commercial real estate and the economy v2 (1)

7/26/2019 Commercial Real Estate and the Economy v2 (1)

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Economics29 November 2013 Assessing the true value of Commercial Real

Estate to the UK economy

Introduction

Commercial real estate (CRE) is an area which is undervalued and

studied in far less detail than it ought to be Research that has been

done in the !ast has been inconclusive and somewhat narrow minded"here are wa#s in which !ro!ert# has value that are sometimes notta$en seriousl#% or even ta$en into account at all &t is not 'ust the CREsector itself that should be eamined it is also the $noc$ on e*ects onthe other !arts of the econom# "he aim of the research !a!er is touncover and anal#se the true value of CRE% b# delving into each of thedi*erent areas of the econom# on which it has a signi+cant im!act,lthough there will obviousl# be overla!s with ever# section we discuss- another !oint that shows 'ust how valuable commercial !ro!ert# is (its!ills over into almost ever# !art of the econom#) - we have sorted theim!act of CRE into several themes% in order to ma$e clearer the e*ectit has on the econom# as a whole

"he !ur!ose of this !articular s$eleton !a!er is to give an idea of the

areas that we feel should be e!lored further in order to uncover theetent of the value of CRE &t will give an indication to wh# these!articular themes ought to be eamined

1

Author:.r /avvas /avourirof Richard ac$manatie rlandi

Contact information"oscafund ,sset 4anagement5590 5ong ,cre5ondon 6C2E 9R,England

t7 8 (0) 20 :;< =100f7 8 (0) 20 :;< =101

e7 ir>toscafundcomw7 wwwtoscafundcom


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1. Denition and scoe of commercial real estate,s discussed in the introduction% the aim of this !a!er is to uncover the com!lete value of

commercial real estate (CRE) in order to achieve this% it is necessar# that we +rst establish thesco!e of it ?rom the local newsagents at the end of the street% to the o@ce buildings with man#store#s% CRE is found in an in+nite arra# of sha!es% siAes% and functions "here are% of course% themain areas of CRE - the ones that +rst come to mind - including retail% o@ce and industrial realestate Bowever% 'ust as im!ortant as these are% there a man# other sides to CRE there is leisure(such as the cinema or the g#m)% hotels% !ubs and restaurants% garages% and !etrol stations?urthermore% student accommodation% hos!itals and schools can all be counted as CRE "hus% thede+nition and range of CRE can be so broad and com!le% and it is% in !art% this which ma$es thevalue of CRE worth# of further stud# "he issue is that research done before% and even data foundon government websites% each use a di*erent idea of CRE "he +rst ste! of this research !a!erwould be to !ut down a clear de+nition of what we include in the term commercial real estateD?rom this% it will be signi+cantl# more straightforward when we come to anal#se the im!act of CREon the rest of the econom#

,s well as CRE itself% it is im!ortant to de+ne the activit# that surrounds it% whether it beconstruction% management% develo!ment or design &t is not 'ust the outward im!act that CRE hason the econom# that is im!ortant% but also the in!uts that go into it these will% themselves% havetheir own e*ect on other sectors (as we will see in the net section) "herefore% we will also !rovidea de+nition of what we understand to be counted as CRE activit# "here is no use in eamining thevalue of CRE if we are not sure of how we would describe it

ne of the initial ste!s ta$en will be to stud# the functions of commercial !ro!ert# it is this that willlead us towards +nding its value "o start with% we will loo$ at the volume of CRE in the and thevalue that is given to it% in its most basic form F# identif#ing the ca!ital gains that are made fromCRE we can start to form a !icture of how it is valuable in itself% as a !h#sical structure "able 1gives an idea as to the rateable values of the di*erent t#!es of CRE% coming together to give avalue of almost G9bn F# loo$ing at the changes in Hoors!ace com!ared to the rateable value !er

m

2

% we can begin to get an understanding of how CRE has become more and more valuable overthe #ears (Chart 1) &n terms of the functions of !ro!ert#% it is worth e!loring the di*erent uses ofCRE and the ratios between them ?or eam!le% although we can see how CRE is divided intosectors (?igure 1)% it would be interesting to see how these relative siAes have altered over the#ears art of the reason that CRE is valuable - !robabl# the most obvious reason - is because itholds a function that is usuall# vital to those who use it (this is a !oint we will return to in latersections)

"able 17 Commercial !ro!ert#% 200; Chart 17 Ialue of commercial !ro!ert#

Ful$ Classes?loors!ace(000m2)

Rateablevalue(G000)

erm2

Retail 10=%299 13%=20%


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?igure 17 Commercial real estate sectors%2011

