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Jeff Meli Ryan Preclaw

Episode 28

Jeff Meli in conversation with Ryan Preclaw

Will the dominance of megacities survive COVID-19?

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The pandemic has highlighted numerous risks to living and working in megacities around the world and now calls into question whether the long-term trend toward urbanization will be reversed. Should this trend come to fruition, there could be profound effects not just on corporate real estate, but on residential too, as the relationship between workers and their office locations is reconsidered.

In episode 28 of The Flip Side podcast series, Jeff Meli, Head of Research, and Ryan Preclaw, Head of Investment Sciences, debate whether megacities will survive COVID-19 and how the potential shift away from agglomeration may benefit smaller cities and the wider economy as productivity and income gains become more evenly dispersed.

  • JEFF MELI: Welcome to The Flip Side. My name is Jeff Meli. I'm the global head of research at Barclays. I'm joined today by Ryan Preclaw, our head of investment sciences, one of the two teams in our data science initiative that's harnessing alternative data to help clients make investment decisions.

    Thanks for joining me, Ryan.

    RYAN PRECLAW: Thanks for having me.

    JEFF: Today, we're going to discuss what changes might occur to cities as a result of COVID-19 and whether the pandemic will reverse some long-term trends towards increased urbanization. There's a lot of talk of an urban exodus for megacities as people flee to the suburbs in the wake of COVID.

    RYAN: Jeff, there's even an entire literary genre of confessionals about authors writing why they are leaving New York City. That said, I'm skeptical that we're going to see any lasting changes to urbanization. In fact, I think that the dominance of megacities is not only going to survive COVID-19 but is going to be enhanced on the other side.

    I think we're going to look back at this and realize that the conventional wisdom was wrong and that the commercial importance of centres like New York, London and San Francisco will go up and not down.

    JEFF: Well, Ryan, that definitely is an out-of-consensus view. I also happen to think it's wrong. Now to be clear, I don't think we're all going to move to a farm and revert to hunter/gatherers. Instead, I think COVID will break this prisoner's dilemma that we've been trapped in where companies and workers in high profile industries are forced to be located in high-cost megacities.

    I think smaller cities will benefit as workers increasingly find that they can find a better trade-off between career opportunities and cost of living outside of megacities. I also think that this is actually going to be a good thing for the economy overall, although megacities themselves will have a difficult period.

    RYAN: Well, let's talk about what the early data shows, and then we can discuss why I think people are wrong to extrapolate from these dramatic headlines that we've seen in the first few months of the pandemic.

    JEFF: Well, you've got to think that the early data is misleading because it's pretty grim for megacities.

    RYAN: So, Jeff, we looked at migration over the past few months using geolocation data. There absolutely is some net migration out of cities from March to July. But it's really only to the tune of a few percentage points.

    JEFF: A few percentage points sounds like a lot over just a couple of months.

    RYAN: In some ways, it is. In New York, that looks like I'm doing about 10 years of population growth, but we have to be careful how we interpret those statistics. At least some of that migration was temporary, as people left cities at the height of the pandemic, went to second homes, moved in with relatives, or rented their own house outside of the city because urban living was pretty impaired.

    Some of those people are going to come back, maybe now as schools are opening. And the net number covers the fact that even in normal times, like 2019, there are a few percentage points of people leaving that are actually offset by a few percentage points of people arriving.

    In fact, our data it looks like more people actually moved into urban areas in 2020 than in 2019. Though, the number of people moving out did jump even faster. But the fact that we saw as much inwards migration as we did is a piece of evidence that the underlying preferences for urban environments remained completely in tact.

    JEFF: And we also look at price data from Zillow, and that's where we see some differentiation between different types of cities. So, the generic price trends aren't concerning. In most cities, housing prices are still going up. It's just they're now going up at about the same pace as prices in the suburbs, whereas previously, city prices used to be rising faster.

