Florida, Arizona, California, North Carolina--The United States has its fair share of pleasant places to live, work and retire. But Americans don't have to limit themselves to the 50 states. More investors are realizing a double dream of vacation home ownership and good returns by taking a look at Mexico. The rapidly developing country to our south is what some experts see as one of the greatest real estate investment opportunities in decades.
Mitch Creekmore, co-author of Cashing In on a Second Home in Mexico and senior vice president of Stewart Information in Houston, says investments in residential real estate in the resort areas of Mexico have seen healthy appreciation. Developments in Cabo San Lucas have appreciated as much as 300 percent in five years, although Creekmore says 100 percent appreciation over six years is much more realistic and common in these resort areas. Bruce D. Greenberg, a real estate consultant and appraiser who has been appraising properties in Mexico for more than 10 years, echoes Creekmore's estimates. Greenberg has compiled his own proprietary database of comparable home values in Mexico and says that over the last five years a conservative average appreciation in value per year in the resort areas is 15 percent, with 10 percent at the low end and 25 percent in the more highly desirable areas.
Creekmore believes the real estate market for Americans in Mexico is on the verge of an explosion as more mortgage financing becomes available and the Baby Boomer generation begins to retire. "Mexico will be the 'Florida' of the Baby Boomer generation," says syndicated real estate columnist and radio show host Tom Kelly--who happens to be Creekmore's co-author of Cashing In on a Second Home in Mexico. "Baby Boomers are looking for a more exotic, adventurous locale to retire," Kelly says. And with approximately $70 billion of wealth coming to the Boomers over the next 10 years, Creekmore believes a good chunk of that will be used to invest in real estate--especially real estate in Mexico.
Part of the reason for the upsurge in American real estate investment in Mexico is that purchasing has become easier for foreign nationals in recent years. However, as Greenberg cautions, "Don't leave your brains at the border." Buyers must be familiar with property ownership laws in Mexico as well as tax laws both in Mexico and the U.S. Greenberg encourages all buyers to assemble a competent team of advisors on both sides of the border who are familiar with Mexican property purchases and tax laws. Financial planner Bill Carter of Carter Financial Management in Dallas, advises his clients to make sure they understand all of the risks of buying real estate in a foreign country. "You have to understand the political risks such as what may happen when the government changes hands," Carter says. He advises clients to know the local market where they are buying, and he recommends they seek out an area with a stable economy.
In 1994, Mexico changed the laws of property ownership for foreign nationals. No longer are Americans restricted to leasing property from the Mexican government for 99 years. They can now own property in the restricted zone of Mexico--any land that is within 50 kilometers of the coast and 100 kilometers from any Mexican border--through a Mexican bank trust called a fideicomiso. The American owner is the primary beneficiary of the trust, which is renewable every 50 years. The buyer has all the rights and privileges of property ownership, such as making improvements or changes to the property, passing it down to heirs and selling it. As a result of the more favorable laws, Greenberg estimates that American real estate holdings in Mexico are now over $30 billion.
In addition to the friendlier ownership rights for foreign nationals, American lending institutions like GE Money (a division of General Electric) and GMAC-RFC (a division of General Motors) among others have begun offering mortgages to Americans buying homes in Mexico. Considering that about 95 percent of purchases by Americans in Mexico have been either all cash purchases or seller financing, according to Creekmore, the recent advent of increased mortgage financing is likely to revolutionize the real estate market in Mexico. Now, he says, a vacation home in Mexico has become affordable to almost any middle class family with a good credit rating and cash for a down payment.
There are, in fact, a few different ways that Americans can finance a vacation home in Mexico. According to Kelly one of the newer and lesser used methods enables a homeowner to access the equity in their home through an annuity-like vehicle called a reverse mortgage. As an example, Kelly points to his 63-year-old brother, a doctor who would eventually like to retire to a small town in Mexico and volunteer his time at a clinic there. He owns his home in the U.S. outright, so Kelly has recommended that he get a reverse mortgage on his home in the States and use the proceeds to buy in the small Mexican town of Manzanillo where a comfortable home can still be bought for around $100,000. He can rent out his Manzanillo house until he retires, and will earn a greater percentage just on appreciation than he would by leaving the equity in his house in the States. So his expenses stay the same, and he doesn't have a house payment in the U.S. or Mexico.
Other buyers who currently have a mortgage on their first home in the States are financing their home purchase in Mexico by accessing the equity built up in their U.S, home either through a cash-out refinance or by taking out a home equity line of credit and using the proceeds to buy a vacation home. With Mexican mortgages starting at around 7.99 percent, buyers who have the option of doing a cash-out refinance may be able to get a better rate than on a mortgage for a home in Mexico.
