After global supply disruptions at the beginning of this decade, manufacturers have further diversified their supply chains to provide consistent access to U.S. consumers. They are motivated by potential labor and transport costs savings, improved supply chain resiliency, and favorable tax and tariff regimes. These investments are creating a compelling industrial investment opportunity now on both sides of the Mexico and United States border.

The growth in border industrial demand is occurring alongside heightened uncertainty about U.S. trade policy that is unlikely to fade soon. While tariffs and a looming renegotiation of North American trade relationships create risks around our bullish base case for border industrial markets, we believe there are too many advantages of locating manufacturing facilities in Mexico that serve the U.S. market to cause manufacturers to reverse course, even if tariffs are higher. One mitigant is to invest on both sides of the border.

Mexico's Industrial Market Benefits from Regionalization (Nearshoring)

The case for institutional investment in Mexico industrial is well established, due to a decades-long expansion in export growth to the United States. This is directly linked to "nearshoring" of manufacturing operations, as companies reduce their reliance on manufacturing in China. Since 2016, Mexico has captured 30% of China's lost market share of U.S. imports, more than any other country.

Mexico is a preferred destination because labor is inexpensive and widely available, and supply chains are well established after decades of investments. The risk of tariffs is partially offset by depreciation in the Mexican peso, which further lowers costs of doing business in the country.

The resultant surge in demand for industrial space in Mexico has not been matched by supply, causing rent growth to spike. As shown below, rent growth at the national level has been above 15% for three consecutive years. Those 15%+ years are unlikely to be repeated, but we still expect elevated rent growth through the rest of this decade.

It is important to note that industrial rents in Mexico are U.S.-dollar denominated, and typically backed by multinational tenants with low credit risk. This means that while there is additional country risk for international investors as opposed to investing in the United States, currency and tenancy risks are mitigated.

We estimate that current pricing for Mexico industrial real estate more than compensates for that country risk, with cap rates about 200 basis points above the U.S. average and a better near-term outlook for rent growth. This makes investment in existing properties attractive, and also supports the case for new development with higher returns expectations.

U.S. Border Markets Can Offer Attractive Risk-adjusted Returns Today

The case for investing in U.S. border markets is less well established, providing a potential advantage to early entrants into markets such as El Paso (next to Juarez), Otay Mesa near San Diego (next to Tijuana), and Laredo (next to Nuevo Laredo with excellent connectivity to the largest northern Mexico industrial concentration around Monterrey).

Until this decade, there was little need for warehousing or further assembly in the immediate border markets. This has changed for at least two reasons:

1. The 2020 USMCA Free Trade Agreement increased requirements for inputs produced in North America, some of which is produced more efficiently in the U.S.; and
2. More importantly, the spike in trade flows over the past two years has required more logistics space on the U.S. side of the border. As shown below, freight volumes have doubled in the period since ratification of the USMCA agreement, as manufacturers rapidly increased output to satisfy U.S. demand. U.S. border markets can be directly served by trucks domiciled in Mexico, most of which are prohibited from driving beyond the areas immediately adjacent to the border. The growing logistics capacity in the U.S. border markets provides importers with the option to sort, package, assemble and ship finished goods locally.

Industrial real estate data further support the case for U.S. border market investing. Over the past two years, the El Paso and Laredo markets combined for over 5% of U.S. industrial leasing, versus their historic average of about 1%.

Returns of the combined markets have also soared since 2019, with a 5-year average annual return of 22% compared to the national average of 15%. Over the past year, when cap rate expansion caused national industrial total returns to decline by 4%, the combined El Paso and Laredo markets were more resilient with a 1% gain.¹

U.S. border markets are still priced at a discount, despite recent excess returns. Cap rates in El Paso and Laredo are about 100 basis points higher than the national average, meaning they provide a higher income return while also having upside from further growth in Mexico trade flows. Some of that cap rate premium is justified by the border markets' lower liquidity and unproven long-term performance, but in our view, they offer attractive risk-adjusted returns today.

The intersection of the evolving global supply chain, labor and transport costs, improved supply chain resiliency, and favorable tax and tariff regimes are creating a compelling industrial investment opportunity on both sides of the Mexico and United States border.

^{1. National average of 15%, based on NCREIF data.}