Empty or boarded-up storefronts are common along what were once the world’s glitziest shopping districts while nearly two-thirds of the city’s restaurants say they could be out of business by the end of the year. Just about anyone who can has fled to weekend retreats in the country, some of them permanently, while home sales in the most sought-after suburbs have doubled. Most hours of the day, Grand Central Terminal is eerily quiet while the city’s subway system, facing a $16 billion shortfall, warns of a 40 percent service cut.
“NYC is dead forever,” blared a recent headline in the New York Post over a lengthy lament by a former hedge fund manager and comedy club owner.
Indeed, the future of big cities has become a hot topic of debate among academics, public officials, corporate executives — and, in particular, the people who own and finance office buildings, hotels, shopping centers and apartment buildings, who have $15 trillion riding on the outcome.To the dozen that I spoke with, it seems pretty clear that the pandemic will transform how and where people live, work and shop. But the consensus is also that while this decade-long process will be painful and disruptive, big cities will emerge more livable, affordable and economically viable than they were before.
Let’s start at the office.
The pandemic has certainly demonstrated that a lot of work can be done without commuting an hour each way, five days a week, to a 150-square-foot cubicle in a downtown office tower that costs an employer $10,000 a year in rent (based on the price of rent in big cities). Surveys show that 70 percent of employers expect to downsize their office space, while two-thirds of their workers would prefer to work at least two days a week at home. A third would prefer to never come to the office at all.
That said, the downtown office isn’t going away. Personal interaction is still needed to insure teamwork and cooperation, create strong corporate cultures and stimulate innovation not only within firms but among them. “The whole rationale for urban density is undermined if people can’t collaborate,” said William Wheaton, a professor of urban economics at MIT and founder of its Center on Real Estate.
It’s anyone’s guess how all this will shake out, but Wheaton and others with whom I spoke speculate that the number of employees coming to the average office on any day could fall by as much as 30 percent. At the same time, they also expect that after years of cramming more workers into open office configurations, the lingering memory of the pandemic is likely to lead employers to offer more space and privacy to workers when they do show up. Add the minuses and pluses and some analysts are projecting that overall demand for office space could fall by as much as 20 percent. In the past, such a steep drop in demand has led to declines in rents of as much as 50 percent.
“There will be a large-scale collapse in values,” predicts Anthony Lanier, whose innovative developments have helped to transform Washington’s Georgetown and West End neighborhoods. “All the king’s horses can’t put this back together again.”
In Manhattan, that re-pricing could be dramatic. Although the number of sales has fallen dramatically, from March through May, the price paid for office buildings was $429 per square foot, down 57 percent from the same quarter a year ago. Share prices for the four real estate investment trusts most heavily invested in New York City — Empire State Realty, SL Green, Vornado and Paramount — have also fallen by roughly 50 percent.
No surprise, then, that New York’s real estate moguls have been calling around to the city’s largest employers, pleading with them to bring workers back to the office. Their pitch is that the longer people remain in hibernation, the less likely they will ever return.
“They understand they are in deep trouble,” Kathryn Wylde, president of the Partnership for New York City, told Bisnow, a business publication.
Other segments of the commercial real estate market are also in the throes of a painful downsizing.
A number of New York’s marquee hotels have defaulted on their loans as the plunge in business and tourist travel hit what was already an overbuilt market. Even when the pandemic recedes and vacation travel resumes, the volume of business travel is unlikely to recover now that companies have discovered just how many meetings and sales calls can be conducted online. One analyst told the Wall Street Journal that 20 percent of the city’s hotels may never reopen, and for those that remain, it will be years before room rates return to anything close to where they were before the pandemic. Recent sales suggest the market value of hotels has fallen by around 30 percent, with further declines expected as more foreclosed properties are put up for sale.
Things aren’t much better for retail properties, with the demise of a number of leading department stores. Amazon recently announced it will buy and convert the former Lord & Taylor building on Fifth Avenue into its New York headquarters, while Facebook is considering the purchase of the Neiman Marcus building that was to have anchored the seven-story shopping center in the Hudson Yard project on Manhattan’s West side. National chains like Le Pain Quotidien, Kate Spade, the Gap, Victoria’s Secret and J.C. Penney have announced they will permanently close some of their New York outlets. CoStar, the real estate information company, expects 7,700 retailers and restaurants in the city will close by year’s end, dumping 115 million square feet onto the market.
On Upper Madison Avenue, where the world’s top fashion designers all felt they needed a presence, rents that once topped $900 per square foot have fallen 15 percent, according to the real estate firm CBRE. In SoHo, it’s 37 percent. Recent sales suggest the market value of retail property has fallen by half.
Even for a sector accustomed to boom and bust cycles, this is shaping up as a bust of biblical proportions, not only in New York but in other hot real estate markets: San Francisco, Seattle, Los Angeles, Boston, Miami and Washington. As prices fall and loans default, many building owners and their investors could lose much of their original investment. “Mezzanine” lenders — insurance companies, pension funds and private investment pools that earn higher interest rates for taking the first credit losses — are likely to suffer significant write-downs. Even the safest and most “senior” lenders — banks — have set aside an additional $111 billion to cover losses on their commercial real estate loans, according to the Federal Reserve.
