Another day, another article about Silicon Valley as the next Rust Belt. Right now, such claims look absurd. The Bay Area has never been wealthier. But that's just the problem. Primary commercial real estate markets are tapped out:
The research arm of NAIOP, the Commercial Real Estate Development Association, released a Feb. 10 report pointing to secondary, or smaller, markets as the wave of the investment future. That’s because high-quality real estate properties in primary markets — mostly big, coastal cities such as Los Angeles, New York, Chicago, Miami, Seattle and Washington, D.C. — have pretty much recovered the property values they lost in the downturn. That means fewer bargains for investors looking to add value and reap big returns relatively quickly.
So investors are looking toward secondary markets, which include Las Vegas, Salt Lake City, Phoenix, Baltimore, Cleveland and Pittsburgh. But interest won’t spread evenly to all markets: The NAIOP study says money will favor secondary markets with “a high concentration of skilled workers and a track record of innovation.” What’s more, the report adds a caveat about economies dominated by a single industry.
The best arbitrage opportunities are in secondary markets where the Legacy Economy is strong. In Pittsburgh, investors will find a high concentration of skilled workers and a track record of innovation. Pittsburgh will attract investment. Las Vegas won't. The reason for this disparity is a perceived liability: Pittsburgh's historical dependency on manufacturing to drive the regional economy. The definition of legacy assets:
Legacy assets can often be perceived as a burden, such as an extensive transit system with deferred maintenance challenges or a network of narrow streets that impede automobile throughput. But that's how arbitrage makes money: by seeing value where others see burden. Narrow streets do limit automobile volume and speed, but they also create the foundation for walkability and its many co-benefits. The pivot from liability to asset describes the strategy that many metropolitan areas appear to be using to chart an economic development agenda.
Because of the concentration of manufacturing, the very feature that sent the region into a death spiral, Pittsburgh was a center of innovation and built world class research universities. Thanks to steel, Pittsburgh produces the talent that Silicon Valley so desperately needs. Pittsburgh has made the pivot from liability to asset.
Success killed the titans of the Manufacturing Economy. High wages in steel factories and automobile assembly plants made a suburban life affordable. Today, success is killing the titans of the Innovation Economy. High wages in innovation factories make a downtown San Francisco life affordable, for some. Silicon Valley is making the pivot from asset to liability as Detroit did some 50 years ago.
The cost of innovative talent is too damn high, in primary markets. The cost of labor in Detroit and Pittsburgh used to be too damn high. So business sought out geographic arbitrage. Business in primary markets is seeking out geographic arbitrage in secondary markets:
Over the next decade, Wall Street banks will cut in half the proportion of support staff they have in pricey cities like New York and London and shift those workers to less expensive cities in the developing world, according to a projection by consulting firm Johnson Associates Inc. ...
... "The industry is under huge cost pressures and that's one way to save money," said Alan Johnson, who heads the firm and helps large financial companies develop compensation plans. "As you look at the cost differentials, and with technology making it easier to do things from remote locations, firms plan to have fewer people here."
I learned from Enrico Moretti that when labor costs start to become an overwhelming bottom line concern, the economy is converging (i.e. dying). In New York and London, finance is dying. In London, innovation is dying and the Legacy Economy is taking over Silicon Roundabout. And don't forget: Silicon Valley is the next Detroit.