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The Financial Pain for Cities from Struggling Downtowns

Nearly four years after the start of the pandemic, downtowns are still short of office workers and foot traffic. That's contributing to significant budget problems in some cities.

downtown Los Angeles skyscrapers
Last year, the owner of two office towers in Los Angeles, including the 777 Tower shown here, defaulted on $784 million in loans. (Photo by Dean Musgrove, Los Angeles Daily News/SCNG)
In Brief:
  • Downtowns across the country continue to be emptier than before the pandemic. The loss of activity is hurting cities’ finances.

  • Transit agencies are particularly hard hit.

  • Cities are looking for ideas for revitalizing downtowns, but no easy solution will work everywhere.

  • It’s been nearly four years since downtowns emptied out, as office workers packed up their laptops and started working from home. In many cities, office vacancies and lack of foot traffic remain major problems that are seriously affecting municipal bottom lines.

    Budget woes have been masked up to this point to a large extent, thanks to additional federal aid. But that money is running out, while downtown struggles remain a major drag on local government finance. Working from home now makes up 28 percent of all working days, according to economist Nicholas Bloom of Stanford University. That’s a fivefold increase over pre-pandemic levels. He expects the number of people working from home to rise, not come down. Office values have dropped by more than a third and will continue to come down, representing a potential $600 billion loss.

    Given the challenges, cities are trying to come up with ways to reinvent or rethink their downtowns. Cities such as Boston, Minneapolis and Dallas are offering major tax incentives for conversions of office space into residences. In San Diego, the new owner of a 25-story office tower announced a $140 million residential and hotel conversion plan earlier this month.

    But such longer-term solutions will take a good while to play out. In the meantime, cities are having to deal with budget shortfalls. In San Diego, the office vacancy rate continued to grow slightly last year. The city’s chief operating officer has called on agencies to cut spending amid a projected shortfall of $172 million for the coming fiscal year, which begins this summer. The Southern California region as a whole finished 2023 with 81 million vacant square feet of office space, almost exactly double the amount in 2019.

    Metro, the transit system in Washington, faces a projected shortfall of $750 million for the coming fiscal year. Last week, its board voted to consider fare hikes of 25 percent. “The more money we get, the less likely it is we would take some of the more drastic actions in the proposed budget,” said Matt Letourneau, the board’s finance chair. “I think we will look at a fare increase regardless, but it may not be as much as 25 percent if the funding is provided.”

    Seattle faces a shortfall of more than $200 million, while its schools began the academic year more than $100 million short. Last month, King County imposed $13 million worth of spending cuts, mostly by eliminating some vacant positions, while warning that its shortfall in the coming year could be $30 million.

    Not All Bad News

    New York’s business districts have only recovered 66 percent of their pre-pandemic foot traffic. Still, the city has more than gained back the jobs it lost during the pandemic. Mayor Eric Adams has backed off from proposed cuts to school, fire, police and sanitation. The city is currently running a surplus, but the comptroller’s office warns it could face a deficit of nearly $8 billion next year, in large part due to the hits to commercial real estate.

    Before the pandemic, office activity in San Francisco accounted for 72 percent of the city’s economy. The city has been the subject of plenty of news coverage suggesting it would be the victim of an “urban doom loop.” San Francisco’s office vacancy rate recently reached a record high of 36 percent. “What I think we need is an office market adjustment that will find the right rents in the offices to attract new tenants or to bring people back,” says Ted Egan, the city’s chief economist.

    Last month, Mayor London Breed called for budget cuts of 10 percent, with the city facing a $245 million shortfall in the next fiscal year — and double that in 2026. And, as in Washington, transit ridership is way down. In November, the Bay Area Metropolitan Transportation Commission approved a $350 million lifeline for the struggling BART system, drawn from $5 billion provided by California lawmakers last year to prop up ailing transit agencies.

    But, while downtown is still a drag, reports of San Francisco’s death have been greatly exaggerated. The Bay Area continues to lead the nation in attracting venture capital. San Francisco proper began growing again last year. In fact, it’s now one of California’s fastest-growing cities. San Francisco is a center for the boom in artificial intelligence, with companies expanding their local office footprint.

    There’s no one-size-fits-all approach that will pull all downtowns out of their doldrums. “Most cities are struggling, but that doesn't mean they're struggling equally,” says Brett Theodos, director of the Community Economic Development Hub at the Urban Institute. “It doesn't mean they're struggling for the same reason, and it doesn't mean they all have the same trajectory.”
    Zina Hutton is a staff writer for Governing. She has been a freelance culture writer, researcher and copywriter since 2015. In 2021, she started writing for Teen Vogue. Now, at Governing, Zina focuses on state and local finance, workforce, education and management and administration news.
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