Five Trends That Will Shape New York
Sam Chandan Jan. 17, 2012, 1:30 p.m.
The daily buffeting of confidence in the recovery’s resilience has demanded an unusual focus on immediate threats to commercial real estate investment conditions. Even in New York City, where improvements in property values and capital inflows have clearly outpaced peer markets, the vagaries of developments in Europe as well as conditions closer to home have necessarily called for consideration in meetings of investment and credit committees.
Apart from the drivers of near-term uncertainties, the long-term evolution of New York City’s real estate market continues apace. Physical changes in the city’s landscape, including the rise of 1 World Trade Center, offer only one perspective on the ongoing transformation. A fluid policy environment that transcends purely local considerations, a sustained diversification away from the bedrock of financial services, and competing demands on limited public resources are all germane to the assessment of the property market outlook.
Financial Services Reconsidered
The ink has dried on the 18-month-old Dodd-Frank Wall Street Reform and Consumer Protection Act. The bill’s signing into law was only the first step in a longer program of reform that holds the potential to significantly alter the business of financial services. Among the efforts still taking shape, the exact implementation terms of the Volcker Rule remain unclear. Even if this widely debated provision proves benign when it is scheduled to take effect in July, other financial reforms may not. For example, the practical enforcement authority of the Consumer Financial Protection Bureau may be impactful for retail and consumer banking profitability.
Although financial services will remain in flux for some time, employment in New York has grown increasingly less concentrated in the industry over time. Trends that negatively impact the industry—while remaining critically significant—will not be felt as acutely. Twenty years ago, financial services accounted for almost one in every five private-sector jobs in New York. That share has trended down over time and has been holding at just under 14 percent since 2009. One might posit that the multiplier effect of finance jobs, like the sector’s income, has increased over this period. In that case, the industry’s declining share of employment reflects that each finance job supports a growing number of jobs in other areas; a bleak outlook for the sector will cascade into other occupations. The data do not support this argument. Jobs have been increasing in areas that may benefit from the city’s overall agglomeration but they are generally not in occupations that are immediately adjacent to financial services.
New Growth Drivers
Not all job are created equal in their implications for space demand and knock on effects in local economic activity. Faced with slower growth in financial services, innovation industries are one area of high-skill and high-wage employment growth that has commanded significant attention. Observing the current job gains in volatile markets like San Jose, the city’s leadership has sought to foment upside outcomes here. The recent trends are encouraging; the city reported $522 million in venture-capital funding commitments in the second quarter of last year, surpassing Boston for second place after Silicon Valley. Public investments that could yield dividends over the long run include relatively small initiatives, such as the Dumbo Incubator, General Assembly and the New York City Entrepreneurial Fund.
While many public projects are small in scale, resulting in payoffs that may be idiosyncratic, other initiatives hold transformative potential. The launch of a world-class engineering and applied science university that can serve as an institutional anchor is a case in point. Cornell will open a temporary location this year for its applied sciences campus; the first phase of the Roosevelt Island campus will open in 2017, with development projected to continue through 2043. New York’s partnership with the Cornell-led consortium holds significant potential. Like venture capital, academic institutions can play an important role in the formation of human capital and the potential for innovation and its monetization.
Even as eleven acres of Roosevelt Island position for dramatic change, the financial district is approaching a major milestone with the projected completion of 1 World Trade Center in late 2013. The introduction of such a large asset represents a supply shock, even in New York, and will exert modest upward pressure on the office vacancy rate. For developers of other new properties, the market-wide vacancy statistics are of qualified relevance; their assets are at an advantage in a market characterized by a relatively old and functionally obsolete pool of properties that will ultimately bear the brunt of tenant migration.
The fruition of plans for rebuilding the World Trade Center precinct are one aspect of a much larger change in Lower Manhattan’s position. Still a small share of Manhattan’s total population, the extraordinary growth in Lower Manhattan households and the introduction of new amenities and infrastructure anticipate or coincide with the employment and tourist anchor. The overall result is a dramatic strengthening of the local agglomeration. Even as Wall Street’s role comes under pressure, Lower Manhattan’s overall attractiveness as a business and residential location is proceeding along a durable path.
The path forward is not free of significant and persistent headwinds. The structural imbalances in the city’s budget are among the most pressing that will dog future mayoral administrations. Steering clear of arguments relating to fairness, raising local taxes in the context of mobile taxpayers can be self-defeating. In their seminal 2007 paper, Wharton Professor Robert Inman, the New York Fed’s Andrew Hauhgwout, Steven Craig and Thomas Luce explain their findings for New York (and Philadelphia) as follows:
… local income and wage tax rates have significant negative effects on city employment levels
… we find that tax increases reduce city jobs and that lowering city taxes is likely to be a cost-effective way to increase city employment†
The current weakness in financial services employment trends, combined with unfavorable conditions in Albany and the nation’s capital, are weighing on the near-term revenue outlook. Residential mobility limits the efficacy of a geographically localized tax increase. At least in part, the answer must come from the expense side of the equation. It is expenditure growth that is of greater consequence for the long-term health of the city’s public finances. As of its November update, the Office of Management and Budget projects a $2 billion shortfall during the 2013 fiscal year. Unattended, that deficit will rise to $3.8 billion the following year and $4.9 billion the year after. Non-discretionary expenses and debt service are rising quickly, requiring cuts in what are deemed controllable agency expenses. Regrettably, many of those controllable expenses are crucial for continued economic growth.
From educational facilities to the city’s streets to the Tappen Zee Bridge, infrastructure is one of the areas that necessarily come under threat when expense pressures arise in force. But a deteriorating infrastructure can be a very real impediment to economic growth. The city’s continued growth depends upon its competitiveness, which is intertwined with its public infrastructure and it capacity to manage diseconomies of agglomeration such as congestion. Public-private partnerships have yet to prove out as a viable solution given the sheer scope of deferred maintenance and investment.
Expanding the definition of infrastructure to encompass the full range of inputs to our schools’ production functions, the negative impact of budgetary pressure is observable. The city’s November financial plan anticipates a decline in pedagogical staff, from 97,347 as of last September to approximately 92,700 in 2015. Charter schools will fill part of the shortfall. This week’s State of the City address underlined that the flexibility required for radical improvements in school quality will be hard-won. The primary actors in that struggle are the administration and the United Federation of Teachers. The mayor’s proposals for merit pay, a system of teacher evaluations, and the expansion of charter schools are far-reaching but do not constitute a comprehensive solution to the intractable problem of school quality.
Sam Chandan, Ph.D., is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.