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Policy Hub: Macroblog provides concise commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues for a broad audience.

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November 7, 2022

Do Freeway Lids Spur Development in Cities? Evidence from Dallas

The Federal Highway Act of 1956 connected Americas cities like never before, but the system of roads also divided and isolated existing city neighborhoods. As a result, people lost neighbors and local businesses and found themselves cut off from other parts of the cityOff-site link. Moreover, exposure to air and noise pollution increased, and some residents simply left the city altogether.

The recently passed Inflation Reduction Act included $3 billion in neighborhood access and equity grantsOff-site link, expanding on $1 billion in funding for the Reconnecting Communities PilotOff-site link grants (part of the 2021 infrastructure bill Adobe PDF file formatOff-site link). These funds are intended to remediate some of the ill effects of urban freeways, and the grants could fund freeway removal or other mitigation strategies. The most ambitious projects, however, are likely to put "lids" composed of parks and surface streets over sections of existing freeways. Atlanta currently has three proposed lidding projects that are likely to compete for this funding: a park over Highway 400Off-site link in Buckhead, a park over the connectorOff-site link (I-75/I-85) in Midtown between North Avenue and 10th Street, and a separate proposalOff-site link over the connector between downtown and Midtown around Peachtree Street.

Capping a freeway with a park and surface streets could play a significant part in ameliorating the unpleasantness of an urban freeway. However, these lidding projects are expensive to construct and maintain and don't completely eliminate air and noise pollution from freeways. Whether such projects are fiscally sustainable largely depends on their ability to attract new investment and residents to the city.

One of the more celebrated recent lidding projects is Klyde Warren ParkOff-site link, a five-acre park spanning three city blocks of freeway in downtown Dallas. The park was partly funded with an assessment on proximate land and, at least anecdotally, attracted considerable investmentOff-site link to that area of Dallas. Like Atlanta, Dallas is a growing, low-density, largely auto-dependent Sunbelt city. If a freeway lid could attract new investment and residents to the city core, then such projects might have broader impact.

One challenge to evaluating any place-based project or subsidy is identifying the appropriate treatment area. Although a new park might attract investment or raise property values for immediately adjacent land, do such parks benefit the city as a whole? Or do they just redirect normal, market-driven development to a different location?

To look at whether the construction around Klyde Warren Park represented development beyond what might otherwise have happened, I looked at SupplyTrackOff-site link data on new construction for six years before and after construction on the park began, both in Dallas and in a control group of six cities. I selected large southern cities not directly on the coast: Fort Worth, San Antonio, Austin, Houston, Nashville, and Atlanta. Looking before and after completion of the Dallas freeway lid and across cities, we can ask if the pace of new construction in Dallas increased relative to the control group. This is, effectively, a simple difference-in-difference estimate of the treatment effect of the freeway lid on Dallas. The table below summarizes the evidence on new construction.

Relative to its peers, Dallas experienced faster office and multifamily construction growth after lid construction began in 2012. Dallas added 1.3 million square feet of office space, a rate that is 50 percent faster than what occurred in the six prior years. Multifamily housing (apartments and condominiums in buildings with 5 or more units) grew even faster. Dallas added nearly 5,300 individual multifamily units after starting the lid, more than twice as many units as the six years before. I should note, though, that this period spans the housing market collapse of 2008. However, most large southern cities were doing well after 2012 as their economies slowly recovered from the Great Recession and developers took advantage of low interest rates. Still, compared to the control group cities, Dallas appeared to outperform. If we subtract the percentage growth in office and multifamily space from that of other large southern cities—either just in Texas or pooling all seven cities together—the growth in Dallas still looks exceptional. Compared to other Texas cities, Dallas office space grew 18 percent faster and multifamily grew 42 percent faster. In percentage growth terms Dallas's performance looks even better when we include Atlanta and Nashville in the control group, suggesting that whatever immediate growth that happened around the park did not simply divert growth from elsewhere in the city.

I also looked at the annual growth relative to 2012 for each city's hotels and retail space. Hotel room growth was weaker in Dallas than in peer cities, suggesting that new hotels built near the park might have come at the expense of other locations in the city and did not represent a net addition to supply. Perhaps parks are simply a more attractive amenity to residents than tourists, or maybe—given the relatively brief exposure—tourists were more indifferent to freeway noise and pollution ex ante. Retail growth never recovered after the Great Recession, but it didn't look particularly worse in Dallas than for the control group of cities.

Of course, none of this evidence is definitive. Cities are complex, and numerous idiosyncratic factors affect a city's labor demand, attractiveness to workers, or their capacity to supply new houses and offices. Still, when looking at investment activity, Dallas's growth in multifamily and housing and office construction is at least consistent with the idea that building the Klyde Warren Park lid over the freeway in downtown Dallas made the city a more attractive place to live and work.