Source:IPD through BPF, Toscafund

"he areas discussed above are% most de+nitel#% im!ortant factors which contribute to the value ofCRE% and% therefore% the# should not be s$immed over% but loo$ed at in great detail the# show thevalue of !ro!ert# in the most basic form Bowever% the !oint of this !a!er is not 'ust to show thefunction of CRE% or its scale% but wh# it is so im!ortant "he to!ic of CRE has not #et been eaminedin enough detail to show what it adds to the econom#% both directl# and indirectl# "his research!a!er will show that the im!act of CRE is much bigger than what it ma# +rst seem

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A day in the life of..."o gras! a sense of the sheer siAe of the commercial real estate industr#% one onl# has to loo$ at how it isused in ever#da# life ?or eam!le% #ou could follow a da# in the life of

a , student, t#!ical student these da#s will wa$e u! mid morning% 'ust in time for their 11am lecture in one of thenewl# built universit# buildings% before which the# will grab a co*ee from a cafe% be it chain or local% to$ee! them awa$e ,fter the lecture% the# will !robabl# !ic$ u! some lunch from the su!ermar$et% before

going to the librar# to continue wor$ing &t ma# be that at


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!roduced is having a !ositive e*ect on the K. n its own% construction of CRE is !roviding =3P ofKross Ialue ,dded (KI,) for all industries% and !roviding :P of total out!ut (see table 2) &f wewere also to ta$e into account the wider involvement in construction% these +gures are surel# to besigni+cantl# higher thus% it is im!erative that we measure the !rocess of construction as a whole

Chart 27 Ialue of constructionChart 37 Construction and real estateem!lo#ment

Source: ONS, Toscafund

?or the research !a!er% we will demonstrate the etent of the de!endenc# of construction on CRE%and% in doing so% will show one wa# in which CRE is contributing to the econom# "hus% we will loo$further into the !rocess that leads to a construction of CRE% and how much of the out!ut !roducedat each !art of the chain is due to CRE 4oreover% we will anal#se how this out!ut is creating gainsfor the econom#

Real estate activitiesf course% what has 'ust been

discussed above all involves thedevelo!ment of new CRE% however% itis 'ust as% if not more% im!ortant toloo$ at the direct im!act of the CREthat alread# eists "he industr# thatis a*ected most directl# b# theeistence of CRE is real estateactivities ,s with construction% it isnot the bene+ts that CRE !rovides tothe real estate activities industr# thatwe are most concerned with% but the$noc$ on e*ect that this has u!on therest of the econom# ,gain% real estateactivities !rovide 9:P of total KI, and :


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ne factor of em!lo#ment surrounding CRE that we will focus on is its com!atibilit# of s$ills 6hatma$es CRE more valuable% in terms of em!lo#ment% is that it !rovides an o!!ortunit# forem!lo#ment for the lower s$illed this is es!eciall# im!ortant for an# government ob'ectivesconcerning rebalancing &t is an area which enables training% which then leads to the develo!ment

of s$ills that are transferable% all of which are essential for im!roved !roductivit# (an area which willbe discussed later) ?or eam!le% the activities involved in CRE can !rovide em!lo#ment forsomeone who has not been to universit# and so% even though the# are develo!ing s$ills and addingto out!ut% there has not been the same cost of education "hus% it seems im!ortant to e!loreem!lo#ment surrounding CRE% not 'ust in terms of volume% but also t#!e

Chart 7 P of gross ca!ital formation Chart


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&. Commercial real estate in roduction

Now that we have covered the in!uts of commercial real estate (CRE) and its direct im!act to theeconom#% it is time to loo$ at how CRE has an indirect e*ect as well "hroughout the remainingsections there will be more of a focus on the welfare economics of CRE% and we will loo$ at theareas of the econom# which have% in the !ast% often been overloo$ed when eamining the value ofCRE "he +rst area we are going to anal#se the role of commercial !ro!ert# in !roduction

'he value of the hysical structure6e aim to e!lore the value of the !h#sical structure itself% in terms of being an in!ut to a!roduction function roduction itself is a crucial !art of the econom#% but there are factors behind itwhich dictate its success ,lmost ever# !art of !roduction% if not all% relies on some form of CRE inorder to be able to !erform its own function in the su!!l# chain% ma$ing it one of the mostim!ortant factors of !roduction F# stud#ing a su!!l# chain% and its reliance on CRE% it is !ossible toshow more clearl# how CRE is even more valuable when loo$ed at collectivel# 6ere one lin$ in thechain to lose the !h#sical structure in which it houses all of its activit#% it would either be ver#un!roductive or fail com!letel# this missing lin$ would then mean that the whole !roduction!rocess would fall a!art &t is not often ta$en into consideration how vital CRE is to the success of!roduction% because it ma# not be something that is !articularl# noticeable net to the rawmaterials or the labour em!lo#ed% however% its im!act is much greater than man# would thin$ "heaim of this section of the !a!er is to +nd a wa# to e!ress how big a role CRE !la#s in the!roduction function and% in doing so% we can show its value in other areas of the econom# Feforeeven loo$ing at the income generated from CRE etc% we are able to demonstrate how it is creatinggains for the econom#% 'ust b# being there

