DePaul University Professor James Shilling | Photo by Kathy HillegondsRemote work and lockdown living due to the COVID-19 pandemic have disrupted urban economics and real estate markets across the United States. What does the future hold for where we will work and live in the future, and how does this impact cities, including Chicago?
We asked DePaul University Professor James Shilling, one of the nation’s foremost
real estate experts, to provide his take. Shilling is the George L. Ruff Endowed Chair in Real Estate at DePaul’s Driehaus College of Business. He also is serving as the 2021 NAIOP Distinguished Fellow, a prestigious designation that provides Shilling an opportunity to engage with leading commercial real estate, economic and public policy experts across the country.
How has the pandemic changed cities economically?
Cities in the U.S. will almost certainly be restructured – with almost immediate effect – because of powerful external drivers affecting something economists call agglomeration economies, the idea that workers become more productive and better paid as city size expands.
We have had agglomeration economies in cities like Chicago for more than a century. Agglomeration economies historically arise for three distinct reasons. First, labor market economies cause firms in given industries to concentrate within urban areas, where they have access to a common pool of trained labor and are able to reduce search and training costs associated with hiring new workers. Second, cities and their business activity are about interactions – people coming together to exchange ideas and for production, and this can centralize efficiently in cities. Third, cities also can offer scale economies through large plants and/or firms clustered together, reducing transportation and other costs.
The idea that crowding firms together in one metropolitan area makes the firms more productive is a central concept in urban economics. As firms become more productive, city size increases, and some of that productivity turns into higher wages for their workers. Demand for housing rises with city size, reflecting the agglomeration economies, thereby causing the willingness to pay for housing to rise. When this willingness to pay exceeds the supply of housing, the city size builds on itself. Thus, cities become places where opportunities exist, where people can obtain work, and where consumption goods (retailing) can be supplied in quantity at the lowest cost.
Certain observations follow from this general theoretical position. If cities are about the convenience of face-to-face contacts for the exchange of ideas and information (which have long been recognized by geographers and planners as an important force shaping the location and construction of office employment), then technological improvements in communications will weaken the benefits of agglomerating production activity, thereby having a negative impact on all city sizes. The fact that in an age of Zoom, we can locate anywhere and still engage in face-to-face interaction means that office employment does not have to concentrate in cities and central business districts. Rather, their operations and activities can move to satellite cities or to the suburbs where rents and wages are lower.
In light of this trend, how will cities, like Chicago, retain and attract workers?
Under these circumstances, is the age of the city over? Are Chicago’s greatest days behind it? If cities are just a place of productivity, one might answer yes. But while capital may be mobile in the 21st century, talent need not be.
At this point one has to bring into the picture community livability and lifestyle preferences, and the fact that in the wealthy world today, urban success is increasingly driven by consumption, not production. Examples of the latter are numerous. Los Angeles, with its magical climate, has always been a haven for the super wealthy. The Miami metropolitan area, which includes Fort Lauderdale and Palm Beach, is a consumer capital for almost all of Latin America. Chicago is a city that values music, art and architecture. Chicago is also a city that values public recreational amenities.
In the information age, where workers can work from almost anywhere, on any device, the question becomes, why not live somewhere you find pleasant? In this world, to attract and retain skilled workers and quality jobs, cities will need to make the city’s quality of life a top priority.
What this means in practice varies from city to city. For example, livability could mean making sure that the city is clean, or making sure the city is safe. In some cases, livability could mean gentrifying some low-income areas, or it could mean carving out cultural or professional districts that cater to the interest of the creative class. In other cases, livability could mean devoting enormous amounts of resources to public health investment or improving transportation, or shoring up financially shaky public worker retirement systems.
How do these trends affect residential real estate markets?
One of the few bright lights has been the residential real estate market. Booming residential-property prices have been driven in part by falling real interest rates. These extremely low interest rates have made homeownership more affordable than it was in 1990-2007. The low rates have made it possible for many aspiring home buyers to qualify for a mortgage, or for those looking to trade up to a larger home to qualify for a larger mortgage.
