SALE AND PURCHASE OF REAL ESTATE
This discussion is not intended as legal or tax advice, and cannot be relied upon for any purpose without the services of a qualified professional.
PLAYA DEL CARMEN CONDO PROFITS
As a CPA who worked for 30 years in the Washington, DC area, I am frequently asked questions along the lines of:
How much money will I make purchasing a vacation rental on the “Mayan Riviera”?
The quick off the cuff or “cocktail party” answer is 20%. 10% yearly appreciation added to 10% rental income.
The following 2 tables represent an attempt at the two-part analysis. The first is a 3 year scenario of purchase to sale. The second is the hands off, yearly return expected using a highly rated management rental company.
|PROPERTY||YEAR ONE||YEAR TWO||YEAR THREE||AVERAGE|
|PRICE||AT BEGINNING||AT THE||END OF YEAR|
|OF THE YEAR||MIDDLE OF|
|5,000 CLOSING COSTS||$5,000|
|OF 30 %|
|TO SELL QUICKLY|
|EACH YEAR’S||$390,000 x 10%|
|GAIN IN||YEAR ONE||YEAR TWO|
|(300,000 X 10% INFLATION FOR EACH YEAR OWNED)|
|NET PROFIT %||55/390=|
NOTES REGARDING THE ABOVE TABLE:
The property may be sold at any time during the three year term or in years thereafter. The maximum gain would be during year 1, selling your option to purchase the unit. Projects during preconstruction are often half sold to investors before the general public has been made aware of them. Those projects are usually the ones from well respected, trusted builders.
|LIST PRICE||USD 245,000.00|
|HOLIDAY||DEC 20 JAN 3||# OF WEEKS||$ DAILY||$ PER WEEK||% OCCUPIED||WEEKS RENTED||$ TOTAL|
|HIGH||JAN 4 – APRIL 15||2||USD 370.00||USD 2,590.00||100%||2||USD 5,180.00|
|REGULAR||APRIL 16 AUG.15 /NOV 20 – DEC 19||16||USD 260.00||USD 1,820.00||80%||12.8||USD 23,296.00|
|LOW||AUG 16 – NOV 19||21||USD 200.00||USD 1,400.00||55%||11.55||USD 16,170.00|
|59.42% OCCUPANCY RATE||30.9 WEEKS RENTED||13||USD 160.00||USD 1,120.00||35%||4.55||USD 5,096.00|
|GROSS INCOME||USD 49,742.00|
|30% COMMISSION||USD 14,922.60|
|BUILDING MAINTENANCE HOA||USD 2,142.86|
|ANNUAL REAL ESTATE TAXES||USD 245.00|
|ELECTRIC, CABLE, INTERNET||USD 2,700.00|
|PROPERTY FEE MANAGEMENT||USD 2,400.00|
|ANNUAL NET INCOME||USD 27,331.54|
|THE NET INCOME OF 27.331.54 / LIST PRICE 245,000|
|EQUALS A YEARLY RETURN OF 11.16%|
NOTES ON THIS TABLE:
The source of this table is from a large property management company. Adding the 30% commission to the property fee management of $2,400 equates to a 35% total management fee. The net return would of course, be higher with a lower cost management company and if completely managed by the investor, the net return could approach 25% (assuming vacation rental companies assisted with bookings).
PURCHASE AND SALE IN GENERAL
In some areas of Mexico, real estate purchasers automatically receive a 5 business day period in which they may cancel the contract. No reason need be given. From Cancun south through Tulum, this is not the case. Deposits to hold the property are often fully refundable and the deposit period often lasts a full month. Although buyers may hire someone to inspect the property, there is no established home inspector system to protect against their mistakes. The track record of the builder is the buyer’s best assurance. If buying raw land, a soil surveyor can determine its stability and foundation requirements.
Residency is not a requirement for foreigners to purchase real estate in Mexico. Upon its sale, residents and nonresidents are taxed the same if the nonresident is willing to appoint a representative to hold the records in case of an audit. If so, the tax rate is approximately 30% on the profit from the sale. If not, the nonresident’s tax rate is 25% of the gross sales price. Sale of the principal residence is exempt from tax in many cases, so establishing residency prior to the sale may be prudent if faced with substantial gains. Closing costs for the seller on a $300,000 property are approximately $2,000 as the buyer pays the majority of them. The seller generally pays the real estate agent commission if one is used. It is approximately 7% and can be negotiated. No value added tax (sales tax) is paid on residential property. It is, however, on commercial property.
When buying real estate with cash, the purchaser pays closing fees of approximately 7% of the purchase price. This includes a 2% acquisition fee (a tax), notary fees, the public registry recording fee and setting up the bank trust. If financing the purchase, closing fees run approximately 10%.
Financing real estate in Mexico is becoming easier if the house or condominium is already built. It is advisable to use an experienced mortgage broker, rather than directly through a Mexican bank. They have current information regarding which U.S. and Mexican banks are currently the most aggressive. Using a U.S. bank may provide a U.S. citizen a more familiar experience while a Mexican bank may be superior due to proximity. Currently, financing is available for a maximum of 7 years at approximately 4.5%. However, the loan is amortized over 7 years, making the payments quite high. It is useful if one is liquidating their other holdings over a period of several years.
The rational for financing versus paying cash usually includes the phrase “leveraging”.
