During the past two years, the global economy and many aspects of our lives have been abruptly and dramatically disrupted by the lockdowns and other restrictions imposed to mitigate the effects of the COVID-19 pandemic. Puerto Rico’s economy has also been affected by an economic recession that lasted for over a decade and which prompted the government of Puerto Rico’s public debt crisis and bankruptcy filing. In addition, Hurricanes Irma and María in 2017, as well as the earthquakes in the southern region of the island during the end of 2019 and the beginning of 2020, have affected infrastructure and communities.

However, based on the following, we can now assert that Puerto Rico is on a path of economic recovery:

• effective on 15 March 2022, the bankruptcy court approved the debt restructuring plan for the government of Puerto Rico, formally exiting bankruptcy;
• in 2021, Puerto Rico reported its highest GDP per capita in the last decade;
• the approximately $20 billion in disaster recovery (CDBG-DR) funds granted by the US Congress, in addition to mitigation funds from the Federal Emergency Management Agency for infrastructure and other needs, are now being disbursed and utilised on various projects; and
• thanks to multiple governmental aid and relief packages and the scientific developments that led to the availability of vaccines and treatments for COVID-19, the pandemic appears to have been tamed.

Furthermore, Puerto Rico recently adopted Act Number 60 of 1 July 2019, as amended, known as the Puerto Rico Incentives Code (“Act 60”), which consolidated and amended tax incentives under multiple laws, providing a comprehensive framework for the grant and administration of tax incentives and benefits applicable to, among others: the export of goods and services; tourism activities; renewable energy and infrastructure projects; industrial and manufacturing activities; private equity funds; and the relocation of individual investors. Also, pursuant to the adoption of the Tax Cuts and Jobs Act of 2017, the US federal government designated geographical areas comprising approximately 98% of Puerto Rico as eligible for the tax benefits provided under the Opportunity Zones Program. Benefits available thereunder may be supplemented by the local tax incentives under Act 60 for investments in qualified Opportunity Zones.

Due to its tropical weather, the availability of highly competitive tax incentives, the flexibility in working conditions that the pandemic has brought and its status as an unincorporated territory of the USA, Puerto Rico has become an attractive relocation and tourism destination for individuals and companies from the USA.

One of the most important lessons that we learned from the events described above ‒ and, in particular, from the COVID-19 pandemic ‒ is that real estate is, in general, resilient, can withstand uncertain and tumultuous times, and can be transformed and adjusted in response to emerging trends. In the following sections, we will focus on analysing the trends that have emerged as a result of the foregoing events and their effect on Puerto Rico’s real estate market.

Office

Many have questioned the comeback of the commercial office sector after the COVID-19 pandemic. As we were forced to change the way we worked and lived during the pandemic, the expectations of many shifted to emphasise a rewarding work/life balance, flexibility and convenience. As a result, many employers are facing the need to implement hybrid work environments that allow some degree of remote work and to physically alter their office spaces to attract employees back.

Therefore, employers are reconsidering how much space is needed for their offices, as well as design, health and safety concerns pertaining thereto. This is expected to create a demand for newly constructed or recently remodelled buildings that have access to technology ‒ such as touchless entry, mobile connectivity, high-quality HVAC for air circulation and energy-efficient equipment ‒ and that have an appealing design and inviting common areas.

Notwithstanding the foregoing, demand for office space in Puerto Rico has not been as affected as in other jurisdictions. This has been, in part, because of the effects of available tax incentives that typically require having an office and certain number of employees in Puerto Rico as a condition to the granting thereof.

Act 60 provides certain eligible companies that establish operations in Puerto Rico a reduced income tax rate, a 100% exemption from income taxes on dividend distributions and partial exemptions on property and municipal licence taxes. These benefits have attracted many call centres and international financial entities ‒ such as international banks, investment funds and hedge funds ‒ to Puerto Rico. In addition, Act 60 also provides tax incentives for private equity funds and their investors, and for international insurers, segregated assets plans and international insurer holding companies.

In addition, the recent restructuring of the Puerto Rican government’s debt is expected to drive economic growth, increasing the demand for professional services and the need for office space.

