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For over a decade, the Mexican economy has undergone many changes

By Nicole Sanchez,2014-11-21 17:56
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For over a decade, the Mexican economy has undergone many changes

    The Mexican Real Estate Industry

    Roger Smeltzer, Jr.

    Finance 7320

    April 10, 2003

     Smeltzer 1

Abstract

    For over a decade, the Mexican economy has undergone many changes which have presented many problems and opportunities for investors. In order to better assess the real estate industry, it is crucial to dissect the reasoning behind Mexican rationale towards investment in a general sense.

The assessment of Mexico’s economy is important to understanding the financial

    environment. Mexicans are accustomed to the volatility of their economy and there are several reasons for this mindset. The 1994 crisis nearly erased Mexico’s economic progress in the early 90’s. Wide-scale efforts to privatize many industries have made

    core industries in Mexico more competitive globally. The rises and falls of the Peso have made Mexicans skeptical about holding domestic currency. High interest rates and inflation problems have made investors more risk averse against the funding of long-term projects. Mexico is an overwhelmingly trade dependent country, which tends to cause problems in demonstrating the real stability of their economy. These are several important issues that explain Mexico’s volatile economy.

    In the real estate industry, there are many key factors. Although this industry is inconsistent due to economic turmoil, the market demand of commercial projects is enticing investors. The Mexican government has been rather involved in developmental projects to improve infrastructure. For over a decade, Mexico has experienced an increase in foreign investment. Potential exists in several market sectors. Legal restrictions towards foreigners, several fees and taxes are deterring many foreigners. Lastly, the availability of financing is a concern in Mexico. Many different elements are crucial in the assessment and opportunities in real estate.

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    Outline - The Mexican Real Estate Industry

I. Introduction

    II. The Mexican Economy

    A. Fixed Rate Regime and 1994 Economic Crisis

    1. Beginning of Fixed Regime and Rationale

    2. Reactions to the Floating Currency

    B. The Inconsistent Performance of the Peso Exchange Rate

    C. Inflation and Interest Rates

    1. Inflation since 1997

    2. High Interest Rates

    D. Privatization

    1. Economic Impacts of Privatization

    2. Increased Desire for Capitalist Society

    E. Trade Dependency of Other Countries III. The Real Estate Market

    A. Demand and Potential of Real Estate and Commercial Market

    1. Investor Interest before N.A.F.T.A.

    2. Government Influence

    3. Opportunistic Industries

    B. Foreign Investment Problems

    1. Increase in Foreign Presence

    2. Difficult Pace for Foreigners

    3. Restrictions of Foreign Ownership

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    4. Taxes and Fees

    C. Lack of Availability of Financing and New Concepts

    IV. Conclusion

     Smeltzer 4

    The Mexican Real Estate Industry

    For over a decade, the Mexican economy has undergone many changes that have presented many problems and opportunities for investors. In order to better assess the real estate industry, it is crucial to dissect the reasoning behind Mexican rationale towards investment.

The assessment of Mexico’s economy is important to understanding the foundation of the

    financial environment. Mexicans are accustomed to the volatility of their economy and there are several reasons for this mindset. The 1994 crisis nearly erased Mexico’s

    economic progress during early 90’s. Wide-scale efforts to privatize many industries

    have made core industries in Mexico more competitive globally. The rises and falls of the Peso have made Mexicans skeptical about holding domestic currency. High interest rates and inflation problems have made investors more risk adverse against the funding of long-term projects. Mexico is an overwhelmingly trade dependent country, which tends to cause problems in demonstrating the real stability of their economy. These are several important issues that explain Mexico’s volatile economy.

    In the real estate industry, there are many key factors. Although this industry is inconsistent due to economic turmoil, the market demand of commercial projects is enticing investors. The Mexican government has been rather involved in developmental projects to improve infrastructure. For over a decade, Mexico has experienced an increase in foreign investment. Potential exists in several market sectors. Legal

     Smeltzer 5

    restrictions towards foreigners, several fees and taxes are deterring many foreign investors. Lastly, the availability of financing is a concern in Mexico. Many different elements are crucial in the assessment and opportunities in the real estate market.

ECONOMIC ENVIRONMENT

    The mind of the Mexican investor is extremely important in order to understand the real estate market. For reasons such as financial crises, exchange rate volatility, inflationary concerns, privatization efforts, the North American Free Trade Agreement, and a rapidly expanding economic environment, Mexicans are cautiously optimistic. There is a wide-spread acknowledgement of the high risks in virtually all markets and necessity for short term projects because of high interest rates for financing. Several important historical issues that play a major role in the Mexican investment markets are the following: the 1994 economic crisis, privatization, trade dependency upon other nations, exchange rate inconsistencies and inflationary problems.

Fixed Rate System and 1994 Economic Crisis

    The primary event that influences the cautious finance industry occurred in 1994. Mexico experienced an economic crisis for several inarguable reasons such as high liquidity of government debt, moral hazard in the banking industry, and the assassination of a presidential candidate. The fixed rate system was probably the key cause of the crisis.

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    In 1988, the Mexican government began to peg the Peso to the United States Dollar. The currency was prohibited to float according to market forces in order to curb inflationary

    1problems, but the change in monetary policy only lowered inflation in the short-term.

    Other costs associated with the fixed rate system were not initially considered. The peg caused a distortion in the value for Mexican capital assets and controlled the changing of price for goods and services. This monetary policy also made Mexico more vulnerable to external issue such as changes in U.S. monetary policy and internal issues, such as political instability that publicly considered changing the pegged rate. These uncertainty issues made investors wary which pushed a currency run towards the more stable, U.S. Dollar.

