The global financial crisis started to show its effects in the middle of 2007 and into 2008 and 2009. This is true more than ever in the real estate industry than in any other one. Around the world, stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems. Some countries emerged from the crisis better and faster than others and a contagious Mexico is trying to breathe.
The real estate industry in Mexico, following struggled to recover in 2009, but with little results, and the path to a full return to health is littered with land mines that could send the sector spiraling downward again, possibly upending the nascent economic revival. This has caused the outlook for the real estate industry in Mexico for the end of 2010 to be uncertain at best. However, there is light at the end of the tunnel. The CKDs, will hopefully help fuel the real estate industry back on track for a slow, but steady recovery in 2011.
Introduction to CKDs
In July 2009, the Mexican National Banking and Securities Commission (CNBV or Comisión Nacional Bancaria y de Valores) published new rules providing for public offerings of investment trust fund certificates called Development Capital Certificates (CKDs or Certificados de Capital de Desarrollo). These rules now permit CKDs to be listed on the Mexican Stock Exchange (BMV or Bolsa Mexicana de Valores). The CKDs are new investment instruments structured as equity funds with the purpose to finance specific projects, such as real estate related projects, and infrastructure, highways, ports, mines, railroads, power generation, and technology among others.
The introduction of CKDs in the Mexican securities market was only possible because the federal government, through the National Commission for the Retirement Savings System (CONSAR or Comisión Nacional del Sistema de Ahorro para el Retiro), proposed a change in the investment regime that applies to SIEFORES (Sociedades de Inversión Especializada en Fondos para el Retiro), the investment arm of the federally regulated Mexican pension funds (AFORES or Administradoras de Fondos para el Retiro). Such change allowed SIEFORES the possibility of investing in a wider range of variable return securities, including CKDs, for the purpose of fostering investment in long-term projects, with special focus on infrastructure projects, including those related to real estate.
These new rules for Mexican pension funds are significant because the total net assets under management in voluntary and compulsory pension systems in Mexico equal an approximate Mex$1.039 billion ($83 billion). Thus, pension funds represent an important potential market for investments in CKDs.
Their main goal is to help reactivate the Mexican economy, by generating investment, employment, and minimising the adverse effects of the global financial crisis in Mexico.
The Internal Regulation of the BMV defines CKDs as investment trust fund certificates which are issued by Mexican trusts for a specific period of time. They have uncertain and variable returns, partially, or totally linked, to the underlying assets which are held in the trust and which compose the trust assets. It is important to note that the issuer of the CKDs has no obligation to repay principal or interest. That is, the instrument is linked to the success of the infrastructure project, in our case the real estate projects, where the money obtained from their placement is invested in. Its returns are derived from the dividends or sale of shares, as underlying trust assets.
In a nutshell, CKDs are hybrid instruments that may include debt and capital. As mentioned, they grant their holders the right to variable income arising from the projects and/or companies where the liquidity stemming from their placement is invested.
In accordance with the Regulation, CKDs may be classified according to the type of investment, in: (i) CKDs Type A, intended for investments in equity securities or in the purchase of goods or rights derived from the cash flow of various companies; and (ii) CKDs B, intended for investments in equity securities or in the purchase of goods or rights derived from the cash flow of one single company.
| Type A investment scheme |
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| Type B investment scheme |
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Structure
As applied to real estate financing, type A may carry out investment schemes in several vehicles (trust and companies) that own underlying real estate properties that may be of a commercial, industrial, residential or combined nature including hospitality. Such CKDs generally require having a manager of the various real estate projects subject matter of investment. Type B may carry out project schemes and adopt investment alternatives among the different type of real estate portfolios that are to be owned by the special purpose vehicle that is used to hold title to such assets.
An irrevocable trust Agreement must be created for the main purpose of: (a) setting the rules to finance the project(s), the company/companies or the structure similar to a private equity fund; and (b) issuing the CKDs to obtain resources from its public offering to later invest it in the vehicles that hold the different real estate portfolios or properties.
