Government, Ecosystem Support Adding To Attractiveness Of Zones

There are few terms as enticing to business executives as “tax-free,” and that certainly includes CRE professionals. That explains why they’re such a big part of the draw seen today by Free Zones, and/or Special Economic Zones (SEZs). SIORs from across the globe agree that demand continues to be strong for areas where investors can operate for many years without having to bear the full burden of traditional taxation. In Poland, for example, the areas with less existing investments give up to 40% in tax benefits, and more established regions about 15%, according to John Palmer, SIOR, partner associate/real estate with Deloitte in Warsaw.

Observers agree tax benefits are among the several advantages offered by these zones. Attractive incentives for tenants/occupiers, they assert, include:

1. Tax exemptions or reductions (e.g., corporate tax, customs duties, value-added tax (VAT).
2. Simplified regulatory and administrative processes
3. High demand from export-oriented businesses
4. Government-backed infrastructure development
5. Capital appreciation potential
6. Long-term lease opportunities

On the downside, they note that these zones present the following challenges:

1. Policy and regulatory risks (i.e., since they are policy-driven they may change with political or economic shifts.)
2. Dependence on external demand
3. Geopolitical and trade risks
4. Zoning and usage restrictions
5. Over-supply risk
6. Exit barriers and resale challenges

To date, however, investors in Palmer’s region seem undeterred by any of these potential risks. “A few years ago, all of Poland became an economic zone,” he asserts. “A lot [of the zones] are full; it has worked fantastically. In the best ones, almost all the land is taken.”

In Central America, for U.S. investors there is the added attraction of nearshoring – where supply chain operations can be moved geographically closer to their main market -- which can result in reduced costs and increased flexibility.

Which is not to say you must be a manufacturing giant to successfully invest in Costa Rica. “The minimum requirement is very low -- $150,000,” says Cortes. “But there are different tiers. With a ‘mega’ project, $10 million or more, you have three years to do so.” In addition to a longer exception period, he adds, you get certain benefits when you’re within a greater metro area than outside.

And what of the other Central American countries? They are less expensive (Labor is only 30%-40% less expensive in Costa Rica than in the U.S., Cortes notes), and their products in places like Honduras and El Salvador tent tend more towards “low-grade” manufacturing. Cortes says the red tape “is a little tougher” in the Dominican Republic, while Guatemala, like Costa Rica, has a free trade zone law and zones of public economic development.

Back in Europe, Poland appears to have been an outlier on some level; its government has been a bit at odds with the EU in terms of their approach to free trade zones. Interestingly, notes Palmer, “In this downturn cycle the EU is reconsidering because they’ve lost so much investment.”

Meanwhile, he continues, his clients “Have done superbly. The real benefit of the zones, apart from tax relief, is that they get sites ready to develop on – which could otherwise take many years to do – and they are served by infrastructure and utility connections. ”

The local authority will do all it can to bring in great services, he adds, and “Value-wise, it’s great, as you are often in a cluster of associated users in an established area.”

They Other Side of The Coin

Of course, some of the “Cons” identified at the top of this article can be impactful in the strongest of markets. For instance, says Palmer, some companies do not appreciate being under a more continual audit of their financials. “Some companies do not want that extra layer of bureaucracy,” he explains. Another layer of officiation, he adds, includes profit thresholds.

“If it’s your investment and you buy, build, and want to sell it, you have to adhere to the rules of the zone,” he continues. “First of all, the government has a pre-emption right to buy it before the marketplace does, although it’s not usually exercised. Second, you can’t just go in, take all the benefits and leave after 5 years. If you do, you lose the benefits and must pay back the tax benefits.”

In addition, he shares “A lot of investments are held back” because of the huge boom in new companies having to be ESG (Environment, Social, and Government) compliant. However, he adds, “When the buttons are pushed the new facilities are more energy efficient and provide better conditions for workers.” This is important, he explains, because “Workers are quite selective."

Even in Costa Rica, notes Cortes, there are limitations. For example, you cannot have perpetual exemptions. Even though you can “reset the clock,” you must show significant “reinvestment.”

Also, he adds, there are the practical realities of the cultural, timing, and language nuances brokers must navigate to ensure successful cross-border deals. Finally, he says, “There’s an absolute possibility to overbuild if the market is weak. Developers here are sophisticated, but not all of them are created equal.” Currently, however, he reports that the market is less than 2% vacant.

As for Murillo, he concedes that there may be some extra paperwork to be done, “But it’s not a big deal.” What’s more, he adds, “The market here is growing exponentially; there’s more than 1.5 million square feet under construction, with demand at around 2 million square feet.”

A Different World

Regardless of how experienced you may be in your local market or your home country, experts in free trade zones caution that you may still have a lot to learn before you dip your toe in their “waters.”

For instance, says Palmer, a number of developers creating a build to suit facility do not have sufficient expertise about the general real estate market. He recommends that you be flexible in your approach to building design.

“So, when you look at a building with an occupier that has been there 10 or 15 years and wants to sell or sublet, it could be designed in a way that is not liquid or flexible,” he observes. “Just looking at the layout and tweaking dimensions and truck bays is not a huge cost, and it can make them much more functional for alternative users and occupiers.”

Cortes points out that there are cultural, timing, and language nuances brokers must navigate to ensure successful cross-border export, although it varies per country. “Many have foreign direct investment agencies that are very sophisticated,” he shares. “But when you go past the first layer of site selection is where you see some challenges – not only from the tenant, but the developer. For example, what is a tenant improvement allowance? In Costa Rica they will understand that perfectly.”

There is also a need to understand the culture and their way of negotiating, he continues. “There are non-written rules,” Cortes explains. “That’s where a broker who understands both parties can have great value. This is part of our value proposition.”

“We recommend you do a business case to understand the country’s macro-economics, the labor ecosystem, utility costs, and cost-benefits,” adds Murillo. “Get a good lawyer to help you throughout the process. Hire a great manager to focus on the construction site. And get someone who does well with real estate, reach out to government authorities, get government support – not only in Costa Rica, but in every country.”

This article was sponsored by the SIOR Foundation - Promoting and sponsoring initiatives that educate, enhance, and expand the commercial real estate community. The SIOR Foundation is a 501(c)(3) not-forprofit organization. All contributions are tax deductible to the extent of the law.

CONTRIBUTING MEMBERS

• Alvaro Cortes, SIOR
• Francisco Gutierrez Murillo, SIOR
• John Palmer, SIOR