Real Estate – Big City Economics

Beachfront Bargains

Having spent most of my life shuttling between the densest and fourth-densest counties in America, when I finished my tour in city government I thought it would be nice to try out a different lifestyle. So I moved to the East End of Long Island, down the road a piece from where Jackson Pollack did most of his pathbreaking work. My wife had already substantially made the move after her scary and exhausting battle with breast cancer.

Though I still love the city that gave me so much fun, friendship and opportunity, I also love my coastal, exurban environment. Until The Shutdown I continued to spend a lot of time in Manhattan and I can’t wait for this pandemic nightmare to end so I can once again stroll anonymously down Sixth Avenue and dive into a plate of ropa vieja, rice and beans. But as it turned out, my dispersal from the city presaged a Covid-induced flight from the city, and the summer season out here seemed to begin around April 1.

The long-term effects of the pandemic on urban-suburban-exurban residential patterns is a complicated question that I’d like to address carefully at some point, but in a nutshell I’m hopeful that they will generally be positive. In the meantime, the renewed interest in vacation-area real estate gave me a chance to opine, along with some other real estate experts, on one of my favorite topics in this WalletHub feature.

Austin Debates Density

One of the most interesting urban planning debates going on in the country right now is happening in Austin, Texas. In 2012, the Austin City Council adopted the Imagine Austin Comprehensive Plan, a three-year effort that established priorities for the city’s growth and development for the next 30 years. Among the priority actions the plan identified were to invest in a compact and connected Austin, to grow and invest in the creative economy, and to develop and maintain household affordability. The next step in implementing the plan is to revise and modernize its zoning regulations. The city is now in the midst of that process, which it has dubbed CodeNEXT.

Austin, of course, is one of the fastest growing cities in the U.S. From 2000 to 2017 the city’s population increased from 657,000 to 950,000, an annual rate of growth of 2.2%. It’s also gained a reputation as a fun place to live and has become a migration magnet for millennials; a Brookings Institution study found that Austin has the second-highest proportion of millennials in its population (27.2%) of the top 100 metro areas. With about 48% of its adult population holding a bachelor’s degree or higher, it also ranks among the nation’s most educated cities, comparable to Boston and Minneapolis.

Not surprisingly, Austin’s economic prosperity has entailed some costs. In particular, during this century it has had one of the fastest rates of housing price increase in the country. According to the Freddie Mac House Price Index, home prices in Austin have increased at about a 5.0% average annual rate since 2000, which is on a par with the Fresno, Salt Lake City and Washington D.C. metro areas. Since much of the city and the surrounding areas are zoned for single-family homes, growth has mostly taken the form of low-density sprawl. The developed land area of the metro area increased from just 53 square miles in 1970 to 372 square miles in 2016.

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A Good Tax

Gina Bellafante, who is usually an acute and sensitive observer of New York’s community life, wrote a somewhat misdirected column about the city’s retailing environment for Sunday’s Times.

The column portrays sympathetically several long-time Manhattan retailers who have been forced to close shop, or might soon, because of the high cost of rental space. And they are sympathetic! However, the column identifies the City’s Commercial Rent Tax (CRT) as a contributor to the rent inflation retailers have faced and hence to the corporate homogenization of the city’s streetscape. There are several problems with this premise, not the least of which is that the CRT probably doesn’t contribute much, if at all, to the high rents for retail space.

The CRT, initially imposed in 1963 and modified a number of times since, effectively imposes a tax of 3.9% on commercial rent payments that exceed $300,000 annually. The tax applies only in Manhattan below 96th Street and phases in beginning at the $250,000 benchmark. The tax raised $816 million in the City’s 2017 fiscal year which, somewhat astonishingly, represented only about 1.5% of its tax revenue.

A savvy newcomer might ask why levy this tax at all, doesn’t it do more or less what a conventional property tax on commercial buildings does? The answer is yes, it does, but its origins and continued usefulness lies in New York State’s constitutional limit on how much property tax revenue municipalities in the state can raise. In New York City’s case, that limit is 2.5% of the 5-year average of the full value of real property within it (with some complicated adjustments). The City has periodically bumped against that cap, so having a revenue source that is similar to a property tax, but which is not subject to the cap, is fiscally useful.

