Odd Lots - Why the CRE Urban Doom Loop May Still Be Coming

Episode Date: April 1, 2024

When it comes to the collapse in office real estate, there's a lot of focus on who owns the debt, and what kind of pain must eventually be realized by someone. But there may be an even deeper challenge for big cities like New York or San Francisco. Office buildings, and the various restaurants and shops that cater to daily workers, are big contributors to the tax base of many cities. What happens if that goes into decline? In theory, you can get a doom loop of population loss leading to lower activity, leading to lower taxes, leading to lower spending, leading to worse public service, leading to more population loss and on and on it goes. So is that still a risk in 2024? On this episode we speak with Arpit Gupta, associate professor of finance at New York University's Stern School of Business, who has been tracking this risk for awhile. He gives an update on where things stand and why some of the pain may still be possible in the future.See omnystudio.com/listener for privacy information.

Bloomberg Audio Studios. Podcasts, Radio News. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway. Tracy, so, you know, we had that conversation the other day with Rich Hill, Cohen, and Steers. And you sort of put like a maybe not too gloomy gloss on the commercial. Not too gloomy gloss.

Right. I mean, like, say that five times fast. Not too gloomy gloss. Right. Not too. That's a good one. Like, not great. but maybe like not terrible

that like price discovery is happening it's not great but it's salvageable there's still room for extending and pretending it's not the end of the world like you know not great but not terrible. Yeah and I think to some extent we've seen that play out in markets

in recent months right so there were all these stories about the looming maturity wall. A lot of those loans a lot of those bonds have been refinanced a lot of companies are surviving a lot of building owners or real estate developers seem to be surviving under the new conditions. But I guess the wild card in a lot of this is still what happens with interest rates.

Here's what I don't get, though. Like, at least when we're talking about office and when we're talking about office real estate in big cities, the vacancy rates keep going up. And I sort of thought that would stop because, you know, especially in the middle of last year, you saw a number of pushes where companies like, no, we're serious. It's return to the office time, guys. And so I was like, oh, okay, like that was it. This was the turning point.

And yet I think by like at least top line metrics, if you just sort of look at offices and the empty ones, things continue to deteriorate. Office buildings are still empty in places like New York and San Francisco. This is very true. But I think real estate, like people still want to live here, residential real estate. I mean, I think those vacancies are pretty low. So there is this like there is this tension where people still want to come to the city it feels like or at least move here. but they don't want to go into the office, which fair enough, I sympathize. So just a full disclosure or, you know, my own stake in this story, which is that last year,

I bought an apartment in Manhattan. So I am really invested in the idea that Manhattan continues to be a thriving, going concern with people on the streets, looking around, moving about. I feel like that's, you know, it feels good for safety, things like that. I really need this whole thing to hang together. And I'm on the opposite side of this trade, I think, where I have no Manhattan ownership. I rent. I would like the rent to go down, actually. And I have a house out in the country. So, yeah, we'll debate. Between the two of us, Tracy, we're perfectly hedged. We're well hedged. Yeah, that's right. We're perfectly hedged. Well, anyway, so we had that conversation with Rich Hill last week. And he mentioned, he said, oh, there's this NYU professor who was once super gloomy about the urban doom loop real estate apocalypse. And he, even he's changed his tone. And then when he said that, I thought two things.

It's like, A, I know that guy. Yeah, he's even been to some odd-laught trivia nights. And B, I didn't realize he had changed his tone. I didn't even know if that's true. Got stated on air. I hope it's true because I want things to be factual on the podcast. So I was like, we should actually, we should talk to that NYU professor. I like that our fact checks have become sources of content now.

It's just another episode to see if what someone already said is actually correct. We could have just done a fact check or we just put it out there and then if it's wrong, then we get it debunked on a future episode. All right. Let's find it out if it's wrong or not. Well, I'm very excited. We're going to be speaking with Arpid Gupta. He's an associate professor of finance at NYU Stern. And back in 2022, he was the co-author of a paper, Work from Home and the office real estate apocalypse. And of course, there's all this fear of doom loops. People don't go into the office, then the local businesses that depended on that foot traffic, like delis and salad bars and restaurants go out of business. And then people don't like being in the city even more.

