US cities must beware the ‘donut effect’

The story of troubled American cities left with empty office buildings post-pandemic is well known. What’s less well understood is that this is really a tale of two cities — downtown, and everywhere else. While many commercial business districts are struggling, their urban outer rings are often thriving. Call it “the donut effect”.

Academics Arjun Ramani and Nicholas Bloom — who named this phenomenon in a recent NBER working paper of the same title — have shown that the majority of people leaving city centres are not moving far, mostly to the suburbs and exurbs of the urban areas in which they already reside. New York is a great case in point: a heat map in the NBER paper shows movement away from Manhattan towards the outer boroughs and Long Island.

Even if the “donut effect” is strongest in large cities like New York and San Francisco, you can see it in others like Chicago, which has some disturbing parallels to the original “donut” city — Detroit. For decades, the beautiful Detroit downtown buildings of the late 19th and early 20th century stood nearly empty, thanks to a combination of racism, the loss of US auto-industry predominance, rising crime and violence, and white flight to the outer rings of the city.

Detroit’s downtown has recovered somewhat in recent years, due in part to the efforts of entrepreneurs like Quicken Loans founder Dan Gilbert to renovate old commercial buildings into loft spaces and bring in new businesses, as well as the shops, restaurants and hotels that attract younger workers. But the lack of a well-functioning transit system makes it tough to rebuild downtown at scale.

This is one of many lessons that Detroit holds for modern “donut” cities: commute time matters, especially in the post-Covid age when working in an office every day is still a choice rather than a requirement for many. Tracy Hadden Loh, a fellow at the Brookings Institution who specialises in commercial real estate, infrastructure, racial justice and governance, notes that while the research into which cities are failing or thriving post-pandemic is still nascent, one variable that seems to matter is ease of transit. This may be one reason why downtown London and Paris seem vibrant compared to many US cities.

It’s not surprising to me that a place like New York, which has a reasonably well functioning (albeit declining) public transport system, has more economic activity downtown (as measured by cell phone usage) than Chicago or Los Angeles, where such infrastructure is notoriously poor. These latter cities are also held back by highly segregated neighbourhoods and city centres which are suffering not only from the commercial real estate crisis, but a decline in the entertainment or amenities that would draw people downtown for something aside from work.

Such problems are likely to get worse before they get better. The Federal Reserve’s financial stability report last week called out the exposure of financial institutions to commercial real estate as one of the major threats to the US economy, as the bursting of the bubble has only just begun. The Fed warned that, since mortgages backed by office and downtown retail property tend to be about a third of CRE holdings, “with CRE valuations remaining elevated, the magnitude of a correction in property values could be sizeable and therefore could lead to credit losses by holders of CRE debt”. As those dominoes fall, so may others in the financial system.

How to avoid the “donut effect” en masse? The conversion of commercial real estate to residential or mixed use space has helped rejuvenate parts of downtown Detroit. But as historian Tom Sugrue, author of The Origins of the Urban Crisis: Race and Inequality in Postwar Detroit notes, the city’s 1920s office buildings were far easier to retrofit than the skyscrapers of today. That’s one reason why rents and housing prices in the outer rings of cities like New York have been rising so sharply since the pandemic. “There are lots of intermediate neighbourhoods that didn’t hollow out, and often they are the immigrant neighbourhoods or more working class neighbourhoods that never really shut down,” Sugrue says.

Unfortunately, that’s now leading to an even broader cost of living crisis for working people and higher rents for small businesses in areas like Queens or Brooklyn. Simply pushing the problems of Manhattan — or San Francisco’s Union Square — to the periphery isn’t a solution, particularly if it results in higher taxes being imposed on those residents least able to afford them. (Most major cities, including New York and San Francisco, already rely more on residential property tax receipts than commercial real estate taxes to fund public services.)

So what’s to be done? I’d take a page out of urban activist Jane Jacobs’s book, and consider mixed usage. Office work may never be what it was, but movie theatres and Broadway shows are back, hotels are booming and service sector wages are substantially above the pre-Covid level, according to data from Apollo. People still want to live in and visit big cities — they just want to do it in new ways.

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