Moving south

After weathering the threat of low-cost production in Asia, mexico's manufacturing sector is booming amid rising domestic consumption and a growing economy—both of which are driving the Mexican logistics real estate market. By Aaron Lovell

For all the talk of real estate opportunities in emerging markets like India and China, some property investors tend to overlook the jet lag-free economic powerhouse just south of the US border.

Mexico is primed to become the world's fifth largest economy by 2040, surpassed only by China, the US, India and Japan, according to the World Bank. Since joining the North American Free Trade Agreement in the mid-1990s, the country has received a gigantic boost in foreign direct investment, particularly from the US.

Foreign domestic investment has jumped from an annual average of $2.6 billion (€1.9 billion) between 1980 and 1993, to $14.9 billion between 1994 and 2005. According to the Economist Intelligence Unit, the only emerging markets receiving more foreign investment in 2005 were Russia and China. Approximately 65 percent of the foreign domestic investment targeting Mexico came from the US.

Despite some early fears, the manufacturing shift towards Asia did not decimate the manufacturing business in Mexico. Vacancy rates for logistics space in the northern, manufacturing-oriented states of Mexico are 4 to 5 percent, according to Jones Lang LaSalle.

The close trade relationship between Mexico and the US in the post-NAFTA era is driven by geographic proximity and cheap labor. The US now purchases 90 percent of Mexican exports, while the country's growing middle class has attracted many US retailers eager to capitalize on Mexico's domestic market.

As real estate investment firms and industrial developers have taken notice of these trends, Mexican logistics development has become an attractive strategy. Industrial developers like Denver-based ProLogis and San Francisco-based AMB have been investing in the country for years and both continue to remain active. ProLogis, for example, recently acquired 3.5 million square feet of space in six industrial parks in Mexico City and Guadalajara for $238 million.

This spring, AMB announced a number of projects, as well. In May, it acquired a 264,000-square-foot facility in Tijuana, which will be used for the distribution of home electronics. Earlier the same month, the firm acquired 1.3 million square feet of space in Guadalajara, which is fully leased to a laptop manufacturer for research, design, manufacturing and distribution.

More broadly focused real estate groups have also entered the market as well. Firms like ING and AIG have entered into joint ventures with local operators, while GE Capital acquired 87 percent of a logistics portfolio from Mexican industrial developer FINSA Group in a $450 million deal in 2005.

Industrial estate
As US firms have looked to Mexico for their manufacturing needs, the demand for international-quality logistics space has increased in kind.

Mexico's northern states—Baja California, Sonora, Chihuahua, Nuevo Leon and Tamaulipas—are the center of much of the country's manufacturing. These borderlands are home to many maquiladoras—factories that import materials on a tarifffree basis for manufacturing, with the finished goods then being re-exported back to the country of origin.

Further south, logistics developers say there is plenty of demand for industrial properties as well, particularly distribution space for international companies looking to tap into the growing Mexican market. Despite severe geographic income inequality across the country, Mexico City and many northern urban centers are prosperous areas, with a per capita GDP of $25,000—comparable to that of Spain. The average per capita GDP for the country is $10,000, still one of the highest in Latin America.

When ProLogis entered Mexico in 1997—its first foreign market—the firm initially invested in manufacturing-oriented projects in the north. More recently, ProLogis has been looking to service the domestic distribution market with properties in the cities of Central Mexico.

Still, Silvano Solis, the regional director for ProLogis in the country, says that there is a much higher demand for manufacturing space than distribution space and that most of the firm's properties near the border are used for manufacturing—production facilities represent around 70 percent of the firm's total portfolio in Mexico. “The percentage is going to change in the future because of the distribution space demanded in the market,” Solis says.

Solis adds that many of ProLogis' foreign manufacturing clients are also looking to expand their distribution networks as consumer business in Mexico picks up. Because of this, many players in the US-Mexico trade corridor point out that flexibility needs to be built into any logistics space. “Our buildings are flexible to the degree that they can handle distribution and manufacturing,” Solis says. “The same building can cater to both needs.”

When San Francisco-based AMB first entered Mexico in 2002, it invested in Mexico City hoping to take advantage of growing consumer demand. The firm's first project was a 780,000-square-foot distribution center for Procter and Gamble, which sought to consolidate more than ten facilities spread throughout the country.

With this in mind, the developer located its project near Highway 57, a thoroughfare that is part of the “NAFTA highway” as it's used to ferry material and goods between the US and Mexico by truck (see map). The location allowed the client to receive goods from the northern part of the country, as well as ship products out from its Mexico City base, says Steve Lekki, vice president and portfolio manager of AMB Capital Partners.

Infrastructure concerns
AMB chose the location because of its proximity to the major roadway. At the same time, when the project was on the drawing board, there were concerns that the airport in Mexico City could be moved—not an uncommon issue in emerging markets where planning is an ongoing process.

Maury Tognarelli, the chief executive at Chicago-based Heitman Real Estate, a firm that has invested in real estate in Mexico, also points out the importance of location with logistics projects. “The location today may not be the location that emerges over the next five-year period as the ideal location,” he says. “Will the surrounding area be the dominant location?

