1.57 percent in 2008), Mexico presents an attractive target for foreign investment, but the long-term impact of the current global financial crisis on such investment remains unclear. Concerns stemming from Mexico’s colonial past and its proximity to and dealings with the U.S. have shaped real property rights in Mexico. Today, the laws and regulations developed to address these concerns can cause difficult maneuvering for an uninformed party. Understanding the unique aspects of Mexican real property law can help prevent unnecessary stumbling blocks for anyone seeking to invest in real property in Mexico. MEXICO’S REAL PROPERTY FRAMEWORK The Mexican legal system is a mixture of U.S. constitutional theory within a civil law system. Mexico’s legal framework concerning real property includes the Federal Constitution, Federal Civil Code, state civil codes, municipal laws and ordinances. Additionally, the Foreign Investment Law and Foreign Investment Law Regulations regulate foreign investment. In Mexico, real property is classified as either public, private or communal, the nature of which will affect the property’s use and potential alienation. While land in Mexico can be owned in a manner akin to fee-simple in the U.S., in Mexico, all rights to minerals, oil and gas are held by the government to “provide an equitable distribution of the public wealth, to take care of its conservation, to attain a well-balanced development of the country and to improve the living conditions of the rural and urban populations.” In contrast, in the U.S., the government does not usually hold the rights to minerals, oil and gas that exist under private lands. In Mexico, the sale of real property must be made in writing and in the form of a public document. Parties must also record all contracts transferring or modifying ownership, possession or enjoyment of real property in the Public Register of Property and Commerce to effect notice to third parties. Public documents are the notarial copies of documents executed before a “notario publico.” Not to be confused with the American notary public, notarios publico are experienced attorneys who have undergone rigorous testing and have received special commissions from the government to authenticate and register deeds and other public documents. A notario publico often organizes all aspects of a real estate deal in Mexico, including verifying the buyer, seller and deed and often serving as escrow agent. Several taxes and fees apply to the transfer of real property in Mexico. The seller must pay income tax on any capital gain derived from the sale. The purchaser may be required to pay a federal value-added tax for nonresidential improvements made to the property during the time the seller owned the property and must pay a real property transfer tax. Once owned, the buyer also may be required to pay an asset tax and will have to pay municipal property taxes. Additionally, public recording fees will result from the property transfer. FOREIGN INVESTMENT IN REAL PROPERTY Article 27 of the Federal Constitution serves as the foundation for property rights in Mexico. Under Article 27, only Mexicans by birth or naturalization and Mexican corporations have the inherent right to acquire ownership of land. Even so, the state has the authority to grant foreigners the same right given to its citizens to acquire real property, but only if foreign purchasers agree not to invoke the protection of their governments in matters relating to real property. This condition, the so-called Calvo Clause—after Carlos Calvo, an Argentine jurist and diplomat—also stipulates that foreigners will automatically forfeit acquired property if they seek protection from their county of citizenship with respect to such property. Moreover, Article 27 prohibits foreigners from acquiring direct ownership of land located within 100 kilometers (approximately 61 miles) of Mexico’s borders (with the U.S. to the north and Belize and Guatemala to the south) and within 50 kilometers (31 miles) of the shores of the country (the “Prohibited Zone”). Mexican corporations that do not accept foreign investment (by stipulating as such in their by-laws) may acquire real property in the Prohibited Zone for any purpose. In contrast, while a Mexican company that allows foreign investment may also purchase real property within the Prohibited Zone, it can do so for non-residential purposes only, and provided that the corporation’s by-laws demand adherence to the Calvo Clause and that the corporation notifies the Secretary of Foreign Relations (SRE). Even more restrictive, foreign individuals and corporations cannot purchase real property located in the Prohibited Zone under any circumstance, but may purchase real property located beyond the Prohibited Zone provided the foreign purchasers pledge to adhere to the Calvo Clause and obtain permission from the SRE. At first glance, the ability of foreigners to invest in real property located in the Prohibited Zone seems limited, but in practice, such investment is within reach for foreign investors. Meandering near the