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The Perils of Private Infrastructure

It is becoming increasingly obvious that the Trump Administration is incapable of pursuing any coherent, sustained legislative strategy. The Administration was unable to play any useful role in fashioning a viable “repeal and replace” health care bill, and it seems equally clueless on the other big agenda item, tax reform. Seeing the Republican legislative machine stall out on those two priority items does not auger well for a third Trump initiative that was once thought to hold some bipartisan appeal: infrastructure spending. That is probably just as well, since any wide-ranging infrastructure bill coming from this Administration and Republican congress would likely be an ideological monstrosity that would entice little Democratic support.

An infrastructure program is, however, more suitable to a piecemeal approach than is health care or tax reform, so it is likely that some sort of new infrastructure policy emerges over the next eighteen months. Trump’s first budget programmed $200 billion over ten years to implement his infrastructure program (while cutting the Department of Transportation’s budget for the coming year by 13 percent). A fact sheet outlined some of the principles that will guide infrastructure policy.

The Trump infrastructure program will invariably seek to maximize the private-sector role, although the Administration’s fact sheet only hints at that direction with proposals such as removing the cap on private activity bonds. Administration officials are also touting the concept of “asset recycling,” whereby government agencies sell existing public infrastructure to private operators and use the proceeds to invest in new infrastructure projects.

The notion of private firms providing public infrastructure is polarizing, with conservatives portraying public agencies as inherently corrupt and inefficient and the left portraying private operators as inevitably predatory. In reality, the economic infrastructure of the United States has always been a patchwork of private and public operations and whatever prevails in a particular region tends to be taken by its residents as the natural state of affairs. Most passenger rail transportation, for example, was originally developed by private firms but virtually all of it was eventually taken over by government entities. Similarly for water supply systems, although about one-quarter of the U.S. population is still served by private water. Conversely, about 70 percent of American households buy their electricity from private, investor-owned firms. Roads and highways, and commercial airports, have always been developed and operated primarily by governments.

In recent years governments have explored privatizing, or re-privatizing, some infrastructure or contracting with private firms to operate it. Encouraging privatization appears to be a key part of the Republican infrastructure agenda, and that will be controversial enough. Even more problematic, though, will be efforts to incentivize the private creation of new economic infrastructure. In that regard the development of Florida’s long-distance passenger rail network is instructive, highlighting both the opportunities and perils of relying on private firms to develop new infrastructure.

The Florida High Speed Rail Project

Efforts to reestablish intercity passenger rail links in Florida have a checkered history reaching back decades. In 2000, Florida voters approved a constitutional amendment mandating the establishment of a high-speed intercity rail system. In order to implement that mandate, the Florida legislature established the Florida High Speed Rail Authority (HSRA) in 2001. However, Florida Governor Jeb Bush was opposed to the idea of a constitutional mandate for transportation infrastructure and was skeptical of the endeavor’s cost. He managed to get the rail mandate repealed in 2004, although the HRSA remained in existence and oversaw the completion in 2005 of an EIS for the Tampa-Orlando segment of a proposed system that was envisioned to eventually run from Tampa to Miami.

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Cat Tracks to Chicago

Caterpillar, Inc. became the latest corporate giant to join the back-to-the-city movement when it announced, on January 31, that it was scrapping plans to build a new headquarters building in Peoria and instead would relocate its headquarters to the Chicago area. Caterpillar has been headquartered in Peoria since 1925.

The company announced that it would be relocating a limited group of senior executives and support functions to the Chicago area. The company disclosed only that the executives would be moving into leased office space by the end of 2017, but did not specifically state that the space would be in downtown Chicago. The company expects about 300 HQ employees to staff the new offices, some of whom would be relocated from Peoria.

The firm’s CEO, Jim Umpleby, provided an interesting rationale for the relocation: “Caterpillar’s Board of Directors has been discussing the benefits of a more accessible, strategic location for some time. Since 2012, about two-thirds of Caterpillar’s sales and revenues have come from outside the United States. Locating our headquarters closer to a global transportation hub, such as Chicago, means we can meet with our global customers, dealers and employees more easily and frequently.”

Although there are surely additional reasons for the move, Umpleby’s statement is right out of Irwin and Kasarda’s classic paper on air passenger linkages and metropolitan employment growth. Peoria is about 165 miles southwest of Chicago in central Illinois. Unlike Chicago’s O’Hare, Peoria’s General Wayne A. Downing International Airport does not offer nonstop flights to, say, London, Shanghai or Beijing.