October 11, 2022

Will Office Conversions Meet Housing Demand?

Recent inflation reports Adobe PDF file formatOff-site link have been disappointing, with core year-over-year inflation remaining well above the Federal Open Market Committee's long-run target. A major driver of the increase in recent months has been the rising price of shelterOff-site link (effectively the rental cost of housing), which has continued to accelerate. At the same time, data Adobe PDF file formatOff-site link highlighted by Jose Barrero, Nicholas Bloom, and Steven Davis, show that 31 percent of workdays are now spent remote, suggesting that much of the work-from-home patterns that developed during COVID may persist. In this context, it is interesting to ask whether underutilized office space could be repurposed as housing, thereby increasing the supply of housing units and slowing rent inflation. Certainly, many anecdotes in the press (such as hereOff-site link and hereOff-site link) discuss this possibility.

After a stunning surge in housing prices and rents, US cities are straining to produce enough units to meet the demand for new housing space. Meanwhile, economists have determinedOff-site link that the residential market needs significantly more density (read: verticality)—especially in the largest cities, where the tallest office buildings are located. However, building new multifamily housing is difficult. Zoning, building codes, height limits, parking requirements, and other regulations restrict the unit count of new multifamily housing and increase the cost of new construction, if they allow it at all. Incumbent residents often oppose new construction and block projects of sufficient scale. The barriers to new multifamily construction include factors such as:

  • Economic constraints: Redevelopment is often more expensive than the status quo because it requires demolition or land assembly or both to combine parcels, which several experts have shown to add significant costs (see hereOff-site link and hereOff-site link).
  • Legal and social constraints: Building height limitsOff-site link, neighborhood opposition, zoning, and other regulations and veto points can all stand in the way of changing the use and density of a property in a large metropolitan area.
  • Structural constraints: New construction technology, compliance with new building codes, and new financing may all raise the cost of replacement above the marginal benefit of the new use of space.

Could existing office buildings, already built and now underutilized, be converted to housing?

If owners of office buildings are undertaking conversions, their plans for change should show up in the SupplyTrack databaseOff-site link, a joint product of CBRE and Dodge Data and Analytics that tracks as many commercial development projects as possible across the United States (see figure 1). Unlike the US Census Bureau's building permits database, SupplyTrack doesn't just tally new development. It also reveals redevelopment, like office-to-housing conversions.

SupplyTrack attempts to identify projects well before the permitting stage. On average, we can observe a multifamily project 16 months before it breaks ground and potentially well before the publicly available permit dataOff-site link. (I should note that some projects discovered by SupplyTrack never break ground. In this blog post, I impose an ad hoc cutoff of eight years and drop projects that were not started within eight years. Different cutoff dates do not materially affect the figures below.) An announced or discovered development project is one of the earliest indicators of the future of the construction cycle. Conversions to multifamily are typically identified even earlier—on average, 18 months before they start. One explanation for this is that conversion projects, unlike a vacant lot, are still producing a stream of revenue, so threshold return required to move forward might actually be higher.

Chart 1 of 2: Multifamily Housing Converted from an Existing Use

Don't see a spike in planned conversions of office buildings after the COVID-19 pandemic hit? Neither do we.

From 2007 to 2019, SupplyTrack found that an average of 2,300 multifamily units were created monthly out of formerly office, warehouse, or industrial use. Historically, adaptation of existing structures is about 10 percent of newly supplied multifamily housing (in buildings with five or more units) or 3 percent of all housing units. Thus, conversions would need to ramp up massively to have an appreciable effect on rents. However, average conversions declined to just 2,053 a month from April 2000 through June 2020 and don't appear to be trending up. Importantly, these numbers aren't affected by any lengthening of construction time due to supply chain shortages because they represent starts rather than completions, and conversions to multifamily housing don't appear to be trending up.

Of course, not all buildings are equally threatened by the work-from-home revolution. Perhaps larger office buildings in abandoned central business districts are better suited to conversion than the often-smaller office complexes distributed around the suburbs. To compare these categories on an equal footing, we indexed the annual conversion activity to 100 in 2007, indicating the relative percent change each year (see figure 2). Again, we see little evidence of a pandemic surge in conversions.

Chart 2 of 2: Multifamily Unit Conversions since January 2007

Large office buildings, which can be converted into 50 or more units, might seem especially attractive candidates for conversion—consider office towers in empty central business districts—but this category isn't unusually active. If anything, both large and small conversion projects appear to be declining.