And then they move out to the middle of nowhere like you. And then suddenly the whole thing falls apart. Um, Arpit, thank you so much for coming in. Thanks so much for having me. Let's just start with like the basic fact check question. Are you as gloomy or do you have the same fears of an office real estate apocalypse as you did in late 2022? Great. So taking a step back, My co-author teams and I, so that includes Stainwan Neuberg, who is at Columbia, as well as Brenda Mithel, who is at UNC, first began with a research paper that was looking at the urban flight and residential real estate. So we were comparing the price of real estate in the center of cities against the price of residential real estate in the suburbs. And what we found is that over the course of the pandemic, the price of suburban real estate. So places like where Tracy lives have gone up dramatically.

This is really like ex-urban, but yes, keep going. No, it's really those far, far exurban places, places that weren't even really considered commutable that actually went up in value the most. Relative to real estate in the center of the city places like where Joe lives, right? And so we find that that spread is corresponding to a rent gradient or a price gradient really narrowed. And in fact, that narrowing has continued even through 2023. So urban real estate continues to lose value relative to suburban and far. our ex-urban residential real estate. We find that that pattern is really driven by remote work. So it's people that are willing to move further and further away from the city and are less willing to

pay for urban amenities and proximity to urban work locations that's kind of driving this spatial arbitrage across markets. How do you square that spatial arbitrage idea or that price discrepancy urban versus the non-urban prices with the sense that, I mean, it certainly feels reading the headlines. And again, Joe and I might be slightly biased here because we work in financial journalism adjacent to the financial industry. But it feels like there is a drive to get people back into the office. Absolutely. And I think this really varies across cities and across industries. So when you look at the entire country, there's really no good indication that people are more likely to come into the office, whether you're looking at surveys that kind of ask people,

how often are you coming to the office or not? Or surveys that ask firms, what are you? your policies or not. But one trend that is pretty noticeable is it's a lot of the largest companies that kind of make up the headlines, firms like Goldman Sachs. They're very vocal about their back to office plans. And you see across some industries, particularly industries like finance, they are a little bit more inclined to get workers into the office. So it's really kind of hard to see a nationwide trend, but it is there in certain industries or firms. So is the doom loop looping? Like, is it spiraling or has anything arrested it? Right. So we looked at this. this aspect of urban flight. And so across many cities like New York or San Francisco,

you see a population loss of about 6 to 8 percent that happened over the course of the pandemic. And this population loss has sort of stabilized. So San Francisco gained a small amount of population last year. New York continued to lose population, but at a smaller rate than previous years. And that kind of motivated us to look into what are the implications for commercial office buildings and this concept of the of the doom loop. So in our paper that came out a couple of years ago, We estimated that New York City office real estate would be down in value about 40 to 50 percent. And this can lead to two possible spillovers, right? So one is the impact on financial institutions and banks in particular that are holding a lot of the debt associated with office building.

So that's a financial doom risk, right? So as the value of these properties declines, loans attached to these properties might enter into default. And we're saying default rates now about 6 to 7 percent. That might trigger foreclosures, distress sales. sales that then amplify back and feed into further real estate price declines. We're seeing the beginnings of this play out, but modification efforts have sort of stemmed this tide for now. The other externality or spillover effect comes under cities, right?

And so that's this urban doom loop idea that you're going to see a cycle driven by remote work leading to office vacancy losses, loss and property value. That then hits city budgets, city governments, therefore lose money and are forced because of balanced budget requirements to either raise taxes or cut. services. And people don't like either of those. And so they might respond by leaving the city in greater numbers, which might then further amplify those losses. And so what we're seeing, I think, as sort of the first wave of those events happens, so the population loss, the loss in value for commercial real estate. And it's really now kind of in the hands of policymakers to kind of decide

how they choose to respond to those trends, right? Whether they're going to respond to these losses by trying to kind of raise taxes, cut spending, or trying to improve the quality of life and amenities in urban areas. So you're the 40% estimate. So the idea that long run office valuations are 40% below their pre-pandemic levels per your paper. That was kind of assuming that everything pretty much stays the same. Is that right? So we are trying to figure out how persistent remote work is going to be. Right. So we're acknowledging the possibility that these firms might be successful in bringing people back into the office. And we're trying to estimate how likely is that going to happen. We ultimately back that number out by looking at publicly

traded stock prices. So the idea is we sort of solve asset pricing model that has a key parameter being how likely are firms to be successful in bringing people back to the office. And basically, the only way we can kind of match publicly traded reed prices, so stocks like Bernato, S.L. Green, is by getting a parameter, an estimate for how persistent remote work is likely to be. It's going to be pretty high. So we're basically estimating how likely is it that we're going to stay in this remote work equilibrium. I mean, we sort of estimate that it's a pretty high likelihood. So this world sort of seems to be persistent for now. Yeah, it is striking. So prior to the pandemic, shares of Vernado were about $70 a share. In the middle of 2023, they hit as low as 1279.

