Income Elasticity of Demand: A Predictive Measure of Market Potential

Income elasticity of demand is one of the best predictors of which shopping malls and centers are most exposed to the structural changes in the retail industry.

This measures the change in quantity of goods sold relative to changes in household incomes.  Retailers such as Pirch, Hanna Andersson, the Apple store, and pure-play online retailers opening physical stores such as Amazon Books, Bonobos, and Athleta, enjoy a more inelastic demand curve.  The buyer tends to have a higher income or net wealth.  Their purchase decision is driven less by price and more about the product.  And, an increase in price tends to have a negligible change in the quantity sold.  (Although Neiman Marcus is discovering the top-end of this dynamic as recently reported in the Wall Street Journal.)

Examples of retail real estate in markets where income-demand is relatively inelastic include Westfield's University Town Center in San Diego, Simon's The Fashion Mall at Keystone in Indianapolis, GGP's Miami Design District, and Macerich's The Shops at North Bridge in Chicago.  These top-tier retail properties are positioned in affluent markets that tend to remain strong long-term.

Retail real estate property in a market that has a less inelastic income-demand curve is exposed to additional risks associated with the structural changes in the retail industry.  Specifically, in markets where consumers seek substitute goods in exchange for price-discounts, off-price merchandise and dollar stores.  The quality-price dynamic is more prevalent in the decisions of this consumer-household segment than for the segment that shops at the Miami Design District.  Modest changes in real income affirms value-seeking buying behaviors.  That is, a shopper will buy a less expensive product to fit in a tighter household budget without sacrificing too much in product quality.  Hence the popularity of TJMaxx over Macy's; or HomeGoods over JCPenney; or Overstock.com over Ethan Allen; or Zappos over Payless Shoes.

Additionally, retailers are exposed to market share shrinkage in markets that have less income-demand inelasticity.  This condition increases the likelihood of cannibalization among existing stores and, therefore, may result in store closures.  The locations of store closures in 2017 announced by Macy's, JCPenney and Sears are examples of this market condition.  For example, read an associated article on Collin Creek Mall in Plano, TX.

Income elasticities of demand have useful predictive attributes in determining market potential for a store and restaurant; in evaluating market-viable value-added strategies to a redevelopment project; in optimal tenant mix analysis; in leasing; and in acquisition due diligence.

There are much broader applications to other real estate uses, especially for multifamily residential, hotel and hospitality product types and price structures.  For example, income elasticities of demand is an indicator for market-viability of luxury apartments, affordable housing, and condominiums; to evaluate optimal rents per square foot for apartment units by mix, unit features and community amenities; and to estimate lease-up velocities.

In summary, income elasticity of demand is a predictive measure of retail, residential and commercial real estate market potential.

 

Jerry L. Hoffman

Hoffman Strategy Group LLC, 4424 Hallcliffe Road, Lincoln, NE, 68516, United States

Jerry L. Hoffman is owner of Hoffman Strategy Group LLC, a firm nationally known for strategic development, economic analysis, and market location consultancy.