Perhaps developers are confronting a daunting, even existential, question: is the office building really dead? Despite all the benefits of the work-from-home (WFH) model, economists have documented many ways that workers are more productive in person (see hereOff-site link, here Adobe PDF file formatOff-site link, and hereOff-site link). Certainly, pausing can be an optimal response when uncertainty is high. One problem is likely, that most of the WFH hours are coming from hybrid work, not pure WFH. Hybrid work may raise productivity or increase the surplus to employees, but it may not actually free up much conventional office space. Whether firms will continue to lease space that is only used three days a week remains to be seen, but at the moment, the hybrid model appears to be keeping widespread conversion of offices to rental on hold. In any case, it seems unlikely that office conversions will blunt rental increases anytime soon.

June 1, 2021

COVID Lasted Longer Than Expected. What Happened to Retail Space?

In our last post, we observed some deterioration in office market fundamentals in the face of the COVID-19 pandemic. Office market vacancy rates increased notably while asking rents remained relatively unchanged from 2019. Did the retail market respond similarly? Due to mandatory business closures and the increase in e-commerce revenue, one might expect retail market vacancy rates to increase and asking rents to decrease. However, the retail property market overall has been much less affected during the COVID-19 pandemic than the office market. As in our previous post, we explore the retail real estate market vacancy rate and asking rent in the 10 cities with the highest retail space stock square footage (according to CBRE-EA's market ranker).

Unlike the office market, we observe that retail market vacancy rates did not behave nearly as uniformly (see chart 1). The overall retail market vacancy rate was 6.2 percent in the fourth quarter of 2019 (pre-COVID) and increased to 6.6 percent in the fourth quarter of 2020. The Dallas retail market experienced the largest change in the vacancy rate, increasing by 21.31 percent from the fourth quarter of 2019 to the fourth quarter of 2020 (from 6.1 percent to 7.4 percent). Washington, DC exhibited the next largest jump, where the vacancy rate increased by 16.98 percent during the same period (from 5.3 percent to 6.2 percent). While retail markets in Los Angeles, New York City, and Philadelphia saw an 8–10 percent increase in vacancy rates during the pandemic, other markets such as Houston and Phoenix experienced moderate vacancy rate increases—3.03 percent and 2.44 percent, respectively. In more positive scenarios, retail markets in cities such as Atlanta and Chicago saw only a slight increase in vacancy rates during the pandemic, with vacancy rates returning to their pre-COVID level at 5.9 percent and 9.1 percent in the fourth quarter of 2020, respectively.

Chart 1: Vacancy Rates

Chart 2 illustrates that the asking rent in most markets increased during the pandemic. The biggest jump in gross asking rents occurred in Dallas where, perplexingly, vacancy rates also increased the most. Dallas's gross asking rents increased from $13.26 per square foot (psf) to $14.79 psf from the fourth quarter of 2019q4 to the fourth quarter of 2020. New York City also experienced a noticeable increase in gross asking rents, with a 6.3 percent increase from the fourth quarter of 2019 ($33.51 psf) to the fourth quarter of 2020 ($35.62 psf). Other markets experienced moderate increases or mirrored rent rate changes experienced between 2018 and 2019. Atlanta was the only market where gross asking rents decreased. However, Atlanta's downward trend in retail rent rates started in the fourth quarter of 2019, so it is difficult to determine to what extent this trend was preexisting or influenced by the pandemic.

Chart 2: Gross Asking Rent

These observations all beg the question: why did the retail market experience only moderate changes in vacancy rates relative to the office market during the pandemic?

We cannot say for certain why the retail market and office market fundamentals for the top 10 markets followed such different paths. However, just as office-using employment drives demand for office space, we also know that the retail market relies heavily on household consumption. The relatively modest changes in vacancy rates and increased asking rental rates in the retail market could potentially be explained by the rebound in retail sales as shoppers returned to reopened stores (as you can see hereOff-site link). Chart 3 illustrates that retail trade sales temporarily decreased in the early stages of the COVID-19 pandemic (February–April 2020), but they rebounded strongly in May and June 2020, returning the total dollar value of retail trade sales (excluding nonstore retailers) to its pre-COVID level.

Chart 3: Monthly Retail Trade Sales

However, surveys conducted by our Atlanta Fed colleagues (discussed here) show that retail and wholesale firms expressed increased optimism in August 2020 when compared to April 2020. This improved sentiment may have further supported overall retail real estate market performance.

After putting forth these observations, though, one caveat is in order. Although the overall retail market appears to have been much less affected than the office market, the effects could vary by the size and type of business. For example, larger firms often have more financing options. They also tend to have online platforms that can help to offset temporarily sluggish sales at brick-and-mortar locations. The data we reviewed for this post does not discriminate between firm size or type, and we did not explore these dimensions.

We'll continue to monitor market fundamentals and report what we find. Meanwhile, you can track trends in the commercial markets with the Atlanta Fed's Commercial Real Estate Momentum Index.

