Meet the New Big City: Even Higher Taxes, Fewer Workers, and More Tough Choices

Data from swipes of building-access cards illustrates the stagnation: In the 10 large metropolitan areas tracked by security company Kastle Systems, occupancy has been at about half of prepandemic levels since the start of this year. “There is no further big return to the office on the horizon,” says Nicholas Bloom, a professor of economics at Stanford University who is studying remote work and relocation trends. “This is it—we are postpandemic.”   

That raises some big questions about the future of the nation’s largest cities, and could pose a problem for their credit. A “looming trifecta” of headwinds brought about by remote work—lower commercial real estate valuations, lower tax revenue, and still-low use of public transit—threatens cities’ economic vitality, a team of S&P Global Ratings analysts wrote in a new report. Cities need to be proactive to manage the risks to their budgets. “They’ve got some time to react, but the risk to creditworthiness is actually escalating in a lot of major cities” in the medium term, says Scott Nees, the lead analyst.

Despite the recent doom and gloom, big city general-obligation bond ratings have largely held up. S&P has rated San Francisco and New York City general-obligation bonds at AAA and AA, respectively, since before the pandemic, indicating strong abilities to meet financial commitments. Both cities’ outlooks were moved to negative during Covid-19’s early days, but have since returned to stable.

The challenges are most glaring in San Francisco, which lost 7% of its population from 2020 to 2022, the greatest share among the nation’s 20 largest cities. The city that had become one of the most expensive places in the country to live has seen home prices slide as much as 11% from year-ago levels, a more dramatic drop than any of the other city tracked by S&P Dow Jones Indices. At the once-bustling Union Square, retail vacancies have remained higher than before the pandemic, according to first-quarter data from
Cushman & Wakefield.

During the pandemic, tech workers living close to the office fled for greener pastures. The condominiums they left behind were still selling slowly in early June, says Damon Knox, president of the San Francisco Board of Realtors. The units, in previously prime spots for commuting to the office, “will get gobbled up” if workers return to the physical workplace, Knox says. “Until then, there’s going to be a bit of a void.”

Think of pandemic migration trends as a doughnut, says Stanford’s Bloom. As the pandemic cleared out office buildings, workers in big cities broadly fled for nearby suburbs, creating a doughnut-shape ring of activity around a sparse city center. 

That doughnut hole never closed. Phone activity in the majority of the 52 downtowns tracked by the University of Toronto’s School of Cities was lower in early April, the latest data available, than it was before the pandemic. The recovery has varied by city, with New York at 71% of its prepandemic norm, Chicago at 56%, and San Francisco at less than a third. 

Stijn Van Nieuwerburgh, a professor at Columbia University’s graduate school of business, estimates that remote and hybrid work could contribute to a $500 billion aggregate loss in the value of office space nationally, a roughly 38% decline from its prepandemic valuation. The professor, with co-authors Arpit Gupta and Vrinda Mittal, wrote in a paper last year that reduced valuations on commercial real estate could spark a so-called “fiscal doom loop” that worsens quality of life in big cities.

The concept of the doom loop is simple: As property valuations fall, cities stand to earn less money from property taxes, leading to budget cuts or higher taxes. The stickiness of remote and hybrid work options means more households could move out as the cost of living in a city goes up and quality of services provided goes down. From there, property prices would fall, more people would move out, and the cycle would repeat itself. 

Should holes open up in city budgets, the bill could fall partially on homeowners, says S&P’s Nees. “Residential real estate is the biggest component of the tax base virtually across the board,” he says. Higher property taxes could provide stability or growth for city budgets, but would also raise the cost of living in an area.

If hybrid work has stacked the deck against dense urban centers, cities have one valuable resource on their hands: time to prepare. “If there is revenue impact, it’s probably going to be within a few years from now,” he says. And large cities won’t be caught off guard: “They’re not places that we expect to just to be completely passive in the face of a major risk coming at them.”

In places like San Francisco and New York, city management teams are starting to incorporate the impact of remote work into their projections, Nees says. “You’re starting to see places pitch a lot more solutions,” he adds.

Cities already have been making plans to diversify their downtowns. Chicago is adding mixed-use apartments to the area surrounding office-heavy LaSalle Street in an effort to diversify its business district. New York City Mayor Eric Adams in January announced a task force to evaluate the potential to convert out-of-date office space into other uses, like housing. In February, San Francisco Mayor London Breed announced strategies that include a program to allow the conversion of underused offices to housing and other uses.

Columbia’s Van Nieuwerburgh’s vision of thriving cities isn’t necessarily one driven by a return to the office. “The long-term play is to turn cities from truly office districts into mixed-use places,” he says. While converting an office into residential real estate has dominated much of the conversation, it isn’t the only option. He says other conversion possibilities—such as medical, child care, education, biotech, and last-mile distribution centers—shouldn’t be overlooked.

“The only way you remain as well-off as you were before is if you attract new people who really want to be there,” says the professor. Along with affordable housing, other necessities include public safety, cleanliness, and efficient transportation, he says. 

The full impact of hybrid work will probably become clearer after the current period of economic tightening resolves. Employers over the next several years are expected to need up to 15% less office space on average per employee than they did before the pandemic, says Julie Whelan, global head of Occupier Thought Leadership & Research Consulting at commercial real estate firm
CBRE.
Whelan expects office demand to begin to rebound with the economy in 2024.

That could be particularly relevant in tech-dependent areas such as San Francisco, which saw many layoffs in the past year. While tech employment in the metropolitan area in May remained higher than prepandemic levels, employment in other occupations hasn’t topped its level from three years ago, according to an analysis of California employment data by Ted Egan, the chief economist for the city and county of San Francisco. 

In the coming years, market forces in office districts might correct themselves, Egan says. As commercial rent prices fall, companies could pounce on what they perceive as deals at existing buildings. Once that happens, new businesses, restaurants, and retail could follow. “Hybrid work is very different for the future of cities than fully remote work,” Egan says. “The office is still important in a hybrid world, and office centers are still going to be important.”

There’s no one-size-fits-all course for the impact of hybrid work, says S&P’s Nees. “In terms of downtown recoveries and the kind of impact that different cities experience, it’s so vastly different from one place to another that it defies generalizations,” he says.

As the debate continues over hybrid work’s role in U.S. cities, one thing is certain: It isn’t going away. “Now that the genie is out of the bottle, we cannot put it back,” Columbia’s Van Nieuwerburgh says.

Write to Shaina Mishkin at [email protected]