    RYAN: That's right. Housing in general actually has been a bright spot during the pandemic. So, mortgage rates have fallen, savings rate rose and people were stuck at home with no place to spend money, so their overall houshold balance sheets have improved.

    JEFF: Yes, but the data is quite different in a handful of expensive megacities, notably in the U.S., New York and San Francisco. In those cities, house prices are actually falling, so Manhattan, for example, prices are down about 5 percent. Rents are falling too, and vacancies are up.

    The immediate beneficiaries in those cases seem to be the suburbs where prices have risen dramatically. So, in these megacities you're creating a real wedge between urban and suburban that you're just not seeing in other metro areas.

    RYAN: Yes, I think people are wrong to draw conclusions from this early price data. So first of al, you've probably pulled forward a bunch of demand for suburbs. Those were people who were planning to leave anyways and, because of a combination of low rates, high savings and then, of course, the immediate benefits of getting a yard and some space, have decided to do it now.

    JEFF: Well, I agree with that. I think if you were ever going to consider a move to the suburbs, now is the time. I think the question is whether this trend becomes self-reinforcing.

    RYAN: I actually think the demand to flee the big cities is going to run out of steam. So, as far as we can tell, the preferences that have driven urbanization, so that desire for out-of-home amenities, things like nightlife, restaurants, cultural institutions, and basically just being around large groups of people, remains in tact.

    Megacities were expensive because they had access to these – enormous numbers of these amenities. And now that that access is impaired because of COVID 19, or at least impaired compared to the suburbs or smaller cities, prices are reflecting temporary disruption in these benefits.

    As long as the preferences, though, remain stable, as long as people really want those things, then those prices are going to recover once those amenities are available again. In fact, the fact that the smaller cities are not seeing price declines suggests that it's not just some big shift just avoiding high-density urban areas.

    JEFF: Ryan, I think you're leaning too heavily on this idea of stable preferences. To me, preferences are a way of balancing the pros and cons of different options. And the outcome of that balancing act can change, even with the same preferences, so long as the pros and cons themselves have changed. And in this case, I think they have and not just temporarily.

    So let's use a hypothetical two-income family as an example. With two incomes, that family could afford the cost of a megacity like New York. And the burden of two commutes if you have kids is pretty high, so the cost of the city are worth it. That family prefers the urban setting under the pre-COVID environment.

    Now, it's likely that those workers will have more flexibility to work from home going forward. The commuting time and the burden associated with it gets cut almost in half if they both work from home two days a week. That makes living outside the city much more palatable.

    RYAN: So wait, Jeff. Are you saying that I can expect to work from home twice a week even after we get a vaccine and return to normal?

    JEFF: No, I'm not going to sign on the dotted line. I do think it will give folks a lot more flexibility going forward. And then imagine that all those city amenities that you were talking about never really rebound, so bars and restaurants, cultural institutions, et., they don't recover or they only recover very slowly.

    Then layer in budget pressures that we know cities are going to be under, which will affect things like the quality of the education in those cities and a whole bunch of other quality-of-life issues. Now, the tradeoffs look a lot different, so even though your preferences may be stable, the world has changed around you, and so, you make a different decision.

    RYAN: Yes, Jeff, that was a pretty good laundry list of all the things that could go wrong with city life. But I am glad you didn't reference higher crime. That is one thing where there's a lot of attention, on crime, but actually aggregate crime has not increased in cities or at least not in New York City despite all of the press to the contrary.

    JEFF: Ryan, I think you're cherry picking statistics there. Aggregate crime is a tough stat to rely on when behavior changes very dramatically. So take smartphone thefts on the subway. That's one of the most common crimes in New York pre-COVID but obviously that crime declines dramatically when subway ridership goes down by 90 percent.

    Now, on the other hand, I also think it's inappropriate to extrapolate the recent rise in shootings say over to a return-to-normal life. I would say that an increase in crime is a risk and should be listed alongside a bunch of the other quality-of-life issues that people have in cities right now.

