Executive Summary
According to Professor Scott Galloway, the next hot city in North America will be Mexico City.
Scott’s case for Mexico City being the next “it” city is that it is densely populated, attractive to remote workers, borders America, and is increasingly becoming an economy full of innovative companies.
There is an opportunity to leverage Mexico City’s status as the current “it” city to make it a dominate regional business and investment hub.
Foreign diplomacy from the regional leaders often seems more focused on dealing with the “rich” countries and less with removing trade barriers and fostering inter-LATAM trade and investment flows.
American investor returns have been lackluster in the region and investor sentiment is low for Latin American real estate. Valuations aren’t attractive, currencies haven’t been stable, and the leading regional economies (e.g., Mexico, Brazil, Chile and Colombia) have recently embraced left-wing politics.
There is a sizable opportunity to attract major American real estate investors to increase their capital allocation to Latin America, especially if they are able to establish a potent regional office in a city such as Mexico City.
Introduction
Scott Galloway, a professor at NYU’s Stern School of Business, gave an interesting presentation at 2022’s SXSW Conference in Austin. He made several predictions in the talk, including that the next hot city in North America would be Mexico City.
A comparison that may one day be appropriate to what is occurring in Mexico City is the relationship Miami has to Latin America. While the city is technically an American city, it’s effectively a Latin American city in terms of culture, language and economic drivers. If the analogy holds water, the future of Mexico City may be at the early stages of a steady wave of inbound migration, and capital and businesses relocating to Mexico City from other countries, most especially America..
Mexico City is the Next “It” City
Scott’s case for Mexico City being the next “it” city is that it is densely populated, attractive to remote workers, borders America, and is increasingly becoming an economy full of innovative companies.
Mexico City has 22 million people, compared to 20 million in NYC and 13 million in LA. The density means making money, and finding creative outlets and mating opportunities are larger and easier to realize. Remote workers are flocking to Mexico City from America and other advanced economies. Many of these digital nomads refer to Mexico City as the top city in the world. They attribute this to their affinity for its culture, proximity to America, favorable time zone, gastronomy and low cost of living.
Bordering America is an advantage difficult to understate. That China has done so well establishing and protecting substantial trade imbalances with many faraway nations can be considered an exception to the general rule of how countries tend to trade with each other. Scott explains that America’s largest trading partner is Canada, and Mexico is on the verge of overtaking China.
He ends the case for Mexico City by pointing out that the reputation of Mexico as a non-innovative economy is changing evidenced by the number of startups in the city receiving large sums of venture capital investment. These startups are buoyed by the existing $1 billion+ Mexican technology companies already making a name for themselves on the global stage.
Leveraging “It” City Status
There is an opportunity to leverage Mexico City’s status as the current “it” city to make it a dominate regional business and investment hub. A hub from where major international investors and developers operate their Latin America portfolios, raise capital, and hire talent. The status quo for foreign investors is to establish offices in each of the regional hubs where investments are made which often include the cities of Santiago, Sao Paolo, Bogota, Buenos Aires, and of course, Mexico City.
Mexico doesn’t rank well on the World Bank’s ease of doing business index. Foreign taxes and obscure regulations are an issue in Mexico, and in the rest of Latin America. Established local players often avoid many of the unfavorable taxation and regulatory schemes through official and unofficial loopholes. Large international investors rarely qualify for official loopholes and will be uninterested in pursuing the unofficial. Mexico should first create a regulatory and tax environment which makes foreign investors as comfortable operating important aspects of their company in Mexico as they would in their home market. If that isn’t in place, why would any company ever open anything much more than a sales or back office operation in the country?
Integration between the Latin American economies is surprisingly low. Foreign diplomacy from the regional leaders often seems more focused on dealing with the “rich” countries and less with removing trade barriers and fostering inter-LATAM trade and investment flows. This is important to consider, as one reason China excelled was by offering a sort of one-stop-shop and removing as much friction as possible for its foreign customers. Mexico can help regional integration by initiating and negotiating certain treaties in the region aimed at helping to align regulatory frameworks, and encourage the establishment of necessary business relationships between the countries. Unfortunately, the bureaucrats in Washington DC don’t appear up to this challenge and are more interested in allocating developmental aid capital and pushing social engineering in the region than in engaging in hard diplomacy to unify all behind a shared economic vision.