Caterpillar’s decision also underscores the complexity of modern global business organization, which defies President Trump’s simplistic approach to trade and protectionism. The firm has 22 “principal” manufacturing facilities in the U.S., but also has plants in Australia, Belgium, Brazil, China, Czech Republic, France, Germany, Hungary, India, Indonesia, Italy, Japan, Mexico, Poland, Russia, Singapore, Sweden, Switzerland, United Kingdom, and Thailand. The firm had 40,900 U.S. employees at year-end 2016, and another 54,500 abroad, including 11,400 in Latin America and 22,800 in Asia/Pacific.

The move also adds a ripple to the narrative of Midwestern industrial belt decline. In this case, the jobs are being lost to a global U.S. city rather than to a foreign country. Caterpillar employs about 12,000 workers in the Peoria area (in a metropolitan labor market of about 175,000 payroll employees) so its footprint there will remain large. However, it is difficult to believe that this is not a continuance of a long-term shift of the firm’s higher-level executive functions to global locations with a higher level of connectivity and a richer pool of human capital.

The Los Angeles Homeless Housing Bond

In few cities has homelessness been as contentious an issue as in Los Angeles. The residents of the city have long displayed a live-and-let-live attitude toward the homeless, and in one recent survey of Los Angeles County residents homelessness was cited as the second-most important problem facing the county. Yet, the city has often resorted to a strong-arm law enforcement approach to the street homeless; in 2009 two national advocacy groups anointed it the “meanest” city in the country for its criminalization of homelessness.

In November, Angelenos will have an opportunitunity to express which side of the street they are on, as a referendum authorizing the city to issue $1.2 billion in general obligation bonds to provide supported housing for the homeless will be on the ballot.

Los Angeles has by far the largest population of street homeless in the country. According to the city’s estimates complying with HUD’s Point in Time enumeration, there were 17,687 unsheltered homeless people residing on the city’s streets in 2015. That compares to 3,200 in New York, 2,000 in Chicago and 500 in Washington DC. Even allowing for errors in the count, the scale of the problem is severe. With about 4.5 street homeless per 1,000 housed residents, Los Angeles is second only to San Francisco in terms of the intensity of the problem.

In 2002, under the direction of Police Chief William Bratton, the city began enforcing, especially in the “Skid Row” district near downtown, a 1968 ordinance that prohibited sleeping in or upon a street, sidewalk or public way. The ACLU of Southern California filed suit on behalf of six homeless individuals, but a district court upheld the city’s sleeping ban. However, in Jones v. The City of Los Angeles the following year, a panel of Ninth Circuit judges reversed the district court’s ruling, finding that the plaintiff’s may have become homeless involuntarily and their choice to sleep on the street was “involuntary and inseparable from their status.”

In 2014, a federal appeals court also struck down a Los Angeles law prohibiting people from living in vehicles, and in 2016 the city was ordered to stop seizing and destroying the property of homeless people left unattended on the street.

In the Jones decision the appeals court ruled that the city could not enforce the prohibition on sleeping on public sidewalks as long as the number of homeless persons exceeded the number of available shelter beds. At that time, and still, the city has nowhere near the number of shelter beds necessary to accommodate its homeless population, although the shelters that it does provide are rarely used to capacity.

In 2007, the City and the ACLU reached a settlement agreement stemming from the Jones suit, whereby the city pledged not to enforce the sleeping ban until at least 1,250 units of additional permanent supported housing are constructed for current or formerly chronic homeless persons. Although the city has supported construction of some excellent facilities, nearly 10 years later the City has not completed building all of the promised units and the exact count is a matter of dispute.

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Luxury Housing and the Rest of Us

Does the construction of ultra-luxury apartments raise the cost of housing for everyone else? Simple logic would suggest it doesn’t, insofar as an increase in housing supply should operate to satisfy some housing demand, even if it’s for a thin upper-crust of buyers, thereby relieving price pressure on the rest of the housing stock.

But before jumping to that simple conclusion, less expensive housing that might be demolished to make way for the ultra-luxury building needs to be considered. In the case of 15 Central Park West, one of New York’s most expensive addresses, the 365-room Mayflower Hotel was demolished and replaced by only 202 ultra-luxury units, thereby eliminating affordable housing and reducing overall housing supply. In other cases, however, sites were previously occupied by commercial uses, so there was no offsetting loss of existing housing. Moreover, in New York at least, luxury developers’ purchases of air rights from adjoining properties can lead to the preservation or improvement of existing housing. Overall, it seems that ultra-luxury housing development generally expands the housing supply.

