January 8, 2020
Activities: Administration, Economic Development, Housing / Shelter, Human Services, Public Works, Societal Benefit
Geography:
Demographics:
Annual ROI: 0.0%
Image source: Unsplash
When organizations talk about creating a “social return on investment,” it often comes in the form of improving GDP of a given area. But what is this really? By definition, gross domestic product is the total market for goods produced within a government’s borders — an overall proxy measure for the success of an economy.
It’s impressive and all, and we can all readily cite impressive GDP growth targets we’d like our country to achieve. But what does it actually mean for the city or state investing in social programs?
The main source of revenue for most municipalities is property tax. And this is influenced by two key drivers: property tax rate and property tax base.
Absent increasing tax rates, a city can devise strategies to increase its tax base, by either bringing in more tax-paying properties, or increasing the taxable value of its current grand list. And here we have our best opportunity to tie social ROI into something tangible for cities — correlating GDP with median property value.
An article by Asian Green Real Estate takes a look at this, examining this relationship across major regions across the world. Accordingly, over the past 45 years, median property values correlate by as much as 95% with GDP. Assuming even half this, gives us a conservative estimate to real social returns on investment that can be expected with many different social and nonprofit programs.
For residential real estate, the basic logic behind the co-integration of GDP growth and real estate capital returns arises from the fact that income has to be accumulated to buy a home. Income, in turn, can be directly derived from GDP with only a few adjustments. Studies in Asia, Europe, and the US reveal that median home prices correlate by as much as 60% to 95% with GDP per capita. In the long run the growth trends of both cycles typically correspond to each other. However, high correlation between GDP and real estate prices might not be given at all points in time. The prevalent real estate cycles do not always mirror GDP cycles, but often follow their own pattern. In the short and medium term real estate dynamics are not just driven by a country’s prosperity and depend on other determinants. These are, for example, urbanization rates, construction activity and demographical changes which all influence supply and demand temporarily.
For commercial real estate, the logic is similar, but investors of commercial buildings – unlike homebuyers – typically evaluate investment properties with respect to their expected income and, therefore, commercial property prices experience a different cyclicality. In general, for investment property the price is a function of current income (cap rate), expected income, opportunity cost (discount factor) and capital value growth expectancy. However, it can be argued that all of these are again highly affected by GDP, albeit in a slightly different way, because economic growth drives demand for commercial spaces.
In sum, GDP can act as reasonable estimator for the progression of residential and commercial real estate markets. Figure 3 exhibits the nominal GDP per capita history as well as the mean residential real estate prices in nominal terms for Switzerland, Germany, the United States, and the United Kingdom. All indices cover the years from 1970 to 2015. The data was collected from central national banks.
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