Starting with NAFTA According to many reports, the impact of the North American Free Trade Agreement (NAFTA) has been modest and increasingly difficult to sort out. NAFTA's objective was to liberalize trade over a 15-year period between the United States, Canada and Mexico. During the first three years of the agreement, however, events such as the severe recession in Mexico, the depreciation of the Mexican peso and U.S. tariff reductions under the Uruguay Round have taken place during the same period - hence, the difficulty in isolating NAFTA's effects.

Along with NAFTA's economic benefits related to enhanced trade between Mexico, the United States and Canada, there are also, presumably, harder to measure ancillary benefits. One such case could be made for the real estate sector of the economy. As border economies grow hotter and hotter (an article in the Wall Street Journal cited some 1,675 maquiladora plants employing well over half a million Mexicans last year), so too would we expect the underlying user-oriented real estate market to heat up. As Mexico's economy grows, and its financial/institutional systems mature, we would expect to see real estate finance techniques become more sophisticated, in turn leading to an abundance of capital-markets-grade investment opportunities as well.

This idea was the impetus for National Real Estate Investor and Deloitte & Touche LLP to initiate a survey among investors inquiring about their current and proposed real estate activities in Mexico. Corporate users were also targeted to gauge the historical and future demand for real estate in Mexico.

Summary of Findings Over half of the respondents considered their companies to be principally real estate-related, investing as owners/developers of commercial property. The majority of respondents were from the United States, although several surveys were returned by Canadian and international companies.

Among those who have invested in Mexico, most did not consider NAFTA to be a significant factor in their investment decisions. Indeed, almost an equal number of respondents invested in Mexico before NAFTA, compared to the number investing after the agreement was implemented.

More respondents purchased or leased existing property rather than developing speculative or build-to-suit real estate. Very few respondents demonstrated interest in the Mexican mortgage market. It appears that a great deal of investment in Mexican real estate focuses on the need for corporate and industrial space, including office, warehouse, distribution and manufacturing property. The tourism industry has also fueled hotel/motel/resort transactions. A certain degree of confidence in Mexico's real estate future is indicated by the respondents' interest in raw land.

When investment services were rendered, such as legal assistance and consulting, most investors reported using Mexican contacts rather than U.S. or Canadian service providers. This seems to reflect the need to understand and negotiate Mexican laws and government regulations.

Most of those who have invested in Mexico raised concerns regarding government stability and currency risks.However, they maintained an optimistic attitude about the future of Mexican commerce and real estate, rating their perceptions of locational factors and real estate potential as positive, overall. The majority of the 271 respondents to the survey expected to do little or no business in Mexico in the future. Among those who were pursuing investments in Mexico, 58 (21%) indicated previous or current investment activity in Mexico and 83 (31%) expressed an interest in pursuing opportunities in Mexico in the coming years.

Conclusion >From a corporate use and general investment perspective, 62% of respondents reported that NAFTA was not a major influence in their investment decision. With the agreement only in its fourth year of a 15-year implementation period, and as we move further away from other major economic events such as the Peso devaluation, we wonder if this perception will change over time. Conversely, as several roundtable panelists commented, it may be a matter of taking NAFTA's initial benefits for granted. That is, once NAFTA was implemented and the borders opened up, corporate and capital markets investors entered the market and now their focus is upon more immediate concerns. Hence, NAFTA is perceived as having less impact on these companies' investment decisions than other factors with which they now contend.

The Mexican capital markets are still generally unexplored. Direct property investment/divestment is the most common real estate investment vehicle.Investors' experiences in Mexico thus far have satisfied or exceeded their initial expectations for the most part. One might assume that part of their satisfaction level ties back to the locational, real estate and general business factors which were rated as positive influences on their investment decisions. Other factors might have to do with the investment returns they are netting or (in the case of manufacturers) the cost savings they've realized.Positive relationships established with Mexican contacts could also factor into these high levels of satisfaction.