Industrial

The COVID-19 pandemic emphasised the need for resilient supply chains, which has heightened demand for industrial and logistics real estate.

The United States Department of Transportation recently granted a waiver to Puerto Rico that enables the transfer of international cargo and passengers. This status, coupled with Puerto Rico’s favoured geographical location (being located between the Americas and Europe), puts the island in a privileged position to serve as a midpoint between the Americas and Europe and establish new routes for travel and commerce; help companies cut expenses and reduce shipping times; and showcase the expertise that its workforce has acquired in logistics and the handling of sensitive materials as a result of the longstanding presence in Puerto Rico of the pharmaceutical and medical devices subsectors.

Furthermore, Puerto Rico benefits from the availability under Act 60 of a reduced income tax rate and partial exemptions on property and municipal licence taxes for industrial and manufacturing activities, as well as from the availability of a skilled workforce at significantly lower wages than the national average in the USA.

The factors described above have recently fuelled the interest of companies in the life sciences, manufacturing and aerospace subsectors to establish, re-establish or expand their operations on the island.

Residential

Remote work was essential during the pandemic for preventing an even-deeper economic recession and it has the potential to become a permanent element of the new working environment, at least in hybrid scenarios. The flexibility to work remotely has enabled or encouraged workers to relocate their homes. This geographic flexibility, coupled with available tax incentives under Act 60 for interest, dividend distributions and certain capital gains for individuals who become bona fide residents of Puerto Rico ‒ and the fact that no visa or passport is required for the relocation of US citizens, since Puerto Rico is a domestic destination for purposes of the USA ‒ has made Puerto Rico more attractive to individuals looking to relocate.

During the last decade, primarily due to deteriorated global and local economic conditions and the excess of available upscale inventory, the residential real estate market in Puerto Rico crashed. For years, residential real estate prices in Puerto Rico dropped significantly, many developers went bankrupt and lenders had to foreclose on projects that had not reached substantial completion. As a result, the construction of new residential projects was practically halted because of lack of demand and the fact that lenders avoided financing the construction of residential projects.

In addition, although a significant portion of the disaster recovery (CDBG-DR) funds allocated to Puerto Rico due to the impact of the 2017 hurricanes has been assigned for housing redevelopment and rebuilding, as well as infrastructure repair ‒ including improving Puerto Rico’s electric power plants and grid ‒ the disbursement of such funds has been very slow. Therefore, the development of these projects is still in the initial stages.

Also, in order to be eligible for the tax incentives available under Act 60, individual investors that relocate to Puerto Rico must, among other requirements, purchase a residential property in Puerto Rico within two years after becoming a Puerto Rico resident.

Furthermore, after having to spend so much time at home during the pandemic, people are now willing to spend more on a comfortable and attractive home.

The factors described above have ignited an unexpected boom in the Puerto Rico residential real estate market. However, since Puerto Rico has a densely populated metropolitan area, sites have become harder to find for the development of the upscale residential units with a wide range of amenities that developers are now focused on delivering. Consequently, there is demand in excess of readily available inventory, which has caused a significant increase in prices.

Hospitality

Although the hospitality industry suffered greatly during the beginning of the pandemic due to the lockdowns and travel restrictions, as vaccines and treatments became available and travel restrictions were lessened, demand for leisure travel surged and Puerto Rico’s hospitality industry has reported record visitor and occupancy rates in the most recent quarters. This has been substantially due to Puerto Rico’s tropical weather, beach accessibility and status as a domestic destination for US travellers, which remained open while other Caribbean islands closed their borders or imposed significant restrictions on visitors from the USA. Another factor that has contributed to the recovery of Puerto Rico’s hospitality industry is the return of cruise ships to our ports.

In addition, for tourism activities, Act 60 provides a reduced income tax rate, a 100% exemption from income taxes on dividend distributions, partial property tax and municipal licence tax exemptions, and tax credits with respect to eligible tourism investments.

