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| 2 Jul 2024 | |
| Context Summer 2024 |
By Bruce Katz
For 25 years, the rebound of central business districts has been a driving force in the rebirth of U.S. cities. That positive dynamic is now threatened as the rise of hybrid and remote work drives detrimental, domino-like effects on commercial real estate, small businesses, transit ridership, and municipal tax generation. In certain sectors, working from home, either part time or full time, has become a structural feature of the post-pandemic economy, not a cyclical aberration. The harsh reality is that there will be no bounce back to the pre-COVID era. As a result, cities need to move fast to diversify their downtowns economically, amplify their downtowns culturally, and remake their downtowns physically.
To achieve this, many cities have begun to focus on maximizing the conversion of office space for residential purposes. While that move is sensible and essential, cities must go further and link downtown revival with the mega-forces and unprecedented federal spending that are reshaping the broader U.S. economy.
A new economic geography is being created in the United States, driven by the reshoring of production, the decarbonization of the economy, and transformative federal and state investments around climate, defense, manufacturing, and infrastructure. This new geography is quintessentially metropolitan in scope, given the land, energy and logistical demands of many industrial facilities. But downtowns can play a fundamental role in this economic restructuring given that it demands continuous innovation in technologies, financial products, and market processes and institutions. This innovation imperative, if mastered, revalues downtowns and the agglomeration and locational advantages they bring.
To this end, a small group of cities are smartly using federal and state investments to remake downtowns for a radically different economy. Philadelphia should join them.
DOWNTOWNS IN DISTRESS
Four years after the first wave of the pandemic, the new normal of hybrid and remote work is challenging the role and function of central business districts in the United States. As recently reported by the New York Times, “Roughly one-tenth of workers are cobbling together a combination of work in the office and from home, and a similar portion are working entirely remotely.”1 Interestingly, the rise of remote and hybrid work has decoupled job growth and demand for office space, as it is becoming abundantly clear in San Francisco.
The structural shift to hybrid and remote work is affecting the valuation of office properties throughout the United States, with particular impact on central business (office) districts in Chicago, New York City, San Francisco and Washington, D.C. The latest news is sobering. A National Bureau of Economic Research paper postulates that 14 percent of the $2.7 trillion commercial real estate loan market (and 44 percent of office loans) risk default.2 Research led by Arpit Guptam, professor at the New York University Stern School of Business, estimates that the national office market lost $664.1 billion in value from 2019 to 2022.3
This disruption has already pushed down transit ridership and revenues in major U.S. cities and metropolitan areas. It is now triggering general concerns regarding the fiscal health of cities, since central business districts and downtowns typically generate a disproportionate share of municipal tax revenues. The prognosis is grim. As the New York Times recently reported: “New York City’s comptroller laid out a ‘doomsday’ scenario last summer where the value of the city’s offices settled at 40 percent below their pre-pandemic peaks. This would translate to budget shortfalls of approximately $322 million in 2025 and $1.1 billion in 2027.”4
A SHIFTING LANDSCAPE
While downtowns and cities struggle, other market dynamics and investments are reshaping the broader U.S. economy. A new global economic geography is emerging in the aftermath of the pandemic, powered by profound geo-political shifts, transnational threats and, in the United States, unprecedented investments by federal and state governments. These and other disruptive dynamics — complex, chaotic and still in formation — are already shaping the fortunes of cities and metropolitan areas.
Three changes are paramount.
First, geopolitical tensions with Russia and China have made the reshoring of production, and the control of sensitive technologies and critical minerals, issues of national security. After decades of offshoring, outsourcing and globalization at any costs, the U.S. is suddenly realizing it needs to make things again.
Second, climate change is forcing the electrification of major sectors of the economy and radical changes in the generation, transmission, and deployment of clean energy. As with geo-political tensions, climate change is driving an industrial transformation of monumental proportions and is already leading to the production and assembly of a broad array of products and parts (e.g. transmission equipment; EV vehicles, batteries, and charging; building components; wind turbines; solar panels; farming technology and equipment; and consumer energy products).
Third, these mega economic shifts are catalyzed by unprecedented federal policies and investments which set the frame for restructuring the national economy but require cities and metropolitan areas to deliver what comes next. Federal funding measures include the $1.9 trillion American Rescue Plan, the $1.2 trillion Investments in Infrastructure and Jobs Act, the $280 billion CHIPS and Science Act, the $411 billion Inflation Reduction Act and the $850 billion-plus annual Department of Defense Appropriations.
