The economics of cities are fascinating. Why do people in this huge country choose to live in a tiny, cramped, apartment riding a subway that smells like diesel? Why would companies choose to locate in the most expensive places with the highest taxes?
Crazy enough, it has to do partly with history and the unique geography of Manhattan – a long, narrow strip of land with deep rivers meant it could have a huge number of ports and become the trading center of the New World in the 1800s.
So what the hell does that have to do with Amazon?
It comes down to one word: density. NYC is NYC because of its incredible density, and that creates unique circumstances. That density is now a liability for the city’s economy, creating challenges for which NYC leaders are hoping Amazon might be the panacea.
(Aside: I am not commenting here about Amazon as a company, or if the tax incentives process used to win HQ2 were ethically “right” – fair arguments exist against – but pointing out that why NYC leaders like Cuomo and de Blasio are so desperate for this deal).
(1) The (high) finance industry is in long term and likely permanent decline.
People think of bankers and Wall Street and imagine vaults full of $100 bills. And yes, the financial industry is highly profitable – on aggregate. But look closer at the particular bits of finance that make New York New York – investment banking and hedge funds, what people sometimes refer to as “high finance” – and it is clear they are in trouble.
Nearly every single hedge fund titan has been losing tons of money and is either closing shop or reducing staff. Hedge funds are an easy target as they are run by billionaires, but those billionaires also have lots of well-paid employees that buy groceries and Broadway tickets.
Investment banking is also in trouble – you can see clearly in this chart that revenues are in a downtrend. Investment banks are relying increasingly on new services like direct listings to appeal to companies and expanding non-NYC offices in Atlanta and Dallas hoping to draw more revenue.
There’s a few complicated reasons for these two to be in trouble, but at a high level it has to do with algo-driven investing, the rise of index funds, disruptive fintech startups and increased use of alternative fund raising like VC – ironically, much of that linked to tech.
But who cares you say – so we lose a few 1%ers. Can’t we just replace them?
The problem is the financial services industry also has unique dynamics that NYC supplies. First, doing business in NYC is extremely costly, as you have to rent space in those skyscrapers and then pay high salaries so people can afford expensive apartments. Only really two industries can afford significant space in core midtown Manhattan – law firms and banks.
The high finance industry is also subject in particular to what is called cluster economics. All the companies on Wall Street need to be near another because they (1) compete for the same talent and (2) need easy access to customers (CEOs, the wealthy) and suppliers (stock exchanges, central banks).
So you could not just replace finance in NYC with another industry like say, manufacturing, for obvious reasons of space. You could not use airlines, because they are too cost sensitive and set up headquarters in places like Chicago and Texas. It just does not make sense for most companies.
In fact, it barely makes sense for banks. In another negative for NYC, banks under pressure are trying to save money by moving more and more staff to New Jersey and Brooklyn. The remote work trend is accelerating these effects even more.
Who cares, you say. I live in Brooklyn. Midtown isn’t important to me.
If that office space goes empty, the property value declines, and property taxes are how cities pay for things. In fact, Manhattan makes up 66% of the taxable property base – double the other boroughs combined – and property tax is NYC’s biggest revenue source at 29% – more than double the income tax.
That means less money for NYC’s crumbling infrastructure that could only be replaced by higher taxes or subway hikes. A declining tax base could lead to an infrastructure death spiral, as NYC becomes less appealing to live in and driving more decline. To de Blasio and Cuomo, the fear of empty skyscrapers invokes images of the “bad old times” of NYC in the 80s.
(2) NYC real estate is at risk of trouble (relatively speaking).
That seems like a crazy concept for a city with absurd rent. But believe it or not, certain parts of New York are some of the worst real estate markets in the country.
This has to do, again, with the unique economics of NYC. Real estate is valued based on what is called a “cap rate.” The lower the cap rate, the more real estate value declines when interest rates rise – which is exactly what is happening right now. Guess which city has among the lowest cap rates in the country?
Add to that the GOP tax cut which likely hurt NYC property owners more than anyone else by cutting their tax deductions.
As a result, the high end segment of over $2M (which is just a 2BR in Manhattan) is in full recession – with some of Manhattan luxury units down more than 20%. Trump Tower in particular is a fun one to look at as one of the city’s worst performers, with units down 30% since the election.
One of the achievements Bloomberg was most proud of was adding the Hudson Yards stop. The city invested billions to add a subway stop to a dump because it would create space to even further expand Midtown, adding 10,000 high end units of property tax (technically, much of it paid in leases to the city in lieu of tax) that would pay back all the money spent for the 7 extension.
But what happens when you add supply to a market in downtrend?
If you have an oversupply of avocados, the avocados go bad and the market corrects quickly. If you have an oversupply of condos, the condos don’t go bad. The prices go down until someone buys. That can take years.
Hudson Yards is adding millions and millions of square feet of space to a city that already is seeing trouble in the real estate market.
“At the current rate of sales, it will take more than six years to sell all of the new development in Manhattan alone, which totals almost 8,000 units, said Jonathan J. Miller, the president of Miller Samuel Real Estate Appraisers and Consultants.” – NYT, Jan 4 2019
On a personal note, the situation in NYC real estate reminds me a lot of Dubai when I moved there. The economy was in a bit of trouble because of oil declines, and skyscrapers were everywhere. Then came oversupply and a 30% decline in two years.
This is where the particular location of Amazon’s HQ2 makes so much sense. The city convinced Amazon to choose LIC – one of the first stops outside of Manhattan on the 7 and E, right along the Midtown corridor of its most important and most valuable real estate?
Just look at the map.
Add it all together, and it is obvious why NYC cut a deal – it is a literal 2-for-1 with NYC hoping AMZN will save potential tax revenue declines in Midtown and add more tax value in Queens.
(3) Creating a tech ecosystem when SF is losing favor.
Those banks losing business? They want to be tech companies. Badly. They are expanding into digital banking, tech infrastructure, new apps, and directly selling their prized software in ways unthinkable before.
Silicon Valley is based on a virtuous cycle. Big tech companies like Oracle, Google, and Facebook attract smart people, who build technology, realize they are good at it, and leave to start a new company. VCs pop up down the street realizing there are a lot of good startups in the area, invest in those ex-Facebookers and guide them to building newer, valuable tech companies. Those VCs make money and re-invest in new startups, and the cycle continues creating a talent pool that cannot be replicated anywhere else.
But SF is a hard place to live. The city is making life harder for startups with new regs, and cost of living is so expensive that companies like Apple are seeking to shift talent elsewhere.
NYC has a tech ecosystem but it is piecemeal. “Silicon Alley” exists, but it is mostly fintech or consumer focused because they are run by ex bankers who are not necessarily great entrepreneurs.
However, the finance industry has started hiring some of the few people in the world that can kick start a world leading tech startup. Ironically, those hedge funds and banks that are in trouble are hiring more and more machine learning, AI, distributed systems, and other cutting-edge software experts to try and bring back the revenue the industry is losing. These are skill that are nearly impossible to find elsewhere.
The biggest likely winners of the Amazon deal are actually likely to be NYC VCs like Union Square Ventures that will likely have dozens more high quality companies in their backyard. They’ll get the best returns, get big funds, and feed the money back to the ecosystem. That in turn will create more jobs, more startups, and create the talent pool – and the density – that you need to sustain the density that makes Manhattan the world’s economic capital.