To understand Mexico’s emergence in the global economy, one must consider the country’s economic relationship with the United States, which has blossomed over the past three decades. In 1994, the United States, Canada and Mexico enacted the North American Free Trade Agreement (NAFTA). Lawmakers pursued this deal in an effort to reduce trading costs and increase business investment among the three countries, creating an environment in which their products can be more competitive against export-driven nations (e.g., the European Union and China). NAFTA was instrumental in solidifying and growing commercial relations between the United States and Mexico, and the relationship has been further enhanced with the implementation of the USMCA as of July 1, 2020. The USMCA provides improved ground rules surrounding intellectual property protections, free market guarantees, and lower costs for trade between the two countries.
Essentially, NAFTA established an interdependent relationship that currently extends into the economic and social structure of both countries. U.S. investment in Mexico has increased from $17.0 billion in 1994 (or $30.9 billion when adjusted for inflation) to $114.9 billion in 2018. In 2019, Mexico surpassed China as the largest trading partner with the United States. By some estimates, nearly 5 million U.S. jobs depend on the U.S./Mexico trade relationship, with California (566,000 jobs), Texas (382,000 jobs), and Florida (290,300 jobs) having the most exposure. Moreover, Mexican immigrants in the U.S. send, on average, between 10 percent and 12.5 percent of their income to family members in Mexico, totaling $40.6 billion in remittance in 2020 (larger than the annual budget for almost half of U.S. state governments). According to the U.S. State Department, Mexico has become the top tourist destination for U.S. residents with 39.9 million visits in 2019 (up 9.9 percent from the previous year), while about 1.5 million U.S. expatriates live full-time in Mexico.
MATURING DEMAND DRIVERS
Why consider investing in Mexico’s real estate market now? While multilateral trade agreements have been in place for nearly three decades, Mexico’s emergence as a new frontier for real estate is relatively recent. Several key demand drivers have matured to create an attractive environment for investment capital.
Reshoring of manufacturing and shortening of supply chains: Reshoring is a phenomenon in which multinational companies seek to bring manufacturing and/or supplies back to, or near, their home country to increase supply chain reliability alongside the ever-present objectives of efficiency and cost. Labor costs are a major factor in determining where to house production, and Asia’s inexpensive labor has historically been an obstacle to North American reshoring. While Mexico’s labor costs were 58 percent more expensive than China’s wages in 2000, today Mexico’s labor costs are 25.8 percent lower than in China. This reversal, combined with rising geopolitical tensions with China and related tariffs, and supply chain disruptions and shortages caused by the COVID-19 pandemic and other global events, have prompted the U.S. government and many manufacturers and suppliers to shorten their supply chains and bring manufacturing and safety stock closer to home.
Mexico also offers several other competitive advantages over China. Proximity to the United States is especially relevant for heavy machinery and vehicles, as well as critical and strategic materials and supplies, as it reduces transportation costs and shortens supply chains, thereby reducing the potential for disruption. Fewer communication issues from linguistic barriers, in addition to being in the same time zone, makes it easier to resolve issues in a timely manner. Mexico also offers a higher-quality labor force, lower land costs, a more favorable legal system, and faster speed to market (in some cases reducing wait times by several weeks). Additionally, Mexican imports to the U.S. are unlike imports from any other foreign trade partner. Through production sharing, 40 percent of the content in U.S. imports from Mexico originates in the United States. Essentially, 40 cents of every dollar spent on imports from Mexico represents capital sent abroad and then returned to the U.S., compared to only 4 cents returned for each dollar paid on Chinese imports.
As a result, Mexico stands to benefit significantly. Since 2019, reshoring activity accounted for nearly 70 separate lease transactions that represented 7.9 million square feet of gross absorption. Further, reshoring gross absorption grew by 28.1 percent in 2020 versus the year prior countrywide and has continued to accelerate in 2021 in markets such as Monterrey, Tijuana and Queretaro. Tenant interest is diverse across the auto, electronics, pharmaceutical, medical equipment and supplies, and furniture and appliance industries.
