Costa Rica: Development projects and the global financial crisis

Author: | Published: 1 Sep 2010
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Costa Rica experienced an unprecedented growth in the real estate sector, which started in the beginning of 2002 and culminated at the end of 2007. However, the exponential growth in local construction and development of new real estate projects subsequently revealed certain systematic deficiencies and obstacles. Nevertheless, the crisis has resulted in a better understanding of the workings of the applicable governmental agencies and the related proceedings with which a developer has to work to develop a real estate project in the country.

In this article, we will discuss experiences of developers, lawyers, and engineers in their dealings with governmental agencies when developing a real estate project in Costa Rica, focusing on the web of bureaucratic procedures and paperwork, or so-called tramitologia. Likewise, we will briefly describe the system for conveyance of real property under Costa Rican law, with particular focus on the registration system and tax issues arising out of the development of such projects.

By the beginning of the 1990s, Costa Rica had positioned itself as an attractive ecotourism destination. The country is one of the strongest democracies in the region, a destination of great natural beauty, and is located relatively near the US, where more than 70% of its tourists come from. Moreover, it enjoys one of the highest educational and social standards in the region. These factors, combined with a protective environmental policy, have made Costa Rica an attractive ecotourism destination.

In 2002, Costa Rica started to experience growth in the real estate sector, driven heavily by direct foreign investment in coastal projects. This period of robust growth transformed Costa Rica from a middle class market image to a more exclusive reputation with more expensive properties (such as Four Seasons), competing with their high end peers in Mexico and the Caribbean.

Regulatory and administrative aspects

In Costa Rica real estate projects must comply with current rules concerning forestry resources. The laws related to this issue are: the Forestry Law, the Biodiversity Law, and the Wildlife Management Law. These laws and their corresponding regulations have produced numerous manuals and guides, which are the basis for management of the country’s forestry resources.

In recent years, the environmental aspect in real estate activities has acquired great social, media, and political relevance and scrutiny. This has inspired a series of modifications to the applicable Costa Rican laws and the establishment of environmental viability as a fundamental requirement to be approved by the competent governmental authorities as part of the development process. To this effect, in order to obtain the appropriate construction permits, it is essential to conduct a prior analysis of each project from an environmental perspective.

One of the most important requirements when developing real estate in Costa Rica is confirmation by the appropriate authorities that there is water available in a way and in sufficient quantity to adequately supply the project and its prospective users. This approval is typically expressed by the governmental authorities issuing a letter popularly referred to as a Water Availability Letter. This letter is an essential requirement for the granting of environmental viability by Setena, the Costa Rican environmental agency. Without it, a developer will not advance far in the process of developing one’s project and will not be able to obtain the needed construction permits.

Unfortunately, the process for obtaining the Water Availability Letter has become a cumbersome and very complicated process. It requires, depending on the case and the specific situation of a project, a well-prepared legal strategy and qualified technical advice.

The development of a property in Costa Rica involves a large quantity of authorisations and proceedings, both prior and during such development. These proceedings may be frustrating if the developer does not have the proper support and advice from his professional team. For this reason, a multidisciplinary team, including attorneys, engineers and consultants, who would navigate and guide their clients through the large quantity of proceedings involved in the development of a property, is critical.

The process requires authorisations from at least the following governmental agencies: the local municipality; the Federate Professional Association of Engineers and Architects (Colegio Federado de Ingenieros y Arquitectos) (CFIA); the Costa Rican Institute of Sewerage and Water Supply Systems (AyA); the National Environmental Technical Secretariat (Setena); the Ministry of Health, and the National Institute of Housing and Urban Development (Invu).

Costa Rica is divided administratively into seven provinces. These are, in turn, divided into eighty-three cantons, each managed by a municipality or local government. In the last thirty years, the central government has tried to delegate more administrative and executive duties to the local municipalities, and each of them has sufficient authority to implement regulatory plans to regulate real estate development and construction in their jurisdictions.

In accordance with the above, construction projects must comply with the regulations established by the municipality in its regulatory plan, including meeting the applicable construction requirements. In particular, in order to confirm compliance, the local municipality must approve the construction plans for the real estate project.

The CFIA is the non-governmental administrative entity in charge of the oversight of good practice by architects and engineers. This body must approve the construction plans prepared by architects and engineers for a real estate project.

This is the first step and requirement in obtaining the construction plans for a real estate project. In order to initiate proceedings for approval of these plans, it is then necessary to pay in advance a series of legal tax stamps in favor of the CFIA.