A third common method for buying in Mexico is seller or builder financing. However, the rates on a seller financed deal are often 10 to 15 percent per year, which likely wipes out any gain the buyer earns on appreciation. Seller financed deals tend to have shorter loan terms, from three to five years. Although these are usually the easiest financing deals to qualify for and complete, many buyers can get into trouble if there should ever be a dispute with the seller. In a seller financed deal, ownership is unlikely to transfer until the loan is paid in full, so if a dispute occurs, the buyer could arrive in Mexico only to find the locks on his house changed--and have little recourse. Although situations like this are rare, they can occur if a buyer is not careful.
Just as the purchase process is different in Mexico, so are many of the tax laws. Taxes play a large role in buying, selling, owning and renting out a home in Mexico. A good understanding of the tax ramifications of your actions is one of the keys to making a home in Mexico a more profitable investment. "You can never get enough good counsel," says Jack Meola, an expert on international taxes in the Bridgewater, N.J., office of accounting firm Amper, Politziner & Mattia. He recommends that buyers get advice from both a U.S.-based expert on international property purchases and an advisor in Mexico who is knowledgeable about property purchases by Americans and tax issues for the local Mexican area.
Meola often counsels his clients--especially those buying retirement homes abroad--to form a foreign business entity to purchase the property. "Using a foreign entity to purchase the property will generally exclude the property from the personal estate and estate taxes should the buyer die. Ownership of property of a corporation in a foreign jurisdiction allows you to exclude that property from your estate if you die," says Meola, who also recommends that buyers discuss with their tax advisor all of their plans regarding their foreign real estate purchase in order to maximize their tax benefits.
One of the most important things to remember is that the IRS Section 1031 exchange--where an individual can defer capital gains on the sale of one property when they buy another property--does not apply when one is selling a U.S. home and buying a home in Mexico. There is an exception to the rule if one sells one foreign-owned property to buy another. For example, if one sells a ski condo in Whistler, British Columbia, Canada, to buy a beach house in Mexico, the 1031 exchange could be advantaged.
American buyers in Mexico need to educate themselves about how capital gains taxes work in Mexico. One of the most common pitfalls occurs when a seller encourages the buyer to agree to a tax cost basis for the home that is lower than the actual selling price. For example, you are buying a condo in Cancun for $350,000 as agreed upon by you and the seller. However the seller may want to report the sales price to the Notario (a lifetime-appointed government official who consummates all real estate transactions) as $300,000, which will reduce the seller's capital gains tax liability. The problem arises when you sell the property in a year for $400,000 and your capital gains will be based on $300,000, which was the price reported to the Notario rather than the $350,000 you paid. The presence of a competent team to assist you with your purchase can prevent "errors" like this.
In their book, Kelly and Creekmore encourage American buyers in Mexico to learn the different ways to use legitimate tax exclusions and deferral options to their benefit. An experienced advisor can help buyers plan to get the most out of their real estate investment in Mexico. For example, one of the ideal investment scenarios Kelly and Creekmore recommend is that a buyer purchase an investment home in Mexico at least 10 to 15 years before their planned retirement and use the home for rental income until then. In a rental, the owner can write off any mortgage interest paid and depreciate the home for tax purposes. Once retirement rolls around, the home will have been depreciated as much as possible and the interest deduction will be minimal. Then the owner can make the Mexico home the primary residence for at least two years and, with a good chunk of appreciation built up, sell the house for a healthy gain. At that point the owner (now the seller) can either use a one-time capital gain exclusion or the 1031 exchange and buy another home.
Another important tax point for Americans is that income earned internationally is taxable in the U.S. However, any taxes paid in Mexico, such as property taxes, are deductible from U.S. taxes. There are property taxes in Mexico, called predial, and compared to property taxes in the U.S. they're a "bargain," say Kelly and Creekmore.
Once investors have become familiar with the tax ramifications and just how buying property in Mexico works, it is time to put together a strategy to make a Mexico home a profitable investment. If your clients plan to personally use a vacation home in Mexico, it is important to decide in what type of environment they would like to own. As Creekmore says, "Mexico has a geography and topography for everyone and every type of interest." Whether it be the calm waters of the Sea of Cortez with their great fishing and sailing or the more cosmopolitan lifestyle of Cabo San Lucas or Cancun, your clients should visit different areas and choose the one that's right for their families. If they plan to use the home for rental income, a location close to recreational activities, restaurants and shopping makes it likely the house will rent out easily.
However, if they have a higher investment risk tolerance and want more house for the money, they might want to try investing in a home in an up-and-coming area. Kelly and Creekmore suggest researching areas where new airports are being built and where major resort companies are building new properties. As Bill Carter says, "With an excellent climate, the ability to buy beach homes at reasonable prices and many recreational opportunities, I believe we'll see much more buying there (in Mexico)." In Mexico the opportunities abound not only to live the good life, but also to create a profitable and enjoyable real estate investment portfolio.
Melissa M. Kellogg is a freelance business writer and marketing consultant specializing in the mortgage, finance and real estate industries. She also publishes two weekly e-newsletters for the mortgage and real estate industries.