constitutional limits imposed by Article 27, the Mexican government developed a mechanism—the “fideicomiso” (trust)—to circumvent the prohibition on direct purchase of real property located in the Prohibited Zone by foreigners and Mexican corporations that allow foreign investment. Under a fideicomiso, a trust is formed whereby the owner of the property, the settlor, places the land in trust for the use of a beneficiary, typically a foreign 2 individual or entity. The role of trustee is almost exclusively undertaken by a Mexican bank. A fideicomiso can last up to 50 years and may be renewed by the parties. The ability to obtain the beneficial use of real property by employing a fideicomiso is attractive to foreigners, but it comes with significant added transaction costs. In addition to holding title to property or having the right of beneficial use through a fideicomiso, there are other ways to enjoy the use of real property in Mexico, including leasing property and participating in time shares. With regard to leasing, there are no restrictions that prevent foreign individuals or entities from leasing property in Mexico. Unlike American law, the Mexican Civil Code places limits on the duration of real property leases. Commercial and industrial leases can be no longer than 20 years in duration and residential leases are limited to a period of 10 years, or 30 years for residential leases on “ejido” land (defined below). Leases should be in writing and contain material terms. Failing to follow these formalities does not invalidate a lease, but rather imputes the burden of persuasion against the landlord in the event a dispute over a term or terms not memorialized in writing should result. Additionally, Mexican law provides that, unless otherwise agreed, tenants generally have “first refusal” rights, allowing them to purchase the leased premises if a third party makes an offer to buy the property from the landlord. There are certain risks purchasers of real property in Mexico must consider, and while Mexican law provides certain protections, they may be insufficient to protect buyers. Mexico’s registration system is not as convenient or user-friendly as the U.S. system or, arguably, as reliable. Registration in many Mexican states is decentralized, with most municipalities having their own registry, and in many cases registries are incomplete or contain errors. A number of American title insurance companies now issue title insurance policies for real property located in Mexico to address concerns regarding land registration and other title problems. Foreign investors should be exceedingly careful when dealing with ejido land. In response to concerns relating to inequities in the distribution of land, after the Mexican revolution the government broke up large private land holdings and distributed the property to farm cooperatives, known as ejidos. Historically, ejido land that had been assigned to farmers continued to be owned by the cooperative. Under communal property laws, a farmer could use the property and pass it along to his heirs, but could neither sell nor lease the property. In 1993, government reforms made it possible to privatize ejido lands, which allowed for the subsequent alienation of the property. Although the laws have changed, the process to privatize ejido property is arduous. Thus, purchasing land that may have formerly been part of an ejido should only be undertaken with a clear understanding of the risks. In some cases, private developers have purchased and developed ejido land, only to have the sale overturned and the land, including all improvements, returned to the cooperative. A significant amount of foreign investment, including investment in real property, has centered on the “maquiladora” industry. Maquiladoras are foreign-owned plants operating mostly in northern Mexico near the southwestern U.S. border that manufacture and assemble products for domestic use or for export. To the extent it has flourished, much of the maquiladora industry’s success has been a result of favorable tax treatment under Mexican and U.S. laws and relatively low manufacturing 3 costs, a result of low wages and the industry’s proximity to the U.S. consumer market. While early on, the industry focused on low-skilled manufacturing and assembly, more recently, maquiladoras have pursued skilled manufacturing, including high-end electronics and aeronautics. Maquiladoras realized $175 million in exports in 2008. Seventy percent of maquiladoras are in some way affiliated with U.S. companies, particularly the American automobile industry. Amid the global economic downturn, foreign investment in maquiladoras in 2009 is projected to drop by 26 percent, according to industry projections, but will still be significant at $2.2 billion. Even so, eight new maquiladoras have opened in Mexico during the first quarter of 2009. Another investment vehicle under development is the Mexican version of a REIT, the Fideicomisos de Infraestructura y Bienes Raices (FIBRA). Under Mexican law, the purpose of a FIBRA must be to acquire or construct real