economic base analysis the foundation of highest and best use

Economic Base Analysis – the

foundation of Highest and Best Use Appraisal Institute Fall Conference

November 1, 2012

Gary S. DeWeese, MAI

Principal, Real Estate Strategic Solutions, LLC

[email protected]

Appraisal Institute | Advanced Market Analysis and Highest & Best Use Slide 2

Economic Base Analysis (EBA)

Economic base analysis.

A survey of the industries and businesses that

generate employment and income (and hence

the demand for real estate) in a community as

well as the rate of population growth and

levels of income, both of which are functions

of employment.


Economic Base Analysis (EBA)

Economic base analysis.

Answers the question:

If employment increases by “X”, what

will happen to demand for a certain

property type?

Appraisal Institute | General Appraiser Market Analysis and Highest & Best Use Slide 4

Market Value

Market

Analysis

Highest

& Best Use

Principles of Supply

& Demand

Foundations of Market Value


EBA: Where does it fit in valuation process?

.

Market Analysis

(Demand and

Supply)


EBA: Level A, B or C?

Primarily a function of

1. Market conditions on effective date

2. Complexity and size of property

Other considerations

3. Needs of client

4. USPAP (credible results)


EBA: used in Level C Market Analysis

C

Complex Property

Large Property

Unstable Market

Simple

Property

Small Property

Stable Market

Level A

Timing Is NowLevel C

Timing Is Issue

Level BTiming Is

Probably Now

3 of 3 2+ of 3

1 of 3


Six-Step Market Analysis Process

Step

1. Analyze property productivity.

2. Delineate the market area.

3.Project/Forecast demand.

4. Measure and project/forecast

competitive supply.

5. Calculate marginal demand.

6. Project/Forecast subject capture.

.


EBA – uncovers growth drivers of demand

EMPLOYMENT GROWTH

GROWTH IN OFFICE

SPACE

GROWTH IN INDUSTRIAL

SPACE

GROWTH IN HOUSING

GROWTH IN RETAIL SPACE


What’s in the “black box” of EBA?

.

.

EBA


EBA: Employment Hierarchy

Basic employment

Produce output that is exported

from local economy

Typically manufacturing & local resource

oriented businesses, (e.g. technology in Bay

Area)

Denoted as Eb


Non-basic or secondary employment

Produces goods and services for local economy

Denoted as ES



Total employment

Denoted as Et

Et = Eb + Es



Step

1 Identify the geographic extent of the local economy.

2 Identify the basic industries in the local economy.

3 Estimate total basic employment for the community.

4 Calculate the economic base multiplier and other employment-linked ratios.

5 Forecast future basic employment.

6 Forecast future total employment and any other factors linked to employment.

Economic Base Analysis


Step

1 Identify the geographic extent of the local economy.

Typically defined by political areas (city, county,

region, usually depends on how data is

presented)

Often a combination – MSA

Main concern

– Local economy must contain basic industry

EBA: Economic Base Analysis


3 Approaches

1. Judgment

2. Direct survey

3. Location quotient (LQ) – focus will be on this!


Step



Step


Judgment approach

1. Based on analyst’s opinion

Can rely on available data + observation

2. Easy to apply

3. Possibility for inconsistent results



Direct survey approach

1. Interviews with representatives of major

employers

Proportional sales to outside economy equal

proportional employment in base industry

(e.g. if 80% of company’s revenue is sales

o/s local economy, it is assumed 80% of its

employees are engaged in basic industry,

leaving 20% counted as non-basic)


Step



Direct survey approach, continued

1. Reproducible empirical results (i.e., from actual

companies)

2. High administration costs, difficult to collect data,

sampling error make this approach somewhat

impractical


Step



Location quotient approach

1. Measures the relative concentration of a

given industry in a given place

2. Employment used as a measure of

economic activity


Step



LQ = LEi ÷ LEt / NEi ÷ NEt

Where

LE = Local Employment

NE = National Employment

i = industry being analyzed

t = total employment


Step



( County United States

NAICS 334111 Computer Software

26,000 300,000

Total private sector employment

500,000 150,000,000

Employment ratio 0.052 0.002

Location Quotient = (26,000/500,000)÷(300,000/150,000,000)

= 0.052 ÷ 0.002

= 26




Step


Location quotient approach

Basic industry if LQ > 1

Non-basic industry if LQ ≤ 1


Step

3 Estimate total basic employment for the community.

Most communities have more than one basic industry, but assume for this example that computer software is the only basic industry. If not, the other basic industry jobs would have to be included.

