January 2009 - Ballard Spahr Andrews & Ingresol LLP

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Challenges and Trends for Fractional Projects in Mexico

Letvia Arza-Goderich and Mauricio León de la Barra, Ballard Spahr Andrews & Ingresol LLP

The worldwide financial crisis has reached unprecedented levels.  Discouraging news about its worsening and apparent lingering for a good part of 2009 hit us each and every day, and they hit us hard.  Accordingly, most developers of Mexican luxury fractional and timeshare projects (“Resort Developers”) are now moving carefully, if at all.  While the vast majority follow this conduct in light of the risks and uncertainty that the crisis has created, others view a crisis as an opportunity.  For instance, Donald Trump, whose reputation in the real estate industry is well established, argues that “there is no time like the present to profit from the gold rush in real estate investing that is taking place right now.”  And this year, Carlos Slim, one of the wealthiest men alive, will invest $800 million in a real estate development project located in the heart of Mexico City.   But because not everyone is Donald Trump and nor has $800 million to invest, the question, then, is: what should a Resort Developer do during these difficult times to survive and prosper?

The answer may be threefold.  First, Resort Developers need to understand the nature of the opportunities created by the current economic crisis.  Second, Resort Developers should foresee and adapt to the challenges and trends of the luxury fractional and timeshare market (the “Resort Market”).  Finally, Resort Developers need to identify and take advantage of the sources of financing available during these difficult times.

I.      Opportunities Created by the Current Crisis

Following Trump’s advice and Slim’s example, Resort Developers should realize that this crisis may be the best time ever to invest in Mexican fractional and timeshare products (the “Resorts”).  While this approach may seem odd and even irrational, several factors weigh otherwise:

• With the devaluation of the peso, from under $9.89 pesos per dollar in 2008  to over $14.20 pesos per dollar,  Resort Developers transacting with US funds received a significant “discount” on the purchase price of the real estate (if appraised in pesos) and in costs of labor and materials;
• US mortgage and commercial loan rates have significantly fallen for qualified borrowers, due in part to the drop in the US Prime Rate from 7.5% in November 2007 to 3.61% in December 2008,  and the LIBOR rates descent from 5.01% to 1.08% in that same period,  thus lowering all financing costs; and
• The escalating trend of the average real estate prices has not only stopped, but gone back to the level of years ago.

The above elements translate into significant lower costs for the Resort Developer and in the ability to produce and offer luxurious yet still affordable Resort products.  Furthermore, considering that the average development period of a Resort is five years, and the economic crisis is expected to show signs of recovery by mid-2009 or the beginning of 2010, Resort Developers who can invest now should have new products to offer when the cash starts flowing.  Thus, Resort Developers who wait until the economy flourishes to restart their Resort investments will be years behind and will face a lower demand or a saturated market.  In other words, “the early bird will catch the worm.”

II.    Trends of the Resort Market

Resort development is a complex undertaking.  It requires thorough and sophisticated knowledge and understanding of Mexican and US law and regulatory processes, experience in dealing with local and federal authorities, and sensitivity and ability to adapt to business, cultural and language differences.  For example, a Resort project in Los Cabos, Mexico, will require (a) the ability to successfully negotiate with municipal, state and federal authorities, (b) an updated knowledge of at least ten different bodies of Mexican law (e.g.  constitutional law, civil law, commercial law, business law, trusts, condominium law, environmental law, foreign investment law, construction and development regulations, consumer protection laws, etc) and (c) extensive experience in a variety of luxury resort products, such as timeshare and vacation ownership products, fractional ownership products, private residence clubs (often the highest-end fractional product), destination clubs, condominium hotels and hotel condominiums, and/or membership clubs, as applicable.  If marketing and commercialization activities are to be undertaken in the US, knowledge of federal and state regulatory and registration requirements (including SEC and HUD regulations) is also imperative.  Thus, having a team of knowledgeable and experienced legal consultants is a key aspect to the success of any Resort development venture.

Having a carefully selected team of non-legal timeshare and fractional consultants is also key to the success of the Resort project.  As the discretionary time and money of the Resort Market increases, so does the sophistication and quality demand on value, services and conveniences.  This is a “want” and not a “need” business, which demands identifying the trends of the Resort Market and a careful selection of the property type, recreational amenities, location, and natural settings.  The fact that Resorts are being developed in exotic locations, with golf courses being designed by the likes of Tiger Woods, Greg Norman and Jack Nicklaus, among others, with residential components designed by Philippe Starck and Jean-Michel Gathy, proves that Resorts now differentiate not only in terms of location, but also with respect to ownership type, service, amenities, and level of luxury.  Thus, non-legal timeshare and fractional consultants may help the Resort Developer to understand and identify the Resort Market and its demands, and to develop products that exceed such market's expectations.  

III.      New Sources of Financing

The third consideration is where to find the required funds.  Due to the scarceness of commercial loans and recent developments in Mexican laws and regulations, new sources of real estate development financing have emerged, including Real Estate Trusts or “Reits” and structured instruments.  While there are clear differences and similarities amongst these sources, they share one common aspect that makes both very appealing: their recent ability to receive Mexican pension and retirement fund investments, now representing around $5.6 billion.  Consequently, Resort Developers may now have a way to find the required funding at their disposal.  

Conclusion

It is hard to be optimistic during this economic turmoil.  Nevertheless, now may be one of the best times ever for Resort investments.  Only history will tell, but our industry needs to be proactive in order to take advantage of all reasonable opportunities.  Years ago, the saying was “don’t miss the boat.” Today, if there is a “boat” -- as there appears to be -- make sure that you are on it!

 
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