3 October 2018

Executive Summary

 

  • New trade deal removes uncertainty, should support property market demand.
  • Key provisions likely will benefit industrial & logistics real estate the most.
  • Auto, pharmaceutical, retail and agricultural industries are key beneficiaries of new agreement.
  • Agreement includes enhanced intellectual property protection.
  • Continuation of steel and aluminum tariffs on Canada and Mexico could further impact CRE construction costs in the U.S.

 

Overview

 

Just hours before an October 1 deadline, the United States, Mexico and Canada agreed to revise the North American Free Trade Agreement (NAFTA), starting with a name change. If the new trade deal is ratified, NAFTA, which facilitates more than $1.2 trillion worth of trade among the three nations, will give way to the United States-Mexico-Canada Agreement or USMCA. It is presently anticipated that the agreement will take effect around 2020, with exact timing dependent upon the ratification process in each country.

 

CRE Impact

 

Although exact effects of the new trade deal remain to be seen, it appears that the USMCA will generally support property market demand. Measurable impacts will be determined as automakers, retailers and distributors calibrate operations to align their businesses with the agreement’s provisions and move forward with capital investments.

Industrial real estate is poised to benefit most from the new agreement. Since its inception, NAFTA has generated significant capital investment in U.S. industrial real estate, especially along logistics/supply chain corridors. Warehouse inventory alone has increased by 3.3 billion sq. ft. since NAFTA came into effect in 1994. Products assembled in various locations throughout North America often contain parts sourced from other countries in the trading block. Since NAFTA took effect, complex supply chains have been established with parts often moving back and forth across borders and value added several times before being completed. Under the new agreement, this interconnectedness will be preserved in various ways.

In terms of manufacturing, U.S. automakers will benefit from a provision mandating a higher percentage of North American-sourced materials in the assembly of autos (this will be a greater challenge for foreign manufacturers with assembly lines in North America). Consequently, some real estate markets may see near-term demand bolstered as supply chains are adjusted and more parts are sourced from North America to meet new requirements. Additionally, greater access for agricultural products and higher minimums for duty-free shipments will support warehouse distribution demand.

To a lesser extent, office markets will benefit from stronger intellectual property protection, special protections for pharmaceuticals and provisions addressing trade in services.

 

Auto Production

 

Five years after the deal goes into effect, a car or truck must have 75% of its components sourced from Canada, Mexico or the United States—a significant increase from the current requirement of 62.5%—to avoid any penalty. The move is aimed at forcing automakers to look within North America for components, as opposed to sourcing them from places like Germany, South Korea, Japan and China and merely “assembling in North America.” Moreover, USMCA stipulates that 40% of a vehicle’s value must be completed by workers earning at least $16 per hour—nearly triple what an average Mexican autoworker makes today. The move is squarely aimed at forcing automakers to shift suppliers from Mexico to Canada or the United States, but could have the unintended effect of driving more auto production to lower-cost markets in Asia.

Automotive analysts have often warned that the kind of provisions mentioned above could raise costs for car buyers. They argue that certain small cars may become too expensive to competitively produce in North America under the new requirements and force U.S. automakers to operate in regions outside the USMCA for exports to Asia and other destinations.

Conversely, the sourcing of labor from “high-wage factories” will diminish over time as the $16-an-hour wage requirement is not indexed to inflation (i.e., an average wage of $16 per hour will be less constraining as time goes on than it is currently). In any case, the avoidance of a threatened 25% tariff on imported autos will lead to a better outcome for consumers.

 

Auto Tariff Exemption

 

The new agreement grants Canada and Mexico exemptions from any future American tariffs on imported passenger vehicles. Nevertheless, the continuation of steel and aluminum tariffs, combined with the stringent sourcing and minimum wage rules under the new agreement, will likely lead to higher costs for car buyers. Consequently, this could impact the competitiveness of North America’s auto industry.

 

Pharmaceutical Companies & Labor Unions to Gain

 

The new agreement extends the intellectual property protections of American pharmaceutical companies selling prescription drugs in Canada and Mexico. Under the USMCA, U.S. drug companies can sell pharmaceuticals in both countries for 10 years, before facing generic competition.

The new agreement also requires that Mexico makes it easier for workers to form and join labor unions—a move to increase workers’ bargaining power and, thus, raise Mexican wages. However, such a move could accelerate the shift to automation in the manufacturing sector. Moreover, it is unclear whether Mexican wages will rise, since much will depend on how the new rules under the USMCA are enforced.

 

Trade in the 21st Century

 

The USMCA includes provisions that address the digital economy with measures that ensure digitally-purchased products (ebooks, music, etc.) remain duty-free, and it exempts companies from certain liabilities. The U.S. Trade Representative asserts that the deal will also more broadly support trade in services.

 

Template for U.S. Trade Agreements

 

The USMCA is viewed by some in the Trump administration as a template for future trade agreements. This is an important consideration, since certain provisions of the USMCA support U.S. influence over trade policy in North America and carry broader implications for global trade. Lastly, while the agreement reduces uncertainty, it does not eliminate it. The USMCA is subject to ratification by the all three signatories and has a sunset clause after 16 years. Additionally, the trade agreement is subject to review every six years.

 

Conclusion

 

The USMCA preserves many important components of NAFTA; however, it also includes various provisions to address the realities of a modern economy. Importantly, the ratification process could be complicated by upcoming elections. Overall, the USMCA will reduce short-term uncertainty for businesses and generally support demand for commercial real estate.

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