On the other hand, although investors and corporations have confidence in the potential for real estate, they remain wary of possible government corruption and instability, and currency risk. Survey respondents indicated a desire for trustworthy Mexican contacts and partners to act as liaisons within an often unfamiliar business, social and institutional culture. This definitely has positive implications for Mexican service providers and should play a major role in how they position their services with U.S. and Canadian-based investors.

The following roundtable discussion includes an array of professionals who have both direct and fringe involvement in emerging markets. Here, with moderator Ben Johnson, they gather to discuss the effects of NAFTA on their business ventures in Mexico and to give their personal insights into the Deloitte & Touche LLP/National Real Estate Investor survey.

NREI: I want to know what the panel thinks, because you are down there in Mexico working, living and breathing it. What has NAFTA meant from your perspective?

Mitch Creekmore: If you look at the statistics derived from the Deloitte & Touche and National Real Estate Investor study you can see that so much has changed in the last four years. How did it impact Stewart Title? It didn't,much along the same way as the respondents answered the questionnaire. Why? Because NAFTA is a tariff and trade agreement. What impacted us was the new foreign investment law that came into effect right at the same time as NAFTA did. It was enacted on December the 28th, 1993. NAFTA began in January of 1994. That had a much farther reach on our ability to do business in Mexico from the standpoint of U.S. multinational companies. The foreign investment law liberalized 95% of economic prohibitions on foreign ownership into Mexico business endeavors.

Daniel Dubrowski: I was honestly very surprised, reading the Mexico survey, it seemed that the majority of the respondents said that NAFTA is not an important issue. It's a little bit counter-intuitive to what we're seeing in Mexico. I live in Mexico and right now we're dealing with about 60 of the Fortune 100 companies that are operating in Mexico, either in a client relationship or in an investment relationship, and they're all doing something. To them it has made a difference. I think there are other factors - changes in the foreign direct investment laws, low-cost labor, the importance of the supply chain - a variety of different factors that are all coming together. But NAFTA is certainly part of it. You can't have $11 billion in foreign direct investment in Mexico last year and think that NAFTA is not having an effect. You can't have imports and exports growing tremendously between the United States, Mexico and Canada and think that NAFTA's not part of it. In the electronics sector in Guadalajara, you have seven of the top 20 electronics firms. Motorola. IBM. Hewlett Packard. Lucent Technologies. All making significant investments and expansions to their plants.

Victor Manuel Lachica Bravo: I'm not completely in agreement. Things are much different than five or six years ago. Mexico is a bridge to the United States, to serve the market, to serve Latin American markets. The position that Mexico has is very strategical and NAFTA eases the regulations for the flow of products and services - one of the major reasons Cushman & Wakefield, or Hines, or many of the others are here. Eighty-five-percent of the business is being done with U.S. and European corporations. Why? Because they see a great market as a bridge to the United States and to Latin America.

NREI: Let me get to the two investment bankers who are racking up frequent flyer miles ...

Roberto Ordorica: ... we have to step back. When NAFTA was enacted a couple of years back, a lot of people ran to Mexico. We did not do an official survey as the one Deloitte & Touche did, but we did an informal poll of our clients and all of them considered Mexico at the time and tried to run down there. I think that NAFTA has helped change the legal system, environmental laws, the tax code, which over time is making a big impact on how we look at real estate in the region. But a lot of people ran down there right when NAFTA got enacted and had bad experiences. I think the probability of success, being able to do a successful investment, has a lot to do with the team you put together. On the accounting side, on the legal side, on the investment banking side. And your probability of success has a lot to do with the advice you get coming into new markets.

NREI: Ed, what's the Goldman perspective?

Edward M. Siskind: I look at NAFTA as one component. We look at investing around the world, and specifically in Latin America, where I focus a lot of my time. We have larger investments in Brazil and Argentina than we do in Mexico, and for no particular reason other than we saw the opportunities there. What does NAFTA represent? NAFTA represents trade barriers coming down ... that's happening in Argentina and Brazil and it's happening in other countries around the world. What else does NAFTA represent? NAFTA represents more democratic institutions. NAFTA represents greater stability. All of the factors that are encouraging people from the United States to invest in emerging markets can be related in some way to NAFTA. But there's 10 other reasons to invest there and to invest in other countries that don't have a NAFTA but have all these other components that are making emerging markets exciting to Americans.

