Find out how trends in business establishments and failures directly affect real estate by influencing where employees live and how much they earn.
This article is the first of a two-part series examining business starts and their economic effect on California real estate. Stay tuned for part two, a discussion of GDP and real estate.
California: Bad for business?
California is perceived by the brokerage community as an unfriendly abode for businesses due to high taxes and heavy regulation. It is true California’s 8.84% business income tax and 7.5% sales tax rates place it among the top ten most heavily taxed states in the U.S. — but that doesn’t necessarily mean it’s bad for business when tax revenues are properly invested.
In fact, California ranked fourth highest in net job creation in 2013, according to Next 10’s California New Business Creation study published in December 2015. The study analyzed the Census Bureau’s Business Dynamics Statistics data, which also revealed California ranks:
- fifth in new business establishment entry rates; and
- fourth in job creation resulting from new business establishments.
The state’s high rank in new business and job creation bleeds directly into California’s real estate industry. People want to live in areas where business is good for their wages and profits. As a result, California real estate markets are hot where businesses thrive.
However, not all regions in California contain lucrative business environments and high standards of living. In fact, areas with high business success are quite localized, explaining the current trends in high-demand coastal, urban markets and floundering outliers in the peripheral valleys.
Localized business trends in California
With the sixth largest economy globally and 13% of the U.S. population, California is home to five of the 20 counties upholding half of national new business establishment growth, according to the Economic Innovation Group’s (EIG’s) New Map of Economic Growth and Recovery survey. These California counties include:
- Los Angeles County;
- Orange County;
- San Diego County;
- Santa Clara County; and
- San Francisco County.
San Francisco and Santa Clara Counties represent top tech hubs in the northern part of the state, while Los Angeles, Orange and San Diego Counties uphold the flourishing industries of the state’s south: manufacturing, distribution and entertainment in LA, and education, health and military in San Diego.
These counties’ new business establishments, or startups – which account for a quarter share of the 166,560 startups established nationwide between 2010 and 2014 – fuel their thriving industries and in turn high demand for their real estate.
California isn’t the only state to benefit from the high concentration of new business establishments. Texas has an equal share of the 20 counties establishing new businesses, with five of its own counties making the short list. Thus, the two powerhouse states combined account for half of the nation’s new business establishments, according to the EIG.
Other contenders include Florida, with four counties, and New York, with three counties. Arizona, Illinois and Nevada round out the list with one county each.
Thus, California’s responsibility for one quarter of the nation’s new business establishments sounds like success, and it is — for those five urban hubs in which new businesses thrive. The aforementioned counties with high employment prospects starkly contrast areas of California – and across the U.S. – which see instead steadily declining rates of new business establishment. In these regions, the lack of startups alters the business climate, which now leans toward older firms — not a good trend for anyone except those long-standing firms who find themselves without competition.
Startups and closures determine business age
However, California’s statewide economy reveals a gradual decline in new business establishments, despite its flourishing urban hubs. New California businesses overall dropped from 17% in 1977 to 12% in the 1990s, then as low as 10% in the Great Recession, according to Next 10. Fewer new businesses lead directly to lower turnover in housing, holding back the real estate economy of the state.
In accordance with California’s declining business trend, the number of startups established across the U.S. amount to:
- 420,850 from 1992-1996;
- 400,390 from 2002-2006; and
- 166,460 from 2010-2014.
The drastic dip in startups from the early 2000s to the 2010s results from the dire effects of the financial crisis and subsequent Great Recession. Economic turndowns with long recoveries – the secular stagnation presently being experienced – make recovery more difficult than during previous recessions for lack of individuals willing to strike out on their own in startups.
Continuing the analysis by decade according to the EIG, business closures exceeded business starts across the nation by:
- 17% from 1992-1996;
- 37% from 2002-2006; and
- 59% from 2010-2014.
The direct result of diminishing startups is the vast and growing share of the economy now occupied by older businesses. The share of businesses aged at least 16 years increased from 23% of the national economy in 1992 to 34% in 2011, according to a study by The Brookings Institution in 2014.
These older businesses in turn employed 77% of American employees in 2011, compared to 67% in 1992. Employees flocked to older businesses since they lacked employment alternatives normally supplied by startups. Thus, wages are affected by reduced or static sources of employment.
Another reason for the increased role of older firms is the increasing rate of business failures. The percentage of failed startups one year old or less rocketed from 16% in the 1990s to 27% in 2011. However, startups aren’t alone in this trend. Failures increased for businesses of all ages from the 1990s to 2011 — except 16-year-old or older establishments, which presumably had the reserves and wherewithal to weather tough economic times.
California’s inland or rural areas reliant on older businesses are less likely to draw in homebuyers and renters, limiting both business and real estate potential in those communities. However, California’s significant share of national new business establishment growth means the net rate of business establishments in the state remains positive despite the overall national decline.
Resolving unsupportive business conditions
Consideration of these factors brings us back to the beginning: hyper-concentration of new business establishments and job creation provides disproportionate benefits in different areas of California.
The California counties in which new businesses and jobs flourish are also the locations of significant home price appreciation. Where jobs and startups accumulate, employees follow. Hence, the lightning-speed escalation of home and rental prices in the state’s most populous counties. Massive sums of money are spent on construction of housing to entice more individuals in these counties.
The rest of the state, however, will not fare so well without continuous development in the business sector. Inland and rural counties lack the siren call of new jobs created by startups fostering change that leads employees to come and invest in their respective local housing markets. Older businesses with less flexibility than startups cannot accommodate even locals seeking employment (and those they employ take home lower wages), causing many to flock to urban hubs — further widening the gulf between major coastal cities and smaller inland communities.
Accordingly, agents and brokers operate businesses of varying productivity between slow inland markets and viciously competitive urban markets. Agents working in highly populous areas see more activity and financially better prospects — an incentive condition which draws brokerages and other real estate-related businesses to urban hubs. Since California’s business environment is incredibly localized, agents will flock to areas rife with flourishing businesses startups – and, naturally, more homebuyers and renters – to reap the benefits of turnover and accompanying rental and sales volume.
Part two of this article series will analyze the state and national Gross Domestic Product (GDP) and its relevance to California’s real estate industry.