property. Property owned by the FIBRA must be leased for a minimum of four years before the FIBRA may sell it. First allowed under Mexican law in 1994, FIBRAs have not taken hold in Mexico. Efforts to create them have stalled primarily due to taxation concerns and because much of the private land owned in Mexico is still controlled by individuals or families. Recent changes to tax laws have made FIBRAs more appealing, but several touted projects have failed to materialize. THE SHAPE OF THINGS TO COME Although the global economic downturn and recent outbreak of swine flu have slowed Mexico’s economic recovery from its deep fall in the mid-1990s, and in many parts of the country the government continues to grapple with eradicating violence precipitated by the presence of drug cartels, Mexico continues to be an important market for real estate development and investment. Average annual foreign direct investment to Mexico tripled from $3 billion in the 1980s to $12 billion during the 1990s. Between 1994 and 2005, Mexico was the fourth largest recipient of foreign direct investment among emerging economies. Between 2002 and 2007, the Mexican housing construction market had experienced constant growth, with 15 percent growth in 2007. In 2007, the Mexican government committed to a national infrastructure program in Mexico to increase the coverage, quality and competitiveness of Mexico’s infrastructure. Tempered by the global economic downturn, foreign direct investment in Mexico in 2008 fell by 19.5 percent over 2007 levels. In the future, the housing sector is expected to continue growing steadily. Recently, legislation has been introduced in the Mexican Senate that calls for amending Article 27 of the Federal Constitution to allow direct ownership of residential real property by foreigners within the Prohibited Zone without having to employ a fideicomiso. Adopting this proposal would likely promote greater foreign investment in residential property along the nearly 7,000 miles of Mexican coastline because purchasers would not face the costs related to fideicomisos and would obtain title to property instead of mere beneficial use. Prospects are equally attractive in the commercial sector. In the recent past, commercial investment in Mexican real property by foreign REITs and institutional investors has been significant. 4 Numerous U.S. REITs and other institutions have invested in real property connected to maquiladoras, retail development and tourism. This trend should persist because Mexico is ripe for continued investment. With respect to retail development, for example, there are fewer than 1,000 malls and shopping centers in Mexico, which has a population of approximately 110 million people. In comparison, there are more than 102,000 malls and shopping centers in the U.S., which has a population of approximately 306 million people. The International Council of Shopping Centers (ICSC) indicates that “there are just 2.4 square feet of retail per capita in Mexico, compared to more than 20 square feet in the U.S.” As Mexico continues to develop its industrial, commercial and tourism industries, and as efforts to stamp out the violence related to the drug trade succeed, greater stability should follow and opportunities for investment in real estate should continue. FOR MORE INFORMATION If you would like to know more about our Real Estate practices, including contact information for our lawyers, please visit www.ThompsonHine.com or www.Burges-Salmon.com. ABOUT THOMPSON HINE LLP Established in 1911, Thompson Hine is a business law firm dedicated to providing superior client service. For the last several years, the firm has been named one of the Best Corporate Law Firms in America (in an annual survey of corporate directors conducted by Corporate Board Member magazine). With more than 400 lawyers, Thompson Hine serves premier businesses worldwide. The firm has offices in Atlanta, Brussels, Cincinnati, Cleveland, Columbus, Dayton, New York and Washington, D.C. For more information about our international real estate practice, please contact Thomas.Coyne@ThompsonHine.com or Mario.Suarez@ThompsonHine.com. ABOUT BURGES SALMON LLP Burges Salmon LLP is consistently ranked amongst the UK’s most successful commercial law firms. The firm’s national and international client base ranges from private individuals to government departments and FTSE 100 companies including Wolseley, The Crown Estate, BAE Systems, Bank of Scotland, The Ministry of Defence and FirstGroup. With 72 partners and a total of more than 650 employees based at a single site, the firm offers a cohesive, communicative environment which results in strong working relationships right across the firm and an enhanced service for its clients. The firm is widely recognised for the quality of its expertise in a range of areas, including property, corporate, commercial, litigation and tax and trusts. If you would like more information about the international real estate practice please contact Beatrice.Puoti-Ffiske@Burges-Salmon.com or Richard.Read@Burges-Salmon.com. 5 ... - tailieumienphi.vn