Tognarelli points out that in more established markets such as New Jersey, Chicago and Los Angeles, submarkets are already largely established, while logistics hotspots in a place like Mexico may still be in various states of flux.

In addition to urban planning, developers and investors must be aware of risks involving infrastructure. Because Mexico is an emerging market, developers may sometimes have to plug the holes. “You don't always have infrastructure,” says ProLogis' Solis. “And as a developer you have to invest in that infrastructure on your own.” This has included building power sub-stations for some of the firm's projects, he adds.

While those in the market say transparency in Mexico has improved, there are still ongoing concerns about the legal system, land entitlement issues and even homeland security. Logistics operators often need to provide 24-hour security with gated entrances and guards, particularly if a manufacturing client is hoping to take advantage of the US government's prescreening programs, which allow for a quicker route into the country.

Asian invasion
Despite some early fears, the manufacturing shift towards Asia did not decimate the manufacturing business in Mexico. Vacancy rates for logistics space in the northern, manufacturing-oriented states of Mexico are 4 to 5 percent, according to Jones Lang LaSalle.

Still, Lekki says that some border areas like Tijuana and Juarez were affected as places like China became an increasingly attractive source of cheap labor. “They had a hard time for a couple of years,” he says.

The close trade relationship between Mexico and the US in the post-NAFTA era is driven by geographic proximity and cheap labor. The US now purchases 90 percent of Mexican exports, while the country's growing middle class has attracted many US retailers eager to capitalize on Mexico's domestic market.

Still, Mexico remains a strong manufacturing point for higher-value goods, particularly those with a technological component. Appliances like washing machines, dryers and refrigerators—known as “white goods”—are still largely manufactured in Mexico, as are many automobiles.

In fact, a number of major manufacturers have recently expanded their operations in (or into) Northern Mexico, including Whirlpool in Saltillo, Siemens in Juarez and Rubbermaid in Monterrey. Automakers also remain committed to manufacturing in the country: Ford, GM, Chrysler, Nissan and Toyota have recently announced combined investments of $3 billion in Mexico, according to research from Jones Lang LaSalle.

The reasons are myriad. The skilled labor and engineers in Mexico are one driver, say some logistics providers. Another reason is simple physics—cars and appliances weigh more and are larger than the sorts of products that are now manufactured in Asia: footwear, toys, garments and other commodity-type goods. This means slower, costlier shipping schedules.

For any manufacturer targeting the US market, Solis points out the tremendous difference in delivery time: Shipping from China will take 30 to 40 days to get to the US, as opposed to 48 hours from Mexico. Of course, the same goes for company employees. “For technicians coming to the US for research and design, it's a daytrip,” he adds.

NAFTA highway: Taking advantage of more liberal trade agreements, a loose network of roads—including Interstates 94, 29 and 35 and Highway 57 in Mexico—connect the US, Mexico and Canada with in-land ports, logistics facilities and rail links.

For all these reasons, some companies that moved their production facilities overseas have rethought the decision. “After the initial wave of companies went to China, a number of them came back,” says AMB's Lekki.

The other side of the border
With the boom in Mexican foreign direct investment, investors and developers are also finding opportunity on the US side of the border. Dallas-based Macfarlan Real Estate Services pursues a Southwestern logistics strategy as a component of its value-added fund series. Solely focused on the US-side of the border, the firm has expanded the geographic focus of the strategy and is now considering projects in markets as far away as Savannah, Georgia and Charleston, North Carolina.

Todd White, a partner at the firm, says research is one of the most important aspects of any logistics investment, including anticipating tenant demand and figuring out how much cargo will be shipped via highway or via railroad. “How big of a box do you want to build?” he asks. “How flexible of a box can you build?”

Texas sees an estimated 80 percent of NAFTA trade traffic via the informal links that make up the NAFTA highway, which links Canada and Mexico via the US. In fact, a number of Texas-based firms are looking to taking advantage of the increased traffic flow to and from Mexico. For example, industrial developer Hillwood, owned by the Perot family, has opened the 12,000-acre Alliance Global Logistics Hub outside of Dallas, which incorporates what was once an all-cargo airport with a rail link to the port at Long Beach, California and access to I-35. Hillwood spokesperson David Pelletier says that some of the hub's clients have a manufacturing presence in Mexico as well.

Meanwhile, San Diego-based developer The Allen Group recently inked a deal to develop links between its 6,000-acre Dallas Logistics Hub, which broke ground in April, with the Mexican state of Nuevo Leon.

As long as manufacturing remains strong in Mexico, there will be some need for corresponding facilities in the US. Many investors point out that for every foot of manufacturing space built on the Mexico side of the border, a significant amount of space is required on the US side to finish products and take advantage of various tariff laws, labor skills and transportation factors. Some note an anecdotal ratio of almost two to one in terms of production space in Mexico to support space in the US.

Perhaps this is evidence that, in the decade since NAFTA, the economies of the US and Mexico are more intertwined than ever. Considering the explosive growth in the Mexican market, consumer demand from the US and a robust domestic market, the relationship seems set to continue for some time to come.