But how does the emergence of an ultra-luxury housing market affect the price of land, and hence the type of housing that can be built in desirable parts of the city? In theory it doesn’t, because the market values land according to the most profitable use it can be put to, and precisely orders sites according to the marketability of the housing that can be built on each. Each site would be developed accordingly. That is a very static view of the land market, however. In the real world, it can be rational for a land owner to keep her property underutilized if she thinks that at some point it will become a viable site for ultra-luxury housing.

Suppose, for example, that the residual value of land for ultra-luxury housing development is three times as much as for normal, upper-middle income housing. Also imagine that there are ten vacant sites available for development, but that the ultra-luxury market can absorb only one of those sites per year. In a static world, the most desirable of those sites will be purchased to develop ultra-luxury housing and the other nine will be sold to developers of more modest housing. In the real world, however, it may pay for the other nine owners to absorb the carrying costs of their underutilized properties until their turn to sell to an ultra-luxury developer arrives.

Something like this may be playing out in Manhattan now. According to a recent New York Times article: The major impediment to more of these projects (apartments modestly priced at $1 million to $3 million) coming to market is the price of land, which has not fallen along with the demand for ultraluxurious properties.

So it seems land owners would rather just hold onto their developable sites, hoping that eventually the ultra-luxury market will revive and their turn to sell to that market will come. In the meantime, development of professional-class housing is impeded.

What’s Up With Retail?

Early this year Macy’s announced that it was closing 40 of its department stores. In April, Sears Holdings said that it would close 10 Sears and 68 Kmart stores. Then last week, Macy’s announced that it would close about 100 additional stores. Do these retrenchments represent just the normal ebb and flow of company fortunes in a competitive marketplace, or is there something more profound going on in retailing?

Well, there seem to be three strong crosswinds impacting the retail sector today, and the large department stores are taking the brunt of them. The three are middle-class income stagnation, globalization and the internet.

Through 2014 (the last year for which data is available), the average real incomes of none of the five household income quintiles had recovered to their pre-recession peaks. However, the recovery of income has been more complete for the higher income groups. While the average income of the lowest quintile of households had recovered to only 88 percent of its pre-recession peak, the average income of the highest income quartile had recovered to 98 percent. The share of total income garnered by the three middle quintiles declined from 46.9 percent to 45.7 percent, while the share of the highest income quintile went from 49.7 to 51.2. Retail chains that cater to higher-income shoppers are reportedly doing well, but for many large chains the three middle groups, with annual household incomes from about $21,000 to $112,000, is where the volume is, and income growth for those households has been slow.

Competition between name-brand retailers and discounters is not new, but in recent decades the out-sourcing of dry-goods production to China, Bangladesh and elsewhere has tilted the playing field in favor of the discounters. Epitomized by the Walmart formula, which combines a cheap foreign supply chain with monopsony buying power and a no-frills “supercenter” shopping experience, the discounters have increasingly pressured the department store chains (as well as smaller chains and independent retailers) that traditionally marketed fashion and quality. Warehouse clubs like Costco have also made inroads among middle-income families whose incomes have stagnated. From 2000 through 2014 the number of department stores nationally declined from about 10,500 to 8,000 while the number of supercenter and warehouse club outlets has grown from about 1,800 to 5,300. Walmart alone operates over 3,400 supercenters. Total retail sales in warehouse clubs and supercenters are now about triple the sales volume of traditional department stores.

Traditional retailers also face intensifying competition from internet sales. In 2015, internet sales topped $432 billion. While that represents only abut 9 percent of all retail sales, e-retailing has captured about 30 percent of the retail sales growth since 2007. As a consequence, in-store retailing has grown at only a 1.2 percent real annual rate over the past eight years, compared to the 8.2 percent growth rate of e-retailing.

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Corporate Eisodos

On August 1st the NY Times ran an article on corporations leaving the suburbs for downtown city locations. Featured in the article are GE’s move to Boston, McDonald’s to Chicago, and Chemours’ decision to stay in Wilmington. The exodus of corporate headquarters to suburban locations shaped metropolitan development in America for half a century, and a reversal of the trend could have equally profound implications.

