sq.ft and The City
‘I’ve spent $40,000 on shoes and I have no place to live? I will literally be the old woman who lived in her shoes!’??Carrie Bradshaw, Sex and the City
Bright city lights
In HBO’s 1998 series, New York City stands as an unwavering companion on the eponymous heroine’s life journey. Appropriately, the series finale takes place in another metropolis, Paris.
The allure of the big city has not changed since the turn of the century. In fact, urbanisation, along with technological change and global warming, is one the secular megatrends of the 21st century according to a leading investment management body[1]. The UN projects that by 2050, 68% of the world's population will live in urban areas. That is an extra 2.5bn people in cities, mainly in Asia and Africa.[2] In Europe by 2050, urbanisation levels are expected to reach 83.7% in 2050.[3]
Why do people create cities and more importantly, decide to habituate in them? Classical economists attribute existence of cities to so-called location fundamentals: workers and firms cluster in cities due to benefits cities provide. [4]? One of the biggest drivers of location decisions are transport costs. Historically, these have been high. People travelled by foot and water was one of the main modes of transport for goods.
This is why out of all modern capitals in Europe, only one is not built around a body of water. This exception is Madrid, the creation of which was largely a political decision driven by internal politics of the Castilian court.
Classical Location Theory
Firms as rational agents, seek to find location which minimises the costs of doing business, therefore maximising profits. When firms and customers are close to each other, costs are reduced. Production of manufactured goods becomes cheaper; firms make bigger profits and consumers can access cheaper goods. This is one of the main tenets of the Classical Location Theory.
To be sure, there are significant externalities caused by cities that one needs to consider when clustering of people in small spaces.
However, starting from mid-20th century, these location dynamics started to change. The advent of cheap oil and the container revolutionised transportation and international trade, making them more cost-effective. Modern globalisation began. Concurrently, the explosion of knowledge-based economy in the west meant that information became a currency of trade, rather than a physical widget. This, in turn, reduced the need for transportation, simultaneously increasing the need for telecommunications to transport the emerging ‘commodity’.
Agglomeration Economies
Cities continued to grow in size and number. Some of the reasons for growth can be attributed to Agglomeration Economies, also known as, economies of scale. These are synergies resulting from clustering:
Cost Saving
Firms save money and time and can respond quicker to changing customer needs through more frequent interactions. This is why retail occupy central districts in the cities- these areas offer higher concentrated footfall which reduces customer acquisition cost.
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Sharing of services and infrastructure
Examples are financial districts such as the City of London or Canary Wharf. By locating in close proximity, firms can offer customers a full suite of A-Z of professional services. They can also share resources; i.e. professional services firms rely on legal services as much as banks and financial services providers. It makes sense for all of them to be clustered together.
Knowledge effect – proximity of ideas
When invention by one firm leads to similar inventions in the cluster, thus creating a positive feedback loop of innovation. Prime example is the Silicon Valley, but also London’s coffee shops in Victorian times. One particular coffee shop was a place of congregation for merchants and sailors who exchanged news and ideas about maritime shipments and weather on the high seas. This led to the establishment of the Lloyds insurance syndicate.
Labour market pools
Close proximity of qualified labour. The Silicon Valley or the Biotech sector which is located around the leading Russel Group universities in the UK.
Specialisation and division of labour
Businesses add value by specialisation. Example: London’s film industry is a centre of global entertainment production where Hollywood films and produces a lot of its content. As a result, the city is a host to over 4,500 production companies that employ around 50,000 people. The Harry Potter film franchise is just as instrumental to London’s real estate as the city’s parks and property laws. Perhaps this explains why politicians of all masts love to create ‘hubs’ because they offer a huge multiplier effect.
Conclusion
This article explored the reasons why humans choose to build and live in the cities and why workers and firms locate within close proximity. There are benefits for all – firms that compete with each other, and firms that are in different sectors. Food court yards are a good microcosm of a city. Food courts have many vendors offering various cuisine options, they all compete for the same custom. Food vendors are competing with each other, but by clustering together, vendors stand to benefit collectively from increased footfall. The benefit occurs due to increasing specialisation and location.
Real estate remains a sound long-term asset class, despite price fluctuations caused by interest rates, bubbles and pandemics. What underpins real estate values are location fundamentals of agglomeration economies and the long-term urbanisation trend. And whilst some may prefer investing in Jimmy Choo shoes (no judgement), long-term value will continue to be created around places where humans live and create next to each other.
Disclaimer:
The information provided in this article is for educational and informational purposes only. It does not constitute an offer to solicit any securities, nor is it intended as financial advice. The views expressed herein are strictly those of the author and do not necessarily reflect the opinions or positions of the company. Readers should consult with a qualified financial advisor before making any investment decisions. The company disclaims any responsibility for actions taken based on the content of this article.
[1] According to the CFA Institute.
[4] The theoretical material for this article is sourced from the London School of Economics Online Real Estate Certificate Course, 2019 LSE.