The AyA is the centralised governmental agency responsible for managing sewage and water supply service in the country. It has had these responsibilities for the whole country for more than seventy years. However, the process of decentralisation initiated by the government to delegate more duties to local municipalities has also promoted private initiatives to provide water services.

Setena is the governmental entity in charge of overseeing compliance with the environmental legislation and the environmental requirements for development of real estate projects. Developers for all new construction projects that are subject to compliance with environmental requirements must file an application with Setena for review of their real estate project, seeking to obtain environmental viability.

Before a project is granted environmental viability by Setena, it will be subject to a series of studies including: forestry, hydrological, sociological, viability, impact, and pollution studies. These studies are a fundamental part of the real estate development process, not only because it is impossible to obtain construction permits without this approval, but also because these proceedings may take up to twelve months. This can have an important impact on the development agenda, the ability of the developer to obtain financing, and even its pre-sales ability.

The plans of a real estate project must be approved by the Ministry of Health, specifically by the leading health care unit in the place of development of the project. Through these proceedings, the Ministry of Health verifies that the structural plans of the project comply with the provisions established in the General Law of Health and in the Law of Equal Opportunities for Persons with Disability.

The proceedings before Invu are the final step prior to the submission of the construction plans of a real estate project to be built under the condominium property regime. Invu’s duty is to see that the plans have the approvals described in the foregoing sections and that the construction plans meet the requirements established in the Construction Law, the Urban Development Law, and, when applicable, the Condominium Property Law.

The right to private property is recognised and protected by the Constitution of Costa Rica. Such provision indicates that no person can be deprived of one’s private property unless it is for reasons of public interest. The Constitution also guarantees equal treatment to Costa Rican and foreign citizens with regard to private property and its disposal regime (Articles 19 and 23 of the Political Constitution of the Republic of Costa Rica). In this sense, any individual or legal entity that has acquired a property can freely dispose of it, without limitations other than those established by law.

These are various legal models by which a property can be developed in Costa Rica. In the past, the most commonly used model was the one established under the Urban Development Law. This permitted the partitioning of lots inside the same property, granting to these a new property numbers for their subsequent sale to third parties. Unlike the Urban Development Law, the Condominium Property Law (which replaced the previous Horizontal Property Law) permits the development of real estate projects horizontally and vertically, and not requiring the developer to donate a portion of its land to the local municipality.

The Urban Development Law, which remains in force, was very popular before the enactment of the Condominium Property Law. It permits the creation of the so-called urban developments, whereby a property was divided into new properties, which were in turn served by public streets and parks, on land donated by the developer to the local municipality. This required the municipalities to be responsible for the maintenance and care of the streets and parks created within said urban developments. As an essential requirement, the developer had to donate 10% of its land to be used as a public park inside the urban development.

With the enactment of the Condominium Property Law, (and arguably even before, with the amendment to the Horizontal Property Law), this model had lost its popularity. This was in particular due to the above mentioned requirements, which imposed on the developer an obligation to donate 10% of its land to the local municipality and convert the internal streets of the urban developments to public streets, generating concerns for the safety of the urban development residents.

The developments created were required to comply with the regulatory plans issued by the local municipalities and to have their plans approved by the National Institute of Housing and Urban Development (Invu) and the local municipality.

Under the Urban Development Law, the condominium plans must be duly approved by the local municipality, the AyA, the Ministry of Health, and Invu. Likewise, with respect to condominiums or real estate projects to be developed in a coastal zone, the condominium plans must be approved in preliminary form by the Costa Rican Tourism Institute (ICT by its Spanish abbreviation).

Once the plans have been approved by said entities, and following completion of the initial stage of the proceedings, the condominium plans are delivered to a Notary Public for preparation of the public instrument of organization of the condominium. Based on these plans, this instrument describes the future units to be built in the condominium. Following preparation of the public instrument of organization of the condominium, which must be signed by the owner of the property placed under the condominium property regime, a Notarial Certificate issued and filed with the Journal Section of the Real Estate Registry for registration, together with the condominium plans, shall be filed in the National Cadastral Registry.

Global credit crisis and its impact

The global credit crisis directly affected the Costa Rican real estate boom because most of the foreign investors came from the US. Moreover, many foreign banks (Citibank, HSBC, GE Financial, Scotiabank and so on) entered the Costa Rican market, at least in part to capitalise on the growing real estate sector and the enhanced liquidity they provided contributed to the growth of the real estate sector. However, these same institutions were vulnerable to a deteriorating global lending environment and they responded by curtailing lending in Costa Rica.

