Before any real estate investor – ourselves included – makes a decision to purchase an investment property, they sort through a tremendous amount of data about both the target property and the market in which it is located. As a sign of a strong market, one of the major things that investors look for is economic growth and its sources. One of the ways they do this is to use an analytical technique known as “shift share analysis.”
In this article, we will describe what shift share analysis is and how it can be used in the pre-purchase due diligence phase of a commercial real estate transaction. To illustrate these points, we will also go through an example. By the end, readers will be more familiar with this type of analysis and should be able to apply it to their own due diligence activity.
At First National Realty Partners, we commonly use shift share analysis as part of our broader market analysis activity. However it is just one of many tools that we employ to screen and select deal opportunities for our investors. To learn more about our current investment opportunities, click here.
What is Shift Share Analysis?
There is a saying in real estate investment circles that “a rising tide lifts all boats.” This means that strong economic growth trends tend to be good for all asset classes and it is a useful adage to highlight the importance of shift share analysis.
Shift share analysis is an analytical model that attempts to determine how much of a region’s growth, in a defined time period, can be attributed to broader, national growth trends versus some unique feature or competitive advantage within that region. In other words, shift share analysis attempts to explain why market conditions in a given region may differ materially from those nationally.
To accomplish this goal, analysts have developed a specific shift share analysis formula that states:
Actual Growth = National Growth + Industry Mix + Regional Shift
In order to understand this analytical methodology, it can be helpful to break it into its components.
The national growth variable attempts to explain how much growth in a region can be attributed to broader national growth trends. For example, if the economy as a whole is growing at a rate of 1.5% annually, it should be a safe assumption that the economy in a specific region is growing at that same rate. But, this is not always the case.
The “industrial mix” variable refers to the composition of a region’s industrial base and how much growth can be attributed to the growth of those same industries on a national level. The formula used to calculate the industry mix effect is:
Industry Mix Effect = National Growth Rate – National Growth Rate of a Specific Industry
For example, assume that the national growth rate of the lumber industry is 5% and the national growth rate of the broader economy is 1.5%. From this information, it could be reasonably concluded that 3.5% of the industry’s growth rate could be attributable to factors other than the national growth rate.
The regional shift variable attempts to explain how the unique advantages of a given region cause the growth in a specific industry to differ materially from the growth of that industry on a national level. Using the lumber example above, the national economy was growing at 1.5% and the lumber industry was growing nationally at 5%, causing us to conclude that 3.5% of the lumber industry growth was happening outside national trends. Now, let’s go one step deeper. Assume that the lumber industry in the pacific northwest was growing at a rate of 9%.
From this 9% growth rate, it can be assumed that 7.5% of this growth comes outside of national economic trends (9% – 1.5%). It can also be assumed that 4% of the growth is unique to the pacific northwest (9% regional lumber growth – 5% national lumber growth). The conclusion that can be drawn from this analysis is that there is some unique factor in the pacific northwest that causes their lumber industry to grow faster than both the national and regional rate. Perhaps it is because there are a lot of trees, or because the lumber infrastructure is better, or because there is an abundance of mills, processing facilities, and skilled labor.
With this definition in mind, let’s take a look at how shift share analysis can be used in commercial real estate investment due diligence.
Using Shift Share Analysis In Commercial Real Estate (CRE)
When this analysis technique is applied to commercial real estate due diligence, it can be a helpful way to forecast future supply and demand in a given regional/local economy based on its forecasted economic activity and unique characteristics.
Continuing the lumber example from above, this type of growth may bode well for industrial and warehouse property types. Or, if it is determined that a given region has a fast growing healthcare industry, it may be a signal that leasing activity for medical office space may rise in tandem.
The broader point is this, in real estate investment, the utility of shift share analysis is to identify markets with outsized growth rates relative to national averages and to use that information to make more informed investment decisions.
Where to Get The Needed Information
Clearly shift share analysis is a very data intensive activity. Fortunately, the information about the U.S. economy needed to perform it can be found from publicly available sources like:
Regional Economic Development Commissions
Most of these agencies make their data publicly available for analysis, but it may take a skilled analyst to know where to find it, how to download it, and how to pull actionable observations out of it. Separate from the above sources, paid data subscriptions may be required to obtain the information needed to perform shift share analysis.
Summary & Conclusions
Shift share analysis is an analytical methodology used to determine how much of a region’s economic growth can be attributed to unique conditions versus broader growth trends. For example, if total employment on a national level shows growth of 3% annually, but a region’s local employment growth rate is 5%, there must be some factor that is causing it to grow faster than national averages.
There are three variables used in shift share analysis, national growth, industry mix, and the regional shift.
As it relates to commercial real estate investment, shift share analysis is useful as a tool to forecast future demand for specific property types. For example, if a local industry like healthcare has a growth rate that is far above the national average, it may be a sign that demand for healthcare related properties will also rise faster than the national average.
Information needed to complete shift share analysis can be found through publicly available sources like the Bureau of Labor Statistics and Census Bureau.
Interest In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.