Originally published July 2023.
Another instalment in a series of articles detailing how to design a secure, income-producing portfolio.
It was in the most unlikely of locales that I first learned how to win with hard assets. The year was 1988, and the place was Galveston, Texas. At that time, I was working in commercial real estate in Boston. My brother was in medical school in Galveston, and I decided to take advantage of all that Gulf sunshine and go down for a visit. While I was there, it occurred to me to tour some real estate in nearby Houston.
Boston at that time was in the midst of perhaps the greatest boom the city has ever seen. Michael Dukakis was governor and the biotech industry was exploding. Condos and office buildings were springing up all along route 128. Prices were through the roof. Down in Texas, meanwhile, I walked through buildings that appeared in every way to be identical to ones back in Boston. I looked at buildings where the going rental rate was $1,000 per unit, just as it would have been in Boston. But to buy the building outright would cost $3 million in Boston, while in Houston, I discovered, the price was around $500,000 – a sixth of the Boston rate.
I had a sudden realisation that I could do more business per square foot in Texas than Boston, despite boom conditions in the latter. The cost structure plus the taxes, not to mention wages for maintenance and management, were all much lower down in the Lone Star State. On top of that, it was an especially opportune time to buy in Houston, because an energy bust had caused a regional economic downturn, which pushed down prices. Yet there was every reason to think Houston would bounce back.
The first deal I closed in Texas was the purchase of a building for less than the cost of the glass skin on that building. We then rented out the space to Compaq computer employees.
And just three years later, our equity had tripled in value. My investors sold and pocketed the cash.
That sounds like a great success – triple your money in 36 months – but it turned out to be a stupid move. That building’s value went on to triple again. It would have produced a more than a tenfold return on equity, if only we hadn’t sold so quickly. Still, the project was an irrefutable success, and it was only the very beginning of where I was headed.
Then something astonishing happened. The lights went out in Boston.
Boston’s boom turned out to be a bubble, and one day it was like business there just stopped. Here I was making money hand over fist in the unlikeliest of places – Texas – while the northeast, which was supposed to be an economic stronghold, ground to a halt. Why?
According to a brilliant economist named Ed Moscovitch, it would have been easy to see Boston’s downturn coming down the pike if we were looking at the city’s economic base.
A region’s economic base is the industry, or industries, that produce goods or services for export to other places. Only through the creation of valued exports – as opposed to the production of goods and services for its own residents – a region can grow in income and wealth. Export industries create high-wage jobs that stimulate local spending, and therefore every job that’s part of the economic base effectively supports more than one local job. In fact, one good job that exports a manufactured good or service to outside the region can import enough – from other parts of the country, or other parts of the world – to support, in some cases, as many as three local jobs. In this way, the economic base is the engine that propels a local economy.
A region’s economic base is almost always concentrated in one or two industries. Detroit’s economic base is primarily car manufacturing. New York’s is finance and media. For Boston in the late 1980s, it was biotech and mini-computers. The downturn shouldn’t have been a surprise – except that the slowing economy had been temporarily masked by the construction boom. Construction jobs are high wage and have a similar multiplier effect as jobs in the economic base, but they come and go as demand waxes and wanes. Boston’s construction boom had concealed a slowdown in the economic base that was well underway.
I decided to pay this Ed Moscovitch guy a visit, and after a couple days discussing the theory and the math, we decided to build a computer model. What we thought would take two months ended up taking two years, but it was worth it. When we were done we had a model containing data on the economic base for all 300 cities in the U.S. Suddenly I had a way of seeing which places were headed for an upswing and which were headed for a downturn, nine to 24 months in advance. This was nothing magical, of course. We had simply applied a concept from economics that was developed back in the 1920s, plus the grit necessary to compile all the data and build a model.
It wasn’t magic – but it would prove to be a valuable edge.
