Nicholas Bloom explains the “donut effect” and policy concerns for cities

By TAP Staff Blogger

Posted on December 3, 2021


Working from home has caused commercial office occupancy rates to plummet and commercial property prices to fall in crowded zip codes. Falling property values in cities are likely driven by richer, more skilled residents leaving high-value properties. That will cause a drop in property taxes and strain city budgets.
Nicholas Bloom, from “The donut effect: How COVID-19 shapes real estate”


Stanford economist Nicholas Bloom and research assistant Arjune Ramani quantified the effect of COVID 19 on migration patterns and real estate markets across US cities in their working paper “The Donut Effect of COVID-19 on Cities,” published earlier this year by the National Bureau of Economic Research (NBER).


Using data from the US Postal Service and Zillow, they found evidence that about 15% of population and businesses appear to have moved from the centers of large cities to the suburbs—creating what they call the “donut effect”: rising prices in the suburbs and slumping prices in major city centers.


In “The donut effect: How COVID-19 shapes real estate,” a policy brief posted by the Stanford Institute for Economic Policy Research (SIEPR), Professor Bloom and Mr. Ramani take a close look at what has caused the donut effect, future trends, and policy issues that major cities will face as a result.


Below are excerpts from “The donut effect: How COVID-19 shapes real estate.”


Where We See The Donut Effect


In major cities including New York, Chicago, San Francisco, and Washington D.C., cell phone data shows a substantial urban exodus since the virus struck, with wealthy areas taking the biggest hits. The central business district (CBD) and top 10 percent of zip codes by population density saw more than a 10 percent drop in rents, confirming that demand for real estate in dense city centers has actually fallen.


Interestingly, the donut effect for prices appears to be limited to highly populated dense cities. We didn’t observe much of an effect for metro areas outside the largest cities. As an example, Manhattan’s Battery Park neighborhood—close to Wall Street—saw a 9.6 percent decrease in prices from the last three months of 2019 to the last three months of 2020. By contrast, middle-class residential neighborhoods like suburban Suffolk County on Long Island have boomed. Home prices in Suffolk County are up in every zip code with an average increase of 7.2 percent over the same period.


The Impact of Working From Home (WFH)


CBDs and dense areas of cities have a greater WFH exposure than less dense areas. As explained by Althoff et al. (2020), this is likely due to the high concentration of skilled service industries like information technology, finance, professional services, and management in cities.


We also found that most of the changes in property prices across different zip codes can be explained by the share of jobs that can be done from home, with density only contributing a small amount. We take this as evidence that people with the ability to WFH are moving away from city centers to lower-cost areas on city outskirts because they will not have to commute as frequently.


The Risk of Flight to Smaller Cheaper Cities


We’ve also observed that housing demand hasn’t shifted much from expensive cities to less expensive cities. This suggests that most who work from home after the pandemic will be doing so only a few days each week, rather than full time. Therefore, employees who previously lived and worked in city centers may be willing to move further away to the outskirts of cities or nearby suburbs. But since they still have to come to work sometimes, they are not willing to completely uproot their lives and move to a less-expensive city far away.


Considerations for Policymakers


People will commute to work less frequently, which will cause more people to flock to areas farther from city centers. This may increase the need for expansive public transportation networks with slower frequencies.


Furthermore, tax revenues in city centers will take a hit, which may require city governments to make tough choices on cutting services. The loss of revenues will come from many directions. Sales tax revenues are falling in the short term due to less city economic activity from the pandemic. And the long-term loss will come from less frequent commuting to cities in the WFH world. Cities with hotel taxes, and extensive public transportation systems, and income taxes like New York City will further suffer from the pandemic shock. Property tax revenues may fall in the long run due to lower property valuations in city centers.


In the short run, the federal government may continue to support cities through the recovery. But in the longer run, cities will need to “right size” their budgets.


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Read the full article on the Stanford Institute for Economic Policy Research website: “The donut effect: How COVID-19 shapes real estate,” by Nicholas Bloom and Arjune Ramani.


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