May 20, 2021

Has the COVID-19 Pandemic Affected Demand for Office Space?

Last July, our Atlanta Fed colleagues concluded that the COVID-19 pandemic would not decrease demand for commercial real estate (here). As the COVID-19 pandemic passes the one-year mark, have expectations on what a "return to the workplace" looks like changed for businesses and their employees? Many firms continue to allow employees to work from home (here and here). Anecdotes suggest that many are reimagining their office culture as they scrutinize empty or underutilized office space in an effort to reduce structural costs. Has this also resulted in a significant shift in demand for office space?

To understand how office market performance fundamentals have changed since the COVID-19 pandemic began, we examine office-using employment, vacancy rate, and rental rate trends across the 10 cities with the highest office space square footage stock. We hypothesize that markets with higher office space inventories likely have more office workers and may experience larger, longer-lasting effects resulting from massive shifts to remote work arrangements.

The United States experienced significant declines in employment due to COVID-19, but what was the effect on the office-based workforce? Using the Bureau of Labor Statistics' office-using employment series at the metropolitan statistical area (MSA) level, we observe in chart 1 that the number of employees using commercial office space has declined significantly in the pandemic. The graph on the right illustrates the monthly change in the number of employees using offices, which decreased by 6 percent on average from March 2020 to April 2020. The decline was most severe (11 percent) in the Los Angeles-Long Beach-Anaheim, CA MSA and mildest (2 percent) in the Washington-Arlington-Alexandra, DC-VA-MD-WV MSA. Although most markets saw a positive change in May 2020, the graph on the left shows that the number of employees using physical office space is still lower than it was before the start of the COVID-19 pandemic.

Chart 1 of 3: Office Using Equipment

The survey conducted by our colleagues in June 2020 (here) indicated that roughly 80 percent of respondents had no plans to change their current floor space needs. It seems reasonable, however, that the significant decline in office-using employment across metro areas with the largest office stock might translate to higher vacancy rates. Recent office market data from the CBRE Economic Advisors (CBRE-EA)1 indicate that office market vacancy rates increased significantly in 2020. Chart 2 illustrates stable vacancy rates before the COVID outbreak. Following the outbreak, in the second quarter of 2020, vacancy rates moved up. The overall office market vacancy rate was 12.2 percent in the fourth quarter of 2019 and 12.3 percent in the first quarter of 2020, then steadily increased through the year to 15 percent in the fourth quarter of 2020. All markets experienced vacancy rate increases for office space, with markedly different changes. Changes for the Denver and New York office market vacancy rates, for example, were larger than for most other cities. Denver's increased by 30.89 percent from the first quarter of 2020 to the fourth quarter (from 12.3 percent to 16.1 percent) while New York saw the largest jump (36.78 percent, from 8.7 percent to 11.9 percent). Interestingly, although Denver experienced the second highest jump in vacancy rates in 2020, the Denver and Houston MSAs did not experience a dramatic change in the number of employees using office space in 2020.

Chart 2 of 3: Office Market Vacancy Rate

Observing that office space vacancy rates increased significantly during the pandemic, we wondered if landlords renegotiated rent rates, so we explored the trend in gross asking rent. This is the estimated rent rate for a gross lease type where a landlord is responsible for expenses such as utilities and property taxes. Chart 3 illustrates trends of gross asking rent per square foot from the first quarter of 2016 to the fourth quarter of 2020. The data indicate that the asking rent rate did not change significantly during the pandemic compared to the previous period. While gross asking rent in the Dallas market increased slightly from the third quarter of 2020 to the fourth quarter, it was a relatively minor change. With such a high level of uncertainty, it's possible that real estate firms and investors were not convinced they needed to adjust asking prices. Another possibility is that tenants received longer periods of free rent in exchange for not adjusting rent prices downward. This second scenario effectively makes rents cheaper, although contract rates appear to be the same. We are unable to investigate further due to the unavailability of prerequisite data.

Chart 3 of 3: Office Market Asking Rent


We explored office market fundamentals since the onset of the COVID-19 pandemic and found that office-using employment declined while vacancy rates for office space increased significantly. How office property asking rent rates have responded to the pandemic remains unclear. Due to the long terms required for commercial leases, landlords appeared unwilling to lower rents because they expected that market conditions would soon improve.

Since firms remain uncertain as to when employees will return to the office, policymakers and investors should monitor current office market vacancy rates to best prepare to operate in an environment with sustained high vacancy rates. Will some firms have to reimagine their space and convert assets into different property types? We'll continue to monitor these market fundamentals, including property conversions, and report back. Meanwhile, you can track trends in market fundamentals with the Atlanta Fed's Commercial Real Estate Momentum Index.

1 [go back] CBRE- Econometric Advisors (EA) release quarterly data on the commercial real estate markets.