The Economy

Peter Crabb: Real estate, construction firms should join forces

Professor of finance and economics at Northwest Nazarene University in NampaJanuary 15, 2014 

Real estate and construction managers may want to look to the airlines and banks for a way to improve profitability and prospects in their industries.

We are well past the global financial crisis, but the real estate and construction industries are still weak. The economic downturn was also hard on banks and airlines, but these two industries have bounced back well.

To understand the structure of an industry, economists look at concentration ratios. The ratio shows if an industry is composed of a few large firms or many small firms. For example, a four-firm concentration ratio, the most commonly cited, gives the total market share held by the four largest firms.

Federal regulators consider concentration ratios when judging the benefits of announced mergers. A merger suspected to increase the concentration within an industry, and thereby the potential pricing power of the dominant firm or firms, will get more scrutiny and sometimes be blocked.

The real estate and construction industries have no real dominant leadership. According to the most recent data from the U.S. Census Bureau, the real estate industry has more than 300,000 firms nationwide, and the four largest firms constitute only about 5 percent of total sales. The Census Bureau does not even calculate concentration ratios for the construction industry as it is so fragmented and diverse.

Meanwhile, the airline and banking industries are growing more concentrated, with the hope they will be more efficient and profitable.

There are more than 5,600 air transportation companies in the U.S., but the four largest carriers have more than 45 percent of all revenue.

This concentration ratio will now get larger, since some of those same four carriers are combining — United with Continental and U.S. Airways with American Airlines.

The banking industry got through the financial crisis and recession with a lot of government help and is now much more concentrated. The Census Bureau reports a four-firm concentration ratio for the commercial banks of 26.5 percent. That is, the four largest firms in this industry account for more than 26 percent of the revenue earned.

Since the financial crisis, the four largest U.S. banks have increased in size. According to the Federal Deposit Insurance Corp., there are more than 6,800 banks in the United States, but the top four — JPMorgan Chase, Bank of America, Citigroup and Wells Fargo — now hold 42.5 percent of all deposits.

Bank consolidation is coming to Idaho as well. Nampa-based Home Federal recently agreed to merge with Cascade Bancorp, and other Idaho institutions are looking for merger partners to remain competitive.

The risk from all this consolidation is that these firms gain undue political power and protect themselves from competition. But with slow overall economic growth, it makes sense for managers to consolidate operations to gain efficiencies and raise profitability.

Since both the national and local economies are unlikely to achieve the growth rates we experienced before the housing bust, real estate and construction firms will need to partner up.

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