The settlor may contribute any kind of real estate assets to the trust (the settlor and the manager may be the same), including a combination of commercial, residential, or industrial real estate related properties.
The trust and the Settlor/Manager execute a services agreement for the management of the trust's assets. The trust will hold the assets/rights contributed by the company or the project seeking financing, and the resources obtained through the public offering of the CKDs.
The trust invests pursuant to the instructions issued by the Manager in multiple special purpose vehicles or projects.
Parties acting as managers include sophisticated real estate funds, such as AMB, PREI, and others, or individuals with experience in the field that have joint ventured with funds or other type of financing entity that is interested in investing and helping to manage real estate portfolios.
- The settlor must adopt the regime of a Sociedad Anónima Promotora de Inversión Bursátil (SAPIB) or Sociedad Anónima Bursátil (SAB).
- The trust issues the CKDs.
- The trust invests all of the funds it collects through the placement into a sole company, which may be the settlor or the company that carries out the real estate project.
- The SAB lists its shares at the BMV. The settlor may be the same SAB subject to the investment.
- The settlor must amend its bylaws to include the administration and surveillance regime of a public/listed corporation (SAB) and prepare a program to adopt the complete regime of a SAB, through an initial public offering within three years.
As defined above, CKDs programs are structured through the establishment of an irrevocable Mexican trust that issues CKDs for their placement in the Mexican stock exchange (BMV). CKDs are targeted to domestic and foreign institutional/qualified investors (for example Mexican pension funds, or Afores, although not restricted only to such, permitting as well foreign investors to participate).
The settlor of the trust, who is usually the manager of the underlying assets, uses placement funds to acquire different investment opportunities, which are usually shares of special purpose entities that own a real estate project or a property, or that will develop a real estate project or acquire a property which the manager is interested in investing in and considers as a good investment opportunity.
Every CKD represents to its holder the right to collect dividends, capital reductions, redemptions of shares representing the capital stock of the special purpose vehicles in which the manager invests in, including the manager itself, and on the sale or disposal of the shares or of other securities issued by the grantor, upon maturity of the CKDs. That is, upon expiration of the program, all real estate investments are liquidated and the CKDs are paid back to their holders, along with an expected return on their investment.
Note should be taken, however, in that CKDs, as equity investments for a pre-determined period, are securities with no nominal value. So there is no obligation on the issuer trustee, the grantor, or the common representative, to pay principal, interest and/or any return/yield under a CKDs program.
This is because source of payment derives from the financial performance of the underlying project/business, which is mainly generated from income earned from sales to third parties relating to the underlying real estate project. Thus, CKDs are not rated by any rating agencies, because risk does not depend on the issuer's payment capacity, but rather on the earnings generated by the underlying assets (the trust assets). Although for a CKD program to be approved, certain due diligence over the investment plan by the party acting as manager needs be carried out and its feasibility blessed by specialised consultants, which currently include the Boston Consulting Group.
The purpose of using the trust as issuer of the CKDs is to ensure that funds obtained from their placement will be invested in the underlying real estate related shares/projects according to the investment regime that each of the CKDs programs needs to include, as well as to ensure that any costs and/or expenses of the placement will be paid out of those funds. In addition, any shares or assets contributed by the grantor of the CKDs program will become part of the trust assets.
CKDs may be guaranteed through a security interest on the trust assets, usually a pledge over the shares of the special purpose vehicles that hold the underlying real estate projects. Grantors must list those shares with the National Securities Registry (Registro Nacional de Valores) as a SAPIB or a SAB so that a pledge on the securities (prenda bursátil) can be granted over the shares. In fact, the Regulation provides for the obligation to register such shares as a requirement for issuing CKDs (that is, the CKDs may be placed only if their underlying assets are shares of an entity which is a SAPIB or a SAB).
The authority vested in the trust's technical committee includes the ability to approve any future real estate projects pursuant to an independent experts' feasibility opinion (committee members representing at least 25% of the committee will be independent members from the project companies and its grantor).