    RYAN: I think if you want to put that full list out there and think about all the ways that things can go wrong in cities, there are going to be a few families that go through that process and maybe think about leaving. But you also need to consider the fact that the apartments that they lived in or the houses that they lived in are not going to go away. They're still going to be there and markets are still going to clear.

    And so, what you're talking about now is that housing prices fall but that just brings on a new wave of inwards migration. If anything, smaller cities were actually benefitting from the high housing costs in New York, London and San Francisco. People were priced out of those places. Now, if prices fall there, what's going to happen is new people who could not have otherwise afforded it are going to move in.

    JEFF: On the one hand, Ryan, as an economist, I tend to agree that markets will eventually clear, but current stock at housing in big cities will eventually get filled. And I agree that the high cost of housing in megacities was a deterrent to inwards migration. That's a point I want to come back to in a few minutes.

    But markets clearing at a lower price doesn't mean that tax revenue doesn't decline. So if you were to place a high-income earning family with a bunch of kids right out of college, the city could lose a lot of revenue, and that's what kicks off this spiral of worse services which then pushes more people out, etc.. We need to be thinking about the future tradeoffs people will be facing, not the ones they're facing today.

    RYAN: That brings up another issue that we need to consider, which is, where are the companies going to be located? Now, I think the flexibility that you're talking about actually strengthens the case to be located in the heart of a megacity. As we've learned through the pandemic that individual work can get done at home, the best evidence is saying that remote work is something that is going to be a day or two a week for most people, or for half the people maybe, but not a big increase in the number of people who can work from home all of the time.

    So that means you're not seeing people move to very distant cities or move out to the country. Plus, people do value the office as a place for interactions and collaboration, so if you put those things together, what you get is that most of the time when people come to the office to work, they want to see people. That means you want to centralize as much of your staff into one place as possible.

    JEFF: So you're not a believer in the idea that we'll have a bunch of satellite offices spread throughout the suburbs?

    RYAN: Definitely not. Why do you need a bunch of distributed offices where people can simply work from home? The best reason that we had offices spread all over was for resilience, and we just learned that working from home is a much more resilient solution than any number of satellite offices. On top of that, if you are only going to be in the office for a few days a week, then commuting into the city center is not really that much of a burden. So the benefits of having people in one place is that much stronger.

    I think that companies are going to have an incentive to keep offices in city center and a bunch of inwards migration in megacities that is about to happen in response to lower prices. So as long as the outward migration is to the suburbs, then you've really just increased the pool of workers in these megacities, and the result is that their dominance actually increases.

    JEFF: I think your thought process is too incremental. Let's take a step back. Megacities become centers of excellence in high-profile industries because of the benefits of agglomeration. So you concentrate tech companies in San Francisco, financial services companies in New York, and that generates positive externalities. Companies benefit from a deep talent pool; workers benefit from having lots of career opportunities, and everybody benefits from knowledge sharing.

    Like with everything else in life, this agglomeration has diminishing returns to scale, so at some point, you have enough critical mass to get the benefits, and you don't really need the next finance firm or the next tech firm. And I think you can give some examples of this just in finance. There's a vibrant leveraged finance community in Los Angeles. It's a legitimate knowledge center. It's just on a smaller scale than New York City.

    RYAN: Yes, so Jeff, the origins of that cluster in L.A. are thanks to Mike Milken being in the ‘80s.. So even though some very high profile senior people are probably still around there from his time, most of the people in high yield in L.A. are way too young for that. It's become self-sustaining. And in fact, I'm going to give you that example. I'm even going to cite some other ones.

    So there's already plenty of other examples. We have these non-silicon valley tech clusters in Seattle and Austin. We've got insurance in the Midwest. We've got biotech in Boston. These are all clusters that popped up before COVID. None of them threatened the status of the megacities.

