Viewpoint
Article Type: Viewpoint From: Journal of Property Investment & Finance, Volume 33, Issue 5.
For much of the last two decades globalisation has dramatically increased the supply of labour and capital. Enterprise and growth have flourished as a result. Land has also felt the effects of this process.
Classical economists believe that land, labour, capital and enterprise are the factors that combine, in varied measure, to produce growth. Each makes a differing contribution in the economic interactions and growth that result from the process of making things. Such roles change over time as their relative productivity changes.
It is hard to control relative productivity. Life is not a linear progression of gradual improvement. Resources run out, machinery wears out, fiat capital can be devalued and workers age. The economy’s ability to keep grinding out growth has evolved a dependence on an enterprising culture that allows us to do more, for less and for longer. Technology is at the centre of that creative process. Given, we have increased our productivity by more than 1 per cent annually since Stevenson harnessed the power of the steam in 1830[1], we should probably now accept that technological innovation is a treadmill that we cannot now afford to get off.
Confronted with such a dynamic, changing landscape, it is no great surprise that when money markets began to innovate financial securities to feed the need for investment capital, many people moved their newly made financial fortunes from business ventures into land. The importance of land as a factor of production has been more stable and, after all, as the saying goes, they aren’t making any more of it! For hundreds of years productive land has been a scarce, highly contested resource. It became acutely contested in the 1800s as the industrial revolution drove incredible urbanisation. War, legislation, taxation, natural catastrophes and man-made financial disasters have all attempted to dislodge its appeal, but time after time, crash after crash, crisis after crisis; still, people are prepared to pay a multiple of their net worth for the capacity to provide themselves with the staples of access to food, work, shelter and warmth.
Today our world can still be seen as dystopian. We continue to live with a profound sense of uncertainty. This is a function of continuing change. It is easy to attribute our unease to the ubiquitous effects of technology and global conflict that is magnified by the media, but the reality is that there are other productivity factors at play. Our labour force is ageing,it is shrinking in its relative importance and some would say that we are increasingly lazy. The only way to maintain its productivity is to expand our labour markets to include countries that we believe to be profoundly politically unstable to reduce costs. This is unsettling for many communities. At the same time the demand for high-value foodstuffs is rising and global supply is struggling to keep pace as weather events reduce yields. Likewise commodities extraction rates encourage us to believe that production of oil and other critical materials are reaching their natural limits placing pressure on us to innovate faster. At the same time, we have seen the productivity of capital decline dramatically – countries are devaluing,interest rates are low, investment capital is moving slowly and profit growth is modest. The productivity of food output,commodities output, financial output and labour output seems to be changing a lot, we are responding with more enterprise and innovation but increasingly there is an unshakeable sense of uncertainty in developed markets.
In such an uncertain environment the stability that land offers has a significant intuitive appeal. The rural land stock in the UK has remained, for the most, part static. The total supply of urban land remains broadly the same, but in the UK since 1990, brownfield development preference has meant that unused urban land stock has gradually been soaked up. This has triggered waves of incremental infrastructure expansion and redevelopment activity. As the benefits of “place-making” have become more clear cut, this has also facilitated flexible approaches to planning and use designation that have contributed to even faster urban transformation. The net result has been that demand has outstripped supply. Land is being more used more intensively and prices have gone up in response.
Key to this trend has been the process of increasing urbanisation. The “Millenials” are particularly important to the continuation of this trend towards urban agglomeration. As the spawn of the “baby-boomers”, they are an important generation and with many being borne into an epic recession, they are increasingly beating the same path trodden by economically disenfranchised agricultural workers of the industrial revolution. They have marched to the cities. Our modern day “Jarrow marchers” have beaten a somewhat less disruptive path than their predecessors. After a quick week of camping outside St Pauls Cathedral in 2009, they now seem to have harnessed their inner-innovator and with some help from the business community and government have begun to create a new entrepreneurial growth surge. London is clearly reaping the benefits this trend, with over 100,000 new arrivals joining the ten million person morass every year. This sets up the potential for a persistent supply/demand imbalance that is, almost as we speak, driving up rents and prices in the capital.
Similar trends are not as clear in Europe, but it seems clear that working age population is growing quickly in almost all of our largest cities. Population is flowing from the rural hinterlands into the cities and the greater the rural privation and distress, the faster the flow. Europe’s working age population is static but its cities are filling up with technologically adept, young, cheap, educated, skilled, enterprising, globalised, motivated, productive young men and women. That seems to us to be good reason to be optimistic.
What does this mean for investors? There are always risks in investing. What are these factors today? Disease, climate change,terrorism, war and nuclear proleration all come into the equation. Technology itself is right up there, geo-politics and resource scarcity clearly all have a role in determining risk. We could easily drive ourselves insane trying to second guess what will surprise us next. The challenge is to recognise that as we continue to innovate and strive, the big risks that we fear may be reduced by the growth and innovation that we foster.
Equally as investors we need to recognise that it is not the big risks that we know about and fear that matter because we compensate for them in relative prices. The risk is that we do not know or fail to understand, trip us up because they destroy capital permanently. Fortunately, flattening the built stock inadvertently is a very remote risk. In practice when it comes to property, the risk of capital destruction is usually about the asymmetric impact of leverage. Property is good collateral for leverage because produces an income and you can expropriate it, without it running away. As a result, banks are inherently predisposed to lending against it. When this goes wrong, the extensive and excessive use of leverage almost inevitably means that a big downside surprise in the economy can have a massive effect on property prices, leading to repossession, insolvency,liquidation, permanent loss of capital and banking crises. Unfortunately, our predisposition for debt leant at the margin,means that no matter how good the supply/demand dynamics might be, property will continue to rollercoaster its way from peak to trough with unerring regularity. This is, in our view, why property is the preferred investment for the savvy entrepreneur and why, time and again, banker’s fortunes are wrecked on the rocks of property cycles. Although pro-cyclical policies and high capital requirements might slow this down, it is hard to see the cycle disappearing completely. As such, we believe it makes sense to monitor the balance of supply/demand, the use of bank credit and aggregate leverage and to spend a little time thinking about big “fat” events that have the capacity to change the consensus so rapidly that they might unseat received wisdom without warning, both on the downside or, indeed on the upside. If you can do this then perhaps, you can find your own ocean of calm amidst even the most turbulent seas of globalised uncertainty.
Simon John Martin
Note
For a detailed exposition of UK growth since the Industrial Revolution please visit: www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb100403.pdf
