March 13, 2017
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As the United States’ neighbor and second-largest trading partner, no country has followed President Trump’s rhetoric quite like Mexico. While sometimes it seems that even soothsayers cannot predict what the President will say or do next, below we summarize several themes that may impact the commercial real estate markets, Mexican REITs (FIBRAs) and cross-border commercial real estate investment from the United States to Mexico.
Although the US president has the power to rescind trade agreements, any attempt to rescind NAFTA would be met with resistance by policymakers on both sides of the border. The more likely scenario is a renegotiation of the 22-year-old trade agreement. This would play out on a more even playing ground than initially expected. US and Mexico economic ties have never been stronger. Mexico recently became the second-largest exporter to the United States, and NAFTA has created five million jobs in the United States. Recently, some manufacturers have accepted tax breaks to keep American jobs in the United States. While that strategy is effective in isolated cases, shifting the burden of a competitiveness gap to taxpayers is not a sustainable long-term strategy. If NAFTA is in fact renegotiated, the outcome will directly impact real estate assets both north and south of the border, particularly with respect to industrial properties.
Facing a depreciating peso, the Bank of Mexico has increased interest rates—aiming to maintain its target inflation rate of 3%. While conventional wisdom suggests interest rate increases negatively impact FIBRAs (due to the inverse relationship between cost of debt and the rate of return on equities), long-term inflation also leads to increased rents and capital gains. Public-market investors will ultimately connect the dots and real estate equities, including FIBRAs, should rise.
Retail and hospitality FIBRAs may also see asset appreciation due to the weaker peso. Remittances from the United States to Mexico now have significantly increased purchasing power, driving up Mexican retail sales. Indeed, some retailers saw increased net profits by 30% in 2016 alone. Moreover, the weak peso has made Mexican resorts more attractive to both national and international vacationers. While many destination resorts hedge themselves by tying their pricing to US dollars, unwitting international vacationers can be expected to flock to Mexico nonetheless. These factors should make Mexican retail and hospitality assets increasingly attractive to real estate investors.
Under the GOP’s most recently proposed tax plan, businesses would no longer be required to pay US federal taxes on overseas profits and US corporate taxes would be “border-adjusted”. A border-adjusted tax is levied where goods are consumed, rather than where they are produced. These changes could make cross-border transactions more appealing to real estate investors by both reducing the taxes associated with repatriation of capital to the United States and making US produced goods cheaper to Mexican consumers.
The election of President Trump brings one certainty for real estate investors in Mexico—changing times lie ahead. With change, shrewd market participants, paying close attention to fundamental market drivers, will find significant real estate investment opportunities
Malcolm K. Montgomery leads the Real Estate Group at Shearman & Sterling LLP. He handles financings involving assets and currencies in multiple countries and works regularly with REITs and FIBRAs.
Alex H. Rosenthal is an associate in the Real Estate Group at Shearman & Sterling LLP.
Horton McKinney Huerta is an associate in the Corporate Group at Shearman & Sterling LLP.