Jose Garcia Mata: I think it's pretty easy for those of us who live in Mexico to perceive the benefits of NAFTA. One must keep in mind that the Mexican economy is pretty small with respect to the U.S. economy. Our GDP is 5% of the U.S. GDP. I think the real benefits of NAFTA are yet to come. We have, in my opinion, seen very little of what NAFTA will bring to the region. NAFTA became effective on January 1st, 1994. And then we had a couple of big political assassinations. And by the end of 1994, we had the mother of all economic troubles in Mexico. In 1994, we experienced massive devaluation. I agree that NAFTA is only one of the rules of the game that we're playing in Mexico, but many clients who are coming into Mexico have performed studies to determine the positive effects of NAFTA and they argue that the benefits will be significant. This is just the fifth year of NAFTA. The electronic industry in Guadalajara, where I live, is expected to be the North American capital of electronic manufacturing. IBM, for example, exports $2.6 billion. They're growing 60% a year.

NREI: >From an American perspective, I would be interested in the stability of the political system, the stability of the currency. I think those two things are uppermost in investors' minds going into any market ...

Roberto Ordorica: Mexico has continued to sign trade accords left and right with Central America and other countries in South America as a U.S. stop with Mexico. For Mexico, I think we look more at free trade as being the key word. It has really separated the political train from the economic train, and they're now on very separate tracks. I think that the Asian crisis pretty much serves as an example that although we did have an impact on Latin America, the government has tightened up and has allowed to continue its economic program. I think that the oil crisis has put pressure on Mexico, but the government is responding with a very strong policy. We used to be a very paternalistic country where our president said exactly what we had to do ... but democracy is changing this. We are in transition, and this transition helps the economy.

Jose Garcia Mata: Back to government stability, more than 50% of Mexicans live in states or municipalities governed by opposition parties. To me, that stability is democracy. Ten years ago this was unthinkable, so I think that's unquestionable proof that we do have government stability in Mexico. The Zapatista uprising has, in my opinion, been totally overplayed. They have less than a thousand men ... their uprising or movement has been basically ignored by business.

Daniel Dubrowski: I thought that was a really interesting survey conclusion - to highlight risk and government instability. I think you need to really put Mexico in its context. If you say, "Is Mexico a high risk place to do business?" compared to an industrialized country like the United States, yes, it's higher risk. But in the context of emerging markets ... compared to Indonesia or Russia, compared to Malaysia, Mexico, from a government stability standpoint, feels like Iowa. The other interesting point that came out of the survey was currency issues. For us, from a development standpoint, currency is much less of a risk because it's a dollarized business. We rent and we lease and we price completely in dollars.

Victor Manuel Lachica Bravo: I agree with you. You only have a risk when a specific percentage of the leases you do in a building are with Mexicans and they're going to try to renegotiate when the opportunity comes. But that's not the norm. You're right. It has turned out to be a very dollarized business right now ... and timing is very important. The majority of the professional developers are doing pretty well. If your expectation of recovering your investment was seven years, now it's 10 or 11 or 12. But if you have enough patience and you're doing business for the long term,you're going to be okay.

Audience Member: I wanted to ask the panelists who are in the hotel business a question. My experience years ago was that you had a very strong dollar hotel economy during the season, and then you were relying heavily on the Mexican middle class peso-based economy to fill in at off-season periods. I wonder if that's still the case, and if so, how do you deal with that on a real basis in your resort hotels and commercial hotels?

Edward M. Siskind: If you're talking about resort hotels like the Hotel Palmia, which we have in Los Cabos, it is almost exclusively a U.S. destination. In the off-season the rates drop, but it's to Americans who want to pay less. The Four Seasons in Mexico City is almost entirely an international hotel. Probably the best example is our Quinta hotels. We have these hotels in secondary cities in Mexico. I guess the good news is that we have invested subsequent to the devaluation. What's happened actually in the hotel business is that if you're a peso-denominated hotel [and we have several that are almost entirely domestically driven] what we've seen over the last 18 months is the opposite phenomenon. The peso has been appreciating and we're coming out of an economic recession so you get a double whammy of more activity and an appreciating peso. So for the dollar investor, it's the best possible scenario.