and they've rebounded, but they're only back up to just under $30. So still about basically cut in half versus pre-pandemic levels. And I think SL Green looks pretty similar. Yeah. And the other major pricing indicator to look at is the CMBX series, right? So back in the financial crisis, a lot of short traders were looking at the ABX series, which was tracking credit default swaps on the price of non-agency mortgage-backed securities. So the CMBX index similarly tracks the value of CMBS deals, which are backed by bundles,

of large numbers of commercial real estate mortgages. And these bundles vary in how much office they have, but what we're seeing is a value loss in the CMBX index, which might vary from between 15 and 25% for a triple B minus CMBX reference index. So that basically means that market participants expect there to be some value loss in these debt securitizations backed by commercial real estate.

Since you mentioned the ABX, and now I have all these subprime memories flooding back, But part of the problem there or part of the reason the losses were a lot higher than a lot of people expected was because we estimated the correlation wrong, right? Mortgages, when they started going bad, it wasn't just isolated incidents. It ended up being across the country. What do you see in terms of correlation or relationship when it comes to vacant office buildings? Do you see like if one office building doesn't have a lot of business inside it or a lot of renters, does that impact the ones around it? So there probably is this correlation risk within office and maybe other adjacent asset classes like urban retail.

And the reason for that is if an office building is vacant, if people aren't going there, well, that just makes it a less attractive destination, even for other people within the same office district. So a good example of this might be D.C. So D.C. actually has a really high remote working rate, in part because a lot of federal government employees have fairly generous remote working policies. And so that means that a lot of different office buildings in the D.C. market are all experiencing high vacancy at the same time. That does have some spillover effects to other corners of commercial real estate. So if I'm looking at retail in D.C. or in some markets like San Francisco, even hospitality hotels are impacted as well. But it is confined more to those specific asset classes and doesn't necessarily spill over to all of commercial real estate, which, as you both know, is a very large heterogeneous universe, a lot of different asset types. I remember we used to talk sometimes like on TV to emerging markets manager and it's like,

oh, it's very important to remember not all EM is a monolith. And now I feel like all CRE discussions. Similar thing, you must get in there that CRE is not a monolith that includes many different categories. The key maybe dichotomy or question as you sort of set it out is, do cities respond to population flight by raising taxes, which might accelerate population flight or cutting spending, which might do the same thing, or do they find some way of actually reversing that trend and making people not want to move out? Like, what are they doing so far? So I think the important thing to keep in

mind is the really long lags built into all of this, right? So the office leases are really long-term in nature. And so even to this point, many firms haven't had to make an active space decision yet because they're still inherited a lease from before the pandemic. Then you have the mortgages on these assets that are also really long term in nature. And so you haven't had to hit a refinancing point yet for these owners. And then finally, you have the property tax assessment cycle, which is also really long. So it takes a really long time for cities to necessarily recognize a loss in property value in their tax receipts, right? So a lot of cities haven't yet really face this fiscal reckoning yet. It's really more of the long term that they're going to be potentially facing

lower property tax receipts coming from lower property tax revenue from these commercial office buildings coming from lower income taxes from people that have left, as well as lower sales taxes from less spending that's happening in urban districts. So most cities haven't really had to face the impacts of this yet. They've also benefited from one-time federal relief funds. But in the future, a lot of cities are projecting future deficits. And part of that just reflects conservative accounting on the part of city governments. So they're sort of accounting for the possibility that revenues in the future may just kind of come in slower. So it's, It's not yet clear whether these deficits will materialize in the future.

But what you can say is when we look back in the past, the conservative forecast on revenues wound up being exceeded because cities actually wound up getting a lot more money than they expected in property taxes. So a lot of these core assets like office buildings are really providing cities with a lot of additional revenue in the past 10, 15 years. And so they may not be in a position to get the same amount of revenue from those office buildings, which then forces cities to do a variety of different things to try to make sure that they remain attractive, vibrant places to be. So one big response cities are trying to do is conversions, right?