All of these factors, coupled with the decline in the purchase of second homes by investors (particularly from the US) contributed to the collapse of the Costa Rican real estate market. Even to date, these consequences are being felt in the market.

Additional factors that greatly hindered the development of real estate projects were the delays and obstacles in obtaining permits and licences from governmental agencies. This factor, combined with the deteriorating credit climate described above, had a devastating effect, particularly on the tourism and hospitality sector. The occurrence of the global credit crisis while many projects were in their initial or middle stages of construction or development, caused many to be suspended and even cancelled. Examples include Rosewood in Guanacaste, St Regis in Herradura, and the Ritz Carlton in Guanacaste.

The lack of institutional credit and the loss of confidence and purchasing power in the market targeted by most real estate projects, and in particular those located in the coastal areas, generated a dramatic decline in demand which, in turn, forced a large majority of the projects to enter into, in the best-case scenario, a hibernation state. In other cases, it led to the closing of the project. This has been the trend and reflection of the Costa Rican real estate market in the last 18 months.

However, in the last two or three months, the local real estate market has started to show signs of recovery. Although most of the transactions being conducted are financed by speculative capital – typically seeking to create opportunities by acquiring property or projects in distress - both developers and purchasers are again now showing some confidence. However, not until there is available institutional credit for the real estate market, will we be able to say that the worst of the Costa Rican real estate crisis is behind us.

A positive effect of the real estate crisis is that it has caused a fundamental change in the way developers and investors conduct their activities and investments in Costa Rica. This experience has enhanced our perspective of the legal system and of the way to navigate through the excessive proceedings entailed in developing real estate in the country.

One of the main errors committed by many foreign investors when they entered the Costa Rican real estate market was their failure to adapt their modus operandi to the local way of doing business. They imported their business models and their commercial and management techniques and tried to impose them on Costa Rican institutions which were not accustomed to them. This conflict of approaches negatively impacted the relationship of foreign developers, financial backers, and local actors. The first lesson that many foreign investors had to learn was to adapt to the local practices and mentality; and also to be flexible enough to modify their business methods and models to obtain the success of the project.

Like many other real estate markets in the world, the Costa Rican market experienced rapid and sudden growth that was perceived by foreign investors as an unbeatable opportunity to make money quickly and at low risk. In retrospect, the experience has demonstrated that real estate prices can move rapidly in either direction.

This volatility, not widely perceived at the time, has been demonstrated and should serve as a lesson for future investors and lenders. In particular, we think the main lessons learned include: (1) foreign investors should do thorough market studies and due diligence before investing, (2) earnest money should be deposited with a reputable escrow agent with clear terms and conditions, (3) a through understanding of the legal framework and processes should be obtained at the outset, and (4) a realistic time horizon needs to be used for the investors’ exit strategy.

Likewise, the experience gained in the development of real estate projects in Costa Rica during these last five years has permitted the identification of areas that require more attention in connection with proceedings, thus creating the opportunity to improve such areas and strengthen the investment climate of the country.

Due to contemplated changes in the current legislation and government initiatives currently being promoted by the private sector, the Costa Rican business sector is working to ensure that real estate development in the country remains an important area.


Author biography

Alejandro Antillón
Pacheco Coto

Alejandro Antillón is the managing partner of Pacheco Coto and heads the real estate and hospitality division in the firm.

His expertise in the area of corporate tax and estate planning is an added value to his real estate and hospitality practice, where he has handled complex and innovative real estate ventures in conjunction with comprehensive tax structures.

In 2004, Antillón accepted the appointment as general manager of Stewart Title Costa Rica, a prominent international title insurance company with extensive business in Central America. His experience within that organisation, coupled with his spearheading the legal practice at Pacheco Coto, vastly enhanced his understanding of the Costa Rican and Central American real estate markets.

Antillón is listed by Chambers Global and Chambers Latin America as “Leader in the Field,” Real Estate and Hospitality Law category (2006 to 2011). He is also listed in Marquis Who’s Who Legal – Real Estate (2009 and 2010). He has authored several articles and publications in connection with Real Estate and Hospitality.

 


Author biography

Larry B Pascal
Haynes and Boone (Dallas)

Larry B Pascal, the chairman of the Americas Practice Group at Haynes and Boone (Dallas), has extensive experience advising multinational companies with their investments throughout Latin America and the Caribbean. He has been particularly active advising clients with their real estate investments in Costa Rica and elsewhere in the region. Mr. Pascal is recognised in both Chambers Latin America 2010 and Latin Lawyer 250 for his work in Latin America. He is currently serving as the chair of a Texas Supreme Court task force investigating the merits of liberalising international practice rules in the state.