The rapid recovery of the Puerto Rico hospitality industry and the surge in domestic leisure travel, coupled with the tax benefits described above, caught the attention of investors and resulted in a heightened interest for the purchase and sale of hotels on the island between 2021 and 2022 at prices that exceed what would have been expected pre-pandemic. In recent months, multiple hotels around the island have been purchased by investors from the USA (in some instances, together with local minority investors) or by local investors, and the acquisitions of others are currently being negotiated. A growing trend of new investments in smaller boutique hotels and conversion of residential units and buildings into short-term rentals (such as Airbnb rentals) has also been the norm.

However, many have anticipated that, as international travel reopens, tourism to Puerto Rico may decline or revert to pre-pandemic levels. It remains to be seen whether the recent conflict between Russia and Ukraine will keep travellers away from Europe and attract them to destinations in the Americas, or what the effects of another COVID-19 variant will be, if any, on the local tourism sector.

Factors to Consider across All Property Types

Cost and availability of labour

Many employers were forced to operate with a reduced workforce during the pandemic due to government-imposed restrictions and lack of demand. As “normal operations” have resumed, the return of employees has been slow due to ongoing safety concerns, the higher unemployment benefits that were provided during the pandemic, childcare difficulties and migrations to other jurisdictions or markets. As a result, available hourly wage workers are scarce across the USA (including Puerto Rico), limiting the capacity of nearly all industry sectors to adequately fulfill the higher demand and requiring increases in wages and upgraded benefits in order to recruit and retain employees. In addition, the recent adoption in Puerto Rico of an increase in the minimum wage payable to construction workers in certain reconstruction projects that benefit from funding provided by the US federal government is likely to require developers of other types of projects to offer competitive wages in order to be able to recruit and retain employees.

Cost and availability of products and materials

The disruption in the supply chain caused by the COVID-19 pandemic has resulted in a shortage of products and materials that has increased the cost of construction projects. In addition, being an island, Puerto Rico imports a significant portion of the products and materials used as part of its economic activities. Thus, the disruption in the supply chain has also caused delivery delays, which usually entail an increase in the cost of doing business.

• Inflation The increase in operating costs caused by labour, product and materials shortages is fuelling the highest inflation that we have seen in many years. 

Cost of funding

In order to deal with rising inflation, the Board of Governors of the Federal Reserve System announced in March 2022 an increase of 25 basis points in interest rates, and it is expected that such interest rates will continue to be increased in subsequent meetings of such board. Thus, the cost of funding future projects could be significantly higher and borrowers under variable interest rate credit facilities should be considering refinancing at fixed rates in the near future.

Cost of insurance

Awareness with regards to the risks associated with climate change and recent natural disasters, such as the passing of Hurricanes Irma and María in 2017, as well as the earthquakes in the southern region of the island during the end of 2019 and the beginning of 2020, have resulted in a significant increase in insurance premiums and the reluctancy of insurers to provide coverage for certain risks in Puerto Rico. This has impacted investor return calculations and has become an important consideration for potential investments in the Puerto Rico real estate market.

Governmental grants, licences, authorisations and permits

Governmental approval in the form of grants, licences, authorisations and permits is required in Puerto Rico for the development of construction projects, the establishment of operations, obtaining tax exemptions and benefits, as well as many other activities. Although the Puerto Rican government has been actively trying to simplify and expedite these processes, there is still significant bureaucracy. Also, due to a high volume of requests, among other factors, obtaining such grants, licences, authorisations and permits could, in some instances, take time and be burdensome.

As discussed above, recent years have been challenging for the Puerto Rican economy and its real estate market. Despite the reduction in cases, hospitalisations and deaths, and the elimination of most lockdowns and other governmental restrictions to stop the spread of the virus, COVID-19 continues to be a risk, as the economy remains vulnerable to changes in consumer behaviour in response to health concerns. However, investors and lenders that had not been able to deploy capital during the pandemic are now eager to place that idle capital and close deals. The restructuring of the government’s debt, the friendly tax environment, the current demand for construction of housing and infrastructure projects, the rapid recovery of the hospitality industry, the resilience of the commercial office sector and the growth expected in industrial and manufacturing activities could allow Puerto Rico to take advantage of the liquidity that is currently available and increase the profitability of its real estate market.