Ordinarily, in a normal recession, as people lose jobs and their incomes fall, foreclosures drag house prices down. In this pandemic, however, the federal government has allowed borrowers facing financial hardship to pause or reduce one’s mortgage payments by participating in a federally sponsored mortgage forbearance plan. Thanks also to the federal stimulus money, many homeowners were able to keep up with the mortgage and other bills.
The third factor behind the booming residential-property prices is changing consumer preferences. With work-at-home, people seem to be fleeing cities for the suburbs, looking for more space at lower prices. At the same time, as more and more consumers look for bigger houses in the suburbs or look for bigger houses near where they already live (if they already live in the suburbs), the increased demand for housing has caused house prices to increase.
Can house prices continue their upward trend? Low mortgage rates and continued out-migration from city centers should keep activity strong in 2021, which in turn should fuel home-related spending.
Single family homes on 1700 block of Melrose St., Roscoe Village. | Photo by Jeff Carrion
What about housing affordability?
Cities may face many headwinds going forward, including addressing issues of housing affordability. The pandemic has increased wage inequality across income, across socioeconomic groups, and between genders. Zoning changes, rent controls, housing vouchers and tax credits for real estate developers and investors who make their properties available as affordable housing for low-income households are the main policy tools used by cities to improve affordability. Places that build a lot of housing appear to be thriving. These places also tend to be drawing talent.
How will a continuing work-from-home trend, even after the pandemic, affect commercial and retail real estate?
While there is little doubt that office buildings are here to stay, with a shift to work-from-home, demand for large office buildings in metropolitan areas should shrink in the intermediate run, causing office rents to fall. Over half of employees indicate they will to prefer to work-from-home at least two or three days a week once pandemic concerns recede.
Some of the switch to work-from-home will be offset by employment growth, with new workers replacing older workers. People will be returning to jobs, but many of these jobs will be different kinds of jobs and different kinds of employers. Some of the switch to work-from-home may also be offset by commercial-to-residential conversions (and conversions into affordable and supportive housing). The switch to work-from-home has also massively accelerated the demise of brick-and-mortar retail stores at the hands of e-commerce. Notwithstanding these developments, cities will adapt.
What will be the impact on jobs in the urban service sector?
Social distancing has had a negative impact on jobs like selling coffee at the local baristas, serving food in a fine-dining restaurant, or serving a pint at the local pub. These face-to-face urban service jobs all but vanished in the pandemic. These jobs represent 32 million workers in the U.S., or approximately one-fifth of America’s employment pre-COVID.
Many people have been left wondering whether these jobs – which are absolutely critical for the future of the city – will come back. Cities have been proven to be highly resilient. Many of these in-person service jobs are likely to come back as high-income households who have sharply reduced their spending on in-person services in the pandemic increase their consumer spending in a post-COVID vaccine world.
As of today, spending on in-person services in Chicago by high-income households is 10.8% lower on health care, 46.2% lower on restaurants and hotels, and 50.9% lower on entertainment and recreation than in January 2020. A reversal of these trends in a post-COVID vaccine era, and the flowing back of in-person service sector jobs in the labor market, should grow the economy significantly in 2021, thereby reversing many of the negative economic impacts of COVID.
What’s ahead for Chicago?
It seems to me that there are signs of hope staring us in the eye. Cities are resilient. Cities are places of urban pleasure. At the very heart of cities are the performing arts, theaters, museums, restaurants, parks and so on. Cities are not just about agglomeration economies and the exchange of ideas and production. People feel home in cities. Cities have capacity to bring joy.
No doubt the best days are ahead for Chicago. Humans are social animals, who find pleasant amenities like diversified entertainment opportunities, cultural facilities and high-quality restaurants, and value proximity to central business districts. Given that, cities that are consumer cities or places of pleasure, like Chicago, are likely to be our most successful cities going forward.
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