By Michele Lerner

In recent years, companies looking southward have expanded into areas beyond the United States-Mexican border, focusing on cities and towns all over Mexico. This push is fueled by optimism about the Mexican economy that is generated by recent years of currency stability and banking reforms. These characteristics have encouraged U.S. REIT investment within the country. Several U.S. REITs are particularly interested in Mexico because of improvements in the country's domestic economy that will increase demand for goods and services.

Crossing the Border

Philip Kibel, senior vice president of real estate finance with Moody's Investors Service, says U.S. REITs in the retail, industrial and hotel sectors are interested in Mexican properties and are entering into joint ventures with established operators.

An example of a U.S. REIT that has been investing in Mexico for the last 10 years is ProLogis (NYSE: PLD), a global provider of industrial distribution facilities and services. In July 2006, the company expanded its business by approximately 40 percent, acquiring more than 3.5 million square feet of industrial space and land. Out of the company's entire Mexican investment, approximately 80 percent is in existing properties, with the other 20 percent in land.

"Prior to the July 2006 acquisition, ProLogis was solely invested in northern Mexico, along the border," says Silvano Solis, senior vice president and head of Mexico operations for ProLogis. "The northern border is the manufacturing base for the country, primarily for products being exported to the United States. The Mexican economy has improved in overall stability, higher incomes and increased domestic spending, so now we are expanding into the central part of the country where there is growing demand for more distribution facilities."

Solis adds that approximately 80 percent of ProLogis tenants are international companies, with another 15 percent to 20 percent Mexican-based companies. "We're seeing Mexican companies increasing their productivity, which means they are requiring different types of spaces for manufacturing and distribution."

The Mexican REIT Law Mexican REITs, or Fideicomisos de Infraestructura y Bienes Raices (FIBRAs), were established in 2003 by changes in Mexican tax laws. As of Jan. 1, 2006, new rules were included, which state that if the certificates of participation in the trust are not publicly traded, then the trust must have at least 10 investors, and no individual investor may hold more than a 20 percent interest in the trust A FIBRA holds real estate and other rights derived from real estate FIBRAs can be financed through debt or a CP (Certificados de Participacion, which is equivalent to the equity share of a trust) The FIBRA must be incorporated under Mexican law The purpose of the FIBRA must be the acquisition or construction of real estate that will be used for leasing and later sale (and must be leased for at least one year prior to its sale); and the acquisition of rights to receive the revenues coming from the leasing of the real estate At least 70 percent of the FIBRA’s assets must be invested in the acquisition, leasing or sale of real estate. The remaining percentage (to a limit of 30 percent) must be invested in Mexican government securities or in shares of debt and mutual funds At least 28 percent of the FIBRA’s taxable income is paid to its certificate holders

Kimco Realty Corporation (NYSE: KIM) started investing in Mexico in 2002 with the acquisition of two shopping centers. Today, the company owns and develops shopping centers in most major Mexican cities, including Juarez, Mexico City, Monterrey, Reynosa, Saltillo, San Luis Potosi and other locations. Kimco also owns 60 industrial properties clustered in Chihuahua and Juarez, which are net leased to U.S. and multinational companies.

"There are basically four items we get in Mexico that we don't get in the U.S.," says David Henry, chief investment officer of Kimco. "First, we get a high percentage of rents from our anchor tenants in the retail locations. Second, every lease has a cost-of-living escalator clause that drives up our income. Third, the tenants are used to paying their own fix-up costs, which saves us money. Fourth, we get what's known as 'key money,' especially in the larger cities. This is six to 18 months of rent paid upfront by the tenants for the benefit of us renting to them. In addition, we also get real rent growth."

Henry points out the dramatic shortage of Mexican retail space. "There are about 48,000 shopping centers in the U.S. versus 650 in Mexico," he says. "The Mexican population is very underserved. American retailers are well aware of this, so retailers such as Costco and Wal-Mart are expanding rapidly into Mexico."

Some companies don't cross too far over the border to find value in Mexico. Verde Corporate Realty Services is a real estate development, operating and investment company focused on the U.S.-Mexico border region. The company's strategy is to capitalize on the substantial real estate opportunities created by dynamic economic and population growth in the U.S.-Mexico border target market, from Tijuana to Matamoros.

Bill Sanders, Verde's co-chairman and co-CEO, says that there are three principal reasons to target this region. "First, I believe the U.S.-Mexico border region is North America's leading manufacturing platform to compete with China and other rapidly developing economies. There is tremendous pressure on manufacturers to reduce costs, and this region is clearly the most competitive location in North America. Second, this region will continue to experience significant population growth for the next 25 years and beyond. The Mexican side of the border is growing 68 percent faster than the country's average. Lastly, our target market has limited competition, competitive product and investment capital. This combination of factors makes the U.S.-Mexico border region a very attractive place to be."

