by Anwar Elgonemy and Ander Legorreta
Jones Lang LaSalle - July 2002
International hotel investment has never been more challenging; both
the obvious and subtle differences amongst different countries need to
be carefully understood. The niche of hotel deals in Mexico is driven
by its own buyer/seller dynamics that, if not fully recognized, can surprise
foreign investors who are new to the Mexican business operating environment.
The supply and demand paradigm, competition and underlying operating
costs are some of the issues that every hotel investor must confront in
Latin America. Taking a view on these variables, Exhibit 1 provides
a benchmark of 12 major influences on hotel real estate investment in Mexico,
Argentina, Brazil and Chile, with Mexico currently the more desirous country
for lodging investments.
Exhibit 1
Rating of Influences on Hotel Real Estate
Investment
in Major Latin American Markets
|
| |
Mexico
|
Argentina
|
Brazil
|
Chile
|
| Foreign Investment:
- Foreign Ownership Permitted
- Foreign Investment Incentives
- Foreign Exchange Controls |
*****
****
****
|
***
**
*
|
****
***
***
|
****
***
***
|
| Taxation/Regulation:
- Tax System
- Legal Framework
- Building Codes |
****
***
****
|
***
***
***
|
***
***
***
|
****
****
***
|
| Economic:
- Economic Growth
- Availability of Debt
- Strength of Currency |
*****
**
*****
|
*
*
*
|
***
**
**
|
***
***
***
|
| Other:
- Political & Social Stability
- Competitive Cost Structures
- Availability of Reliable Research |
****
****
***
|
**
**
**
|
***
***
***
|
****
***
***
|
* Very poor
** Poor
*** Average
**** Good
***** Very good
|
Source: Jones Lang LaSalle Hotels
Exhibit 2
Investing in Mexico
|
|
The Upside
|
The Downside
|
| Booming resort destinations (Los
Cabos, Ixtapa, Puerto Vallarta, South Cancun and the Riviera Maya) |
Extremely dependent on the U.S. |
| Emerging secondary markets (Guadalajara,
Monterrey and Tijuana) |
Financing has to be attained through
Mexican banks, or foreign bank representative offices in Mexico |
| Ranked as an investment-grade
country by Standard & Poor�s, Moody�s and Fitch. Mexican and foreign
banks are active in financing quality asset purchases or new development |
Cumbersome ownership rights �
as in every real estate market, a partnership with locals has to be explored |
| A better investment climate under
the business-savvy President Vicente Fox, the first democratically elected
head of state after some 70 years of PRI party dominance |
Major infrastructure projects
are on hold due to a lack of consensus in Congress |
| Economic stability (inflation
is at 4.7% compared to 52% in 1995) |
Due to the relative strength of
the Peso in recent years, Mexico is starting to lose its reputation as
a very cheap manufacturing labor market, compared to other industrialized
Latin American countries |
| Large middle and upper middle
class of nearly 30 million people |
Unions are controlled by aging
leaders who protect their affiliates with chronic pressures on companies |
| NAFTA has instilled more transparency
in the Mexican markets, as well as endless cross-border business opportunities |
|
| A well-established, high-quality
service culture |
|
| Possibility of exchange rate arbitrage |
|
Source: Jones Lang LaSalle Hotels
Savvy investors should be aware that there are some significant financial
opportunities for investing in lodging real estate in Mexico. Expense
ratios usually average 60% of total revenue for a typical full-service
hotel in Mexico, compared to approximately 70% of total revenue for a similar
hotel in the United States. This is a substantial efficiency that
is mainly a function of the much lower hotel industry labor costs in Mexico.
International investors can also benefit from a certain degree of exchange
rate arbitrage. Since 1996, the Mexican Peso has depreciated versus
the U.S. Dollar. Revenues collected by beach resorts and high-end
Mexican lodging facilities in major cities are denominated in USD, and
most expenses are paid out in Mexican Pesos, which is advantageous to international
investors in two ways. First, investors benefit from the expense
reduction brought on by the depreciation of the Peso in the lag time between
revenue collection and expense disbursement. Secondly, since what
remains net after expenses is all USD-denominated, investors can remove
their money from Mexico while hedging some of the exchange rate risk.
