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Rotman Insights Hub | University of Toronto - Rotman School of Management

COVID-19, working from home, and the future of cities and downtowns

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William Strange

Early in the COVID-19 pandemic, comedy club owner James Altucher wrote a post on LinkedIn with a highly provocative title: “New York City is Dead Forever.” The facts at the time certainly supported considering this issue. Cities are expensive places, with residents bearing high commuting and housing costs, as well as the burdens of financing necessary urban infrastructure. City residents eagerly accepted these costs in order to access the various interactions that cities allow, such as learning from nearby colleagues or patronizing specialized restaurants or shops. But the office interactions were shut down by lockdowns and lessened by distancing. And interactions with restaurants and clubs (including comedy clubs) were also adversely affected. At the same time, COVID-19 hit cities hard and early precisely because city residents are highly interactive, and this facilitates contagion. Higher cost and lower benefit naturally suggest the possibility that cities would suffer as a result of COVID-19 and their dense downtowns would suffer.

In response to Altucher's post, comedian Jerry Seinfeld wrote an op-ed making the case that New York’s interaction was so valuable that New York would not die. “Real, live, inspiring human energy exists when we coagulate together in crazy places like New York City,” he wrote. “Feeling sorry for yourself because you can’t go to the theater for a while is not the essential element of character that made New York the brilliant diamond of activity it will one day be again.” City life, he argues, would return. Of course, this argument applies to other cities and their downtowns, as well. Looking beyond New York City, what will be the role of cities and downtowns in the future?

We are now two years into the pandemic, and a picture of the new normal has begun to emerge. Working-from-home is probably the most important feature. Such a situation is certainly lonelier than working in a crowded office, and the loss of interactions with co-workers seems likely to have a cost in productivity as well. Even so, many firms, including Google, have announced that working from home will continue to a degree as offices re-open. Many workers have expressed hope that working from home could continue, at least for part of the work week.

Why are employers and workers receptive to a blended work-from-home/office experience? Because working from home has the potential to create value. A worker who stays home a few days a week incurs lower commuting cost. With fewer days commuting, it becomes possible to consider living farther from the office, possibly even in a different metropolitan area. Working from home will tend to increase the demand for space, which tends to push households to less central locations where housing is less expensive. A big city's many appeals are counterbalanced by the high cost of urban living, specifically its unaffordable housing and long commutes. Even a partial switch to working from home can help alleviate these costs. All of this suggests that, while big cities like New York and Toronto could return to their fairly happy pre-COVID states, there is good reason to believe that the new normal will be different from the old one.

It is not possible to know for sure exactly how the recovery from COVID-19 will play out, so it is worth considering empirical evidence of the responses so far. We can learn how market participats — including real estate landlords, commercial and residential tenants, developers and homeowners — value thenir environments by looking at the rents and prices that they pay.

A recently published paper I co-authored with Stuart Rosenthal and Joaquin Urrego considers commercial real estate markets across a sample of large U.S. cities. In large, dense, transit-dominated cities, the pattern of commercial rents changes significantly in a way that is consistent with decentralization. Commercial rents typically decline as one moves away from a market's central business district. Our research shows that, following the onset of COVID-19, the rate at which rent declines with distance fell by roughly 20 per cent. This means that businesses are willing to pay a smaller premium to be near downtown than they were before. And these are long term leases, roughly five years in length, so this is not simply a temporary response. Perhaps, the premium will rise again when the costs of the disease itself have abated. But perhaps they will not. If fewer workers are downtown, there is less reason for any given firm to locate downtown in search of interactions and synergies. And if the work can be carried out effectively outside of the office, there is less demand for central business districts. The evidence so far is suggesting not an abandonment of central business districts, but instead a weakening of their appeal.

This pattern for commercial real estate markets is echoed in residential markets. A paper by Arpit Gupta and co-authors estimated the amount that housing prices and rents fall as one moves away from a city's central business district. The authors found that across a sample of U.S. cities, the premium for being closer to downtown has fallen, and considerably. Pre-COVID, prices fell by four per cent per mile. Post-COVID, the decline is only 0.5 per cent. As with commercial leases, the reduction in the price of a long-lived asset suggests that this is not just a temporary response. And the change in price is larger the greater is the city's potential to expand working from home.

What does this all mean for businesses and households? The key conclusion here is that cities and downtowns are not dead or dying; they are just decentralizing. This has important implications for both businesses and residents. Businesses are coming to understand that they need not concentrate as much of their activity in dense downtowns and big cities. In the same way that much back-office activity decentralized starting in the 1980s, businesses may be able to move less-interactive activities out of expensive locations. This will leave those activities that benefit most from spatial concentration, for example, investment banking. This, in turn, will impact residential markets. Households may find that they do not need to be as centrally located as previously, making housing more affordable by increasing the supply of good locations. On the other hand, working from home seems to have increased the demand for residential space, with negative effects on affordability, so the total effect is uncertain. What is certain is that profound changes are underway, fundamentally impacting how people will live and work.

"JUE insight: Are city centers losing their appeal? Commercial real estate, urban spatial structure, and COVID-19" was published in 2022 in the Journal of Urban Economics. 

William Strange is a professor of economic analysis and policy at the Rotman School. He works in the areas of urban economics and real estate