The argument in favor of financing is:
Say you purchase a $300,000 property for cash and the real estate agent says it should appreciate at 10% per ear. This yields $30,000 appreciation per year. (What agent has ever said “don’t expect any appreciation”?)
If you finance and put down 25%, the gross appreciation before interest expense is still $30,000. Your mortgage of 75% of $300,000 or $225,000 at 5% will cost you $11,250 in interest per year. The $30,000 gross appreciation less interest of $11,250 yields a net appreciation of $18,750.
Finally, for the math lovers like the writer of this article: a net appreciation of 18,750/75,000 investment gives a yield of 25%
So, leveraging your down payment of $75,000 to purchase a $300,000 property appreciating at 10% per year, in theory, gives you a 25% return on your down payment of $75,000. Had you not financed, you would have a return of 10% on $300,000.
An argument can be made for the diversification benefit of leveraging. From that point of view, it is safer to make 4 diversified investments for $75,000 each, rather than 1 for $300,000.
The saying “CASH IS KING” holds true here as in the U.S. Considering the fact that 95% of the purchases are for cash, sellers will give preference to a cash transaction. If your seller is equally amenable to a financed purchase versus cash, and you are certain you are not paying a premium because of financing, the seller may have excess inventory.
Foreign individuals may directly own land in Mexico, except within 31 miles of the seacoast. However, through the use of a trust fund, a fideicomiso, foreigners may own property within this 31 mile strip of land nearest the ocean. A Mexican bank administers the trust and the foreigner pays the yearly real estate taxes to the bank. The trust is for the benefit of the foreigner who has the power to transfer, rent or improve it as they wish. The buyer chooses the bank, and two to consider might be HSBC, the world’s largest bank and a member of Citigroup, Banamex. These trusts are indirectly guaranteed by the Mexican government, so the solvency of the bank is not an issue. A Mexican corporation, even one wholly owned by a foreigner, may purchase real estate directly, without the use of a fideicomiso.
The U.S. and Mexico are members of NAFTA. This ensures that Mexican land purchased by a North American cannot be expropriated except for public purposes (a road, for example). In the rare case that happens, the owner is fairly compensated.
The yearly real estate taxes are called “predial” and are very reasonable compared with the U.S. In a city such as Merida, Mexico, they are approximately ½ % of the purchase price. On the “Mayan Riviera”, they are approximately ¼ %.
Ejido Land (Untitled Agricultural Land)
One result of the Mexican Revolution was the Government taking land from the large haciendas who acquired it illegally. The land is now owned by the Mexican Government and held in trust for the indigenous communities. A 1992 policy now allows the heirs of these original inhabitants to convert Ejido Land to private property through a process called PROCEDE. This process requires between 2 and 5 years.
Professional property developers initiate this process on large parcels of Ejido Land. They may subdivide it, putting in utilities and roads, and selling the building lots. Many of the large resorts were formerly Ejido Land. The legal fees to carry out the PROCEDE process may be substantial and are best handled by an attorney specializing in this area.
It is possible for a smaller investor to undertake this legalization process. Due to fees and time required, it would only be cost effective to purchase at a minimum, say, 4 hectares (approx. 10 acres). Those could be subdivided and after putting in a dirt road, sold to spread the cost. Bringing in electricity if not at the site is not necessarily required, as some home owners prefer to be “off the grid” and use solar. Water is often available by means of a well.
In the U.S., Canada, UK, etc. we are accustomed to the concept of “bundle of rights” regarding the beneficial interests or rights attached to the ownership of real property. It includes the right to possess, sell, lease, encumber, use, enjoy and exclude. Ejido land is thought by some to be the best “deal” in Mexico. Say someone’s family has lived on a piece of property for generations and offers to sell it to a foreigner. When they say they are willing to sell their rights, they mean they are selling their right to use it only.
The term “buyer beware” is as true in Mexico as in the rest of the world. After speaking with a few real estate agents, one often hears of the foreigner who thought they were getting a great deal on a piece of land. Cutting out the services of a Notary and a real estate professional, they come to find they are the third or fourth buyer of the same untitled land. Another horror story is the buyer who realized too late that his property is covered in protected vegetation which cannot be disturbed.
Common sense in this type of real estate transaction is:
- If one is a real estate professional
- Has been successful in their home country locating and developing raw land
- Understands the benefit of surrounding themselves with local experts
Then, one might consider purchasing Ejido Land
If the potential buyer/investor is bitten by Mexican real estate “gold fever”, perhaps a middle of the road approach might allow one to sleep at night. Regarding the professional property developers mentioned above; some welcome investors at any point as they purchase, title and sell building lots. Before the roads are in, and the utilities trenched underground, parcels are generally available at a much lower cost than years later when houses are being started.
Title insurance increases protection for real estate purchases. Both the notary and the title insurance company research the title chain of ownership so there is duplication in what the buyer is paying for. The Mexican public title registry system is another level of legal assurance provided to the buyer. The title insurance policy goes one step further in also safeguarding against unrecorded claims to the property’s title. The company issuing the policy has the obligation to provide legal defense or compensation up to the insured amount.
As with any insurance policy, the buyer weighs the risk versus the premium. If the property purchased is ex-ejido land or if one is concerned with the increase in title fraud and identity theft world-wide, its purchase would be recommended.
Title insurance is paid once at the time of purchase and the cost is approximately 6$ per $1,000 U.S. of the purchase.