.
Source: Banco de Mexico (1989 to 2001 average annual
exchange rate; 2002 as of June 15)
.
Hotel Transactions
With hotel pricing at replacement cost levels in the U.S., offshore
real estate has recently attracted a great deal of attention from U.S.
and European investors. For those aware of the challenges and willing
to assume the underlying risks, 2002 and 2003 should turn out to be years
of opportunity for lodging investors in Mexico.
Turnover activity, other than for condominium hotels and timeshare properties
in Acapulco, 2001 was dormant in terms of large hotel transactions, primarily
due to the damper affect of 9/11 and economic malaise in the U.S.
In 2000, the biggest sellers were government-related entities disposing
of assets acquired during the mid-1990 banking system crisis, at or below
replacement cost, such as the sale of the 2,287-room, $212 million Camino
Real portfolio by the Mexican Government�s IPAB bank fund to Grupo Empresarial
Angeles.
A number of large financial institutions have been active in the hotel
acquisitions arena. Bancomer owns approximately 23% of Hoteles Presidente
Inter-Continental, a large chain that has disposed and acquired several
properties. Banamex has also been an active player in the lodging
sector; in 1999, it took control of the Grupo Situr hotel portfolio via
foreclosure.
A sample of Mexican hotel sales between 1995 and 2002 is summarized
in Exhibit 4. It is to note that many hotel transactions in Mexico
are executed between individuals or privately owned companies, therefore
the details of such transactions are usually not disclosed.
,
Exhibit 4
Sample of Mexican Hotel Transactions
1995 - 2002
|
|
Property
|
Location(s)
|
Sale Date
|
Rooms
|
Price/Room
|
| Club Med Huatulco |
Huatulco
|
2002
|
552
|
Not disclosed
|
| Acapulco Plaza |
Acapulco
|
2002
|
506
|
$ 18,000
|
| Four Seasons |
Punta Mita
|
2001
|
140
|
$371,000
|
| Marriott Casa Magna |
Cancun
|
2000
|
450
|
$127,000
|
| Camino Real (1) |
Nationwide
|
2000
|
2,287
|
$ 93,000
|
| Hotel Las Hadas |
Manzanillo
|
2000
|
233
|
$ 64,000
|
| Marriott Hotels |
Mexico City (Polanco and Mexico City Airport)
|
1998
|
1,259
|
Not disclosed
|
| Krystal Cancun |
Cancun
|
1998
|
364
|
$ 80,000
|
| Westin Regina Resort |
Cancun
|
1997
|
385
|
$119,000
|
| Sheraton Hotel &
Towers |
Cancun, Huatulco and Ixtapa
|
1995
|
1,148
|
Not disclosed
|
| (1) Average
price per room for the portfolio transaction. |
Source: Jones Lang LaSalle Hotels
The future growth of hotel transactions in the Mexican lodging market
will depend largely on the open-mindedness of foreign investors looking
to spend money in Mexico, as well as on the country's future macroeconomic
situation, which appears promising at the moment.
.
Source: Banco de Mexico and Merrill Lynch
.
Aside from critical mass issues, the relatively low number of hotel
transactions in the past was a reflection of the difficulty of finding
both legally saleable hotel properties and hotel owners willing to sell
at market-level prices. The sale prices listed by Mexican hotel owners
have rarely been in sync with the underlying business values. Rather,
it is usually a case of owners paying too much to build excessively opulent
properties and expecting to attain a sale price on par with construction
cost. However, in 2002 and 2003, this is expected to change.
The current lack of trust in U.S. equity markets by foreign investors is
creating a �flight to quality real estate� in emerging markets. Emerging
markets such as Mexico are now perceived as being relatively attractive,
given improved corporate governance standards and their superior economic
growth standards.
Doing the Deal
The art of doing a deal successfully in Mexico lies in three key elements:
1) Applying the traditional fundamentals of due diligence and investment
analysis; 2) Finding the right structure and vehicle for a Mexican investment;
and 3) Understanding the local business power-structure, and the intricate
interplay of real estate finance and Mexican family relationships.