'he evolution of commercial real estate

&t is not reall# !ossible to gras! a sense of the value of CRE in the current da# without loo$ing intoits !ast "he research !a!er% therefore% will ta$e some time to e!ress the evolution of CRE in orderto show how it has become ever more valuable over the #ears &n the !ast% there was ver# much abinar# relationshi! between a !ro!ert# and the industr# it served it had a !articular function% andwas usuall# designed for this function alone "he !roblem with this was that% in onl# being able toserve one !ur!ose% for a s!eci+c industr#% were that industr# to fail% the income of the !ro!ert#would be 0 "he design of CRE meant that it could usuall# be transferred for use% which meant thatit became a waste when its function was no longer needed it was too de!endent on its industr#

"he di*erence between then and now is that now% with the im!rovements and investment in CRE% itis !ossible to have the best of both - a !ro!ert# can be ver# s!eci+c% or hold a !articular !ur!ose% ifit needs to% but it is also !ossible to have multiJuse buildings% or ones that can be easil# ada!ted to+t a di*erent !ur!ose ,n eam!le of this can be seen in buildings that are develo!ing soresidential and commercial real estate are being to integrate more - this is all !roviding a more

e@cient use of s!ace "hrough the e!loration of this idea% we can eem!lif# the value of CRE%because its diversi+cation means it can ada!t Luic$l# to changes in demands% hel!ing the econom#remain stable through the changes

:


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(. "ccuiers of commercial real estate

"his section will focus on how commercial real estate (CRE) is valuable because it has a functionccu!iers are such a signi+cant area when evaluating the value of CRE because of how much the#rel# on it and what the#% in turn% contribute to the econom# due to their use of the CRE

'yes of occuiers&n order to gras! the etent to which the occu!iersrel# on CRE% we will +rst loo$ into who thoseoccu!iers are% and what it is that ma$es CRE vital totheir abilit# to function !ro!erl# ?or most% if not all%occu!iers% CRE is so valuable because it !rovides thestructure from within which the# can !erform theirfunctions ta$e a hotel owner for an obviouseam!le% the# cannot !ossibl# !rovide their service -

a room to sta# in - without the building to !ut theroom in

"his section of the !a!er will not 'ust focus on howCRE is valuable to its occu!iers% but also how theseoccu!iers can contribute to the econom# due to theuse of CRE - after all% it is the CRE that enables themto carr# out their function ccu!iers add to theeconom# in several di*erent wa#s for instance% the#!roduce out!ut% the# !rovide em!lo#ment and the#!rovide the services necessar# for the econom# tocontinue functioning !ro!erl# "he aim would be toidentif# the etent to which the bene+ts that the occu!iers !rovide the econom# with are owed to

the use of CRE)o# vital it is, wa# to measure the value of CRE in terms of occu!iers would be to loo$ at how much the# arewilling to !a# to rent the building% or even 'ust a !art of it this is es!eciall# relevant when loo$ing atthe com!etitiveness for !rime locations "he rateable value !er m 2 of the di*erent t#!es of !ro!ert#begins to give us an idea of 'ust how valuable the CRE is to its occu!iers (/ee table 1) Bowever% itis worth loo$ing further into this as it will hel! to measure how much CRE im!acts on the out!ut ofthe occu!iers , !oint worth mentioning is that CRE can !rovide some stabilit# to the occu!iers%es!eciall# in terms of costs% that the# ma# not +nd in other areas of their business this is anotherfactor that could be included when eamining the value of CRE in these terms

;

*arming&n terms of occu!iers of CRE there is atendenc# to thin$ more of businesses andcor!orations &n fact% we tend to onl# thin$of those Bowever% if we want to uncoverthe com!lete value of CRE% we must ta$eall t#!es of occu!iers into account "a$e

farming% for eam!le - livestoc$ are alsooccu!iers of !ro!ert# "he# rel# on realestate as much as an# business orcor!oration there needs to be somewhereto hold the animals that are a crucial !artof the agricultural industr# "his is not tomention the machiner# and eLui!mentthat also needs to be stored in a secure!ro!ert# F# loo$ing into the full s!ectrumof occu!iers% including those that are less


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+. Commercial real estate in further develoment

6hen we tal$ of construction% we are obviousl# tal$ing about new !ro!ert# and develo!ment in theindustr# Bowever% this further develo!ment relies on commercial real estate (CRE) itself% whether itbe through direct funding% or through investment as a result of the ca!ital made on the CRE "hissection !rovides an o!!ortunit# to e!lore the role of CRE in develo!ment this is one of areas inwhich the value of CRE is often overloo$ed or underestimated

