Palos Verdes, CA. With many states increasing the minimum wage, a demand for labor plays an important part to real estate investors. Why is this so important for these investors? |
Consider the following scenarios: Let us assume that the labor share and the profit margins remain constant at current levels of around 44% and 10% respectively, labor productivity growth continues to be weak at 0.5% and policymakers manage to push wage growth to levels of around 4%. The sum of the labor share of output and inflation has to grow at 3.5% per year.
Now we have reached the crux of the matter for real estate investors. Given that the labor share of output remains nearly unchanged, this implies that inflation rate would have to rise to 3.5%, drastically reducing returns, given that current inflation expectations for the next five years are barely over 1%. Such an outcome would be harmful to the economy and, hence lowering the outlook for the real estate market.
Secondly, higher wage costs given a maximum inflation rate of 2% and steady labor productivity growth of around 0.5% would lead to a much higher contribution of labor to output, and thus to lower profit margins. In such a scenario, the labor share of output would need to grow by 1.5% yearly, and as evidence shows profit margins would be compressed by nearly 1.3% per annum from their present level of 10%. Currently levels do not suggest that real estate investors are prepared for profit margins to halve over the next three to four years.
The hypothetical scenario of nominal wage growth accelerating to pre-crisis levels with productivity growth still stuck at current levels is just one potential outcome analyzed here to highlight the debilitating effects for real estate investors.
The actual outturn might deviate from this scenario on a number of parameters. Productivity growth could start to rise again based on the reasoning described above, or wages might fail to rise to pre-crisis levels. Alternatively, the burden of labor’s rising share of output might be spread among various real estate investments. However, and investors should bear this in mind when forming their assessment of possible future outcomes, someone has to foot the bill for the cost of lower productivity growth.
Increasing the minimum wage would have two principal effects on low-wage workers. Most of them would receive higher pay that would increase their family’s income, and some of those families would see their income rise above the federal poverty threshold. However, some jobs for low-wage workers would probably be eliminated, the income of most workers who became jobless would fall substantially, and the share of low-wage workers who were employed would probably fall slightly affecting low-income rentals.
Rather than pursuing policies such as minimum wage increases that create winners and losers, policymakers should focus on policies that generate faster economic growth to benefit all workers. While minimum wages may be a well-meaning attempt to help workers, economic research clearly shows that somebody must pay the price for any increase, and it is usually the least skilled and least fortunate among us.
ABOUT THE AUTHOR: Eugene E. Vollucci is the Director of The Center for Real Estate Studies, a real estate research organization. He is author of four best selling books and many articles on rental income investing, real estate in general and taxation. To learn more about the Center for Real Estate Studies and its educational resources, please visit us at http://www.calstatecompanies.com
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