Business deals are mainly closed between friends and family, and the rules
and practices of business negotiation in Mexico are very different from
those in Canada and the U.S.
Generally, there are two structures for acquiring an ownership interest
in a hotel in Mexico - as an Asset Purchase or a Stock Purchase.
There are distinct advantages and disadvantages to each structure.
The choice between an Asset and a Stock Purchase for a Mexican hotel may
have a material impact on an investor's bottom line.
Exhibit 6
Asset Purchase vs. Stock Purchase
|
|
Asset Purchase Considerations
|
Stock Purchase
|
| As in the United States, the Mexican
Federal, State and Local authorities will recognize a true Asset Purchase
as a transaction, which will allow the purchaser to avoid some of the most
important successor liability issues.
An investor's due diligence of its hotel investment may
be limited to those matters associated with the operation of the hotel
and property-specific matters. In an Asset Purchase structure, there is
little need to perform a detailed review of the corporate level liabilities
and other matters typically associated with a Stock Purchase deal. However,
with an Asset Purchase in Mexico, an investor should look carefully at
the records of the seller's affiliated companies which often employ the
executive (and rank-and-file) employees of the hotel. If the seller does
have such an affiliated employment company, further due diligence is warranted
because the Mexican authorities may impose successor liability in such
situations.
An Asset Purchase deal in Mexico requires the conveyance
of real property by deed, which triggers certain additional transaction
costs. Firstly, and most surprisingly to most U.S. investors, is the additional
cost of a Notario (an attorney who checks the public records to
assure that title is properly vested in the seller). A Notario's
fee typically runs 2% to 3% of the gross sales price of the hotel depending
on the size of the transaction. (fees and taxes, of course, vary according
to the specific market). Notarios are responsible for retaining
and paying taxes to Local and Federal authorities. Notarios are
experienced attorneys with an excellent reputation in Mexico, who go through
a long process of certification.
The cost of title insurance in Mexico is significantly
higher than in the United States, and has often resulted in additional
six-figure transactional costs for U.S. investors when buying a hotel in
Mexico. New competition of title insurers should reduce this cost in the
future.
In Asset deals, the purchaser also pays an additional
acquisition tax based on the value of the hotel, as will be discussed in
Exhibit 8. |
In a Stock Purchase, the purchaser
avoids additional transactional costs such as the Notario fees,
and the additional acquisition taxes. A Stock Purchase deal also provides
a purchaser greater flexibility in structuring the transaction to purchase
the shares of the parent company which may well be a U.S. or other foreign
domicile entity with distinct tax advantages.
The biggest problem with a Stock Purchase transaction
is usually the purchaser's assumption of successor liability for all matters
relating to the operation of the hotel, in addition to the liabilities
of the seller.
A Stock Purchase is feasible when the company only holds
the hotel. If the company holds other properties, then divesting those
assets prior to an acquisition of the held hotel will increase transaction
costs.
The seller pays capital gains tax on stock profit if it
is not a publicly traded company. |
Source: Jeffer, Mangels, Butler & Marmaro
LLP
Negotiating the Mexican Due Diligence
Minefield
Investing in hotels has never just been about taking a gamble on real
estate. When a hotel is acquired, a complex business is bought, and
where that business operates can determine how the investment stacks up.
So what do investors need to focus on in Mexico when it comes to the due
diligence minefield?
