Large coastal cities with high population density are under tremendous pressure from recent crises. In fact, they were already under significant pressure due to changes in the tax code, which took effect in 2016 and significantly reduced the tax deductibility of state and local taxes, taking away a federal benefit for high tax states and local jurisdictions. Cities such as New York had been under significant outmigration pressure even before 2020.*
Are there implications for publicly traded real estate investors? The answer is probably yes.
Let's take a look at a cap-weighted approach to managing REITs, which is the way most such money is invested. The regional allocation of capital is determined by the value of publicly investable real estate in that region. In other words, if you add up all of the office buildings in the New York metro area which are available for the general public to invest in, and you decide to invest your real estate money based on that, that’s cap-weighting.
For example, according to one well-known approach (there's slightly different ways to do this), the value of all of the publicly investible office space in New York metro is roughly a quarter of all of the publicly investible office space in the United States. So, a cap-weighted portfolio index would dedicate roughly a quarter of the portion of the portfolio to office space in New York metro.
Let's take a look at what that does on a national scale:
(Source: Vident Financial, S&P Global, as of 2/3/2020)
The height of each bar is determined by the share of the office portion of the portfolio invested in that particular part of the country, like we discussed above, with New York getting a little more than 25%. As you can see, there is a very heavy concentration in big cities with large, dense populations, mostly on the coasts. These allocations tower over 'Flyover' America.
It's not a matter of how economically productive these cities are -- they are clearly highly productive, but their share of cap-weighted REIT money is lower than their share of national economic output.
For example, the New York metro area produces a little less than 8% of GDP (Gross Domestic Product, the most widely recognized measurement of economic production). That's a lot for one city, but it's not 25%, which is the share of office space investment in the cap-weighted index.
This is a large 'overweight', which means the investment bet is larger than one based on the economic output. A lot of this is a matter of judgment, not pure math. Does New York metro strike you as a place with a risk profile which justifies such an outsized bet? Or does it seem more prudent to diversify things a little more, reallocating some (not all) of those big New York, Boston, and LA bets across the rest of the country?
* CNY Central, Study: New York ranks in top 3 most moved-out-of states for 7th year in a row