NEARSHORING & MEXICAN INDUSTRIAL REAL ESTATE

Nearshoring & Mexican Industrial Real Estate

Shifting international supply chains have been a major investment topic in recent years. Supply chains constantly change but their evolution has been accelerated in the past five years in the face of greater global instability. In this new age of trade and manufacturing, India and Vietnam are often mentioned as potential winners, but Mexico is likely to be the major beneficiary of “nearshoring,” or the strategy in which a company moves at least part of its production closer to the final consumer.

History

Mexico and the USA have long been major trade partners. Per the United States Trade Representative as of 2022, Mexico was the USA’s second largest goods export market (USD$324.3 billion) and second largest goods imports market (USD$454.8 billion), in both cases after China6. The US has historically benefited greatly from the lower cost of labor in Mexico through channels like the Bracero Program (temporary visas to Mexican workers to fill agricultural labor shortage in WWII) or immigration.

A major turning point in this relationship was the establishment of the Border Industrialization Program (BIP) by the Mexican government in 1965. The intent of the BIP was to promote industrialization along the Mexico-United States border, to attract foreign investment, and to create employment opportunities. Under the BIP, a special customs regime was established to allow foreign companies to import materials and equipment into Mexico duty-free, as long as those goods were processed or assembled in the country for re-export. The BIP resulted in the creation of numerous plants, or “maquiladoras,” whose purpose was to assemble, manufacture, or process raw materials and export the finished product to the United States. The maquiladora industry now manufactures for a range of sectors, including automotive, aerospace, medical devices, and electronics, mostly for export north of the border. Mexico has liberalized trade with a number of other countries through consistent participation in international organizations and the establishment of 13 free trade agreements with 50 countries, including the European Union, European Free Trade Area, Japan, Israel, 10 Latin American countries, and the 11-country Trans-Pacific Partnership15. These efforts have transformed Mexico into a manufacturing power and international logistics hub.

Nearshoring is today seen as the primary catalyst for the next stage of the trade relationship. This is driven by the tariffs placed on China in 2018, lessons from disrupted supply chains during the COVID-19 pandemic and recent wars, plus incentives from the United States-Mexico-Canada Agreement (USMCA). The USMCA is the 2020 replacement of the North American Free Trade Agreement (NAFTA) that requires increased utilization of North American-sourced components for products to be considered “made in North America” and eligible for duty free trade, creating an incentive for producers to relocate their supply chains. Per a Deloitte report, the two primary groups reallocating operations to Mexico are American companies with existing operations that are expanding their capacity and Chinese companies that want the benefit of producing in North America while maintaining low costs of labor and reducing risks to supply chain disruptions3. Per the same report, 2022 foreign direct investment (FDI) in Mexico from these two countries was USD$12.24 billion from the United States and USD$530 million from China/Hong Kong.

FIBRAs Mexicanas

Investors are enticed by the opportunity and could gain exposure through real estate. Mexican REITs, or “FIBRAs,” (short for “Fideicomiso de Infraestructura en Bienes Raíces”) were created in 2011 following successful legislation and the public listing of the first FIBRA, Fibra Uno (“FUNO”; BMV: FUNO11), in the first quarter of that year7. Over the years FIBRAs have been listed for virtually every mainstream real estate sector. Given the scale of the manufacturing and exporting industries, many of the largest and most popular FIBRAs are focused on or have a high portion of their holdings in the industrial sector. Nine out of the total 17 Fibras focus on  industrial properties. As of Q1 2023, these FIBRAs reported 201.9 million ft2 (18.8 million m2) in gross leasable area (GLA), of which only 4.2 million ft2 was vacant19.

Per Fibra Prologis (BMV: FIBRAPL14) – owner of 225 industrial properties with a gross leasable area (GLA) of 43.6 million ft2 managed by a local affiliate of Prologis, Inc., the leading owner, operator, and developer of industrial real estate around the world – the demand for industrial space due to nearshoring grew at a compound annual rate of 73% between 2019 and 20221. Approximately 75% of the overall new demand in 2022 was related to nearshoring1. Vacancy in Fibra Prologis’ six key markets (Mexico City, Guadalajara, Monterrey, Reynosa, Tijuana, and Ciudad Juarez) fell to 1.1% and rents soared by 16% on a YoY basis through August 20231. The boom is driving development. Per research from Datoz, a provider of data on Mexican commercial real estate, nearly 43 million ft2 of industrial space was under construction in the first three quarters of 2022, a record that was 60% higher than the same period in 20212. Morgan Stanley estimates that approximately 140 million ft2 of new inventory is needed across the country over the next five years due to nearshoring1.