Exhibit 7
The Pre-Purchase Checklist for Hotel Buyers
in Mexico
|
|
Due Diligence Issue
|
Approach
|
| Understand the
Current Market Position in the Cycle of the Market Being Invested in |
After a period of
prolonged growth in a particular market, returns will be attractive, established
hotels will be selling at levels above construction cost and investment
in the industry will seem an attractive option. |
| What are the Barriers
to Entry of New Hotels? |
The more barriers
there are to new entry, the less chance there is to add new supply. Scarcity
of available sites makes it virtually impossible to develop new hotels
in many cities. |
| Undertake Thorough
Due Diligence on the Building and Plant Equipment |
Capital expenditure
and ongoing maintenance in a property can play critical roles in the hotel�s
future profitability. Prior to any acquisition, knowledge of what may need
to be upgraded or replaced can dramatically affect future returns. Tired
rooms and common areas, especially in a competitive market, will make it
difficult to increase room rates. |
| Prepare an Investment
Strategy by Region |
As groups expand into
new regions, landmark cities (namely Mexico City) are often the main target
to commence acquisitions. All markets go through cycles and those parties
who are patient can strategically acquire properties at discounts to replacement
cost. |
| Think Laterally
in Terms of Additional Cash Flow or Revenue Generating Opportunities |
Investors who have
the ability to think outside the box often triumph over others. The ability
to find the "edge", or unlock the site�s or the property�s potential, can
add substantial value to an acquisition in Mexico. |
| Understand the
Terms of an Existing Management Agreement |
An incumbent management
agreement over a property can present many challenges. The relationship
between the previous owner and the manager may be reflected in the current
trading figures. If vacant possession is not available, the ability to
work with the manager and "manage" the asset can substantially improve
a hotel�s profitability and, in turn, its value. |
| Know the Local
Tax System Inside-Out |
Expert advice on the
Mexican tax system is crucial and can have significant implications for
the success (or otherwise) of the hotel investment. Exhibit 6 brings to
light those taxes that are directly pertinent to Mexican hotel transactions.
There are several initiatives currently in the approval
process in Congress that will incentivize investment in new hotels, especially
outside of the metropolitan areas of Mexico City, Guadalajara and Monterrey. |
| Understand the
Airline Accessibility Matrix |
Flights are a real
critical issue in markets such as Huatulco and Ixtapa. Aeromexico and Mexicana,
the two dominant airlines, are both controlled by the Mexican Federal Government,
yet are expected to be sold in 2003. Some markets are not accessed by foreign
airlines, and domestic flights are very expensive (i.e. Mexico City � Ixtapa,
Mexico City � Los Cabos). An analysis of airline access is paramount, especially
in poorly served destinations. |
Source: Jones Lang LaSalle Hotels
U.S. investors need to be cognizant that Article 27 of the Mexican Constitution
of 1917 prohibits direct ownership of real estate by foreigners in what
has come to be known as the �restricted zone.� The restricted zone
encompasses all land located within 100 kilometers (about 62 miles) of
any Mexican border, and within 50 kilometers (about 31 miles) of any Mexican
coastline. However, in order to permit foreign investment in these
areas, in 1973 the Mexican government created the fideicomiso, which is
basically a real estate trust. This type of trust is similar to trusts
set up in the United States, but a requirement is that an approved Mexican
bank must be designated as the trustee and, as such, has title to the property
and is the owner of record.
Alternatively, under the 1993 Foreign Investment Law, a corporation
established in Mexico is considered Mexican under the law, even if all
the shareholders are foreign. Thus a Mexican corporation with 100%
foreign ownership can acquire real estate property in fee simple ownership,
even in the �restricted� zone if the property is for non-residential purposes.
On the surface, the deal structures available to a buyer in acquiring
a hotel in Mexico may appear similar to those in the United States.
But hotel investors do gain a competitive advantage if they seek guidance
from commercial real estate investment advisors regarding the many subtle
distinctions and potential snags in acquiring a hotel in Mexico.
Exhibit 8 sets forth some of the most common tax implications for large
lodging acquisitions in Mexico that need to be on every buyer and seller�s
radar screen.
.
Exhibit 8
Major Taxes Relating to Hotel Deals
in Mexico
|
Tax
|
Description
|
| Acquisition Tax |
The buyer in an Asset Purchase
must pay an acquisition tax of approximately 2% of the value of the land
and the buildings. This tax (which can be reduced) is payable at closing,
but the amount of the tax varies with the local jurisdiction and is often
negotiable with the local authorities. This tax does not apply to a Stock
Purchase. |
| Asset Tax |
Asset tax is 2% on total assets,
regardless of the valuation. In an Asset Purchase, when an investor buys
a hotel with a newly incorporated company, the Mexican government generally
will allow the new company to enjoy a four-year grace period within which
it will be relieved of making any asset tax payments. The asset tax is
based on an annual valuation of the enterprise's worth and is payable annually.
