You can’t blame the virus for poor productivity | EG News

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The UK’s unemployment rate rose to 4.8% in the three months to September, up from 4.5% in the previous quarter. This figure is expected to reach 7.5% as we get closer to the bottom of Rishi’s Free Money Pot. The metrics across the pond are not much different. Prior to the pandemic, the US entered 2020 with an unemployment rate of 3.5%. At the end of October 2020, it stood at 6.9%.

Stark figures. But are we blaming the virus for what was already a brewing macroeconomic problem?

Despite increases in employment in the past decade, the average wages adjusted for inflation are lower than they were a decade ago. The last decade may have been job-rich but it has been wage-poor. Coronavirus or not, the UK economy was spiralling into stagnation and it is all due to its very poor productivity. And real estate is one of the least productive industries on the books.

What is productivity?

Before we consider the property productivity problem specifically, it is worth delving into what the term means. Commonly defined as a ratio between the volume of output and the volume of input, productivity basically measures how efficiently production inputs, such as labour and capital, are being used in an economy.

The importance of this measure is best expressed by Paul Krugman in his book The Age of Diminishing Expectations: “Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”

To understand how and why our lifestyles are linked to productivity, we need to think of the economy as our personal income statement. To earn money, we put in labour hours as well as capital investment. We all get exactly the same 24 hours a day but some of us produce more economic value than others. In addition to our man hours, some of us invest capital. For each dollar, some activities create more value than others. If we produce more income with fewer hours and capital invested, we will have more time and money for excess, which is what we call lifestyle.

Countries are just a sum of this individual understanding of productivity. Unlike the UK, the Singapore economy has been increasingly driven by productivity growth rather than employment growth in recent years. It has not added as many jobs as the UK but it has encouraged more productive sectors such as finance, insurance and even manufacturing at the expense of less productive sectors like construction and real estate.

How unproductive is real estate?

The above statement and Singapore’s approach may suggest that the real estate sector is purely an economic drain. This, of course, is not the case. As an industry, both in the UK and globally, it comprises many activities that contribute to the economy. These include property investment, development and management, which can then be separated into multiple asset types. As a result, there is no singular metric of productivity to benchmark the industry.

It is true, however, that the output value produced from the industry is often work done by capital and the industry’s labour market simply supports the capital. When capital is cheap and able to produce additional value just based on the competitive nature of capital deployment, it allows for the labour market to be forgiven for inefficiencies, which are often hidden by the increase in output as a product of the efficient use of capital.

The marginal productivity measure of real estate — especially commercial real estate — has often been skewed by the assumption that the bottom line continues to expand. But with the demise of some asset classes accelerated by Covid, the role of the labour market in real estate is becoming more important.

In simple terms, if adding an extra employee to the payroll brings more revenue than that employee costs to hire, then hiring the employee is productive. On the other hand, if the wage and the hiring costs (including costs like rent, benefits, tech licence fees) exceeds the extra sales and income, then it was a bad hire.

Once you reach an optimal number of people, there is a diminishing return to your marginal productivity. It’s what is best known as being overstaffed. Every pound or dollar spent is now giving you less return and, by definition, is now less productive. In this scenario, you either need to increase your profit per employee cost or reduce the cost for every pound of profit.

The digital solution

It is the adoption of technology in most industries that supports diminishing return. Employees are armed with technology and tools which reduce the need to add additional employees where there is no marginal advantage.

Productivity is often misunderstood to be a function of cost. It is actually all about earnings. The tech giants Facebook and Apple both make $400,000 per employee in margin. Alphabet (Google) and Microsoft make $250,000 per employee. These are businesses which function at the scale of countries, with highly paid productive teams generating more value per dollar and person hour than any enterprises in the past. The only companies to beat their productivity are financial and energy enterprises which optimise both the capital market and the labour markets.

The problem is that the property sector struggles to accept that its contribution to the economy is capital-driven at best, while neglecting all potential for intellectual capital.

There are very few, potentially no, products which include scalable use of the asset. Nor has the sector yet built or invested in any technology which can bring a true step change. As every sector, industry and asset class rethinks its existence in the new world, the property industry must act now to avoid being left holding the keys to a sector characterised by diminishing productivity.

How? Transition people who can’t or won’t change, make technology and scalable strategies the core of your new approach, experiment — the worst case is that your tech team will fail but your wider business will learn and be better prepared for some improvements. And finally? Try to understand your unique problems.

Tripty Arya is founder and chief executive of Travtus

Originally published at https://www.egi.co.uk on November 26, 2020.