- Mark B. Raven, Esq.
These days everyone involved with Mexican real estate is buzzing about the boom in vacation homes and condos in resort areas such as Rocky Point, Cabo San Lucas and Puerto Vallarta. Judging from the activity in my law practice, the buzz is well justified. At the same time, I am convinced that for growth to reach the next level there needs to be another ingredient, one which is still missing from the market. That ingredient is financing.
Experts will tell you that freely available financing is indispensable to a truly solid and healthy real estate market. It was this factor that enabled the U.S. housing boom after World War II and which is fueling the current long-lasting expansion in our single family housing sector.
Unfortunately, with few exceptions, no U.S. lenders are accepting Mexican vacation properties as collateral, either for acquisition or refinancing. This situation is acting as drag on the market and creating difficulties for buyers, sellers and real estate agents.
There are various reasons for this reluctance on the part of U.S. residential lenders. One is the fact that over the past several years of rock-bottom interest rates, they have had enough trouble simply keeping up with the flood of home purchases and refinancings in the United States and have not felt any need to look further afield. However, as interest rates begin to come up from the record lows we have experienced in recent years, the thought of a huge, virtually untapped new market in Mexico is attracting more interest.
The biggest stumbling block for potential lenders into the Mexican market, however, based on my own conversations with many of them, is their lack of confidence in the Mexican foreclosure procedures available in the event of a default by the borrower. This same question mark also has a negative impact on the primary source where lenders themselves obtain funds to lend out. That source is sale of mortgage backed securities, accessed through the Wall Street capital markets, and it is an extremely important part of the financing picture.
There are two major areas of the residential real estate market where lender financing would have an immediate positive impact. These are (1) refinancing of existing homes, and (2) sale of new and existing homes.
- Refinancing. Bruce Greenberg, a Tucson Arizona MAI appraiser active in Mexico, estimates that there is over a billion dollars in home equity tied up in Mexican vacation property owned by U.S. citizens. This is because up to now, due to the lack of lender financing, the only way to pay for second home purchases in Mexico has been either cash or seller carryback financing (which becomes a cash investment when paid off).
If even a part of this locked-up equity could be tapped, it would be of enormous benefit to owners by freeing up funding for additional investment in both the U.S. and Mexico. There is no reason why the home equity loan product could not be as successful in Mexico, albeit on a far smaller scale, as in the United States. Home improvement and trading up to more expensive properties are just a few of the outcomes that could be expected to add new energy to the market.
- Home sales. Mexican second home sales to U.S. residents have been held back from reaching their full potential by the virtual unavailability of financing at competitive interest rates. Sales have been sustained to a significant extent by the common practice of buyers refinancing their U.S. homes to obtain the funds to buy a vacation home in Mexico, but this source of cash is bound to diminish as U.S. interest rates increase and as the rapid run-up in home values slows down in most parts of this country. Meanwhile, developer financing is typically at 12%, which is a deterrent to many buyers.
In addition to the high cost, however, there are other disadvantages to the present system of seller carrybacks and developer financing. This stems from the Mexican legal system itself. The only way sellers have been able to feel secure about receiving less than the full purchase price has been by retaining legal ownership until the balance is paid off. This holds true for developers as well as individual home sellers. One reason is their lack of confidence in Mexican mortgages and foreclosure proceedings, referred to in the first part of this article. This is especially true because Mexican mortgages can only be foreclosed by court action, a process than can literally take years. As a result of the seller retaining ownership until the purchase price is paid in full, buyers who do not wish to pay all cash are put into an unfavorable and insecure legal position. Why is this the case? First, the purchase is not recorded. Thus the property can become subject to a lien that takes priority over the buyer’s interest. Second, the buyer might have paid 90% or more of the purchase price, yet risk losing the property and a big chunk of his investment if he misses even one payment. This is because Mexican law permits large contractual penalties in the event of a default (i.e., the seller can retain a big percentage of the amount the buyer has paid). Mexican law also does not require mandatory reinstatement if the buyer offers to make up the past due payments. Third, the seller may be uncooperative in transferring ownership once the loan has been paid off or may be difficult or impossible for the buyer to locate.
To sum up, concerns on Wall Street and secondary capital markets regarding offshore lending in general and the enforceability of traditional form of Mexican mortgage in particular, have delayed the arrival of the key ingredient of U.S. lending in the Mexican residential real estate market. Although these concerns are in my opinion exaggerated, especially in light of the extremely low rate of default on seller carrybacks for Mexican vacation homes, the binational legal and financial community needs to invest more time and energy in improving Mexican mortgage documentation.
I am happy to report that the Mexican government has realized the importance of streamlining real estate financing. Over the past 4 to 5 years, the Mexican Congress has enacted several versions of a law providing a more functional alternative to the traditional mortgage. This new security mechanism is called the “Guaranty Trust.” It is analogous to the deed of trust used in the United States in that it provides for non-judicial foreclosure and private sale rather than the judicial foreclosure required under the traditional mortgage. The time period involved to retake possession from a defaulting borrower can be as little as 30 days. While a detailed description of the guaranty trust is beyond the scope of this article, it may well be what we in the Mexican real estate field have been looking for to provide a much needed comfort level to both Wall Street and the buying public.