American Real Estate Investor Experiences in Latin America
There are few American real estate investors and developers who have operated in a meaningful way in Latin America. A substantial handful entered the region, primarily to invest in Mexico, shortly after the passage of NAFTA in 1994. The trade agreement was a boon to Mexico, and the resulting positive economic improvement in the country was easy to predict. The developers and investors who entered then came into a country on a steep growth curve, possessing few local competitors and plenty of inexpensive land.
Two examples of American investors which have come and gone from Latin America are Kimco and Mexico Retail Properties (“MRP”). Kimco Realty Corp (NYSE:KIM), the largest public owner of community shopping centers in North America, sold the last of its interests in 100+ properties across Latin America by 2014. The stated primary driver of Kimco’s retreat from Latin America was the challenging taxation and regulatory structures it encountered in the region. In 2017, MRP finished its divestiture in Mexico with a sale of 18 properties, valued at around $500 million, to Fibra Uno. MRP was formed by Black Creek Capital of Denver and contained institutional capital including contributions from Sam Zell’s investment company.
Paladin Realty and Hines are two examples of American real estate investors which presently have meaningful offices in Latin America. In both cases, most decisions appear to be made, or strongly guided, from the American head office. Paladin Realty has invested in over $5 billion of real estate projects in seven countries across Latin America. Hines has over 30 million ft² (i.e., 2.8 million m²) of real estate holdings in Brazil, Panama and Mexico.
Foreign investor returns have been lackluster in the region and investor sentiment is presently low for Latin American real estate. Valuations aren’t attractive, currencies haven’t been stable, and the leading regional economies (e.g., Mexico, Brazil, Chile and Colombia) have recently embraced left-wing politics. It’s therefore unlikely that more capital flows will be pushed into the region, they will need to be pulled in through easing regulations, taxation and cost of doing business.
Foreign institutional investors have shown a propensity to favor regional themes in Latin America, over country specific. They do this to diversify country risk, and to achieve sufficient scale which is often not present through investing in only one country in the region. This is why integration is so important to reduce inefficiencies associated with cross-border transactions in Latin America.
Actions Mexico May Consider Taking
I believe there is a sizable opportunity to attract major international real estate investors to increase their capital allocation to Latin America, especially if they are able to establish a potent regional office in a city such as Mexico City. An office that isn’t focused just on sales, navigating local regulations, or back office support. An office that is empowered to make pivotal decisions, raise capital locally in the region, and hire mostly locally with a handful of expats mixed in from America and other Latin American countries. But these investors need to have confidence that they will be treated fairly by the Mexican government, over an extended period of time and across administrations, and that by locating a nerve center in Mexico City they will gain additional advantages in the region which otherwise wouldn’t be available.
As a starting point, the Mexican government should find a way to give assurances to investors that if they establish serious offices in the country, that their investment will be protected from government overreach. Until that is established would the country even have the moral authority required to persuade the other economies to join in a shared economic vision? There is also the issue of streamlining the work permit process. For individuals from the head offices, but also to bring in top talent and well-networked and knowledgeable individuals from other regional countries to live in Mexico City and be part of the team.
The withholding tax on Mexican REIT distributions for American citizens should be eliminated. By applying the same tax regime of holders of Mexican REITs to all, regardless of citizenship, will encourage greater unification between American real estate investors and Mexican real estate projects and companies. The Mexican REITs should be listed on American exchanges as ADRs to make trading in the shares as frictionless as possible. There are admittedly significant hurdles to overcome to make this happen including the technical challenge of poor liquidity (i.e., low free floats) associated with buying and selling shares of most Mexican REITs.
Mexico City should aim to become to Latin American real estate what Toronto is to global mining. 43% of all mining companies globally are listed on the Toronto stock exchange. This is so because the city has a favorable regulatory environment, fair tax regime, and plenty of mining capital available and was responsible for 48% of all global mining financing in the past five years. The American REIT industry is enormous and the solution is unlikely to come from the Americans who have their hands full with their own REIT market. Mexico might look at extending real estate covered under the REIT regulatory framework to also include properties purchased in other Latin American countries. It could push for favorable tax advantages for qualifying cross-border real estate transactions between nations. A country in the midst of negotiating similar trade treaties with its regional partners is Kenya in Africa. Kenya is doing all it can to attract more international firms to establish their Africa HQs in Nairobi.