Audience Member: I would like to ask Mr. Reynoso, being such a major local player - how do you in Mexico handle the currency risk being a lender, in other words, the ability of the mortgage owners to pay back their loans?

Pedro Reynoso Ennis: Our loans are subsidized by the government, and the interest rates we provide allow for a refinancing of the amount that was originally loaned. If at the end of the loan, usually 30 years, there is an outstanding balance, it is absorbed by the government. In a sense, it is a subsidy paid to minimum wage. Some people think that perhaps there is going to be a real increase in the minimum wage, I think that the effects will not be evident due to the Asian crisis and rising oil prices. I would say that one of the major problems in Mexico is the lack of savings, the lack of a culture for savings, which inhibits people from making down payments even with the low prices for homes.

NREI: There's another question in the audience.

Audience Member: What is your criteria for a Mexico investment compared to a U.S. investment?

James R. Worms: As a benchmark in the U.S., we like to make what I call leveraged equity returns in excess of 25% and that's using conventional amounts of leverage. It's what I consider to be a conservative amount of financing. Our other rule is that in absolute dollars, we like to at least double our money. We don't like to put up $5 million to make $1 million in six months. If we put up $5 million we're going to make $5 million. When you leave the United States and you go somewhere else that is more risky, then you want higher returns. You get paid for the risk, and all the concerns that everybody has in this room about country risk and currency risk and lack of information and crime and finding a good partner, those are all great things for us because they mean that it's a less efficient market and your returns ought to be higher.

NREI: I want to know ... as a hopeful American investor in Mexico, what are the property types that would give me the greatest returns, and is it very much a market-by-market opportunity?

Daniel Dubrowski: ... In our own point of view, Mexico's needs right now are more along the lines of basic infrastructure ... in industrial and the growth of the industrial markets because of issues like NAFTA. Because of relative labor costs, the shortening of supply chains and infrastructure, we really like the industrial markets. It is an architecturally simple product that's all done by locally sourced, national materials. Your issues with currency risk and your issues with getting materials across the border work a lot better ... and there are very short development cycles. It doesn't take you six years to build; it takes you six to nine months ...

Pedro Reynoso Ennis: We've been doing a lot of business in the real estate market and one of the things that the banks in Mexico started getting away from was low income housing financing. They don't like it. We see it as an opportunity. We did about 7,000 loan originations in 1996, about 23,000 originations last year, and we expect to do well over 70,000 loans this year. So our market has been growing. We did 40 million originations in the beginning of this year and feel we're going to close about $1 billion in originations. This is very different to low income housing here in the United States because these houses and the loans average between $12 and $15,000. In our case, we are working with the government on all of these loans.

Roberto Ordorica: ... I think that there's so much demand for all property types. It is not whether the opportunities are in the office or residential market. I think that the fundamentals in many of the different property types are there, and there's such great demand that we've put a lot of focus on the partner - on the partners that we are looking at in the region.

NREI: NAFTA was created to form a trade between not only the U.S. and Mexico, but also Canada and Mexico. What about the scope of the Canadian investment in the Mexican market?

Mitch Creekmore: I can't say that I've seen many Canadian investors nor much Canadian investment .... I can tell you I have seen a tremendous amount of money from the Canadians in the residential market. Some of the biggest new developers in the resort/residential sector are Canadians.

Audience Member - Seymour Temkin, National Director, Real Estate Services Group,Deloitte & Touche - Canada: In the last eight months, there has been a re-look at the Mexican real estate market. In particular the residential market which is perceived to be a far less risky area than the commercial sector. Recently, there has also been an interest in the hotel sector. From a Canadian point of view, Mexico has traditionally been viewed as a manufacturing opportunity rather than a real estate play. Historically, devaluation and job losses is how NAFTA translated to Canadians. Recently, we have witnessed a number of Canadians investigating the Mexican real estate market.

NREI That wraps it up. I thank the panelists for their thoughtful insight.