    JEFF: Now, away from those examples, I think that employees and companies in high-profile industries are stuck in this prisoner's dilemma. They might prefer the lower cost or the lifestyles associated with any variety of smaller cities, but they have no choice but to be located in a megacity, even though we're well past the point where increased agglomeration brings in additional benefits.

    RYAN: Even if you're right, I'm not sure how COVID breaks that process. Once people aren't making every decision based on needing that social distance, the natural gravity of megacities is going to be there to reassert itself.

    JEFF: Well, I agree it's not immediate, but I think instead it happens in stages. So work with me on this. First, families move to the 'burbs, but in New York City and San Francisco, the suburbs are pretty expensive. And as you pointed out earlier, a lot of the families that moved out would have preferred to live in a city under different circumstances.

    So we start getting requests – Virginia, Houston, Upstate New York, Denver. Those are just some of the places that I've already had conversations with people about potentially moving to. I can put those off for a while, but in the end, I suspect I need those workers more than they need me.

    All it takes is a little bit of bad luck from the perspective of a place like New York City, and a cluster emerges in a place like Denver or Nashville. It's centrally located, lots of infrastructure, easy to get to, lots of the amenities that you were talking about before, and a way lower cost of living than New York City or San Francisco. And all of a sudden, these employees have options that they didn't have before. The luster of this high tax, high cost, bad infrastructure city like New York starts to fade pretty quick.

    RYAN: What I think is notable, though, about what you just said is that the demand from those employees you're getting are so dispersed. They're all over the country. So that suggests it would take some pretty bad luck for the outcome you're talking about. That prisoner's dilemma is a stable equilibrium for a reason.

    So even if you let people move all over, having one person move to Nashville and one person move to Houston and one person move to Denver is not going to be a threat to having the main office in London or here in New York. And so, I think that's going to be something that's a basic fact of finance for the foreseeable future.

    JEFF: Another important issue is if the dominance of megacities is a good thing?

    RYAN: Jeff, one point in their favor is that wages and productivity in those cities seem to rise faster than in other places for a long time. Those are centers of innovation and advancement, and that benefits the workers who live there.

    JEFF: That's true, Ryan, but we've also mentioned several times that folks were priced out of these cities. A large number of prospective workers had been effectively barred from participation in the highest profile industries in our economy. And while productivity and wages in megacities was rising, the average growth in these metrics in large developed economies, not just in the U.S., has been slow.

    And that's been a puzzle for economists for a number of years. I think concentration of megacities contributes to a system of haves and have nots, and then if we can scatter these industries more broadly, we'll remove counterproductive barriers to entry, and I think get more shared prosperity. We could all be better off by having more and less-costly centers of innovation scattered throughout the country.

    RYAN: Well, maybe if you're right, I'll do this next episode from my new house in Austin.

    JEFF: Sounds great. I'll dial in from a chairlift somewhere in the Rockies. Thanks for joining this episode of The Flip Side. Clients of Barclays can access our latest research on the long-term implications of COVID on the residential and commercial real-estate markets at #futureofrealestate.

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About the analysts

Jeff Meli is Global Head of Research within the Investment Bank at Barclays. Jeff joined Barclays in 2005 as Head of US Credit Strategy Research. He later became Head of Credit Research. He was most recently Co-Head of FICC Research and Co-Head of Research before being named Global Head of Research. Previously, he worked at Deutsche Bank and JP Morgan, with a focus on structured credit. Jeff has a PhD in Finance from the University of Chicago and an AB in Mathematics from Princeton.

Ryan Preclaw is the Head of Investment Sciences, a group that creates investment insights by combining alternative data, data science, and traditional research. Previously, he was a Director in Credit Strategy, where he focused on special situations, event-driven strategies, and industries facing fundamental transitions. Prior to joining Barclays, Ryan worked as an economist at NERA Economic Consulting and London Economics International. Ryan received his M.B.A. from the University of Chicago in 2008, his M.A. from Western University in 2001, and his B.A. from the University of Alberta in 2000.

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