Tuesday, June 13, 2023

"Urban doom loop" coming for cities with commercial real estate crash

From "The Next Crisis Will Start With Empty Office Buildings" in The Atlantic (no-paywall link), which discusses the rapidly declining value of office buildings in a remote work world, with follow-on property tax revenue declines for cities:

“Many cities face a difficult choice. If they cut certain services, they could become less attractive and trigger a possible “urban doom loop” that pushes even more people away, hurts revenue, and perpetuates a cycle of decline. If they raise taxes, they could alienate wealthy residents, who are now more mobile than ever. Residents making $200,000 or more contributed 71 percent of New York State’s income taxes in 2019. Losing wealthy residents to low-tax states such as Florida and Texas is already taking a toll on New York and California. The income-tax base of both states has shrunk by tens of billions since the pandemic began.”

As more leases and loans come due, the bulk of the pain is still ahead of us. Over the next two years, many downtowns will find that dozens of buildings are no longer fit for purpose. Municipal services will likely deteriorate, and more people might leave. The worst-case scenario is a return to the 1970s, with bankrupt municipal governments, rising crime, and the flight of (primarily white) upper-middle-class residents. Landlords like to point out that “New York always comes back.” But some cities—like Detroit or Pittsburgh—never recovered from the previous waves of technological change. And even in New York, a comeback may take decades.”

“In the ’90s, the internet helped cities come back. As the economy became more dependent on innovation and creativity, many of the largest and densest downtowns boomed. In 2007, the world’s preeminent urban economist, Ed Glaeser, called it a “central paradox of our time” that cities remain “remarkably vital despite ever easier movement of goods and knowledge across space.” Economists have been busy explaining this paradox up until the current crisis. As the theory goes, companies require the rapid exchange of ideas and specialized division of labor that large cities provide. In addition, companies want access to the largest possible talent pool, and top talent likes to live in large cities because of lifestyle considerations.

The consensus among economists was that as technology and media expanded, economic activity would consolidate within a select few superstar cities. But even before COVID, the theory started to crack as some of the top-performing cities saw population decreases, tech giants started distributing their offices across smaller cities, and the office market was propped up by WeWork’s irrational, venture-capital-funded expansion.

The pre-COVID consensus wasn’t wrong, but the leading thinkers did not consider the full implications of their own theories. Once the quality of online collaboration crossed a crucial threshold, the internet itself became the largest talent pool and the premier facilitator of human interaction. And once highly educated individuals could earn a nice living from anywhere, lifestyle preferences became more diverse. This does not mean that superstar cities are doomed, but it does mean that their previously captive audience now has more options.

Cities will have to survive and adapt. In a world of consumer choice, locations must think like consumer products. One way to win is to double down on what only the biggest cities can offer—walkable streets, car-free transportation, and cultural and intellectual diversity. But smaller cities can emphasize shorter commutes, ample parking, proximity to nature, better schools, and lower taxes.

Honestly, I think that last part is why the suburbs of Houston are booming so much - they get some of the best of both worlds. Fortunately for us, I don't think the City of Houston is quite as dependent on office building property taxes. Our office values weren't as over-inflated either, our return-to-office rates are higher, and we continue to grow quickly (which should fill in some of that office space over time).

As far as New York and other "superstar cities", Glaeser and Ratti have a big NYT essay - "26 Empire State Buildings Could Fit Into New York’s Empty Office Space. That’s a Sign." (gift link bypasses paywall) - proposing the conversion of NYC to a “Playground City”. It also graphically shows how "Houston’s vacant office space could fill 29.7 JPMorgan Chase Towers." Lots of interesting thoughts in it. I’m not sure how viable it is, but it sure is an interesting read… and the top comments are really insightful as well.

We could be at a major inflection point for cities in the next few years...

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At 5:44 PM, June 13, 2023, Blogger Tory Gattis said...

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At 5:45 PM, June 13, 2023, Blogger Tory Gattis said...

Or it may not be as big a deal in NYC...

NYC Revenue Won’t Tank in Office ‘Doomsday’ Scenario, Comptroller Says
Brad Lander sees $1.1 billion revenue shortfall in fiscal 2027
Analysis assumes 40% decline in office values over six years


At 2:48 PM, June 16, 2023, Blogger VeracityID said...

I had an interesting conversation with a houston staff member of a major national developer. He's currently working on a new bespoke office tower funded by a local major oil company. His observation is that there's a serious shortage of top tier AAA space in Houston that companies need to persuade top talent to come to the office for when they're offered remote positions by competitors.

At 4:06 PM, June 16, 2023, Blogger Tory Gattis said...

That's really interesting. I know the downtown towers have been renovating and adding amenities like crazy. They must be seeing the same demand. Sounds like the big modern towers will need to invest in major upgrades while the smaller/narrower ones can look at conversion to residential.

At 7:33 PM, June 16, 2023, Blogger VeracityID said...

Hoping you're right. I love downtowns.


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