Determining the right minimum wage has been an item of contention among economists for nearly as long as their profession has existed. Experts will argue about who wins and who loses when the minimum wage is high or low. Yet, as a real estate investor, I’ve often seen in practical terms how a change in the minimum wage can dramatically impact the real estate market.
This is playing out right now in Southern California in the wake of a decision by the City and County of Los Angeles to gradually increase the minimum wage to $15 an hour by 2020. While something needs to be done to assist low-income families, the sad reality is that higher wages translate into higher costs for companies, which often gives them a powerful incentive to pick up their businesses and take jobs elsewhere. Approximately thirty-five percent of L.A. businesses exist within two miles of another city. These businesses could end up cutting their labor costs by 10 to 15 percent by simply locating two miles away.
Hager Pacific owns and manages more than a million square feet of property in Los Angeles’ San Fernando Valley, making us one of the area’s largest private landlords. A number of tenants in the region’s industrial buildings have already communicated concerns about the effect of the minimum wage on their businesses, signaling that the higher cost of labor combined with increasing property expenses may drive them to relocate to other regions in Southern California, most notably the Inland Empire.
Because of its lower cost structure and business friendly cities, the Inland Empire has enormous competitive advantages over Los Angeles County and Orange County. As a result, real estate development companies have invested close to half a billion dollars in industrial real estate in the Inland Empire in recent years. According to the New York Times, the Inland Empire had more industrial space under construction in the second quarter of 2015 than any other city in America by a margin of some 10 million square feet.
These trends have a significant impact on our firm’s thinking as real estate investors. A few weeks after the minimum wage hike was announced, we explored purchasing a large industrial building in the City of Chatsworth, situated in the Northwest San Fernando Valley. At first glance, the property seemed to meet all of our specifications. Yet, we began to think twice about the deal as we considered the challenges of placing tenants in the building, given potential effects of the minimum wage hike over the long-term. Ultimately, we decided to pass.
How will Los Angeles’ industrial sector maintain its footing with ever-higher wages digging into the profit margins of local businesses and multinational corporations alike? Only time will tell, but our experience suggests a continued shift away from manufacturing to a predominantly service-oriented economy.
Ultimately, regional economies – like the eco-systems we find in nature— are delicate things. Even relatively small changes, like a sudden rise in wages or a new regulation, have the potential to destabilize the entire system in significant ways. Successful real estate investors are always looking for these kinds of changes, making bets that keep them one step ahead.