States are also taking a newly proactive approach to investment: the Michigan Economic Development Corporation has invested $100M in three centers of excellence in Detroit; California is investing $500M in regional economic strategies; and New York and Ohio have compiled billions in incentives for semiconductor manufacturers.
These macro forces have profound effects. In many respects, the hierarchy of U.S. metros — driven for decades by service clusters and consumer- and communications-related technologies — is being reshuffled. Given expanded military budgets, for example, metropolitan areas like Dayton, Ohio, and St. Louis, Mo., with large military bases, R&D facilities and production capabilities are benefitting from a defense dividend. Metropolitan areas like Columbus, Ohio, Phoenix, Ariz. and Syracuse, N.Y., for their part, are successfully attracting large semiconductor companies, and the domestic and global supply chain firms that serve these advanced industries. A battery belt of next generation automotive production is being created in real time, stretching from traditional clusters in the Midwest and the Southeast to other parts of the country.
HOW DOWNTOWNS DIVERSIFY
The new economic geography is quintessentially metropolitan in scale. As research has convincingly shown, the first wave of reshoring is disproportionately decentralized, located in places far from urban and suburban communities. Many mega factories designed to produce electric vehicles or chips are landing at the periphery of metropolitan areas or beyond, challenging the ability of stakeholders to connect all the necessary dots and realize the full potential of this resurgence for firms, people, and places.
Despite this, downtowns have a powerful, if still in formation, role to play in the new economic geography. They are not, of course, going to suddenly house super-sized semiconductor facilities. But the innovation imperative created by economic restructuring means that downtowns could, among other things, maximize the use of federal and state funding to:
These innovation moves could be further supported by applying other federal and state funding to:
THE SUCCESS STORIES
A group of cities are beginning to bend federal and state investments to enable the diversification of their downtowns. On the innovation front, downtowns in multiple cities are being infused with a burst of startup energy and public and private capital.
Each of these efforts is relatively small and nascent, but they point to the potential for university outposts, technology firms and advanced research labs to take over spaces once occupied by office work. As an Economist correspondent recently noted about the Fulton Labs in Chicago, “Evidently almost nobody is working from home — probably because they do not have access to bioreactors in their living room.”6 And the proximity to world class universities, and the talent and scientific research they possess, is impossible to ignore.
In some cases, transformative infrastructure investments are setting the platform for new economic activity.
WHERE NEXT?
As the post pandemic economy continues to take shape in the United States, it has become apparent that hybrid and remote work are not the only market or capital dynamics that have been unleashed post pandemic. The reindustrialization and decarbonization of the U.S. economy, and the innovation imperative it engenders, has created an opening for the rise of new companies, technology workers, and districts in traditional downtowns.
As our examples illustrate, a group of vanguard cities and enterprises are realizing the potential to align downtown revival with broader market dynamics by placing federal, state and local funding in the service of urban regeneration. These organic efforts, if codified and scaled, could help bring economic life back to hollowed cores and, consequently, mitigate the fiscal fall out that many cities and transit systems now face.
The federal government, to date, has been a large but passive investor, enabling but not guiding cities to blend innovation and infrastructure funding for maximum effect. That should and must change in the next few years. In cities with a large military presence, for example, vacant office space can be taken by innovative defense firms as well as defense personnel themselves. As in the late 1970s, when President Jimmy Carter signed an executive order favoring downtown office space for federal government activities, federal direction could help scale the promising actions and decisions bubbling up from leading cities.
To paraphrase Mark Twain, reports of the death of America’s downtowns are greatly exaggerated, if the nation marshals the full resources and energies of the new economic geography.
Bruce Katz is the co-founder and inaugural director of the Nowak Metro Finance Lab at Drexel University. He is a distinguished resident fellow of the Lindy Institute for Urban Innovation at Drexel.
Image: An annotated view of Downtown Crossing in New Haven, Conn., a life-sciences oriented innovation district, made possible by major infrastructure changes. Graphic: The Lindy Institute for Urban Innovation at Drexel University
CITATIONS
1. Ben Casselman, Emma Goldberg and Ella Koeze, “Who is Still Working from Home?,” New York Times, 3/16/2024
2. Erica Xuewei Jiang et al., “Monetary Tightening, Commercial Real Estate Distress, and US Bank Fragility, National Bureau of Economic Research, 4/4/2023
3. Alan Rappeport, “City Coffers Feel Impact as Building Prices Fall,” New York Times, March 19, 2024
4. Ibid
5. Laura Bratton, “AI startups are resurrecting San Francisco’s commercial real estate,” Quartz, 2/4/2024
6. “Science and the City,” The Economist, 12/9/2023
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