So if you can take this structurally obsolescent, you know, stranded asset office real estate class and turn it into housing or some other use case. Housing, of course, is great because everyone wants more housing in dense urban areas. That is a great way to kind of fill up the city, fill up the subway systems. Those subway systems are also kind of experiencing declines in ridership as well. And so that's something a lot of cities are looking actively at. In addition to just converting additional office space or just changing regulation around housing more broadly so we can build more housing in cities. This reminds me actually one thing that often comes up in these urban doom loop discussions is the example of New York in the 1970s, 1980s, or even after 2001 and 9-11. And the idea that, well,

there was a sort of discussion about New York is in a long run decline and it's going to be impossible for it to get out. And yet it did in one way or another. How did it manage to achieve that? And what does that say about, you know, the current policy trajectory? So when we coined that term in our paper, we really were thinking about this deindustrialization shock, which hit a lot of rust-belt cities, right? And so you saw cities like Detroit or St. Louis lose about 50 or 60 percent of their population over that time as they kind of lost that center industry, which was holding up their entire ecosystem.

For cities like New York, it also was a pretty bad shock. So the city lost something like a million manufacturing jobs that were previously located right in the heart of the city. So we had this big surplus of real estate associated with these industrial logistics uses that had to get redeployed towards other things. And ultimately, we found here in New York that you could take these buildings and convert them to retail, housing, and support a lot of office buildings. So a lot of white-collar work came to New York in the aftermath of that deindustrialization period. So some cities were able to ultimately prove to be more resilient. We also see across cities that meds and eds were a really big factor. So having hospitals and educational institutions were a great way for economies to kind of pivot

and create new job centers of growth in order to take over the previous blue-collar work that would have been going on in cities. And so some of those cities, again, particularly like New York, were able to kind of redeploy and change their economic environment and response. We are recording this March 25th, 2024. So on March 25th, 2024, how are you feeling? Let's start with New York specifically, because that's all. I care about. No, it's not all I care about, just 90%. How are you feeling about New York right now?

So I think New York has a lot of great advantages going for it. So it begins with the diversified industrial base, right? So in comparison to a lot of these West Coast cities, in comparison to a city like San Francisco right now has something like a 37% office vacancy rate. At those rates, if you had the fastest office absorption in history, you would still need seven or eight years just to fill the existing vacant office space. If you are filling San Francisco office at the average rate of absorption over the last 20 years, you would need something like 15 or more years to actually fill all of that office space. So there's just a huge vacancy problem in a lot of these West Coast tech center extended cities. In comparison, New York just has a broad diversity of different

industrial uses. And you have a lot of firms like big law or financial firms that do seem to be more able to get workers into the office. In addition, you have a lot of great consumption amenities. So people love being in New York for all sorts of different reasons. That's going to mean that New York is in the position to reinvent itself as more of a consumption city rather than a production city. And then finally, there's another great buffer that New York City has, which is if you're looking at office rents that are, let's say, $70 or $80 a square foot, you have the space to cut that rent down and get to a point where you're able to find some other tenant willing to come into that space. Now, office owners, for a variety of reasons we can get into, are reluctant to lower the rent to that point.

But there is space to lower the rent and still be able to operate that building financially. In comparison, you have a lot of other cities, for example, some other Rust Belt cities where there's not necessarily that same level of space to cut the office rent without really eating into the ability to operate that building successfully. This was going to be exactly my next question. So what is the catalyst for office owners or building owners to finally reduce rent? because presumably that's when you get the sort of healing process, the creative destruction, I guess, that allows new types of businesses to come into the city and maybe start redefining some of these urban areas. I think in many cases it's really going to require a change in ownership of the building, right? Because why are building owners reluctant to lower the rents of their existing buildings?

I think there are a variety of reasons, but some of the reasons I've heard include, one, there's this real options problem. So you don't want to lock in a tenant for the long term at a low rent. you kind of want to wait and find the right tenant. Second, you hear about issues related to debt covenants on their mortgages. So the owners of debt may have restrictions in place that prevent that owner from reducing the rent. And then finally, you hear about issues related to strategic vacancy. So owners of buildings may be reluctant to lower rents because that sends a signal to other tenants or signals to appraisals and their mortgage holders that may impact their future financing prospects.

So one way to kind of deal with these things is really, that building to go through a foreclosure or fire sale change ownership, and that new owner is going to be able to purchase a building at a much lower cost basis. That cost basis helps them either a convert the building into an apartment or other use, find ways of investing in that building to really try to compete for that trophy A-plus real estate space, or just take the building and lower the rent and find a way of remaining profitable at a lower rent point. So you've mentioned, And you've written a fair amount about office to resi conversions, and we've talked about it on this show a handful of times. Definitely one of these things that sounds good.