However, in the event that a newly formed entity purchases all of the assets
of a hotel, the Mexican government may take the position that it is not
really a new company, but is a successor to the seller and ineligible for
the four-year tax holiday. This tax applies to any entity. |
| Capital Gains Tax |
The seller pays 34% in income
tax on any net gain realized in connection with the sale of a hotel. In
Mexico, the concept of a capital gains tax does not apply in the sense
by which it is determined in the U.S. That is, the gain from the sale of
the property is considered as "normal income". In order to determine the
gain, the following costs and expenses are deducted from the amount for
which the property is officially sold: 1) The original land cost and the
depreciated construction cost, based on the number of years the property
was held and adjusted for inflation according to the official consumer
price indexes; 2) Additions, modifications and improvements, but not maintenance,
made to the property (construction), adjusted as above; 3) Commissions
paid to real estate brokers by the seller; 4) The closing costs, including
all expenses, taxes and fees paid by the seller. The Notario will
retain the calculated gain after deductions, forwarding it to the Mexican
tax authorities. The seller will then deduct this amount against his/her
annual tax return, which becomes an adjustable tax credit in the U.S. |
| Income Tax |
With either an Asset or Stock
Purchase, the buyer will have to pay income taxes equal to 34% of its net
income from the operations of the hotel, following the closing. |
| Property Tax |
Based on the "assessed value of
property". Property taxes, and the underlying tax rate, vary significantly
across municipalities and states. If the property is leased, the current
property tax rate is approximately 25% of the gross lease payments, except
in cases where the value of Public Registry indicates a property tax higher
than 25% of the lease. It is to note that property taxes are not automatically
reassessed upon the sale of a hotel in Mexico. |
| Transfer Tax |
The buyer pays transfer tax and
related closing expenses which amount to between 3% and 6% of the sale
price. These expenses would include the "transfer tax", notary fees and
an approved-bank appraisal. The "transfer tax" is determined based on the
highest of: the sale price of the property, the appraised value of the
property or the assessed value of the property for property tax purposes
(valor catastral). |
| Value Added Tax |
The VAT in Mexico requires the
purchaser to pay a value added tax at a general rate of 15% on the portion
of the purchase price allocable to the building and other assets that do
not constitute real property. There is, however, a process by which the
purchaser can then obtain a refund for an amount equal to the VAT paid
at the closing of the hotel within a rather short time period thereafter.
This tax does not apply to Stock Purchases. |
| Withholding Tax |
In an Asset or Stock Purchase,
unless both the seller and buyer are Mexican entities, the purchaser must
withhold a portion of the purchase price paid to the seller (as under U.S.
regulations). However, most transactions are structured with both entities
to the transaction being Mexican corporations to avoid such a withholding. |
Source: Jones Lang LaSalle Hotels
Conclusion
Current economic troubles in Argentina, Venezuela and Brazil have channeled
investors� attention towards Mexico. The emerging transparent market
economy in Mexico fills many sophisticated private and public investors
with enthusiasm for the potential opportunities for hotel acquisitions
- particularly in the dollar denominated lodging industry.
Ander Legorreta is a Director of Capital Markets in the Mexico City
office of Jones Lang LaSalle, and Anwar Elgonemy is an Associate in the
Miami office of Jones Lang LaSalle Hotels.
Jones Lang LaSalle (NYSE: JLL) is the world�s leading
real estate services and investment management firm, operating across more
than 100 key markets on five continents. Jones Lang LaSalle Hotels,
the world�s leading hotel investment banking group, provides clients with
value-added investment opportunities and advice. In 2001, its success story
includes the sale of 7,972 hotel rooms to the value of US$1.3 billion in
39 cities and advisory expertise on 100,550 rooms to the value of US$26.3
billion across 255 cities. Jones Lang LaSalle Hotels� services include
transactions, mergers and acquisitions, financial advice and capital raising,
valuation, asset management, strategic planning, operator assessment and
selection and industry research. |
