We conducted three days of due diligence on the nascent REIT industry in Mexico (two days in Mexico City and one in Monterrey), our itinerary filled with back-to-back meeting with management teams of five of the seven exiting Mexican REITs, called Fideicomisos de Infrastructura y Bienes Raices or Fibras for short. Our discoveries:
Mexico is experiencing a manufacturing renaissance.
– With the implementation of the North American Free Trade Agreement in 1994 has spurred bilateral trade between United States and Mexico, growing from $106.4 billion in 1994 to $459.8 billion in 2011, according to the Congressional Research Service.
– In the same time period, U.S. foreign direct investment in Mexico has grown from $17.0 billion to $91.4 billion, nearly half of the investments going to manufacturing.
– Mexico always had the advantage of proximity but with their cost of labor recently surpassing China’s in competitiveness, expectations are high for continued growth in bilateral trade between U.S. and Mexico overcoming the oft-cited objections/risks of drug-related violence, inflation and currency volatility.
The value of all institutional quality commercial real estate is estimated to be $370 billion, less than 1.5% of the global total according to Prudential Real Estate Investors Research; in Latin America, Mexico ranks a distant second in size behind Brazil ($884 billion). Most of the Mexican real estate is still in private hands. Despite the recent spate of IPOs, seven since 2011, the market capitalization of all the REITs in Mexico totals approximately $11 billion, less than 3% of all institutional grade commercial real estate in the country. The public market has been hospitable for the Fibras, assigning them implied cap rates around 5%; with private market cap rates nearly double the public, we can confidently predict (i) cap rate compression for commercial real estate in Mexico and (ii) more IPOs.
Another positive for commercial real estate ownership in Mexico is the low occupancy cost for tenants. For example, asking rents for industrial real estate in Mexico ranges from $3.60sq. meter to $5.20/sq. meter per month compared to $12.60/sq. meter per month in Brazil according to CB Richard EllisAsking rents for Class A office buildings in Mexico City average $25.34/sq. meter per month compared to $75.20/sq. meter and $79.23/sq. meter per month for Sao Paulo and Rio de Janeiro, respectively. Landlords in Mexico will most likely see compression in the spread between their asking rents and those found in Brazil.
There are currently seven Fibras operating in Mexico:
– two that are diversified in property type (Fibra Uno and Fibra Danhos),
– two that invest in industrial (Fibra Macquarie and Terrafina),
– two that invest in hotels (Fibra Hotel and Fibra Inn),
– one that invest in retail (Fibra Shop).
There are compelling arguments for investing in each of the property types. Through the two industrial Fibras investors can profit from Mexico’s steady incursion into the supply chain of U.S. (and global) manufacturing companies. Through the one retail and two diversified Fibras, investors can gain access to the rising income level of the Mexican consumer. While the institutional quality hotels in Mexico currently service business transient demand, there will surely be a rise in leisure travel as the middle class grows in size.
The Fibra structure was introduced in Mexico in 2004 for much the same reason real estate investment trusts have been implemented across the globe – to encourage institutional and individual ownership of commercial real estate. Subsequent to their introduction, Fibras have been classified as structured instruments allowing investment by domestic Mexican pension funds; the first IPO took place in 2011 with Fibra Uno. Many of the regulatory requirements for Fibras are comparable to their U.S. counterparts: Flow through taxation, 95% distribution of taxable income, 70% investment threshold for real estate, etc. The biggest difference in structure is that Fibras are externally managed compared to the U.S. where most REITs have internalized management. While external management of REITs is common outside the U.S. and managers do have a fiduciary obligation to shareholders, the potential for conflict of interest and the outsized fees have elicited complaints from global managers as voiced in a recent Wall Street Journal article entitled Respect Still Eludes Mexican REITs dated October 1. Obviously the Fibras are in their infancy and their maturation will be iterative (each successive IPO since Fibra Uno has seen a simplification and lowering of external management fees). Most likely, macroeconomic tailwinds and improvements in corporate governance will usher in greater investment by global REIT managers in the years ahead.
The views expressed in this update are as of the date of this blog entry. These views and any portfolio holdings discussed in the update are subject to change at any time based on market or other conditions. The adviser disclaims any duty to update these views, which may not be relied upon as investment advice. In addition, references to specific companies’ securities should not be regarded as investment recommendations or indicative of the Adviser portfolios.
