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Intersections of Place, Productivity, and Profit (with video)

Stuart S. Rosenthal sheds light on why businesses locate in tall buildings and urban centers and how policymakers can use that knowledge.

Skyscrapers' mammoth scale can change city skylines, and they house an enormous number of people, but it's only recently that academic researchers began to uncover the way businesses organize within them and why.

If access to the top floor of tall buildings is far more costly and cumbersome than lower floors, why do companies pay significantly more to locate higher? Are rents within commercial office towers driven not just by employment outside their four walls, but also by employment inside?

The audience of a workshop this year at the Federal Reserve Bank of Cleveland had a front-row seat to hear from Stuart S. Rosenthal, a prominent urban economics researcher.

The 2-day Workshop on Public, Urban, and Regional Economics drew a maximum-capacity crowd to focus on how city policies and the structure of cities—such as where business districts are and the ease of transportation within cities—affect the productivity of local economies.

Rosenthal keynoted the event, presenting the findings of his paper “The Vertical City: Rent Gradients and Spatial Structure.” He and his co-authors, Crocker H. Liu and William C. Strange, used novel data, including confidential offering memoranda information, to reveal more about the spatial patterns within tall buildings.

Forefront sat for an exclusive interview to ask Rosenthal how policymakers might use those findings and, given Rosenthal's prominence in urban economics, how cities and what we know about them are changing. An edited transcript of our conversation follows.

Forefront: You describe the research you presented during the workshop as work that's not been done previously. What did you find?

Rosenthal: The urban field has devoted extensive effort to understanding why we have different spatial patterns of development and land rent within cities, why cities are productive places and by how much, and what contributes to city skylines. But all of that has mostly been done in a 2-dimensional plane. We understand that there's more densification in the downtown than farther out into the suburbs. We have lots of papers that have sought to understand better why we have stratification of types of activity: residential versus commercial versus industrial. But almost all of that research has ignored the vertical, 3-dimensional aspect of cities.

There's a very systematic and substantial vertical rent gradient, with a very sharp rent premium for ground-level activity, after which rents fall and then they rise gradually and at an increasing rate.

Nobody until now has really dug into what is happening inside these tall buildings: What is the spatial pattern of activity within tall buildings? Are there meaningful differences in commercial rents?

It's important to recognize that tall buildings are huge. The amount of space in the World Trade towers that came down was roughly 10 million square feet. The number of people employed was on the order of 50,000. These were like small cities themselves.

So what do we find when we look within these tall buildings? First, it's not the case that there's a single cost of space at a given latitude and longitude. There's a whole family of rents present. That's a new insight. The commercial developers have known this, but the academic world has overlooked it. There's a very systematic and substantial vertical rent gradient, with a very sharp rent premium for ground-level activity, after which rents fall and then they rise gradually and at an increasing rate.

We see important stratification of activity when we look at location vertically within tall buildings. Companies have better access to the street, of course, at ground level, and perhaps intuitively we see a lot of retail concentrating at ground level, with office-oriented activities above.



On the reel

Stuart S. Rosenthal shares what he thinks is the best thing policymakers can do as cities evolve. Watch now:

As you move up in a tall building, the cost of accessing the space increases. What we observe and document for the first time is a positive rent gradient. Once you get up above the 2nd floor, rents rise, and they rise at an increasing rate.

The only way that can happen in a commercial office building that is populated by for-profit companies is if there's something about being high up off the ground that is valuable. One possibility is the amenity effect: Workers value the spectacular view from the 50th floor. Another possibility is a signaling effect. Anecdotally, we've heard if you're anybody, you want that office high up. It's more impressive.

We see that nearby employment has a very compelling impact on commercial rent. We also see that your location vertically has a compelling impact on rent. The vertical location is as important for the cost of space as is the horizontal location. And what we also find is the impact of employment inside the building is a couple times larger on commercial rent as compared to employment of the zip code outside.

Forefront: You write that this verticality you studied matters. Why? How should its significance influence policymakers and civic decision makers?

Rosenthal: The more we understand about what it is that makes a location attractive in a world where local government officials would love to have better-quality employment nearby, the more effective the policymakers are going to be. Otherwise, they're shooting in the dark.

Is there something about being high up that is going to attract high-end headquarters, for instance? Do you want those companies to be present in your town?

From the city's perspective, one question arises: Is this going to enhance employment opportunities in the community, or are we going to simply generate a massive amount of unoccupied vacant commercial space that is going to be a boondoggle and undermine the health and vitality of other buildings nearby? How about, instead of an 80-story tower, two 40-story towers?

