Returning 2706% In The Past 40 Years, The Best Performing “Yellow” Asset Is…

Monopolistic supply? Thriving wealth-effect-driven demand?

Medallions – essentially the right to operate a for-hail taxi in New York City – now trade for as much as $1.3 million, an all-time record.

Part of this dynamic is fixed supply – there are just 13,336 medallions available for a city of 8.3 million people. There is also a macroeconomic point, with a stronger NYC economy for those inhabitants who can afford the service. The more surprising observation, however, is that new technology in the form of in-car credit card machines and more recently smartphone hailing apps both materially increase the value of owning a medallion. In a world where every technology is deemed “Disruptive”, here’s a case where the status quo has actually reaped much of the reward.

Via ConvergEx's Nick Colas,

Here’s a news flash for everyone who thinks Elon Musk Is the preeminent automotive visionary of our generation: New York City was running electric taxicabs in the 1890s, a decade before Henry Ford’s Model T ever turned a wheel on America’s roads. A financial crisis in 1907 put a predictable dent in consumer demand for NYC cars-for-hire, and the rise of the internal combustion engine in the 1910s and 1920s eventually did away with the battery-powered cab in Gotham. By the 1930s the city actually had a glut of taxis, by some accounts as many as 30,000 plying the streets for fares in a Depression-era New York.

To clean up the oversupply of increasingly poorly maintained cabs with drivers desperate to make ends meet in a lousy economy, Mayor Fiorello La Guardia signed something called the Haas Act, which limited the number of taxis to 16,900. Over the years this cap dwindled to 11,787, even as the city’s population grew. The basic rules behind this permit, called a “Medallion”, remain largely unchanged from La Guardia’s day, and include:

The license to own and operate a taxicab.
The ownership of the medallion may be sold or pledged as collateral for a loan.
The exclusive right to accept street hails.
Fares regulated and authorized by the NYC Taxi and Limousine Commission.
Owners of medallions must be US citizens or permanent residents
Independent medallion owners must operate their cab 210 nine-hour shifts a year
Corporate owners must operate their cabs 24/7
Inspections of the vehicle occur every 4 months
Medallions sales are subject to a 5% transfer tax

As the number of medallions available is controlled by this process – there are only 13,336 on the streets today – they are quite valuable. Since both individual and corporate owners can sell their medallions at will, there is a ready market for these licenses. We’ve included several charts and tables with historical price information immediately after this note, but here are the highlights:

Owning a medallion has been a winning trade that even the NY hedge fund managers who likely take several cab trips a day would covet. At the beginning of the Financial Crisis in January 2007, an “Individual” medallion went for $414,000 and a “Corporate” version for $522,000. Now, the numbers are $1.05 million (July 2013 “Individual”) and $1.32 million (last trade for a “Corporate” medallion, May 2013). That is an average return of 153% over the last six and a half years.

The longer term track record for medallions is equally impressive – they went for just $140,000 or so in 1993 – but teasing out the actual reasons for these eye-popping returns takes some work. Remember that the pricing economics of taxi cab operation – and therefore the value of owning a medallion – is controlled by regulation. You can only charge so much per mile and for wait time.

We went back to 1948 to see if these statutory fares explained the increasing value of a medallion. In that year, for example, a typical cab ride of 1.5 miles with 5 minutes of waiting time at lights would cost $0.63 and the cost of a medallion was $2,500. It would therefore have taken the average medallion owner about 4,000 trips to pay for his license. Fast forward to 1964, and this number rose to almost 30,000 trips because fare increases did not keep pace with medallion inflation.

The good news for the medallion owner of the 1960s-1990s was that this 30,000 trip breakeven declined to about 15,000 during the difficult period of the 1970s in the city and did not breach the 30,000 mark again until 1997. Fare increases, in other words, offset the ever rising costs of a medallion. Gas prices also play a role in taxi cab profitability, of course, but it is worth noting (and is clear from our data) that medallion prices did not decline as oil prices rose from 1973 to the present day.

Taxi medallion economics have seen a breakout since the early 2000s, as evidenced by our breakeven analysis based on current fare schedules. It now takes almost 83,000 “Typical” 1.5 mile trips for an “Individual” medallion owner to break even, up from 42,700 in 2004. For the corporate owner, those numbers rise to 115,600 – up from 48,600 nine years ago.

Now, if you’ve ever had the chance to meet a medallion owner, you know that these are very tough people when it comes to making money. They know their numbers cold and aren’t shy about expressing their point of view. In short, they make the typical Wall Streeter look like slightly pouty 8 year old. Add to this fact the realization that NYC plans to auction off 2,000 new medallions this year AND introduce a new cheap ($1,500) livery license for the outer boroughs and northern Manhattan, and the fundamentals look pretty bewildering.

Here are a few thoughts on the “Mystery of the Million Dollar Medallion”:

Pricing for a cab ride may be regulated, but nothing says New Yorkers have to take the trip. One interpretation of the breakout in medallion prices is that New York’s affluent classes have had their own step-up in income and/or wealth and are more often taking cabs than even in the 1990s. A wrinkle on this explanation would be that as more of Manhattan and parts of Brooklyn go through gentrification, the total population of potential cab customers increases. This further helps keep the 13,336 medallions busy through the day. A survey from the mid 2000s showed that most cab rides occurred during the morning commute and were generally to midtown Manhattan from the Upper East and West Side. As the areas where affluent New Yorker live and work expand, so does their usage of yellow cabs.

The increase in medallion prices to nose-bleed levels is, therefore, a sign that the New York economy is extremely strong at least among the top 20% of the population by income. Remember that if 14,000 wealthy New Yorkers all stuck their hands up at the same time on their corner, over 500 of them would have to grab a MetroCard to get to work. And the city has 8.3 million total inhabitants.

The introduction of in-car credit card processing has been a boon to cab drivers tips. According to one analysis done in 2009, cash-only tips used to run 10% of the fare. Since the credit card options for driver tips only offer choices of 20% or more, the introduction of these machines over the last few years has meant higher per-trip revenues for the driver. And since part of the value of a medallion is essentially the right to collect these tips, it makes sense that drivers would pay medallion owners more over time.

Perhaps the most interesting wild card for the value of a NYC taxi medallion is the burgeoning technology of smartphone taxi applications like Hailo, Uber, Lyft and others. These do pretty much what you’d expect – find you a nearby cab based with information from your geolocated phone. This could easily improve cab utilization in New York quite dramatically, justifying higher medallion prices. The first usage data from such apps has just come out in the past few weeks, and the results are lukewarm at best. It is, however, early days.

What I find most interesting about this exercise is the fact that technology – credit cards and smartphone apps – has served to enhance the value of established status quo rather than its customary role of “Disruptor”. To understand why, remember who owns the right to issue a medallion: the New York City government. The current plans to issue 2,000 more medallions could net the still cash-strapped city something like $2 billion over the next few years. And they control the laws about who can – and can’t – pick up a fare in New York. Think they are going to let a “Disruptive technology” alter their existing and highly lucrative model?

If so, I have a bridge in Brooklyn I would like to sell you. All we need to do is find a taxi to take us there.