    When the Peso was finally permitted to float, there was a chain effect on the Mexican economy. The Peso made up for lost time and rapidly devalued to adjust to the change in Mexican price level of goods and services. There were sudden changes in the inflation rates which increased risk in the economy; thus, driving up interest rates. Mexican businesses, consumers, and banks were sent into a free fall because many contracts were negotiated in Pesos with the expectations of a stable economic environment. Contracts in U.S. Dollars were suddenly difficult to fulfill and contracts in Pesos were grossly

    2undervalued. The 1994 economic crisis in Mexico wreaked havoc on all Mexicans regardless of their role in the markets.

     1 http://www.cato.org/pubs/journal/cj17n3-14.html

     2 http://db.uwaterloo.ca/~alopez-o/politics/cj17n1-4.html

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Exchange Rate Issues

    Even after the Mexican economy recovered in 1997, the exchange rate has been

    inconsistent. For example, past annual exchange rates between the Peso in terms of the

    ?3-Mar-03?U.S. dollar were the following:

    ?3-Feb-03?

    ?3-Jan-03? 2002 2001 2000 1999 ?3-Dec-02?

    ?4-Nov-02?

    ?3-Oct-02?Mexico (Peso) 9.663 9.337 9.459 9.553 ?4-Sep-02?

    ?5-Aug-02? ?3-Jul-02?

    ?3-Jun-02?

    ?3-May-02?From 1999 to 2002, the Mexican Peso appreciated to the U.S. Dollar. These rates only ?3-Apr-02?

    ?4-Mar-02?reflect year-end values of the Peso in respect to the U.S. Dollar. A further analysis yields ?4-Feb-02?

    ?3-Jan-02?

    ?3-Dec-01?a better understanding of the exchange rate between these two countries. The following ?5-Nov-01?

    ?3-Oct-01?

     has been converted into a graph with data published on the Federal Reserve webpage: ?4-Sep-01?

    ?3-Aug-01?

    ?3-Jul-01?

    ?4-Jun-01?Exchange Rate (Peso/US$)?3-May-01?

    ?3-Apr-01?

    ?5-Mar-01?10.9?5-Feb-01?

    ?3-Jan-01?

    ?4-Dec-00?10.4?3-Nov-00?

    ?3-Oct-00?

    ?5-Sep-00?

    ?3-Aug-00?9.9?3-Jul-00?

    ?2-Jun-00?

    ?3-May-00?9.4?3-Apr-00?

    ?3-Mar-00?

    ?3-Feb-00?

    ?3-Jan-00?8.9

This graph demonstrates why investors are wary of the economy and investment issues.

    A simple example is that when I arrived in Monterrey in July, my rent was 3,000 pesos or

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    US$310, but when I left in December my rent had decreased to US$290. The inconsistent exchange rate places a huge risk upon long-term rental contracts and financing projects.

Inflation and Interest Rates

    Inflation and interest rates in Mexico are a strong reason for the lack of availability of financing for many projects and both of these economic issues tend to be higher than in the United States. As a matter of fact, inflation rates in Mexico are often 300% or higher than rates in the United States. The following graph demonstrates inflationary presence

    3 in the United States and Mexico.

    Inflation 1997 1998 1999 2000 2001

    Mexico 15.7% 18.6% 12.3% 9.0% 4.4%

    United States 2.35% 1.51% 2.21% 3.38% 2.86%

    Historical inflation data between these two countries illustrates why Mexicans would favor short-term projects as generally opposed to longer term ventures.

    Since interest rates are often calculated by the

    sum of inflation and time value of money,

    inflation also plays a major role in interest

    rates. This graph paints a more direct picture

    as to why short term strategies are more

     3 www.state.gov/r/pa/ei/bgn/ and www.eh.net/hmit/inflation/inflationr.php

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    Accumulated inflation in 2001 reached 4.4 percent, well below the 6.5 prevalent in Mexico.

    4percent target established by Banco de Mexico. The real interest rate in Mexico was between

    17.6 and 19.6 for the 2001 year; whereas, in the United States, the real rate was a third of Mexico’s real rate! The incredibly high real interest rate in Mexico decreases the likelihood of investment in the country.

    Interest rates in Mexico are considerably higher than in the United States. Currently, interest rates in Mexico are about 18%, which makes financing a difficult option in the real estate market. As the American Federal Reserve continues to offer low rates in an attempt to stimulate the U.S. economy, Mexico historically has been unable to implement such tactics because of the inflation and general risk for the lenders.

Privatization and its effect on investment opportunities

    During the 1990’s, efforts to privatize the industries had several effects on the Mexican economy and investment arena. Privatization increased the number of publicly-traded and privately-held companies while expanding the national investor participants. The

    5government’s decision caused rapid growth in the securities market. In less than twenty

    years, the Mexican government pursued drastic reform through privatization as the number of state-run enterprises decreased from 1,200 to 250! The initiative was focused upon smaller, more profitable, state-owned businesses in order reinvest business capital into the larger, state-held companies while financing through Mexican capital markets.

    6The total proceeds in this effort were US$1 billion.

     4 http://www.shcp.gob.mx/english/docs/qr01/qr401.html 5 http://www.cid.harvard.edu/caer2/htm/content/papers/paper21/paper21.htm 6 http://www.cid.harvard.edu/caer2/htm/content/papers/paper21/paper21.htm

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