How a Healthy Real Estate Sector Creates a Prosperous City
Specializes in providing actionable insights into the commercial real estate space for investors, brokers, lessors, and lessees. He covers quarterly market data reports, investment strategies, how-to guides, and top-down perspectives on market movements.
According to data from Nareit, the total value of the commercial real estate market in the US is over $20 trillion, and nearly one-half of total US household wealth ($52 trillion) is held in real estate. About 40% of all private assets are held in real estate—more than bonds, stocks, and cash.
What does all this mean? The American economy is dependent on real estate in a unique way: Real estate forms the backbone of cities and municipalities across the nation, and booms and downturns in real estate can ripple across the entire economy.
Here, we'll explore the connection between real estate and growth and how real estate activity creates prosperous and healthy cities.
Let's get started.
What Are the Factors of a Healthy City?
We use the term “healthy” to describe economies all the time, but what does that actually mean? A healthy economy is one that is poised for growth and that can take advantage of economic opportunities.
More specifically, some features you would expect to see in a healthy economy include:
- High business activity;
- Significant investment activity;
- Sustained job growth;
- Stable unemployment;
- Growing household formation; and
- High borrowing activity.
Both residential and commercial real estate have a significant impact on all of these variables. In a stagnant real estate market, business activity stalls, job growth declines, and household formation falls.
Why Is Real Estate So Important to City Growth?
Real estate, especially of the commercial variety, provides spaces wherein economic activity can occur. Businesses need commercial real estate, like office space and other industrial complexes, to conduct activities, and families/individuals need housing so they can live near their workplaces and enjoy access to vital infrastructure.
According to classical economic models of urban growth, the central business district (CBD) of a city forms its economic center. Housing and other buildings are built around this economic center as people look for jobs and entrepreneurs start businesses. Real estate prices are usually the highest in the central district and get lower the further you move out.
In this model, economic development and city growth are anchored by the real estate that occupies these central business districts. When real estate activity suffers, so does job growth, employment, household formation, and business activity. Real estate is also a significant source of tax revenue used for running basic city services.
What Are Three of the Most Important Needs of a City?
Given real estate's importance to city growth, cities and their residents have a vested interest in ensuring that real estate activity remains healthy. When it comes to the production of real estate, cities need three key elements.
#1 – Land
Land is a key element to almost all kinds of economic production and is especially required for real estate development. Land and real estate development go hand in hand: All other things being equal, more land availability generally means the costs of real estate development will be lower.
Land availability heavily factors into real estate production, which is why land use and management policies are critical determinants for real estate development: Certain land use policies can affect the cost of developing specific types of real estate.
#2 – Capital
Capital is an abstract concept that can be defined as the equipment and other resources necessary for producing things. In the case of real estate, capital refers to the money needed to finance real estate projects. Real estate capital is usually secured either through granting equity shares to investors or debt capital from a mortgage loan.
Between building materials, permitting, inspections, and construction, real estate projects require a significant amount of capital to finance. As such, capital investment is a main driver of real estate development. When the costs of capital are high, investment activity and subsequent real estate development fall.
#3 – Labor
Labor is human input into the production process — i.e., work. Cities that want to build real estate need people to research, design, and construct the actual buildings. As a production factor, a low labor supply can increase the price of developing real estate.
For instance, the COVID-19 pandemic caused significant spikes in construction costs due to both labor and supply constraints.
What Happens When Real Estate Activity Falls?
Given that real estate ownership is a vital part of American household wealth, when real estate activity slows down, the entire economy can grind to a halt. For example, the housing market crash of 2008 precipitated one of the greatest economic recessions since the Great Depression in the 1930s.
Shocks to the real estate market can spiral into other declines. As borrowing and buying activity slows down, business formation and job growth also start to falter. Higher interest rates and increased risk mean that fewer people are willing to take on debt, which is a major source of real estate capital. For instance, recent interest rate hikes have caused declines in office space sales volumes in cities across the country.
Real estate recessions also affect labor activity because it affects where people can live. Cities that have high housing prices can price out lower-wage workers, leading to labor shortages that can further hamper business and investment activity.
The Challenges of Sustainable Real Estate Development
Sustainable and responsible real estate development that balances economic growth of cities with other human needs will form a critical part of real estate strategies and investment.
The core aspects of any sustainable real estate development strategy include:
- Climate change;
- Energy security;
- Pollution and water scarcity;
- Poverty;
- Health; and
- Biodiversity/ecological health.
As we move into the future, creating sustainable economies will require changes to virtually every sector, including mining, energy production, agriculture, and real estate. The production of materials for real estate construction alone is responsible for over 11% of global energy consumption and greenhouse gas emissions.
The goal of any real estate development project should be to improve the economic and physical health of its cities' industries and residents. The path to creating sustainable forms of economic development in cities is one of the great challenges of the 21st Century, but it's one that will require the work and collaboration of numerous economic actors.
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