I OVERVIEW OF THE MARKET
During 2018, the inability of Mr Kuczynski’s government to reach a minimum political agreement along with an aggressive opposition in the Congress, forced Mr Kuczynski’s resignation. Since the new President Vizcarra took office, his government has been working on avoiding confrontation with Congress to focus on creating policies to seek the normalisation of the economic process.
In 2017, Peru’s economic growth only reached 2.5 per cent – the lowest rate of the past three years – mainly owing to the Odebrecht corruption scandals that paralysed many infrastructure projects and the Niño Costero natural disaster faced by the country.
Although the consequences of these corruption scandals continue to impact on the construction and infrastructure sectors, the increase in the price of metal and the increase in production in the mines in 2017 were the main factors that influenced the growth of mining exports. Also, the construction companies involved in such corruption scandals have been allowed to continue operations with private clients, public sectors and banking sectors, which enables positive growth.2
According to the World Bank, Peru’s estimated growth in 2018 will be 3.5 per cent.3 According to the Peruvian Ministry of Economy,4 a strong impulse from the public and private investment will reactivate the country’s productive activity, specifically with respect to mining.
Furthermore, real estate has maintained its strength, in all segments, including commercial, offices and housing. Recent government measures have been implemented into supporting social programmes such as Techo Propio and Fondo MiVivienda, which promote formal (i.e., legally registered) housing by subsidising its acquisition in the lower-income socio-economic groups. Also, the government has issued regulations to allow for the set-up and operation of real estate investment trusts (REITs), and the first three Peruvian FIRBIS have been launched.
i Real estate – formal sector
Apartment sales in Lima were revived in the second half of 2017, with an estimate of more than 12,000 units being sold. However, such number is still far from the levels reached in 2011 and 2012 during the years of the real estate boom.5
Taking into consideration the Apartment Purchase Intention Indicator of BBVA Research (IICDG), the number of apartments sold would level out in 2018, reaching an estimated close to 11,000 units.6
With respect to prime office market (A and A+), the number of units continued to increase in 2017. Therefore, the vacancy rate continues to increase, placing downward pressure on prices.7
ii Real estate – informal sector
Reducing the housing gap continues to be a major challenge for the Peruvian government. The problem mainly arises from the lack of access to credit among the lower-income socio-economic groups, which is where the demand for housing is highest.
The high prevalence of self-construction has aggravated the problem. Individuals with no access to the credit system often find a solution to their housing problems through self-construction or informal housing, which in most cases does not provide access to adequate habitability conditions or public utilities such as water and drainage systems. According to recent information from the Peruvian Real Estate Developers Association, approximately 18,000 units of formal housing are being built every year, whereas the number of informal buildings is reaching 30,000 a year.8
Semi-formal developers increase this problem. Often companies do not provide appropriate guarantees to ensure the culmination of a real estate project, resulting in serious infringements and frauds. To mitigate this problem, the government has created a central agency to register property developers and provide accurate information to individuals about formal companies in the real estate market. However, based on public information, to date, there are approximately 8,000 informal real estate developers in the country.9
According to public information disclosed by the private pension fund management companies, individuals are willing to use 25 per cent of their pension funds mainly to repay existing mortgage debt but not to acquire new real estate.10 Nonetheless, according to the Peruvian Bank Association, the mortgage portfolio has registered its highest growth rate since October 2015.11
To tackle the housing problem, the government has been running two public housing support programmes aimed at securing financing from the banking system: Techo Propio provides financing to families with lower income (approximately less than US$636 per month)12 to help them acquire, build or fix an existing home; and Fondo Mivivienda, provides loans (between US$19,000 and US$128,000)13 to lower-middle and middle-income families to acquire, build or improve an existing home that can be repaid in five to 20 years. This programme also offers access to the Good Payer Subsidy (Bono de Buen Pagador), a non-reimbursable economic aid (of a maximum of approximately US$5,470)14 granted to persons who acquire a house through the Fondo Mi Vivienda, which enables them to use it towards their downpayment.
II RECENT MARKET ACTIVITY
i Public real estate investment fund transactions
Traditionally the formal sector has been dominated by joint-stock corporations; however, since the mid-2000s, public and private real estate investment funds have begun their incursion into the real estate market.