Must factor out non-basic employment from basic industry (see next slide)



Location Quotient = 0.052 ÷ 0.002 = 26

Non-basic employment

0.002 × 500,000 (i.e.

surrogate for the % of basic industry employees performing non-basic type jobs=

1000 non-basic employees (e.g. truck drivers, secretaries) work in the basic industry

Basic employment = 26,000 – 1000 = 25,000

Alternatively:

Basic employment = Total local employment in basic

industry × (LQ – 1) ÷ LQ

= 26,000 × (26–1) ÷ 26 = 25,000



NAICS

Code

Economic

Sector

Local

Employment Local %

National

Employment

National

% LQ (LQ-1)/LQ

Basic

Employm

ent

Non-

Basic

Employ

ment

Computer

software 26,000 5.2% 300,000 0.2% 26 0.9615 25,000 1,000

Total private

sector

employment 500,000 150,000,000

Total

Population 1,100,000 311,000,000



Step

4 Calculate the economic base multiplier

Ke = Economic base multiplier

Ke = Total employment in the county ÷ basic

industry employment

Ke = 500,000 ÷ 25,000 = 20

Every basic job supports about 20 total jobs If other basic industries exist in subject market, then

denominator changes for Ke Relationship assumed to remain constant over time



Step

5 Forecast future basic employment.

Sources

News reports

Basic company plans

Announcements of relocations

Reports of planning agencies or economic

development departments

Consider national trends (interest rates etc.)



Step

6 Forecast future total employment and any other factors linked to employment.

ΔEt = ∆Eb × Ke Where

ΔEt = change in total employment

ΔEb = change in basic employment

Ke = economic base multiplier

Can be done based on change in basic employment (ΔEb ) for a market or a specific company



Ke

Economic Base Multiplier

x ΔEb = ΔEt

20

x 200 = 4,000

Say Computer Software firm will add 200 new basic jobs over N5Y. What is the expected change in total employment N5Y?



Step

6b Forecast future total population change

ΔPt = ∆Et × Kp Where

ΔPt = change in total population

ΔEt = change in basic employment

Kp = population base multiplier (next slide)



What is the expected change in population in the next 5 years? Calculate the population multiplier.

Kp = Total community population ÷ Total employment

Kp = 1,100,000 ÷ 500,000

Kp = 2.2



Impact on Population

Kp

x ΔEt = ΔPt

2.2

x 4,000 = 8,800



How does this translate into demand?

. EMPLOYMENT GROWTH (200) FROM NEW SOFTWARE FIRM

OFFICE SPACE SOFTWARE FIRM’S WORKERS

EMPLOYMENT GROWTH (4,000) IN TOTAL JOBS

INDUSTRIAL

RETAIL

OFFICE

POPULATION GROWTH (8,800)

HOUSEHOLDS

SFR

RENTAL


Cautionary Notes re: EBA

1. Particularly valuable in smaller

communities

2. Multipliers vary depending on

community size

Lower EBA multipliers associated

with smaller communities

3. Best suited for short-term analysis (<

5 years)


Sources of information: EBA

Commercial sources such as:

www.stdbonline.com

www.buydemographics.com

www.claritas.com

www.scanus.com

http://www.stdbonline.com/

http://www.buydemographics.com/

http://www.claritas.com/

http://www.scanus.com/



Non-commercial providers such as:

www.bls.gov

www.factfinder.census.gov

chambers of commerce

regional councils of government (ABAG)

state employment offices, franchise tax boards

Universities (UOP, UCB Fisher Center)

www.economy.com

http://www.bls.gov/

http://www.factfinder.census.gov/

http://www.economy.com/



REIT websites Prologis http://files.shareholder.com/downloads/PLD/1998542800x0x475087/2DD86B87-02E7-42C8-9828-95290DA2F3D8/AMB_IBI_May2011_final.pdf Proprietary industrial index Essex Property Trust http://www.snl.com/Cache/1500041955.PDF?D=&O=PDF&IID=103163&Y=&T=&FID=1500041955 BRE PROPERTIES http://www.snl.com/Cache/1001167859.PDF?D=&O=PDF&iid=102924&Y=&T=&fid=1001167859 http://www2.snl.com/Cache/c14149576.html http://www2.snl.com/Cache/1001167857.PDF?D=&O=PDF&iid=102924&Y=&T=&fid=1001167857 EQUITY RESIDENTIAL TRUST http://investors.equityapartments.com/Cache/14163760.pdf?O=3&IID=103054&OSID=9&FID=14163760 These sites also have information regarding land purchase prices, construction cost estimates, sales prices and revenue to extract GRMs, cap rates and yield rate information

http://files.shareholder.com/downloads/PLD/1998542800x0x475087/2DD86B87-02E7-42C8-9828-95290DA2F3D8/AMB_IBI_May2011_final.pdf









http://www.snl.com/Cache/1500041955.PDF?D=&O=PDF&IID=103163&Y=&T=&FID=1500041955

http://www.snl.com/Cache/1500041955.PDF?D=&O=PDF&IID=103163&Y=&T=&FID=1500041955

http://www.snl.com/Cache/1001167859.PDF?D=&O=PDF&iid=102924&Y=&T=&fid=1001167859

http://www.snl.com/Cache/1001167859.PDF?D=&O=PDF&iid=102924&Y=&T=&fid=1001167859

http://www2.snl.com/Cache/c14149576.html

http://www2.snl.com/Cache/c14149576.html

http://www2.snl.com/Cache/1001167857.PDF?D=&O=PDF&iid=102924&Y=&T=&fid=1001167857



http://investors.equityapartments.com/Cache/14163760.pdf?O=3&IID=103054&OSID=9&FID=14163760

http://investors.equityapartments.com/Cache/14163760.pdf?O=3&IID=103054&OSID=9&FID=14163760


.

economic base analysis the foundation of highest and best use

Documents