By Chris Zarpas, Zenger News
Commercial real estate investors face a lot of headwinds these days — remote work emptying downtown offices, ravaging inflation, rising interest rates, shrinking family sizes — but they may not be hedging for another “Great Migration.Of course, commercial estate investors see their business as cyclical, managing costs as markets bottom and bullishly chasing them when they climb. Real estate markets crash at varying velocities, and return, often with even greater vigor than before, as if by some natural law. But another “Great Migration” would be outside the natural swing of real estate markets.
A rapid decline in quality-of-life is draining American cities of its people and bleeding the revenue of both governments and investors. There are many reasons to leave major U.S. cities: surging violent crime, failing schools, climbing taxes, soaring housing costs, a sidewalk-occupying army of homeless.
The pandemic opened the door for remote work, which got many office workers asking “Why do I have to live within commuting distance?” Brooklynites have discovered that when they move to the Hudson Valley that they no longer have to pay New York City income tax, Manhattanites have discovered that sheltering in a Bucks County farmhouse means that honking horns no longer burst through their bedroom windows. Many more have discovered Florida, where they can trade away snow and state income taxes for humidity and hurricanes.
All of these revelations have produced the greatest exodus from America’s declining “super-cities” in more than 50 years. Fifty-four of the 88 largest-population U.S. cities reported population losses between 2020 and 2021, according to Brookings Institution data. By the end of 2022 only 37 of the largest cities reported ongoing losses, but among them were Los Angeles, Portland (Oregon), Seattle, and every major Northeast city — from Philadelphia to Boston, according to the Economic Innovation Group. City centers have hollowed out, with half-vacant hotels and acres of empty offices and storefronts. Offices now lead the distressed property category, surpassing even enclosed malls and suburban hotels. A new “Great Migration” is now underway.
Investors and mayors can debate who should worry more. Hundreds of billions in property value is being lost, as is tens of billions in tax revenue as city assessments are recalculated downward. Experienced investors, foreseeing this calamity, have amassed billions of dollars earmarked for acquiring mortgage notes secured by these declining properties. It’s a dangerous game because no one knows where the market’s bottom is, but fortunes can be made by the bold.
Some scholars refer to the “urban doom loop.” That’s when declining property and income tax revenue leads to reductions in city services — fire, police, water, sewers, and schools — which prompt a new wave of departures, further squeezing city revenues, starting the cycle again. At the end of the road is Detroit, 1989.
Cities lost some $360 billion due to lost tax revenues from 2020 to 2022, according to the National League of Cities. If the exodus of wealth continues, lower municipal bond ratings could escalate financial pressure on major cities, leading to default, according to credit analyst Merrit Research Services.
Consider the last “Great Migration.” Almost 30 million poor, rural — black and white — citizens from 1910 to 1970 fled the segregationist South and rural Appalachia to Northern industrial cities in search of a better life. That plentiful pool of labor fueled unprecedented prosperity for decades after World War II, much of which was concentrated in the Northeast and the midwestern heartland. As people moved, the fortunes of regions flourished or withered.
Now, in an ironic reversal, over two million Americans have relocated to the Southern U.S, most from the North, according to data from the U.S. Census Bureau, and the Economic Innovation Group. The Internal Revenue Service reviews tax returns annually to determine when and where taxpayers move. From 2020-2021 alone, Northeast states lost $60 billion in income tax revenue, while Florida, Texas, Georgia, the Carolinas, and Tennessee, gained $100 billion according to recent Internal Revenue Service wealth migration data. New York State alone lost 468,200 people, $24.4 billion, and one seat in Congress.
While some commercial real estate investors are betting on legacy city recovery, busily acquiring distressed assets, others are looking South for new opportunities. Of the top ten markets attracting the most commercial real-estate investment, eight are in Florida, Texas, Georgia, North Carolina, and Tennessee, according to Urban Land Institute and Price Waterhouse Cooper.
For the first time ever, in 2022, the GDP of those six southeastern states (23.8 percent) exceeded that of Washington, D.C. and all northeastern states from Maryland to Maine (22.4%).
Notably, three of those southern states- Florida, Texas, and Tennessee – have no state income tax, and all six have less burdensome regulatory environments than those up North.
Corporations have followed. Since 2020, Texas has gained more relocations than any other state except Florida, landing Tesla, Oracle, Caterpillar, and Hewlett Packard. Their workers who can do the math are eager to go. The standard of living that requires a $250,000 salary in New York City, requires only $94,603 in Houston according to financial services marketplace, NerdWallet.com.
For those who dismiss the idea of an urban doom loop caused by another “Great Migration” as pop culture nonsense, remember the urban doom loop has happened before. As the post-war American service economy grew, there began a slow-motion collapse of American manufacturing from 1950 to 1980, and urban devastation ensued. Between 1970 and 1980, New York City and Its suburbs lost 1.6 million people, 10% its population. The other cities of the Northeast corridor from DC to Boston, saw similar declines. Or, from another perspective, the seeming prosperity of Northeastern cities from 1990 to 2020 was an aberration and now those cities are returning to the earlier trend line.
Urban consultant Bruce Schaller recalls that period of urban decline from 1970 to 1980 when drugs, violent crime and poverty emptied city centers of those with the resources to flee, in a recent report titled “Boom Times or Doom Loop – America’s Future Post- Pandemic.” By 1974, New York City’s annual deficit had reached $487 million, its outstanding debt topped $13 billion, and the city was on the verge of bankruptcy. Every single day between 1970 and 1980, an average of 6 people were murdered and almost 250 assaulted and robbed, a rate 500% higher than that in 2022. If those crime rates return, cities would empty and investors would lose.
During that dark period, commercial real estate values collapsed. Thousands of owners of urban apartments, offices and retail spaces were wiped out. In the Bronx, perhaps the most devastated urban landscape in America, some landlords set fire to their properties to collect insurance money. Seven census tracts in the Bronx, between 1970 and 1980, lost more than 97 percent of their buildings to fire and abandonment, Schaller writes.
The hoped for “full return to work” has failed to materialize, The result has been devastating. A report by researchers at NYU and Columbia– “Work From Home and the Office Real Estate Apocalypse;” sums up the damage. Soon after the pandemic began in 2020, office occupancy collapsed to 20% in major office markets. Occupancy has slowly recovered but is now stalled at 49.9%. Decreased daytime population coincided with increased crime. Compulsory pandemic face masks enabled a crime wave of shoplifting, carjacking, armed robbery, and burglary that is ongoing. In Metro DC, 1000 people were carjacked in 2022, a rate of almost three per day.
Brazen, organized gangs of shoplifters led essential retailers like CVS, Target, Walgreens, and Walmart to shutter stores, and lock up laundry detergent, toiletries and even ice cream.
Cities including DC, Philadelphia and New York have no cash bail policies that return recidivist criminals to the streets hours after an arrest, demoralizing shrunken police forces. The lawful became fearful, the lawless, fearless.
A 2021 study by Howard Chernick, at City University of New York’s Hunter College calculated the commercial real estate tax revenue of eight major cities. Including Atlanta, Chicago, Los Angeles, New York and San Francisco. In these cities, commercial real estate accounts for an average of 37% of these property taxes ranging from 26% in Los Angeles to 56% in Atlanta.
The future of America’s largest cities depends on the tax revenue paid, directly and indirectly, by commercial real estate investors. If those investors decide to invest more in the Sun Belt, the future of Northeastern cities will go south too.
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