Predicting the Real Estate Market

Economic Base Theory holds that basic industries and support industries are requisite for the population growth that spurs residential and retail development.

This post originally appeared on the Hermit Haus Redevelopment website on 2016-02-12.

When I wasn’t watching the rat race or helping prepare for the educational events at the Dallas conference this week, I was taking notes on what the speakers were saying. My biggest takeaway was to learn about economic base theory (EBT). Economist Robert Murray Haig first put forward the theory in 1928. It essentially says that jobs lead the economy both when it is getting stronger and when it is getting weaker. This is something that we all have intuited, but it was good to have this feeling stated overtly and have the underlying science behind it explained.

I won’t go into all that, but I do want to provide the sequence and define some of the terms used in the theory.

EBT holds that development happens in a specific order for specific reasons.

In Houston, the Medical Center has become a basic industry, providing more hospital services than the local economy consumes. People come from around the world. Photo source: Wikipedia

1. Basic industrial development

A basic industry generates more of a “product” that is required by the local economy. The surplus is exported. Exporting creates more jobs than the local economy would otherwise support. Basic industries create jobs beyond what the local economy would generate without them.

The important thing to remember is that manufacturing is only one type of exportable industry. In Orlando, tourism is a basic industry. In Omaha, it’s insurance. Real estate is not a basic industry because it can’t be exported, but real estate education can be. For most of our history, agriculture was a basic industry.

2. Support industries

Support industries such as accounting and consulting move in once the basic industry grows to the point where it becomes able to outsource these functions more efficiently than it can perform them in-house. Support industries equate to even more job creation.

Industrial development brings in jobs at all pay grades. Some of the new people will demand single-family homes of various prices. Others will drive demand for multifamily development. If you’re going to invest in real estate, you must understand the basic industries that support the real estate market where you work.

3. Residential development

The basic and support industrial job growth create demand for additional housing once they have demonstrated that the jobs are there to stay (whatever that means). Workers like to live near where they work.

4. Retail development

As families move into the area to take advantage of the job growth, they need to buy things. Again, most consumers prefer not to travel very far to buy groceries or clothing.

In rural areas, the school district often is the largest employer. Education is like retail in that it depends on the strength of the local economy to survive. If the basic industry goes away, both retail and education will have to downsize and may eventually become completely unsupportable.

Finally, the advent of internet commerce slows down the demand for retail development and speeds up the deterioration of the retail market if a basic industry moves out without replacement. In fact, you may now see demand for retail space decrease even in a stable economy.

This model can help predict the direction a real estate market will move. It is not 100% predictive because the real estate market is imperfect in that everyone is working with incomplete information, each individual property—single family, multifamily, commercial, or industrial—is unique, and a single seller controls the availability of each property. Nevertheless, we all need to understand the direction our local economies, and therefore our local real estate markets, are moving.