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Two principal factors drive real estate growth across markets: household and income growth. More households increase the demand for housing units and retail goods, while higher incomes allow those households to spend more on those items. The net result is higher rents, faster absorption, and stronger value appreciation across the local real estate market.
The driver of household and income growth comes from a city’s Tradable sector. Understanding this concept is fundamental to assessing a city’s likelihood to grow and deliver strong real estate returns in the future.
A city’s economy is comprised of the Non-Tradable and the Tradable sectors.
The Non-Tradable sector services the local population. Think restaurants, yoga studios, local banks, and real estate agencies. These establishments provide goods and services used almost exclusively by the city’s residents.
Meanwhile, the Tradable sector produces goods and services that are “traded” to residents in other cities or countries. Imagine a clothing company that produces T-shirts sold around the country. Or a technology company that produces an app used around the world.
The growth of the Non-Tradable sector is limited by the existing population and income of the city. For instance, it would be difficult for the revenue earned by a city’s restaurants or community banks to grow by 50% in one year. Local population and incomes simply don’t grow that fast.
But that type of growth is very possible in Tradable sectors such as Tech and Manufacturing since those industries can leverage the world market. In a matter of years employment across these industries can grow by tens of thousands in a particular city with massive windfalls of income and wealth. As this occurs the Non-Tradable sector within a city will then grow (more people and income for restaurants and yoga studios).
There are five key industries that influence the vitality of a city’s Tradable sector. In order of importance, they are:
Let’s dig into each of these a bit further.
- Tech: the highest growth industry (by far) across the US in 2020. Large companies like Facebook and Apple, along with thousands of smaller startups, maintain a global reach. Within a matter of years, these companies can go from garages and basements to the S&P 500, bringing massive windfalls of employment and wealth to the city they’re headquartered. While much of the US tech industry is situated in the Bay Area, cities such as Austin, Denver, Raleigh/Durham, and Salt Lake City are legitimate tech hubs. How to spot growth? Look out for new tech startups, venture capital funds, and IPOs/acquisitions.
- Manufacturing: while manufacturing employment has declined in aggregate across the US, it still has the ability to boost a city’s economic growth rapidly. Take Tesla’s existing Gigafactory in Sparks, NV and their planned one in Austin, TX. The buyers of Tesla cars from around the world are creating jobs and wealth in the Sparks and Austin economies. How to spot growth? Track the expansion of industrial properties, particularly those built for manufacturing uses.
- Healthcare: certain types of healthcare establishments, like family doctor’s offices and trauma centers, are Non-Traded since they serve primarily the local population. However, large medical centers and teaching hospitals fall under the Traded Umbrella. For instance, Boston Children’s Hospital has an entire department devoted to the intake of international patients from around the world. The medical services being provided for these patients import jobs and wealth into the Boston region. How to spot growth? Pay attention to large hospitals expanding their specialty areas; e.g., building a new cardiovascular or eye and hearing center.
- Government: the jobs, lifestyle, and wealth of Washington DC is primarily paid for by the tax dollars of citizens across the United States, making it the largest Traded sector in the US. A similar situation occurs on a smaller scale in state capitals like Albany, NY and Columbus, OH. Government presence also tends to result in an associated increase in lobbying and contracting work, which creates more jobs and wealth. How to spot growth? Look to invest in cities with strong public-private partnerships; prioritize being in state capitals.
- Education: the presence of high-end universities that import students and faculty from across the country has a large impact on local economies. However, this is sector is in the midst of stagnation and potentially regression in the near future. The most important aspect of forecasting growth in Education is the quality of research the university is doing. How to spot growth? Pay attention to federal and state grants for research; research universities will often spin-off successful startups into the local economy.
The Tradable sector explains virtually all of its future household and income growth. The discerning real estate investor should focus specifically on measuring the size and quality of the Tradable sector in their investment markets. There is no universal statistic that tracks this. However, measuring the level and changes in skilled jobs, tech startups, and industrial manufacturing should provide a good indication of the Tradable sector.