Intel recently announced it was selling its sprawling four-building San Jose campus — home to 8,700 employees. It’s part of a larger phenomenon documented in September in a paper titled “Work from Home and the Office Real Estate Apocalypse” published by the venerable nonprofit research organization National Bureau of Economic Research (or NBER).
The paper, authored by Stijn Van Nieuwerburgh, a real estate/finance professor at Columbia University Business School, concludes that the pandemic “had a major impact on both current and projected future cash flows for office buildings,” and forecasts that New York City alone is facing a 39% decline. Decline in office values - “a $453 billion worth destruction”.
The loss has wide-ranging implications, starting with how the work-from-home revolution hurts other parts of the inner-city economy and ultimately reduces the tax revenues cities collect. As recently as August, restaurant visits in San Francisco and New York were down from pre-pandemic levels — 41% and 37% respectively — according to online reservations service OpenTable (cited in NBER’s paper).
In January, the Washington Post editors even came up with a catchy name for the larger problem: “Dead inner cities … office workers are still missing from the field.”
They pointed out that office occupancy in New York, Los Angeles and DC was down more than 40% from 2019 levels, according to business tax revenue. “The losses were largely attributed to private companies’ remote work policies.”
“But the pain doesn’t end here. As city economist Ted Egan noted at the committee meeting, the office space industry contributes about 72% of San Francisco’s GDP, meaning that ‘if something happens to the office sector, it impacts virtually every aspect of the city’s economy.’”
And the NBER paper extrapolates to the ultimate danger. Plugging the holes in the tax base will require either increasing taxes or cutting public services, neither of which is an attractive option. The report warns that because it’s much easier to work from home now, it’s also a lot easier for people to move out of cities if they’re unhappy with a city’s tax rate — or its crime rate. So if cities are forced to address one or the other, “it risks activating a fiscal doom loop.”
Indeed, the New York Times pointed out this week that most major American cities are already “facing a daunting future as middle-class taxpayers join an exodus to the suburbs and choose remote work at the expense of empty offices and… vacant retail stores, bleak inner cities are leaving space and a deteriorating tax base.”
“Downtown is at a crossroads,” the Washington Post editorial board recently warned.
The suburbs rock
William Frey, a demographer and senior fellow at Brookings, told the New York Times that from 2015 to 2019 there was a constant level of migration to the suburbs — but then that migration sharply increased in the first year of the pandemic (largely due to out-migration of people). cities). And those who headed to the suburbs tended to be the top earners — from the tech, finance and real estate industries — taking their income and property taxes with them.
Stanford economist Nicholas Bloom told the Times that every big city is seeing professionals moving to the suburbs. Once settled in their suburban homes, they can enjoy the extra space and convenience of their workdays from home while still being within commuting distance for their “hybrid” work schedules.
But Bloom actually believes “this is especially good for cities — younger, hipper, lower-income people, essential service workers, personal retail workers are all more able to afford city-centre accommodation.
“Bankers, techies and other graduates are moving to the suburbs. This will make cities younger, more diverse and less gentrified.”
It’s a trend reflected in several statistics. In a recent executive briefing, Bloom cited Zillows figures on a large increase in rents and property values in the suburbs that started around early 2021 and did not stagnate through the end of 2022. Public transit trips still haven’t recovered from an 80% drop in 2020. Bloom cites figures from the National Transit Database showing they’re still about a third below their pre-pandemic levels. Cities even avoid retail taxes on their purchases (which they now do in the suburbs). Bloom estimates that this revenue flows from San Francisco to the surrounding counties
So where is it going? Joel Kotkin, executive director of Houston’s Urban Reform Institute, recently published an article warning that America’s great cities are “on the road to decay.” In America’s largest cities, 17.4% of the population lives below the poverty line, according to data from the US Census Bureau (cited in a recent Forbes article). While cities were once “engines of upward mobility,” Kotkin writes that they are struggling to distribute those gains, adding, “Perhaps it is not surprising that migrants and minorities in America’s suburbs, sprawling Sunbelt cities and smaller towns pull.”
Kotkin argues that cities simply are unable to compete with the suburbs, suburbs, and so-called “garden cities” that exist on the fringes of city cores. Not only do they offer shorter, energy-efficient commutes, but they are also “increasingly places with their own thriving city centers and cultural institutions.” (Although Kotkin hints towards the end of his article that cities, although losing their supremacy, could still “see a resurgence shakily based on tourism,” noting that “both New York and Chicago are planning to build big casinos — the kind of Hail Mary Pass that has seldom delivered solid economic results.”)
“While urban areas may revive, they will no longer be the unrivaled centers of population, economic power and innovation. The game has changed and cities must learn to adapt in order to survive. Because if they don’t, the fate of ancient Rome awaits them.”
Can offices become apartments?
Maybe there is a solution. In January, while the Washington Post editorial board raised the prospect of “ghost inner cities that could lead to increased crime and homelessness,” they also noted that “there is growing interest from developers and investors who are part of the office-to-apartment -want to be a revolution. And two months later, the newspaper’s board of directors revived the idea in another editorial. It notes that cities like Atlanta and Washington DC are already on board with the idea, even announcing specific targets for the number of new residents or offering tax incentives for office-to-apartment conversions.
According to the Economist, New York City is already considering tax breaks for landlords converting offices into homes, as well as less restrictive zoning laws. And there’s already a new $250 million redevelopment project underway in New York City to convert a 22-story office building into a 1,300-unit apartment building, reports the Commercial Observer — one of the largest deals of its kind in America.
In early March, Axios reported that Washington DC already had 383 new housing units under construction, another 2,105 more were planned in upcoming projects, and “a few more projects are still under wraps.”
City promised tax breaks if 15% of units were affordable housing…
In New Mexico, the city of Albuquerque transformed a lumber yard into the hip Sawmill Market Food Hall, a social hub with shared dining tables, in 2019.
While hope is there, cities still face a glut of unconverted office buildings. And aside from rising mortgage interest rates, the Post editors note that developers face an even greater perverse incentive: “The easy-to-convert buildings — those that are vacant and on lots with lots of light and alleyways — are already largely exhausted… What remains are difficult properties that need significant overhaul or demolition.”
In January, The Economist spoke to Dylan Burzinski, an equity research analyst at commercial real estate analysis firm Green Street, who calculated that of Manhattan’s 420 million office space, only 20 million square feet could be converted to housing. (“Apartments with no windows or apartments without a kitchen? I don’t think that’s a good idea.”)
Though instead of windows, some developers might try to offer access to a sunlit courtyard, according to Gary Cohen, head of development firm Willco. In a recent interview with Axios, Cohen admitted that updating older buildings is getting expensive.
But despite the need to upgrade the plumbing, rebuilds are still cheaper than starting from scratch – and are still cheaper in general. The Post’s editorial board urges leadership and creativity, calling it “a golden opportunity to redesign inner cities for the future.”
Or, as they wrote in January, “America’s cities are ripe for new skylines and fresh streetscapes. The best leaders will soon get started…
“Rapid erection of cranes and scaffolding is critical to success. City leaders need to start thinking like this.”
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