Growing demand for high-quality industrial real estate: While mass reshoring will not occur overnight, the trend toward reshoring will have a significant impact on Mexico and the North American region as a whole, creating additional demand for high-quality industrial real estate. Many companies are now recognizing the added cost and risk of disruption associated with long supply chains. They are now taking a much closer look at the “total cost of ownership” in making sourcing decisions, instead of just “piece price.” This may result in a significant portion of what is currently being imported from overseas being profitably reshored closer to home. This effort has the added benefit of increased self-reliance with regard to certain critical and strategic industries and products, including personal protective equipment, defense and pharmaceuticals.
Diversified and stabilizing economic outlook: Mexico’s 2020 GDP was $1.1 trillion, which represents the second-largest country in Latin America and the 15th-largest economy in the world. While 77.9 percent of Mexico’s exports were to the United States in 2019, the country has taken steps to diversify its trade partnerships by establishing agreements with some 45 nations including Japan, Israel and the E.U. Mexico’s trade policy is one of the most open and accommodative among emerging nations; it has consistently been one of the largest emerging market recipients of foreign direct investment. The Mexican government has generally been strategic in funding critical sectors such as oil production, travel/tourism and manufacturing. All of these factors have led to a strengthening economy, as Mexico has averaged nearly 3 percent GDP growth since the global financial crisis ended in 2009 through March 2020, and the 2021 forecast calls for a 5.5 percent increase. A steady economic expansion has created a more stable environment rather than the volatile pattern often associated with emerging markets.
Mexico has continued to reform its monetary and fiscal policies, boasting several positive macroeconomic indicators. The unemployment rate fell to 4.2 percent in June 2021. Inflation had dropped to below 3 percent as recently as mid-2020. Public debt stands at 60.6 percent of GDP, while the public deficit fell to 1.4 percent of GDP in 2020, down from 3 percent in 2015. Mexico has over $183.1 billion in foreign currency reserves, as compared to the roughly $20.0 billion on hand during the country’s currency crisis in 1994 — a sign that Mexico’s fiscal balance sheet is much healthier today. These positive indicators have led to an investment-grade sovereign credit rating from Moody’s in every year since 2001, the longest tenure of any Latin country except Chile, which makes for a more attractive environment for potential investors.
Emerging middle class and favorable demographics: The Mexican economy has taken steps toward transitioning from an emerging market to a developed economy. Generally, economists classify a country as “developed” once its GDP per capita reaches $12,000-$15,000. Mexico is approaching this threshold, posting $8,347 per capita in 2020, more than doubling the amount from 25 years ago. This progress is a result of the country establishing a more diverse economy capable of creating prosperity for its citizens. By 2050, Mexico will likely evolve from the 15th-largest economy in the world to the seventh largest, according to The Economist Intelligence Unit. Mexico’s middle class is the country’s largest and fastest growing segment at 45 percent of households. Further, the middle class will eclipse 19 million people by 2030.
Mexico has a relatively young population, which has begun to create a rapidly growing professional cohort. More than 90,000 engineers graduate from Mexican universities annually, three times the number of U.S. engineering graduates. Free trade has globalized the middle class and created a generation of educated and highly skilled workers, many of whom are fluent in English and therefore are able to contribute immediately in international roles. Furthermore, 66.6 percent of the population is within working age (15 to 65 years), and the median age is 29 years old. To put this into context, the U.S. has relatively strong demographics as well with 65.9 percent of the population within working age, but the U.S. median age is nine years older than that of Mexico. As the second-fastest growing country in Latin America, Mexico will add approximately 19.9 million people by 2030 — a faster growth rate than both the United States and Canada. These favorable demographics should make for a positive economic and real estate outlook.
WHY INDUSTRIAL REAL ESTATE
Given the previously described demand drivers, it is understandable why Mexico is attracting strong investor interest across many of the major property sectors (industrial, retail and office). The industrial sector, however, seems uniquely positioned to serve an existing demand base within the country’s surging manufacturing and reshoring efforts. The sector should also benefit from an emerging middle class that will likely push consumption levels higher, increasing demand for warehouse space from retailers and e-tailers. Additionally, the Mexican government pledged a $25 billion multi-year housing initiative aimed at building 500,000 new homes, and this effort should help support long-term industrial demand. Mexico also has the fastest growing internet-usage rate in the world and, given Amazon’s relatively recent entry into the market in 2015, demand for modern warehouse space should continue to increase.