(Oddly enough, there is no direct English antonym for ‘exodus.’ The English word derives from the Greek ‘exodos’ meaning an exit or departure, and of course is associated with the biblical narrative of the Israelites’ escape from slavery in Egypt. Unfortunately, the English language never got around to expropriating its Greek antonym, eisodos, which mean an entrance or act of entering. Anyway….)

The article is mostly anecdotal so it might be premature to extrapolate an inversion of metropolitan geography from it. Nevertheless, such anecdotes have been accumulating, suggesting something might really be going on.

Two basic explanations are offered for the increasing appeal of urban locations. One is the tax incentives (increasingly?) being offered by municipal governments to companies that are considering downtown relocations. The other is the increased livability of urban areas and corporations’ desire to access a skilled labor force that prefers city living. What’s interesting is that those two reasons represent very different philosophies of urban redevelopment, and are even somewhat contradictory. The first reflects a 1970s-era belief that it’s all about tax competition. The second reflects a Richard Florida-type strategy that if you make cities attractive enough, the creative class will flock to them and corporations will have no choice but to follow suit. The potential contradiction is that if cities give away their tax base to attract business, there won’t be enough of it to make the quality-of-life investments necessary to attract the creative class.

But maybe they aren’t ultimately contradictory. If a virtuous circle takes hold, opposite of the vicious cycle that occurred in the 1960s and 1970s, cities could both lower tax burdens and improve the QOL. There is nothing to suggest that central cities are at an inherent tax disadvantage; economies of scale in metropolitan infrastructure and services might even give cities a structural tax advantage. Maybe we’re reaching that stage of city-suburban competition. In any case, the $7.9 million in grants given to Chemours, cited in the article, came from the state of Delaware, not the City of Wilmington, as the DuPont spinoff was considering a move to Pennsylvania or New Jersey.

Homeownership and Retirement

The New York Times today presented a “Room for Debate” feature on the declining rate of homeownership, which has declined 6 percentage points from its peak. The debaters include Dean Baker, Elyse Cherry, William E. Spriggs, A. Michele Dickerson and Ed Glaser. Though I have some qualms with Cherry’s prescription of mass principal write-downs for underwater borrowers, the debaters generally offer reasonable takes on the pros and cons of home ownership and the implications of a declining ownership rate.

It is surprising, however, how little attention these reasonable commentators give to the retirement security benefits of homeownership. That oversight is particularly stark in Glaeser’s comments, where he states bluntly that “there is little public benefit in pushing people to own rather than rent homes.”

Consider a simple example where two identical families earning $75,000 annually at 30 years of age are contemplating renting permanently or plunging into homeownership. Say the first choses a permanent rental apartment for 20 percent of their gross income (about $1,250/month) and the other purchases an equivalent house with a similar monthly mortgage payment, although they will have to pay another 10 percent of their income in property taxes, insurance and maintenance expenses. To keep things simple, let’s ignore the tax benefits of homeownership and the opportunity costs of the home buying family’s initial down payment. Furthermore, assume that all rental and ownership costs inflate by 2 percent per year, except of course the homeowners’ mortgage expense, which is fixed for its 30 year amortization period.

Initially, in this simple scenario, the buying family would be paying a housing cost premium of 50 percent to own rather than rent. But since their mortgage costs are fixed, that ownership premium falls steadily, so that by the time they are 60 years old they are paying only a 6 percent monthly premium over their renting counterparts. By the time they are 61, their mortgage is fully amortized (No refinancing! No home equity loans!) and their ownership costs drop to 50 percent of their counterparts’ rental costs.

In nominal dollar terms, at age 65 the renter family will be paying $2,451 in monthly rent while the home-owning family will have total monthly housing costs of just $1,225. That difference will make a huge difference in the retirement welfare of the two families, not to mention the benefit of cost predictability enjoyed by the homeowners.

Of course, many embellishments to this simple model can be made, but the basic conclusion will stand under a wide variety of assumptions. The renters would have to display a great deal of savings discipline over their working lifetimes to generate enough investment income to offset their housing cost disadvantage and be better off overall than the homeowner at retirement age. I haven’t done a lit review of renter/owner savings behavior, but I’ll guess that very few renter families would display such savings discipline.

So, if there is a public benefit that the elderly be securely housed there is a public benefit to encouraging home ownership. If there isn’t a public benefit to homeownership in this sense, is there a public benefit to other retirement security policies, such as Social Security or 401-k tax advantages?