Also, since 2015, new legislation on two types of real estate investment trust (REIT), has been introduced in the market to promote real estate investments. We refer to the real estate rent investment fund (FIRBI) and the real estate rent securitisation trust (FIBRA), both of which have been widely influenced by the Mexican FIBRA model.
In March 2015, Credicorp Capital Fondos announced the launch of its real estate investment fund with an engaged equity of 366 million Peruvian soles and a lifetime of 10 years, five of which will be the investment period. The fund was not intended solely for land banking and to prioritise rents, but instead to focus on the development of the real estate investments.15
In June 2016, the first IPO for a public REIT (in this case through a FIRBI) was launched by Sura Asset Management. Over 50,000 retail investors invested in the fund, with a minimum entrance ticket of US$50,000 (later modified to US$25,000).
With its first issuance, the fund acquired an office located in the A-list business centre of San Isidro (the Real 8 building).16 Although it is a public fund, the participations are freely negotiated through a private mechanism. By September 2017, SURA’s fund announced a capital increase that will lead the fund to manage a portfolio of between US$36 million and US$70 million.17
In February 2017, Graña y Montero sold to Urbi Propiedades its 50 per cent participation in the development of the Cuartel San Martín project, an ambitious real estate project that the company owned through its subsidiary Viva GyM. The project, which is located in the upscale district of San Isidro, will be developed on a land of more than 68,000 square metres (a former military base) and is expected to have a five-star hotel, four residential towers, and a shopping centre, among other amenities.
In the first half of 2018, three FIRBIs were registered before the Peruvian securities market regulator (SMV), (1) F Rentas Inmobiliarias, under the managing of ER Capital, a company part of the Grupo LarrainVial, with a US$200 million authorised capital,18 (2) Metroport, managed by W Capital SAFI SA and advised by Hunter Capital SAC, with a 600 million sol of authorised capital,19 and (3) AC Capitales Renta structured and managed by AC Capitales SAFI with US$50 million authorised capital.20
ii M&A and other transactions
A successful example of an M&A transaction in investment funds was the sale in 2016 of the Fibra office building, one of the main assets of the Larraín Vial-Colliers Real Estate Investment Fund, which is managed by Larraín Vial SAFI and operated by Fibra Activos Inmobiliarios. The asset – a prime building with excellent location and oriented towards A-list clients – was sold for US$35 million to a German investment fund that has had an active presence in the Latin American market for a few years.
This transaction was one of a kind, as it was the first time a buyer with international standards acquired a participation in the Peruvian real estate market.
Furthermore, another example of a successful M&A transaction was closed in August 2017, by the San Miguel Group, acquiring Agrícola Hoja Redonda, a company previously owned by Grupo Breca for US$64 million. This transaction involved the acquisition of 1,708 hectares of land.21
Moreover, in the retail sector, in January of 2018, Centenario acquired two subsidiaries and other real estate assets from Parque El Golf S.A.C., a subsidiary of Parque Arauco, currently the third largest shopping mall company in Chile, for US$78 million.22
III REAL ESTATE COMPANIES AND FIRMS
i Traditional real estate companies
The main real estate investments and activities are developed by traditional corporations. Peru does not have specific regulation for corporations dedicated to the real estate market.
The Peruvian Corporations Law contemplates three types of joint-stock corporation: a general type of joint-stock corporation, the limited company (SA) and two other special types of joint-stock corporations, the SAC, which is a closed joint-stock corporation, and the SAA, which is a public joint-stock corporation.
In addition to the above-mentioned forms of joint-stock corporations, the Peruvian Corporations Law also regulates other forms of companies and partnerships, including the limited liability partnership, which is very similar to the SAC and is also often used.
All the above corporations and companies confer limited liability on their shareholders, who will only be liable up to the amount of their capital contributions. Also, all the above forms of corporations and companies receive the same tax treatment.
ii Public and private real estate investment funds
The Peruvian market has evolved in recent years because of the sustained increase in the number of public and private real estate investment funds (the investment funds). The investment funds are independent asset pools comprising contributions made by individuals and legal entities for investments in the acquisition and development of projects that generate financial returns through the sale or rent of real estate units.
