The Cantillon Effect:
An Unhealthy 100-Year Correlation
In 1999, Andrew Lawrence, then of Dresdner Kleinwort Benson, created his skyscraper index. He suspected that construction of the world’s tallest buildings coincided with the business cycle — and he was right.
The indicator was ‘nearly perfect’, showing ‘an unhealthy 100-year correlation’, suggesting that the construction of ever-taller buildings was a good warning sign of a looming economic slowdown. Now that’s an idea worth considering…
Here’s the full story. In 1887, a Manhattan realtor named John L. Stearns had a problem. He owned two plots of land, off lower Broadway. Stearns, however, found the front plot hemmed in and practically unsaleable. Frustrated, Stearns approached Bradford Lee Gilbert, a nearby architect for a possible way out.
The solution, Bradford recalled in his reminiscences, was to build an iron bridge truss, but stand it on its end. This took him a full six months to conceive and design.
The result was the real structure of the building would start several stories above the curb and help produce the best design to maximise occupancy and rentals. Satisfied as to the design’s safety, and once negotiations with the New York building department had been completed (the structure was so different, no law was present on the books to approve it), Gilbert began building.
New York’s newspapers ridiculed the idea, calling it ‘idiotic’. Fellow architects pronounced the building unsafe. Building experts said it would blow over in the wind, if the building ever got off the ground that is. New Yorkers themselves were aghast with the notion that a building in the city would tower above their sidewalk to a height of 160 feet.
A fellow engineer and friend begged Gilbert to abandon such a stupid idea, pointing out that if the building really did fall over, his legal bill would ruin him. Lawyers confirmed the likelihood.
Stearns himself began having second thoughts, but Gilbert knew better. He pointed out that the structure of the building mean that, with wind bracings from top to bottom, the harder the wind blew, the safer the building would actually become.
This was a scientific certainty Stearns heard Gilbert suggest. To put the matter to rest, Gilbert requested the top two floors of the new building for his offices. Building began shortly thereafter, attracting crowds of onlookers as the building grew taller. On one particular Sunday, the wind was really howling. Gilbert went down to inspect his project, where a huge crowd had gathered in anticipation of the inevitable collapse.
Gilbert asked the foreman on the job for a plumb line and began ascending one of the ladders to the top of the construction. Dana L Thomas, author of Lords of the Land, takes up the tale:
‘When Gilbert reached the thirteenth story, the wind was blowing so fiercely he was unable to stand upright. He got on his knees and began to crawl along the scaffolding. He dropped the plumb line, lowering it to the ground. There wasn’t the slightest vibration; the building stood steady as a rock. Exhilarated, Gilbert straightened up, waving exultantly to the crowd.’
Suddenly, one of those prevailing wind gusts caught him and carried him right out towards the end of the scaffolding. ‘It is in emergencies like this that a man prays, if he ever prays,’ Gilbert recalled afterwards. As he hurtled toward the end of the platform, a rope swinging in the wind from an upright beam of the tower swept within his reach. Gilbert grabbed onto it firmly, went down on his knees and crawled slowly back to the ladder…
So began the birth of the world’s first skyscraper, as the invention became known. It was so ingenious, utilising the land space as never before, that the design enabled its owner to reap $90,000 a year more in rentals than would otherwise have been possible.
The elegance of the skyscraper structure soon became obvious to all architects and engineers; the further the steel skeleton is buried in the foundations, the stronger the structure becomes.
A rivalry developed to build the biggest, the tallest and the most prestigious: a trend that has continued to the present day.
As it happens, the world’s tallest buildings have had a habit of being completed right at the top of the real estate cycle. I call the phenomenon ‘the Cantillon effect’: so named after Richard Cantillon (1680–1734), an Irish banker of the early 1700’s.
He is generally credited today as the first economist to suggest that a change in the supply of money and credit will affect the economy by changing prices.
Cantillon recognised that an increase in the availability of credit would result in economic expansion but would ultimately be overdone as prices rose and imports increased. His work pre-dates Adam Smith but is just as important.
Since Gilbert’s first tower, there has not been an exception to this occurrence at each real estate peak. The Cantillon Effect is — at least so far — the most reliable indicator of a real estate cycle top.
Completion of the world’s tallest buildings:
Name of Building
|1830’s||Astor House, New York|
|1850’s||Produce Exchange, Studio building, New York|
|Early 1870’s||Haight House, Stuyvesant Apartments, New York.Drexel building, Block Apartments, New York.|
|Early 1890’s||Masonic Temple, ChicagoManhattan building, Marquette, ChicagoOld Waldorf, Cable building, Downing building, New York.|
|1910||Hearst building, Chicago.|
|1929||40 Wall Street (Bank of Manhattan building)New Waldorf Astoria.|
|1930||Chrysler buildingEmpire State|
|1972/3||World Trade Centre|
|1974||Sears Tower, Chicago|
|1989||Zarro’s Arrow 445 metre tower planned by Gold Coast (Australia)developer Pat Zarro, unveiled in the late 1980’s but never built — developer went bust)|
|1997||Petronas Tower, Malaysia|
|2010||Shard of Glass, LondonU2 Tower, DublinShanghai Tower, Shanghai
The Burj, Dubai
Chicago Spire, Chicago
Because skyscrapers are generally speculative projects that developers build with other people’s money, they will be built only when credit conditions are easing or at their easiest. Hence the link with credit and Richard Cantillon.
Although the skyscraper is considered an art form, its construction is essentially a business. The economics of the time and profitability of the project constrain the builder. Most books about skyscrapers do in fact point this out.
Take Ada Louise writing in The Tall Building Artistically Reconsidered, ‘Architecture simply doesn’t count…With pitifully few exceptions in the past, New York skyscrapers have never reached for anything but money.’
Writers on architecture also point out more frequently than economists that it is easy financing that underlies all building booms. Willis in Form Follows Finance wrote ‘all skyscrapers — even corporate showcases — can be viewed as real estate ventures, either as income-generating properties or as long term investments in high-value urban land.’
Which is why the Cantillon Effect will continue to work. ‘The history of speculative bubbles in construction is paralleled by a history of big increases in debt financing whether it is generated by endogenous factors, gold flows, central banks… or bank regulators,’ wrote Mark Thornton.
Skyscrapers are real estate ventures. Land price goes higher the longer we proceed into the real estate cycle and the more available credit becomes. As the land price rises, taller buildings are required to offset the cost of building a square meter of lettable space.
Willis repeats something similar: ‘Because escalating land prices drive up the number of stories needed to spread the cost of a lot, the tallest buildings generally appear at the end of a boom cycle.’ Canning Fok, CEO at Hutchisons, one of Hong Kong’s richest companies said much the same to Fortune Magazine: ‘The more the plot of land costs, the taller the building must be to get your money back.’ Of course, one should not study the Cantillon Effect, like any other indicator, in isolation.
Consider the 18-year real estate cycle at all times and what the yield curve and the land price barometer are also telling us.