CKDs in existence
To date, there are only seven CKDs programs approved by the CNBV and listed in the BMV. The public offerings amount up to Mex$19.4 billion. The companies with approved CKDs are the following:
- Atlas Discovery México. Its main purpose is to invest in private Mexican companies related to internal consumption in sectors such as retail sales. The placement amount was of up to Mex$3.42 billion.
- ICA/Red de Carreteras de Occidente. This is designed to acquire equity of the capital stock of the grantor which is a special purpose vehicle created to operate, maintain, and exploit concessions of highways (Farac I). The placement amount was of up to Mex$6.55 billion.
- Wamex Capital. This invests in Mexican private medium-sized companies through: (i) the acquisition of equity of their capital stock; (ii) granting of loans; or (iii) acquisition of convertible shares. The placement amount was of up to Mex$6.55 billion.
- Macquire Mexico Infrastructure. Here, the CKD is investing in infrastructure assets in Mexico. The placement amount was of up to Me$3.42 billion.
- Nexxus Capital IV. Its main purpose is to invest in Mexican private companies related with financial services, housing, education, logistic services, health and tourism. The placement amount was of up to Mex$1.46 billion.
- AMB Mexico. This is investing in the acquisition and the development of industrial properties. The placement amount was of up to Mex$3.3 billion.
- Promecap Fondo de Capital de Desarrollo. This CKD is investing in debt and distressed assets. The placement amount was of up to Mex$2.5 billion.
As discussed above, now that the first real estate industry related CKD program was issued and approved, this vehicle has become a realistic hope to fuel back on track the Mexican real estate industry and foster its recovery during 2011 and 2012. The market is expecting that CKDs will bring to it a new scenario of investments and resources since it had been desperately looking to raise funds without real success in different vehicles.
The real estate market is now expecting new issuances of pending CKDs placements, which will happen during the rest of this year. These are basically going to be launched by new real estate funds that will seek to raise up to Mex$13.5 billion (including AMB´s placement amount) through the Mexican Stock Exchange. The market predicts that the coming third quarter will show its capacity of sustaining improvements and growth in this area through the use of the CKDs, as main form of real estate financing in Mexico, injecting the capital that the industry was otherwise desperately trying to obtain with little or no luck at all.
Great expectations
Markets are experiencing a rapid recovery at an international level. Such a situation makes it advisable for Mexico to make adjustments to its laws and its financial system which continue to enable it to adapt to the new needs and demands of the market and enable it to compete in this much expected global recovery, including in the real estate industry.
That is why this type of alternative financing in Mexico has become so relevant in the hopes for the recovery of the real estate industry. It covers a segment of the Mexican financial system which had not been used before and which had been used with success in other international markets. Prior to its appearance, only traded debt securities and, to a lesser extent, the placement of equity, were used as financial instruments alternative to traditional bank credits.
As already mentioned, there is great expectation to the use of the CKDs as an instrument that could detonate the stock capital infrastructure and real estate development in our country. The new challenge developers' face will be related to the professionalisation of its transactions in order to attract capital through the issuance of this type of instruments.
It is important to highlight that missing pieces of this complicated puzzle are yet to be found. One of the risks of CKDs is that they are not qualified. In contrast with debt, the risk does not depend on issuer's payment capacity, but on the earnings generated by the underlying assets or the trust property. This will ultimately depend on their managers talent and expertise in the real estate market, and the professionalism and responsibility of the analysis to be made by the Afores when deciding to invest in one of this programs. This will play a key role in the prevention of systemic risks, such as those that caused the real estate crisis in the US.
| Author biography |
Luis Moreno
Haynes and Boone
Luis Moreno is the managing partner of the Mexico City office of Haynes and Boone. He also leads its real estate practice.
Email: luis.moreno@haynesboone.com
Tel: 011 (52 55) 52 49 18 21
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| Author biography |
Cesar Ramirez
Haynes and Boone
Cesar Ramirez is a senior associate at the Mexico City office of Haynes and Boone and he works in the real estate practice group.
Email: cesar.ramirez@haynesboone.com
Tel: 011 (52 55) 52 49 18 19 |