Typically, most of these investments were focused on the residential sector (housing); however, the demand for commercial premises has been growing faster over the past years because of the opening of shopping malls, strip malls and office buildings, as well as the launching of industrial centres.
The investment funds are managed – on behalf of and at the risk of the fund’s members – by private equity companies known as investment fund management companies (SAFIs), whose sole purpose is to manage one or more investment funds.
In addition, the investment funds are monitored by an oversight committee, which oversees the SAFI’s compliance with the law, membership regulations and placement terms, ensuring that the information provided to the fund’s members is accurate and timely, supervising the implementation of changes required following any objections made by the external auditors, and that the general shareholders’ meeting is duly held to report on the management of the fund or when necessary.
Furthermore, SAFIs are monitored by an investment committee, the main duties of which are, among other things, to follow up on the fund’s assets, determining their value and the method to be used for evaluating them, and identifying and analysing different investment opportunities (taking into consideration the fund’s policies and guidelines), as well as making investment decisions for the fund when required.
iii Peruvian REITs – FIBRA and FIRBI
The origin of the FIRBI and the FIBRA lies with the US REIT. REITs are trusts that invest mainly in real estate assets, such as industrial buildings, commercial offices, hotels and residential property, among others. What makes REITs attractive, besides providing a periodic income, is that they must distribute most of their net income among their participants.
In recent years, the government issued new legislation to facilitate the implementation of FIRBIs and FIBRAs. As REITs, FIRBIs and FIBRAs are investment vehicles whose purpose is the acquisition or construction of real estate property that is intended for lease. The requirements of both investment vehicles are similar: (1) their participation must be placed through a public primary offering with at least 10 unrelated investors; (2) the fund must invest at least 70 per cent of its assets in the acquisition and construction of properties for lease; (3) the investments must have a projected life of no less than four years; and (4) the fund must distribute at least 95 per cent of its profits to its security holders every year.
FIRBIs and FIBRAs have several similarities in the way they operate. Both investment vehicles may start with a monetary or real estate asset contribution from a founding investor, they are incorporated with a business plan, materialised through an investment regulation or trust agreement – as applicable – to issue participations, the participations can be acquired by individuals wishing to become investors and may be traded on the secondary market of a centralised mechanism.
The main difference between FIRBIs and FIBRAs is the entity in charge of the trust’s management. FIBRAs, as securitisation trusts, are managed by a securitisation entity, and FIRBIs are managed by a SAFI. In terms of costs, FIRBIs may be less expensive than FIBRAs basically because of the costs related to the participation of a securitisation entity in FIBRAs. Regarding conflicts of interest in FIRBIs, the members of the investment committee and those related to the SAFI cannot enter into agreements with the fund with respect to the fund’s assets; likewise the fund cannot invest in assets related to the SAFI or the members of the investment committee without the authorisation of the general assembly.
The government is promoting the use of these vehicles to investors by granting tax benefits to FIRBIs and FIBRAs. The main benefits include a reduced income tax rate of 5 per cent for the distributions derived from leasing the real estate property to investors who are individuals, the deferral of income tax payments resulting from contributions to FIRBIs or FIBRAs, the deferral of real estate transfer tax payments in the case of FIRBIs (contributions to FIBRAs are not subject to this tax), and the exemption granted to capital gains obtained from the transfer of participation certificates in FIRBIs and FIBRAs negotiated through the BVL as long as the certificates have a certain stock market liquidity.
i Real estate acquisition agreements
The most common type of transaction for the acquisition of real estate properties in Peru is the asset sale and purchase contract, whether related to an existing property or a future asset.
The main reason for the buyer to proceed with the direct acquisition of a real estate property is to avoid assuming the liabilities of the existing legal entity holding the property. Prior to executing a sale and purchase contract, a complete legal and technical due diligence review of the property is highly recommended.
The legal due diligence review will be focused on the property title (to confirm the areas and boundaries of the property, verify the ownership status and the existence of any mortgages, liens or encumbrances; the registration of any limitation for the sale of the property, and the registered constructions), the zoning and urban parameters, the existence of outstanding payments for property and municipal taxes, and any existing licences or permits, among other relevant matters.