The boom is reflected in returns achieved by investors. Between January 2, 2023 and December 7, 2023, FIBRAs on the Bolsa Mexicana de Valores (BMV), the country’s stock exchange, returned 15.51% (measured by the S&P/BMV Fibras index, which includes non-industrial FIBRAs). This return was above the 12.36% return achieved by S&P/BMV IPC, the index that tracks the exchange’s largest and most liquid companies, for the same period16. FIBRAs with high exposure to the nearshoring trend surpassed the S&P/BMV Fibras index’s return, with Fibra Prologis returning 40.19%, Fibra Uno returning 26.70%, and Fibra Terrafina (BMV: TERRA13) returning 18.78%16.

Industrial FIBRAs are capitalizing on the heightened interest. Fibra Uno (FUNO), the first Mexican FIBRA and Latin America’s largest REIT, announced its intention to spin off its industrial holdings via IPO in Q3 2023. FUNO’s holdings are diversified with a bias towards the industrial sector. The make up of its portfolio industrial (54.5%), retail (27.4%), office (10.3%), and other (7.7%)13. If listed, the new FIBRA is to be called Fibra Next. It will be externally managed by FUNO, which will hold a controlling stake in the new company. The Fibra Next portfolio will include 199 mostly stabilized properties with a GLA of 80.73 million ft2 (7.5 million m2), or 10% of the country’s industrial GLA or over twice that of Fibra Prologis, the country’s largest industrial FIBRA. Fibra Next’s future holdings are in the Mexico City metropolitan area (CDMX metro), the Bajío region, Monterrey, Ciudad Juárez, and Tijuana18. 75% of holdings are in the central region of the country (CDMX metro and the Bajío region, an automotive and aerospace manufacturing powerhouse). The portfolio’s occupancy is 97% and the average lease term is four years, which would allow for rent hikes in the mid-term18. The IPO was initially anticipated to raise USD$1.5 billion, but is now expected to raise up to USD$872 million after the firm struggled to drum up sufficient investor interest at the desired valuation17. The initial valuation was in line with those of major industrial developer Corporacíon Inmobiliaria Vesta SAB and Fibra Prologis, whose respective holdings are concentrated in the north of Mexico. Investors argued that the location of the assets in the country’s center and their orientation towards logistics rather than manufacturing warrant a lower valuation15. Despite the slashed valuation, the offering is expected to be the largest Mexican IPO since 201815. The IPO was delayed in November 2023 due to the need for further regulatory approvals, but, as of January 2024, shares are still expected to float this year15.

Aside from the sector’s growth trajectory, industrial FIBRAs offer other benefits to international investors9, 10:

• Exposure to Mexico’s real estate market without direct ownership.
• Diversification in asset type and geography.
• Stable yields.
• High cap rates (dependent on asset type, quality, tenant type, and currency utilized to pay rent)
• Access to local expertise.
• Favorable regulatory environment that promotes further trade liberalization.
• Access to historically one of Latin America’s strongest and most liquid capital markets.

Despite the drivers and international interest, there are many risks to buying FIBRAs, including8, 10:

• External management – Fibras are often managed by external advisors paid by fees based on asset value instead of performance. This creates a misalignment of management and investor interests.
• High Fees.
• Closely controlled boards.
• Conflicts of interest – Families that founded Fibras have sold additional properties at prices that raised investor concerns.
• Anti-takeover measures – Limit industry consolidation and, thus, liquidity.
• Tax treatment – FIBRAs are subject to specific tax regulations in Mexico. Tax treatment and withholding requirements vary depending on the type of income and the investor’s country of residence.
• Currency risk.
• Political risk – Internal, including concerns with rule/enforcement of laws, populism, and geopolitical. Further, Mexico and the USA will have presidential and major legislative elections in 2024.

Conclusion

The shifts in global supply chains and trade policies have led to soaring demand for Mexico’s industrial spaces, offering investors a potentially lucrative opportunity via Mexican REITs, or “FIBRAs.” Despite geopolitical uncertainties and management challenges that investors must navigate, FIBRAs, particularly those with high exposure to the industrial sector, continue to capitalize on this trend. Nearshoring is reshaping the country’s real estate landscape, making these investment vehicles a promising bet for those seeking to leverage Mexico’s emerging role in global trade.