One reason U.S. REITs are investing in Mexico is because there is less competition there, suggests Christian Charre, senior vice president of Jones Lang LaSalle Hotels. "You have lots of dollars chasing fewer deals in the U.S.," he says. "The stability in Mexico during the last few years in terms of the currency has encouraged people to go south of the border."

Mexican Barriers

Despite increasing optimism about Mexican investments, Kibel says some challenges still exist. "REITs tend to invest in already established Mexican businesses rather than acquiring land and constructing a project because of the difficulty with obtaining titles and licenses," he says. "A big issue is ensuring that their laws are enforceable. Sometimes developers can be stuck with land they have purchased and are unable to proceed with their plans because the laws have been changed with regard to density or other issues."

As Henry points out, there is always risk in crossing the border into another country because of its different legal and political system. He says that it can be very difficult to evict Mexican tenants if they don't pay the rent because the tenant-landlord laws are complex and not always enforced.

"It generally takes a long time to put together a deal in Mexico, to find the site and obtain the permits," Henry says. "Also, Mexican land costs are higher than land costs in the U.S., although construction costs are lower and that can offset the difference. However, because the retail side is so underserved, it's generally a development game, not an acquisitions game."

Measuring Political Risk in Mexico Concern about the Mexican political and economic climate has also influenced decisions by U.S. REITs and other U.S.-based companies about investing in the country. "The economy is very strong, with a good prognosis for the long-term, especially with the growth of the middle class," says David Henry, chief investment officer of Kimco Realty Corporation (NYSE: KIM). Silvano Solis, senior vice president and head of Mexico operations for ProLogis (NYSE: PLD), says the company carefully watched last year's election results. "In the past, every presidential change in Mexico created a hiccup in the economy," he says. "When President Vicente Fox came into office, there was no hiccup and the exchange rate stayed the same. Today, they have the largest foreign currency reserve in Mexico's history, so the country is secured against risk issues. Improving incomes have spurred retail development in the major urban areas and national companies are developing partnerships with U.S. companies. We see the Mexican economy as heading on the right path to a bright future." Those investing in Mexico believe that the election of President Felipe Calderón should lead to further improvement in the country's economy. "Over the past six years, we've seen tremendous stability in Mexico, but there are still lots of reforms needed," says Miguel Rivera, senior vice president of Jones Lang LaSalle Hotels. "The Mexican Congress is evenly divided among the three large political parties, but the right alliances haven't been made and the needed structural reforms haven't been passed." Rivera thinks that the lack of reform has to do with the former president's style. "President Fox did not grow up as a politician, he was more of a CEO," Rivera says. "His proposals were great, but he wasn't able to pass them. President Calderón, who's also a business-friendly leader, is perceived as a better negotiator and politician so he should be able to implement more reforms." Additionally, Rivera says tax reform will be one of the new administration's biggest issues, since Mexico has an extremely low collection rate. Yet another important issue will be energy reform. "Currently, only the government can own all the energy infrastructure in the country, but demand is expected to increase to the point that it will be more than the government can handle," Rivera says.

Mexican REITs Slow to Come

Mexican REIT legislation passed in 2003. Since then, there is only one established REIT, Casablanca Trust, which was introduced in June 2006 with 300 million Mexican pesos ($27.6 million U.S.) in senior secured securities. The REIT owns and operates five exclusive private sports clubs in Mexico.

Industry analysts say that the dearth of Mexican REITs is due to the imperfect structure of Fideicomisos de Infraestructura y Bienes Raices (FIBRAs). "The biggest issue with Mexican REITs is that it is not clear whether trusts will pay taxes or not," says Miguel Rivera, senior vice president of Jones Lang LaSalle Hotels. He says he believes that revising the legislation to make it more attractive to property owners can improve the potential for Mexican REITs.

Ameek Ashok Ponda, an attorney and tax partner with Sullivan & Worcester, says, "Many countries around the world flirt with REITs, but they are rarely as flexible, as efficient or as autonomous as U.S. REITs."

In addition, REITs are not firmly established due to the fact that property in Mexico is held by families rather than corporations, Kibel says. "In the United States, companies were mostly run as partnerships before REITs came along, while in Mexico they are still familial organizations," he says. He believes that once one or two Mexican REITs become successful, more families will see the potential and decide to go public with their properties.

"The legislation is in place in Mexico and we are actually surprised that we haven't seen more REITs," Kibel continues. "There are lots of good properties that could be converted to REITs, but most are owned by families. There aren't as many private companies or entrepreneurs in Mexico, and that's what you need to start a REIT. We do anticipate generational changes that will lead some of these families to convert their properties to REITs, and there are some lawyers and investment bankers looking into REITs."

Kibel says that as interest rates go up and people want to grow their business, they will look at REITs. "In the case of Casablanca, it was essentially a take-out for the partners since they wanted to cash out on the clubs."

Ponda has a positive view of U.S. REIT investments in Mexico. "REITs help investors pool their capital for a diversified portfolio," Ponda says. "U.S. REITs are fulfilling their function and mandate by diversifying their investments by investing overseas."