On the other hand, the technical due diligence review will seek to verify the areas of the property, the structural shell and the quality of the soil, as well as the functionality of technical installations (water supply, drainage, power and electricity systems, air conditioning, elevators, exterior lighting, heating systems and others). Also, a physical review of boundaries and environmental conditions may be useful in many cases.
It is also common to execute a future asset sale contract when the real estate property is still in the project or construction phase. These contracts are definitive agreements conditional on the effective existence of the property (usually when the property is registered as an independent unit in the real estate public register).
A share purchase agreement is less common, as it is used when the seller wishes to sell its entire real estate business, and the buyer is interested in acquiring an ongoing enterprise. One of the main reasons for the buyer to acquire the business is to get a fixed rental income arising from contracts executed by the target company (lease contracts or any other type of onerous contract that grants use rights over the property to third parties) and avoid paying the real estate transfer tax. Spin-offs and mergers are also sometimes used to trade real estate.
In this case, the scope of the due diligence review of the target company will involve several matters focusing on identifying the liabilities arising from labour, tax, and contractual matters, as well as judicial proceedings. In addition, the buyer will need to obtain detailed information from the seller with respect to its assets, finances and business operations.
Since the information collected during the due diligence process will be confidential, it is standard to execute a confidentiality or non-disclosure agreement before obtaining access to this information. It is also standard in this type of transaction for a letter of intent to be signed, agreeing on the main terms of the transaction and specifying that the execution of the transaction is subject to the satisfactory results of the due diligence process.
ii Financing considerations
There are no special regulatory considerations regarding the financing of real estate acquisitions in Peru. Real estate operations are typically financed by a combination of equity and debt. The most common types of structure used to secure lending obligations are mortgages, share pledges and warranty trusts.
Under Peruvian legislation, a mortgage works as a lien over a specific real estate property.To be enforceable against third parties, it must be formalised through a public deed and has to be registered in the real estate public register.
On the other hand, share pledge agreements allow companies to use their shares as collateral to avail themselves of a loan. Pursuant to Peruvian legislation, for the agreement to be effective against third parties it must be formalised through a public deed, registered in the public Movable Property Contracts Register and also in the company’s share ledger.
Finally, warranty trusts have been used more frequently over the past few years as security for financings. Warranty trusts can be used in relation to either real estate property or movable goods, and they also have to be formalised through a public deed. If the trust is created over real estate property, it must be registered in the real estate public register, and in the case of moveable goods, the registration has to be made with the Movable Property Contracts Register.
With the real estate market being boosted by the entry of investment funds, it is expected that the public market will be targeted as a source of funds for the financing of real estate acquisitions or projects. However, the traditional mechanisms of financing remain those mentioned above.
iii Tax regime on real estate transactions
Buying real estate
The acquisition of real estate property is subject to real estate transfer tax at a rate of 3 per cent of the transfer value of the property. An amount of 10 UIT may be deducted from the transfer value to determine the tax base. The UIT is a unit of monetary measurement, updated every year by the government to handle payments to be made to the government, such as taxes and fines. The UIT for 2018 is 4,150 Peruvian soles. It should be noted that the taxpayer of the real estate transfer tax would be exclusively the purchaser of the property.
In the case of the first sale of a new real estate property by the constructor (a real estate company), real estate transfer tax would only apply to the value of the land. In addition, the transaction will be subject to value added tax (VAT) at a rate of 18 per cent, applicable to 50 per cent of the transfer value (i.e., an effective rate of 9 per cent).
Selling real estate
In general terms, the transfer of real estate property located in Peruvian territory is subject to income tax. Income tax has to be paid on capital gains derived from any transfer (e.g., sale or capital contribution in kind) of real estate property qualifying as taxable income. The capital gains are determined as the difference between the transfer price (which must meet market value standards) and the tax base the seller has in the corresponding property. The tax rate applicable to the capital gain depends on the seller’s status. Currently, the following rates may apply.
Peruvian domiciled and non-domiciled individuals will have to pay 5 per cent tax on the gross income. However, non-domiciled individuals may request to be taxed only on the difference between the initial purchase price and the selling price through an administrative procedure before the tax authority, known as ‘reimbursement of invested capital’.