Infrastructure"here are two main wa#s in which funding for infrastructure can stem from CRE "he +rst is directl#- this can either be through the investment of the ca!ital that is created through the CRE% or it canbe through the ta revenues generated from it ne eam!le of this !rocess is the Communit#&nfrastructure 5ev# !aid b# new develo!ments the revenue from this lev# is fed into furtherinfrastructure% which adds to the ca!ital gains that come through !ro!ert# "his is also a goodeam!le to use for showing how CRE can aid the achievement of government ob'ectives% as the

lev# can be used for !articular infrastructure that ma# be necessar# to $ee! u! with the econom#%for eam!le roads% schools and hos!itals "he other main wa# that CRE funds further develo!mentis through those who invest in !ro!ert#% but this is a !oint we will return to in a later section

"he value of CRE can be eem!li+ed through the identi+cation of the origin of funding for newinfrastructure ?igures show that =;3P of funding comes from the !rivate sector - this is a valuethat we would eamine in more detail in order to get a clearer idea of how invested the !rivatesector are in develo!ing infrastructure% including CRE "heir investment is arguabl# because it isthem who feel the direct bene+ts of this infrastructure (owning :;2


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Contri-ution to the Eche/uer,s well as loo$ing at ta in terms of regional rebalancing% we will include a section on the totalcontribution made b# commercial real estate to the EcheLuer "his will com!rise of both direct!ro!ert# taes and indirect taes% including cor!oration ta% I,"% income ta and ca!ital gains ta

?or the indirect taes we will use weights to calculate their +gures% loo$ing to +nd a more accuratemeasure of their contribution nce this value has been found% it can be measured against% andcom!ared with% other sectors to get a clearer idea of the signi+cance of CREDs contributions

M"he challenge of calculating 'ust how much its commercial real estate contributes tothe econom# generall#% and its EcheLuer s!eci+call#% will Luite fran$l# never beaccuratel# solved &ndeed% the challenge onl# increases in tandem with the rise in thenumber of channels which feedJout of the commercial !ro!ert# mar$et "his said wemust ma$e an attem!t at a reliable estimate% but with one caveat "he +gure wesuggest will be a lower bound to the true number &t has to be a lower bound becauseeconomic multi!liers are easier to miss than to see ,nd it will be a lower boundbecause where we do identif# channels and multi!liers we are certain to understate

their LuantumO

10


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0. cotland

2. Regional re-alancing

"he to!ic of regional rebalancing% and commercial real estateDs (CRE) role in it% is one that has beenrather overloo$ed in !ast research "he subtlet# of CREDs role in rebalancing means that !eo!leoften fail to ac$nowledge it or measure it !ro!erl#% even though it is a more than signi+cant wa# inwhich its true value can be demonstrated &t is one of the +rst areas that is ma$ing ste!s towardsthe localisation that !rovides a rebalancing that will% in turn% bring huge bene+ts to the econom# inthe long term

M?or its !art Fritains commercial real estate has become much less regionall#distinct% its fungibilit# hel!ed in large !art b# the considerable growth in servicesectors whose locations are not rooted to a !articular region ?rom education acrossto business services location is governed b# +nancial e!edienc# not availabilit# ofan essential localised resource

Fritains much altered real estate landsca!e is not sim!l# hel!ing in its s!eedier interJregional ad'ustments it is also accommodating (Luite literall#) for internationalmigrants and allowing them to settle and !rove economicall# !roductive widel#O

'aation"his is the most direct wa# in which CRE is !romoting regional rebalancing ?or instance% if we wereto consider regional rebalancing in terms of infrastructure% it can easil# be demonstrated how CREhel!s to enable this ,s mentioned earlier% the Communit# &nfrastructure 5ev# (C&5) ensures that thegains from new develo!ments !rovide for new infrastructure "he lev# being localised means that

the revenues made are used to bene+t the local econom#"hrough handing more res!onsibilit# to local authorities% in terms of taation involving CRE% it is!roviding them with the o!!ortunit# to use the revenues in a wa# that will aid the develo!ment ofthe local area the most "his means that each area can bene+t more than if the government were tocontinue with a one siAe +ts allD attitude to taation "hus% we will s!end some time eamining theareas of taation that are localised% including C&5 and /tam! .ut# 5and "a% in order to show theetent to which CRE is leading the wa# in regional rebalancing "able

?urthermore% it would be worth ta$ing a loo$ at other areas in which local authorities are beinggiven more leewa# in terms of CRE ?or eam!le% one area to loo$ at in more detail would be nonJdomestic ratings% for which local governments have control over "his will become the case more%and more% often in the future% as other areas of the econom# follow the lead of CRE

"able 27 "ransactions and /.5" of commercial !ro!ert#%

2011J12

Number 4illion% G Qield% P

North East 3%1< 1%33

commercial real estate and the economy v2 (1)

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