Commercial real estate actors are three years into a transformative time for their businesses. The radical surge in remote work and higher interest rates to battle inflation have brought both challenges and opportunities. Many commercial real estate owners, regardless of their sector, are now wrestling to keep up with rising payments on adjustable-rate mortgages. Higher rates, combined with a dip in office demand and uncertainty over the future value of this asset class, are also complicating the refinancing of some expiring loans. Some fund managers, however, are seeking opportunities in REITs or unique situations with good assets and bad balance sheets, especially in an environment of tightening lending standards, according to new reports. In general, everyone is deciphering what has happened and what lies ahead.

A diminished demand for proximity to large employment centers is driving down office asset values, according to Green Street. In addition, research—conducted by Stanford University Department of Economics researchers Arjun Ramani and Nicholas Bloom, using data from the U.S. Postal Service and Zillow—that was released during the pandemic revealed that major urban areas have undergone residential migration from densely populated zip codes toward their less-crowded counterparts.

This shift seems particularly pronounced for higher-income earners, as detailed earlier this year by economists Wenli Li of the Federal Reserve Bank of Philadelphia and Yichen Su of the Federal Reserve Bank of Dallas. Retail, both in terms of businesses and employment, appears to be following a comparable pattern.

Big CBDs, Smaller CBDs

都是中央商务区(cbd)注定to reduced office use, lower retail foot traffic, and decreased residential allure? In a newly released research paper, “Remote Work and City Structure,”—which I coauthored with Charly Porcher, assistant professor of economics at Georgetown University’s McDonough School of Business, and Esteban Rossi-Hansberg, the Glen A. Lloyd Distinguished Service Professor in the Kenneth C. Griffin Department of Economics at the University of Chicago—we investigate the initial impact and recovery patterns across a large number of American CBDs.

The figure below shows monthly CBD trips, as reconstructed from cell phone mobility data, for two cases: San Francisco, California, (left) and Madison, Wisconsin (right). Each line is “normalized” so that the value of 1 corresponds to the pre-pandemic level of visits in January 2020. As many press reports indicate, San Francisco is now in a very different place than it was just three years ago: residents’ trips to its CBD are about 40 percent of what they used to be, as of July 2022. In contrast, the same measure shows Madison has fully recovered from a practically identical drop.

This story, it turns out, is quite general. An analysis of hundreds of cities indicates that trips to CBDs in large cities (say, ones above 1.5 million residents) have plateaued around 60 percent of their pre-pandemic levels; smaller towns (for example, ones with fewer than 150,000 residents), in contrast, have fully bounced back.

ZIP Code–level Zillow data confirms these trends. Although housing values may have gone up or down overall, the premium for living closer to the CBD has followed a similar pattern, remaining deflated in large metropolitan areas but returning to pre-pandemic values in smaller places.

A story of coordination

How can we explain these differences? A CBD is a hub of density and social interactions that delivers tangible benefits to those who participate in its life: after all, firms were, until not long ago, willing to pay high rents, and workers spent valuable time commuting to be next to one another.

These advantages constitute one reason that some cities grew to be so large and successful. However, such advantages also implicitly rely on coordination: an individual expects a benefit only if others are present. A nearly complete—albeit temporary—push to remote work might break this coordination, where it exists.

Where was this coordination mechanism more likely to be in place? The value of interactions and the feasibility of working from home are strongly influenced by cities’ industry and occupation mix. Cities also vary in their commuting infrastructure, which affects the ability of workers to commute longer distances in little time.

Our research finds that larger cities in the United States, which have probably reaped the most benefits from these factors, are also more exposed to this coordination problem—and hence, less likely to recover.

What do we learn?

The response to the 2020 work-from-home push has been heterogeneous. A nuanced understanding of local economic activity in terms of the effectiveness of remote work options and the relevance of social interactions may help in assessing the recovery prospects of particular submarkets. More speculatively, metropolitan areas with reduced office demand might experience coordination of some office activity around selected areas with high-quality buildings.

Such a shift may catalyze a corresponding movement in retail that leaves certain neighborhoods grappling with persistently lower asset values across various classes. Lower real estate values can reduce tax revenues and strain local finances. Either through higher taxes or scaled-down services, certain areas might further lose attractiveness as places to live, work, and perhaps invest; more exposed municipalities have already seen higher spreads on their bonds. The effectiveness of the response of local governments and business improvement districts and municipalities remains to be seen.

FERDINANDO MONTE is an associate professor of economics in the Georgetown University McDonough School of Business.