It seems expensive. It seems slow. I can never really tell even if everyone got their ducks in an order, whether it would move the dial enough to meaningfully, A, e some of the housing strains, or B, sort of fill in some of this empty space. What is your work saying right now? Is this happening on any scale, or is this just a thing people tweet and write papers about? So we did write a paper on this and have tweeted about it as well. So we've contributed in the last few components at least. What we find in our work is, again, joint with Stainwin-Norberg and another co-author, Candy Martinez,

is that there is a prospect for physically converting about 10 to 15% of the nation's office stock, and that would produce something like 400,000 apartments, where our annual average apartment production is something like 260,000 a year. So it's a reasonably large prospect relative to the size of annual production, but it's still a pretty small overall part of the entire office ecosystem. Across cities, we do see some cities that are exploring it more aggressively than others. Cleveland actually is a city that seems to be engaging in these office to raise the conversions a little bit more. So when you say explore, this is what I'm trying to get. Is there like in New York or maybe even Cleveland? Like, is this actually happening?

Yeah. It seems like these conversions are happening. here in the financial district, we converted, you know, somewhere in the order of tens of thousands of apartment units out of former office building. So that's something that happened, particularly after 9-11. And it is happening now, it seems like, at an increasing rate across a lot of cities. So you mentioned timelines earlier and the idea that this dynamic is really operating on a lag. And so it might not seem that the doom loop is upon us right now, but a lot of those rents have, or leases have yet to be renegotiated. And so it might just take.

longer than a lot of people anticipated. Maybe we could reframe the question as like, when would you expect this to play out? Like, what is the approximate timeline that you're sort of envisioning at this stage? So I think there are two important things to keep in mind with this urban doom loop concept. First is that it's sort of a cycle, not necessarily a prediction of something that will happen, right? So we kind of talked about how aspects of these dynamics have happened in the past. And I think it's an open question whether we're going to see this element of urban downward spiral happen in the future. If it were to happen, I would sort of expect it to really materialize as you see this federal stimulus dry up and the impact of these property losses start to accumulate for cities.

So as one benchmark, New York City had a relatively severe recession in the early 90s. We had a big problem commercial real estate back then. So we had a lot of failures of banks with the SNL crisis, big losses for commercial real estate back then. And it actually took a really long time until the late 90s for New York City to see the losses from those commercial real estate property tax losses materialized, at which point the city had already experienced a growth cycle because of the dot-com bubble. So the forecast, I think, is, you know, in the next few years, you're going to potentially see the impact of these property tax losses combined with the drying up of co-ed funds, and that's going to be the moment of greatest stress for cities. I think the other thing

to keep in mind is that in parallel with the urban doom loop, you have the suburban boom loop, which is the phenomenon going on in suburban areas. As more people move to these areas, you're seeing more amenities pop up, and these make them more desirable locations, enabling a positive flywheel of the economic activity. So remote work in aggregate is probably a good thing for the economy. It just has these concentrated pattern of winners and losers. Can I just say, the suburbs are getting so good. No, I really believe this. I may have mentioned it recently on an episode, but I was like halfway between Austin and San Antonio recently, which is now basically just one giant contiguous suburb. And like the sheer number of like new different kinds of

restaurants that are opening up out there and different concepts and stuff. Like it's so wild. It's so good. Like there's so much good stuff out there. So the New York City is already seeing budget strains, right? Yeah. So there was a big back and forth about some cuts to things like libraries. And then I think the controller has estimated that in the coming years, we're going to see out budget gaps, you know, something like 8, 9% of the city's budget in future years. So I think it hasn't really yet materialized for the city because revenues, I think, ultimately came in higher than expected, enabling us to avoid some of those cuts to things like libraries. There's the prospect of future cuts on the horizon as we're forced with the prospect of increasing expenditures

down the road and thinking about what will be the revenue sources to pay for it. Joe mentioned how good the suburbs are getting to which all I can say is you're dooming, Joe, and I'm booming. But actually, this brings me to another thing that I wanted to ask you about, and this comes up, again, a lot in these conversations, but the idea of perhaps making it easier to build, deregulating or rezoning or whatever you want to call it. And there is an argument that one of the reasons you've seen a lot of people, a lot of businesses move to places in the sunbelt is because it's easier to build there. There's more room. It's change. cheaper in many ways, or at least it used to be relatively cheap, versus places like New York.

Could you talk about that sort of regulatory aspect of all of this? Are there levers that the city could pull to make New York an easier city in which to construct new buildings or repurpose old buildings? Absolutely. So the lowest hanging fruit, I think, is the FAR cap here in the city. So we have a limit for multifamily buildings. They can only have an FAR of 12. So that basically means for every... What's an FAR stand for? So it's the ratio of all the usable space in a building divided by the plot size. Okay.