So understanding what different companies seek when they look for space in an urban area is important if you are the town official who has the authority to say, “We're going to grant that permit” or “We're not going to grant that permit.”

So understanding what different companies seek when they look for space in an urban area is important if you are the town official who has the authority to say, ‘We're going to grant that permit’ or ‘We're not going to grant that permit.’

There are serious for-profit motives at work here, and that means somebody who is willing to put up his or her investment capital and the town officials who are willing to authorize the building permits are hoping this is going to be a source of enhanced productivity and greater and better-quality employment opportunities for the local community.

Forefront: Name a significant insight we've gained about city structure and policies in the past 5 years.

Rosenthal: Cities are, of course, expensive places. And you could ask yourself, why would a for-profit company ever want to do business where it's so expensive? Space is expensive, labor is expensive.

The answer is we get something back in exchange for operating in that space, in that location. There's something about cities that is enormously productivity enhancing that makes it easier for businesses to get the job done. If that wasn't the case, companies would move away from cities.

One of the really important sets of insights in the last 20 years has been to better understand the nature of what is it about cities that causes labor and causes businesses to be that much more productive. The same worker is going to be a lot more productive in Manhattan than in Syracuse. So then there's the question of why. What's driving that? And we are increasingly learning about what those mechanisms are and how important they are.

A very fanciful but real mechanism is that we learn from each other. When we are in proximity, we see each other more readily. It's easier to have face-to-face interactions.

One possibility is that if I'm operating in an area where there are other innovative companies in my industry nearby, maybe I'm a little quicker at learning new ways to get the job done. One place where we hear this sort of story quite frequently is in the high-tech area, research and development, computer technology. Silicon Valley is the most famous example, but it's not the only one.

The same worker is going to be a lot more productive in Manhattan than in Syracuse. So then there's the question of why.

Part of it also is about the ability to tap into a pool of skilled workers. If you lose your key technical worker and you need to replace that person—if you are trying to operate a facility that has industry-specific skill requirements, and you're in the middle of North Dakota—you're probably out of luck. There's no one else nearby. If you operate that facility in an urban area, where there are other companies similar to yours, you have a much greater chance of being able to replace that key individual.

In the last several years, the academic literature surrounding what is it that makes cities productive places has been increasingly successful at providing evidence of both the nature and the magnitude of these sorts of underlying factors.

Every town mayor has a desire to bring more effective employment to his or her community. If you have good quality employment opportunities in the community, all kinds of things are easier. Income is going to be higher. There's going to be less stress socially, more resources to fund local services, including schools, fire, crime protection, you name it. In order to have any chance of proactively attracting and retaining quality jobs in your town, you need to understand what it is that businesses care about and what causes cities to be productive in the first place.

Forefront: You are the managing editor of the Journal of Urban Economics. We wonder what you see as the key policy issues in the near and/or long term for urban economics. Why?



On the reel

Stuart S. Rosenthal shares what he thinks is the worst thing policymakers can do as cities evolve. Watch now:

Rosenthal: I think climate is one factor that's going to come up. There is a paper in the Journal of Urban Economics called “The Greenness of Cities” that argues that densification is an energy-efficient way, a low-impact way for us to organize ourselves. Those sorts of energy and climatic issues are going to remain important and grow in importance over time, concerns about CO2 emissions, for example. How we organize ourselves spatially makes a difference for the environment.

There are enduring challenges for cities that include the downside of cities. They are, by definition, congested places. We tend to have higher crime rates in cities. That's going to be a challenge for every city going forward.

Technology is going to continue to impact the function of cities. If you go back in time, cities began primarily as manufacturing centers. As technology has changed, as our ability to move people and products has changed, manufacturing has moved away from the downtown cores, and the function of cities has changed and become much more information oriented. So any policies associated with urban development are going to be influenced by the nature of the activity that takes place in cities.

Sum and substance: Understanding what drives businesses to locate in tall buildings and in cities can arm policymakers with important information to consider when making decisions.



Stuart S. Rosenthal

Photo courtesy of Stuart S. Rosenthal.

Stuart S. Rosenthal

Position

Maxwell Advisory Board Professor of Economics, Department of Economics and Center for Policy Research, Syracuse University
Editor, Journal of Urban Economics

Education

  • Bowdoin College, BA in Economics, May 1980
  • University of Wisconsin–Madison, MA in Economics, December 1984
  • University of Wisconsin–Madison, PhD in Economics, May 1986

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