Industrial property attributes required or desired by tenants also tend to cross borders more easily relative to other property types. For instance, many multinational companies (e.g., Amazon, Walmart, Costco and Home Depot) already have standardized industrial platforms in the United States and those requirements are relatively easy to replicate in Mexico with only minor modifications. Conversely, cultural preferences and idiosyncratic attributes tend to influence the other primary real estate sectors. While the other property types may also offer viable investment opportunities, the industrial sector benefits from a distinct advantage given the established manufacturing industry and existing demand base in Mexico.
Mexico’s industrial sector is unique in that its renaissance dates back to NAFTA’s origination in 1994, but only more recently has the market significantly attracted global investment capital. The current industrial stock as of first quarter 2021 was about 571 million square feet, according to CBRE, roughly equivalent in size to the Dallas/Ft. Worth market. Please note this data likely accounts for only core quality space, as Mexico has plenty of lower-
tier warehouses that are obsolete relative to modern industrial requirements (particularly for ecommerce tenants). Consequently, foreign capital has attempted to fill the need for new high-quality warehouses at a time when absorption rates have outpaced supply.
RISK EXPECTATIONS
Foreign investors should be mindful that Mexico is still an emerging market. Consequently, there are a number of issues to consider that do not typically warrant attention in developed countries. There are three major risks requiring some mitigation when pursuing opportunities in Mexico.
Political uncertainty: Mexico’s relationship with the United States has been its most critical economic advantage over the past two decades and, with the implementation of the USMCA in 2020, the political uncertainty around the future trading relationship between the two countries has been significantly reduced. Although challenges may have a dampening effect on some relocations, the long-standing alliance, geographic proximity, preferential trading rules, bounteous natural resources, and the demand drivers outlined above will unquestionably continue to drive growth in the industrial real estate sector in Mexico.
Currency volatility: The Mexican peso has a history of instability. The most notable collapse occurred in 1994 when the Mexican government devalued the peso by half, sending inflation soaring, and ultimately setting off a severe recession. Since that time, the peso has continued to weaken against the U.S. dollar on a secular basis and, in 2020, the peso marked a historic low relative to the U.S. dollar. The currency will likely continue to experience volatility.
Corruption: Government corruption has been endemic in Mexico. A survey found that 60 percent of entrepreneurs say corruption is a cost of doing business in Mexico. The government has taken steps to reduce corruption, but it has been unable to solve the problem and now ranks below Latin American countries like Colombia, Peru, Brazil, and Cuba on the Index of Corruption Perception. Despite this level of corruption, it is possible to successfully conduct business in Mexico without paying bribes. Investors would be wise to perform extensive due diligence and background checks on potential investment partners and other counterparties.
CONCLUSION
The potential reward for investing in Mexico’s industrial sector will be well worth the effort as the country’s real estate market offers healthy demand drivers and long-term growth potential as Mexico transitions from an emerging market to a developed economy. It not only has a stabilizing and growing partnership with the U.S. but has also taken steps to diversify its economy. Mexico’s demand drivers are maturing and getting stronger, while the institutional real estate market is still in its relatively early stages. These factors support a robust opportunity for foreign capital — particularly within the industrial sector.
The challenge for investors is to mitigate the risks within their control, while understanding that some unwieldy issues will persist as part of the investment environment.
Despite the challenges, the opportunity is real. The U.S. national security imperatives emphasizing proximate production and supply of critical goods and materials will not end anytime soon. Mexico’s geographic proximity, transportation and labor cost benefits, preferential trading rules under the USMCA, and other related supply chain synergies will continue to drive company expansions and relocations, leading to growing investment opportunities within the industrial sector in Mexico.
Authors Lange Allen, David Buck, Mark Fitzgerald, Jay Johnston and Will McIntosh are executives with USAA Real Estate, and this report first appeared on the company’s website and can be read here.