Law firms and investment banks are scrambling to add staff to handle a flood of real estate foreclosures and restructurings. And over the past six months, tens of billions of dollars have been raised for “distressed” funds to buy up real estate or real estate loans at deeply discounted prices — some of it by the same fund managers who now face steep losses on previous real estate investments.
What seems like bad news for real estate owners, investors and lenders, however, could well turn out to be good news for America’s biggest cities.
Over most of the past 20 years, real estate prices and rents have been driven to economically unsustainable levels in big cities by well-educated young people eager to live in them, successful companies wanting to locate in them, tourists flocking to visit them, retailers demanding to sell in them — and, in particular, investors eager to invest in them. The combination of insatiable demand and fixed supply drove urban land prices through the roof. Chris Leinberger, who chairs the Center for Real Estate and Urban Analysis, says that in most cities, land typically accounts for about 30 percent of the cost of a house. In San Francisco and New York, it rose to 75 percent.
Eventually, the prices got so high that only the rich could afford to live in these cities, driving the poor and much of the middle class to suburbs and exurbs, where they faced horrendous commutes. Growing companies, unable to attract the workers they needed, began opening satellite offices in more affordable and livable cities like Austin, Portland, Ore., Nashville and Denver. The widening gap between rich and poor gave rise to populist backlash and social unrest.
Indeed, in the months before the pandemic struck, New York and other major cities had already experienced several years of population decline. Unsold condos and unleased offices and apartments had begun to pile up on the market. Hotel occupancy and room rates had begun to decline from record levels. Popular neighborhood restaurants and retailers had begun to close their doors, unable or unwilling to meet the ever-escalating rents.
“The economics of development didn’t make sense, even before Covid,” Lanier said.
In the short term, the pandemic is likely to accelerate this out-migration of jobs, people and capital to the suburbs and midsize cities. But once rents and real estate prices decline, a different dynamic will take hold.
“There will be a rebalancing within cities, and between cities,” predicts Richard Florida, whose 2002 book, “Rise of the Creative Class,” has influenced the way the world thinks about urban development.
Vacated space and falling rents in the most desirable downtown office buildings will allow firms in less convenient or less desirable buildings on the fringes of downtown, or in the suburbs, to move to the buildings they could not afford earlier. And growing companies that might otherwise have shifted work to satellite cities will decide to keep them at headquarters instead.
At lower prices, the city’s most desirable condos and apartments would be bought and rented by people who previously had to settle for smaller units or less desirable neighborhoods, or been shut out of the metropolitan area entirely.
Visitors with three-star budgets will be able to move up to four-star hotels, while those once relegated to suburban hotels during peak seasons can afford to stay downtown.
With the demise of department stores and the retreat of many national retailers, independent merchants and restaurants will be able to afford to locate in the shopping centers, retail districts and neighborhoods that attract the most customers with the most money to spend.
“If rents are right-sized, we will see a retail resurgence in cities,” predicts Ed McMahon, a senior fellow at the Urban Land Institute.
This bumping up will take years to work through, with lots of foreclosures and restructurings along the way. And while most property owners will take a hit to their rental incomes and property values, the biggest losers will be those with the least desirable properties, where the higher vacancy rates and lower rents will be insufficient to cover operating costs and debt service. Once losses are written off, these unwanted properties will be ripe for conversion to some better use. And my guess is that in most cities, that would be housing for middle- and working-class families.
I’m not talking here about the high-rise apartments and condos that developers almost always want to build. I’m talking about three-bedroom single family homes with front porches on small lots, and three-story townhouses with back patios and updated versions of double-deckers, arranged along tree-lined streets within walking distance of parks and schools and trolley stops and a neighborhood shopping district. These are the kind of urban neighborhoods that once formed the backbone of all great cities, and that remain in such demand today that only the professional classes can now afford to live in them. Big cities need more of such neighborhoods — lots more — if they are going to be affordable and livable again.
There is plenty of precedent for this kind of transformation. After the twin towers of the World Trade Center were brought down by terrorists on Sept 11, 2001, people and businesses fled Lower Manhattan and nobody was sure what would become of all those empty glass towers and turn-of-the-century office buildings. But in the years since, nearly 14 million square feet of real estate were converted to new uses, the number of residents tripled, and today it is a thriving community of offices, apartments, shops, restaurants.
With the right zoning and financial support from state governments, there is no reason New York and other big cities should not be able to rebalance themselves for a post-coronavirus world of slower growth, less density and lower prices. Over centuries, the reason big cities have survived as engines of efficiency, creativity and opportunity is precisely because they have proved to be remarkably dynamic and adaptable. As Mark Twain might have put it, reports of their death are greatly exaggerated.