So if I have a one square foot, I can create 12 more square feet of livable space on top of that, but no more. Whereas in fact, that ratio is higher for office buildings. And this is actually a big barrier for conversions, because if I take a large office building and convert that into apartments, I may only be able to use a portion of that building for residential use, and I have to leave the other floor is empty. There's also why those giant super tall buildings kind of, south of Central Park are so skinny. They're sort of trying to meet these regulatory requirements on

density. So that, I think, is the easiest fix. And policymakers are looking at that one right now. More broadly, we have a lot of restrictions on the ability to build in the city. And even here in New York, we have some neighborhoods that are still zoned for essentially single-family homes. So you're not allowed to build a multifamily building. Or if you are, they're really strong density requirements. So I think there are a host of regulatory shifts that cities can do to make it easier to build, which will then narrow that cost of living advantage between urban cities and the Sun Belt. I hadn't realized that about the sort of regulatory rationale for the skinny building.

So the smaller the plot on the ground, the more you're allowed to go up. It's more that you're taking a certain plot of land. And if you want to sort of have a better view, you kind of have to make the building a little bit skinnier. And sometimes you have to leave some of those floors in the middle unoccupied in order to really take advantage of the high benefits. On San Francisco, as you mentioned, like, under a reasonable normal assumption about new office leasing, I think you said 37 years would take to, like, fill that hole or something like

that? I think at an average rate, I think it's more than 15. What happens to a city with that big of a deficit? Like, is this like a serious, like, you know, there's a lot of excitement because basically every smart AI person in the world pretty much lives in San Francisco is my understanding. Like, in your view, is this a sort of deep structural impediment to like the viability of the city and the city's budget going forward? I think it's certainly a big problem. So the city's own estimates, I think, suggests that they've lost something like a half a billion dollars due to remote work.

And in the future, they're looking at a lot of property tax reassessment. So basically a lot of people that own office buildings are appealing their property taxes, arguing that their building is worth a lot less now that you have all these vacancies. And so it's definitely a source of stress, I think, for the city. budget. I think this is really amplified by some San Francisco, California-specific issues, right? So you have Proposition 13, which means that you're not able to raise taxes as much on residential real estate. So that puts more of the burden on other sources of taxation. They also have these things like business gross receipts and things like that, which are additional taxes levied on businesses in the area. So firms hate that and don't like having to pay these additional costs. And then in addition, I think you have the kind of

spatial development of the city. So going back to the 70s and 80s, there was basically this deal whereby the city agreed to a down-sowning of most of the residential neighborhoods in exchange for a very concentrated building of commercial riding in the downtown area. And this allowed the residents of San Francisco to kind of live in these small, nice, quaint little homes preserving their neighborhood character. They're nice. Oh, these are the ones with the Victorian woodwork and stuff. Right, right, exactly.

Which people hated at the time, but grew to sort of love and see as kind of historic parts of their character. I visited a friend a few years ago who lives in like not one of the nice Victorian homes, but just like a sort of like little nice neighborhood with the Wichit single family housing. And he's like a big Yambi guy. And I was like, oh, I love your neighborhood. It's so nice. And he's like, Joe, you can't you can't say that. I hate it.

You said the wrong thing. But anyway, keep going. Absolutely. So the tradeoff was you're going to have this down zoning of the rest of the city in exchange for this very concentrated development happening in downtown. And the problem is that that left the city really unprepared when the pandemic had because you had all these people commuting. from really long distances to try to get to that downtown court because they really couldn't

find or afford any housing nearby. And that's one of the reasons why people were so excited by remote work because it allowed them to take advantage of the ability to move to Austin or wherever else and get a lower cost of living in order to continue working at the same place they were before. So you have just massive mismatch between the jobs and the people. And so that has to be corrected one way or the other. Either you move the jobs now to where the people are, so move the jobs over to Austin or wherever they are now, or where you're find ways of bringing more people back into San Francisco, and that'll actually fill back up the transit system, fill back up those downtown office course. So people don't just want to

live in cities because there's work there, although clearly that's one aspect of it, you know, at least in recent decades, going to a place like New York, that's where all the jobs are, and so that's where you need to be in order to make a certain type of living. But there are people who will move to a city just because they want to be part of a city. They want that vibrant experience. They want to be close to other human beings. They want to have options for restaurants and going out and experience everything that a city like New York has to offer. Is there a world where maybe cities get divorced from or slightly more separated from the economic opportunities? I think so. That would be essentially a world in which cities are really

defined by those consumption opportunities, right, by their dating markets rather than their labor markets, right? And people... Oh, we're doomed. Sorry. I haven't heard anything good about them. And people, you know, what we see in the data is a lot of people are working remotely, even in Manhattan, right? So clearly a lot of people, when given the choice, will still choose to live in these large cities. I think the challenge is establishing the quality of life and cost of housing to enable people to do that. So, for example, the Citizens