Peruvian domiciled entities will have to pay 29.5 per cent tax on their net income, and non-Peruvian entities will be subject to 30 per cent tax on the gross income.
As to transfers of real estate property through corporate reorganisations (e.g., mergers, spin-offs, simple reorganisations), it is important to highlight that the income tax and VAT regulations establish special tax regimes, so assets can be transferred without generating tax effects. Nevertheless, the acquisition of real estate property between Peruvian entities through a corporate reorganisation would still be subject to real estate transfer tax, as previously explained.
Renting real estate
Peruvian domiciled and non-domiciled individuals who obtain an income from the lease of a real estate property must pay 5 per cent on the rental income.
Peruvian domiciled entities that lease a real estate property in Peru will have to pay 29.5 per cent tax on the rental income after applying the tax deductions permitted by the applicable laws, and non-Peruvian entities that lease a real estate property in Peru will be subject to 30 per cent tax on rental income.
Holding real estate
Real estate property owners are subject to property tax and to municipal taxes, the rates for which are calculated based on the value of the property and the area where the property is located.
FIRBI and FIBRA tax regime
The contribution of real estate property to FIBRAs and FIRBIs is subject to a special income tax regime, which defers the moment when the transfer is generated (and consequently defers the capital gains taxation) until whichever occurs first of (1) the person who contributed the real estate property transfers the FIBRA or FIRBI certificates related to the contribution; or (2) the FIBRA or FIRBI sells the real estate property.
In the case of the FIRBI, the real estate transfer tax liability would also be deferred until the above-mentioned situations occur.
In addition, the special tax regime for FIBRAs and FIRBIs establishes a reduced income tax rate of 5 per cent (compared with 29.5 per cent or 30 per cent) applicable to the income generated by these vehicles when it is attributed to individuals.
iv Hostile transactions
No public hostile transactions have occurred recently regarding real estate companies or investment funds in Peru.
v Cross-border complications and solutions
The legal framework governing foreign investments in Peru is established on a national basis. Foreign investments are allowed, without restrictions or prior authorisations being required for most economic activities. However, foreigners may not acquire mines, land, woods, water, fuels or energy sources within 50 kilometres of the borders, except in cases of public necessity, expressly declared by a supreme decree and approved by the cabinet.
V CORPORATE REAL ESTATE
In recent years, there has been a trend for Peruvian companies to separate their real estate business into operating companies and property companies, generally as a result of a risk-diversification decision. However, the traditional real estate market model is still a single company combining operation of the business and ownership of the real estate property.
We expect that, with the incursion of FIBRAs and FIRBIs into the market, the number of cases where a company decides to separate the real estate property from the management of the business, to contribute it to a REIT, will increase.
A slow recovery of the real estate sector is expected for 2018. The recovery may occur first in the housing segment particularly boosted by the Good Payer Subsidy from the Fondo Mi Vivienda. The recovery in the office market may take more time and will probably materialise in 2019; however, this creates interesting growth opportunities for small offices and co-working spaces.23 The new FIBRA segment is expected to grow substantially during 2018 and the following years.
1 Alfredo Chan Arellano is a partner, Alexandra Pázzara is a senior associate and Erick Lau is an associate at Payet, Rey, Cauvi & Pérez Abogados.
4 Source Thomson Reuters: https://lta.reuters.com/article/businessNews/idLTAKBN1HX2IZ-OUSLB.
12 Source Mi Vivienda: https://www.mivivienda.com.pe/portalweb/usuario-busca-viviendas/pagina.aspx?idpage=30.
13 Source Mi Vivienda: https://www.mivivienda.com.pe/PortalWEB/usuario-busca-viviendas/pagina.aspx?idpage=20.
14 Source Mi Vivienda: https://www.mivivienda.com.pe/PORTALWEB/usuario-busca-viviendas/pagina.aspx?idpage=22.
18 Source www.smv.gob,pe/Frm ReglarnentoParticlpaclon?data=E67292D74CD0207DFFD0FBF022.
19 Source www.smv.gob.pe/Frm ReglamentoParticipacion?data=E67292D74CD0207DFFD0FBF022.
23 Source Semana Económica: http://semanaeconomica.com/article/sectores-y-empresas/inmobiliario/