Exchange-rate risk mitigation with price-level-adjusting mortgages: The case of the mexican UDI

Journal of Real Estate Research, The, Jan-Mar 2003 by Lipscomb, Joseph B, Harvey, John T, Hunt, Harold

Three times this rule was modified, investing when the peso was undervalued by at least 3%, then 5%, and finally, 10%. In each case, the average return increased and standard deviation decreased even more. As an example, if mortgages were purchased only when the peso was at least 10% undervalued, the return increased to 17.44% and the standard deviation reduced to 2.30%. The least restrictive rule, to invest whenever the peso is undervalued by any amount, limited investment opportunities to 92 of 146 months, or 63% of the time. The most restrictive rule, to invest only if the peso is undervalue by 10% or more, still allowed the investor to participate in the market in 76 out of 146 months.

The macroeconomic impact of numerous foreign investors following the strategy of buying UDI mortgages when the peso is undervalued should push the peso toward its PPP value. This in turn lowers the exchange rate profits that produce real-dollar returns that exceed real-peso returns. The real-dollar return would be driven closer to the real-peso return while simultaneously reducing the standard deviation. Similarly, a sizeable increase in the amount of foreign capital flowing into Mexico's UDI mortgages should drive down the real rate on UDI mortgages, thus making housing more affordable and mortgage financing more available.

The findings indicate that had they existed prior to 1983, UDI mortgages would have mitigated most of the exchange-rate risk between 1983 and 2000. Although UDI mortgages were not available in 1983, they are now and have been since the government introduced them in 1995. In future transactions the price-level-adjusting feature of UDI mortgages will mitigate much of the exchange-rate risk. However, there is no guarantee that the exchange-rate patterns of the past will repeat themselves. In the past fifteen years, the peso/dollar exchange rate has deviated from its theoretical value, eventually returning to PPP. As long as the relationship between PPP and the peso value continues to hold, dollar investments in UDI mortgages will not suffer significant exchange-rate losses.

Endnotes

1 In the 2000 Census, there were 97.3 million Mexican citizens living in 21.5 million households. The occupancy level is 4.5 persons in Mexico. That can be compared to 2.3 in the United States. The average size of houses in Mexico is 700 square feet, compared to an average of 1900 square feet in the United States. Moreover, of the 21.5 million houses in Mexico, approximately one-half are believed to be substandard due to age or inferior construction. Fewer than half the houses in Mexico are built in the formal market by developers or builders. Over half the housing in Mexico is self-built, meaning no developers or building companies were involved. The land on which self-built houses are built may or may not be owned by or titled to the persons building the house and not all, if any, utilities are available. Most of these units are not eligible for mortgage financing. The housing consulting firm, Softec, estimates that the potential market for housing will average approximately 1.6 million new units per year until 2010, but the actual production is likely to be 800,000 units, half built in the formal market and half self-built. The source of this information is Mexican Housing Overview 2002, published by Softec, S.C., 2001, Mexico City.