Budget Commission has been serving people over time, and they find that in New York, far fewer people rate their quality of life as being high compared to what they were rating it before the pandemic. So they're important concerns about the quality of life people are experiencing in urban areas. Now, they also found that people actually liked their neighborhood more than the city, kind of the same way that people rate their personal financial situation a lot better than the national one. So there's maybe some issue of negative urban vibes that are kind of impacting people's decision making here. But I think definitely something around trying to make sure that cities can remain these vibrant, exciting places is really great. way to make sure that they continue to live there, even when they have options and can choose to live elsewhere.

That's such an interesting phenomenon about like everyone's own situation is not as bad as they perceive everyone else is. Like I think you see the same thing and like people talk about their representatives too. Like it's like, oh, my center, my rep is all right. Isn't it like. But Congress is terrible. It's like the Dunning Kruger effect, right? Like everyone just assumes they're doing better than everyone else.

I like my neighborhood. But yeah, I guess maybe maybe everyone likes their neighborhood do. But, you know, on this point, so it's like there is this dimension that is not just about numbers. And it sort of gets to the quality of life effect. And, you know, recently, for example, there was the headline about Governor Hokel deploying the National Guard to the subway. And obviously there's a lot of anxiety about safety on the subways these days. And like, you know, in my neighborhood, which I like, there are certainly many public vices that one sees as I walk here, take my kids to the park. or take them to school, et cetera. And some of these things aren't really just money things that can

be solved with spending or taxes. There's a certain amount of political will or political consensus about the degree to which, you know, we crack down on, you know, illegal weed shops and stuff like that. How much is the future of some of these cities going to be determined by the ability to get political consensus for some things that aren't just sort of dollars and sense questions? I think that's really important because I think the pandemic was this whole desocialization period in which we were just not near each other as much, and that sort of broke down a lot of social norms, right? And if you think about how new people are entering the city, they're sort of seeing people behave as they currently are and just assuming, okay, well, these are the social norms in the city.

So it's really important, I think, to maintain sort of pro-social behavior. So just to take one example that you raised at the subways, so I think overall crime in the subway is down slightly compared to before the pandemic, but if you look at felony assaults, so people actually experiencing and being victims of crime in subways, that's actually up pretty substantially from what it was before the pandemic. And again, back in that CBC survey, they found that people basically rate the safety of the subway during the daytime, the same as they rated the safety of the subway at nighttime before the pandemic. So there's been a huge shift in the perception of crime and safety on subways. And I think part of that is driven by remote work because you have fewer people

taking the subway, so that's fewer eyes on the street, less sociable, you know, kind of enforcement, coming from other people, and that sort of drives more anti-social behavior in ways that can compound on themselves unless it's addressed by, you know, for example, putting more police officers in the subway or sort of changing the social norms in other ways. So you're obviously at NYU. I'm curious if you're able to talk about it. Do city officials ever ask you for advice or ask for additional information on your research? We've, I think, talked to a number of city officials from across the country, particularly on the office problem, you know, thinking about conversions and things like that. I would say that this whole

research has definitely resonated far more than any research I've done previously or probably will do in the future. But I'm hopeful that it's a sort of wake-up call for city and local governments to think about what do they need to do after the pandemic in order to really continue to make sure that their cities are really exciting and vibrant places to be. Out of curiosity, just because you mentioned more, what has been the general gist of your work prior to this? So I did a lot of work related to the financial crisis. So thinking about all those subprime mortgages and defaults and things like that. I also do research now thinking about housing regulations and costs, right, and how we can use AI to better extract information from these zoning codes and better figure

out ways of making housing cheaper. Real quickly, on that AI thing, I think you did a recent research paper using AI to do something about regulations and codes. What did you, what was your experience? We've got to get in an AI question on that. So I think it's a great use case, actually, because we have, you know, across the country, every municipality has a very long, complicated document, hundreds of pages long, that outlines all of their regulations, you know, these density requirements, lot size restriction, so and so forth. And people really haven't dug through and read all of these documents to really categorize and figure out what is inside them. And so that turns out to be a great application where we can basically get chat TPT to do it and thereby create a data set of housing regulations across the country. So I think that's something we can really ramp up kind of across municipal government regulations to be. you better understand where the rules out there we should charge servers rent that's the solution like

charge the bots rent and property taxes and this will solve the issue i mean data data center cRE is like the hottest area in the world yeah i know so higher higher taxes there we go that what office to data center conversions i think is the move rather than office to rezi office office to a i like that idea arpid gupta uh associate professor of finance at n yu thank you so much for uh coming on Great to finally chat with you. Thanks so much for having me. Tracy, so I guess my takeaway is maybe it's still coming. Like, I don't know.

Maybe like the coast is not totally clear yet. Well, I take the point that in all of commercial real estate, it feels like it is operating on this incredibly lengthy lag time. And it takes a long time for leases to get renegotiated. A lot of property owners don't want to have lower rents for the reason that ARPIT discussed. But the other thing I would say is like, coming. away from that conversation, I kind of feel like there's two possible pathways, like two extreme pathways. One is the doom loop scenario that ARPIT described. And the other one is the sort of like redevelopment of the urban environment where offices do get turned into new residential units.

And maybe as rents are lowered, there are new types of businesses that come in. It's that consumption economy rather than this is the place that you go to work idea. If everything when perfectly if policymakers like pursued that path, that could be a relatively amazing outcome. I do not always have 100% confidence that policymakers are going to be sort of visionaries when it comes to redefining huge urban cities. But it's kind of, it's kind of a nice lot. Totally. There are three things there that struck me. So first of all, disinclination to lower rent is like one of these great examples of accounting affecting the real world, right? So it's like something that exists on a spreadsheet somewhere creates a reason to not find that

market clearing price for rent. And maybe the moment will come when the new businesses that like the cheaper rent can come in. And I think that's something interesting to watch. Two, I liked the way ARPett put it in response to your question about, you know, people, maybe people come to the cities for the dating markets instead of the labor markets. And that's sort of grim. But I think like it's interesting if you think like about things like Tinder or DoorDash or some of these apps and like, how much better they probably are on the cities, rather than out in the sticks where you swipe and see the same three restaurants

are the same, you know, six people. Same three people. And that these technologies that we think of as potentially diffusing could actually encourage physical concentration. And then third, you know, one thing I think about, and we talked recently about the megacity that the UAE might build in northern Egypt, is like this idea of like cities divorced from production generally. And I sort of think that's like the thesis of some of these megasties.

cities in the Middle East is like the main thing they're selling is not some industry that exists in the city. It's the main thing is they're selling a nice quality of life. A quality of life and lower taxes and low taxes and low crime, et cetera. And then like the idea that the production has to happen there is like sort of not particularly necessary. That's a really good way of putting it. The one other thing I'd say is so obviously the big cities could develop themselves into like consumerist or human connection capitals of the world, I guess. But you could also see smaller cities, smaller towns, suburban areas start to build up their own like nightlife and restaurant options, sort of what you were talking about earlier. And we have seen some places outside of New York.

I think there was a really good Bloomberg article on a small town in Connecticut. Am I? I'm talking my own book now. But there was a there was a nice story about, you know, a relatively small town and Connecticut that had seen a lot of people move away from New York. They don't want to do the commute into the city anymore. And so their downtown area is booming. Now, that's relative for a smaller town, but they have new restaurants opening up. They have new shops. They have offices being built there. So you could see these sort of like smaller versions, I guess, of cities kind of develop across America where it is, to your point about the mega cities in the UAE and the Middle East, where it is much more about that quality of life. Tracy, I have a favor to ask. Can you go to town planning meetings and be

ultra nimbie so that people can't move out of the city? And, you know, like, this is how we could exploit our natural hedge together, which is you fight to preserve your quality of life out in the middle of nowhere so that people have to stay in New York and keep rents and foot traffic up here. I think that would be a very dangerous thing for me to do personally. All right, I respect it. But we can talk about it, Jim. All right. Sounds good. Shall we leave it there? Let's leave it there. All right, this has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me at Tracy Allaway.

And I'm Joe Wisenthall. You can follow me at the stalwart. Follow our guest, Arpid Gupta. He's at Arpetrages. Follow our producers, Carmen Roderigis at Carmen Armin. Dashel Bennett at Dashbot. Kale Brooks at Kail Brooks. Thank you to our producer, Moses, Andam.

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