Office Space Extinction? A Look at Agglomeration Economies

McKay Price addresses agglomeration economies in a pandemic.

If necessity is the mother of invention, then chance meetings might well be the father. 

That, anyway, is part of the thinking behind what's called “agglomeration economies” and the reason some economists think it might be too soon to sound the death knell for the office in the wake of the coronavirus pandemic. 

Illustration of a dinosaur looking at an office building

Last spring, the future of commercial real estate went from robust to painfully uncertain, with the financial press sounding the alarm. Since then, millions of people have been working at home. More than a few companies have found that employees can be productive working from their living rooms in Zoom meetings and conference calls, despite the distractions. Is office space really headed for extinction?

Not so fast, says McKay Price, director of the Goodman Center for Real Estate at Lehigh. 

“I don’t think this experience signals the end of the office nor the clustering of companies and people in large cities,” says Price, who also holds the Collins-Goodman Chair in Real Estate Finance. 

His optimism can be traced to agglomeration effects.

“Agglomeration economies themselves are broadly defined as the benefits of bringing people and companies close together,” he says. “It’s been a longstanding explanation for the reason why we have cities.  

“Imagine living in New York City. You pay a high price in terms of congestion, people on top of each other, the pollution, the noise. You pay a very high price for a very small apartment. So there are costs.” 

But the benefits of a large talented labor pool, extensive services and all the cross pollination of ideas outweighs the costs for many companies and workers, he says.  

That’s why, for example, the San Francisco Bay Area is a mecca for tech entrepreneurs. 

“Everything you need is right there, from programmers to venture capital to legal support. All these people, clustered together have specialized knowledge for that particular realm. So that’s the benefit of agglomeration economies, of coming together,” Price says. 

In addition to such advantages, agglomeration offers a less tangible but equally important benefit: knowledge spillovers–the sometimes-accidental ideas and innovations that come from meeting other people in person.  

“I’m in New York, and I’m going to lunch, and I cross paths with so and so whom I know from a previous transaction,” Price explains. “We catch up and ask, ‘What are you working on?’ All of a sudden new ideas come about. Now, I’ve got fresh insight for a current project that I’m working on at my firm. These knowledge spillovers happen, sometimes intentionally, and other times just by accident, because everybody is in close contact with one and another.” 

Platforms such as Zoom and Webex are helpful and certainly remote meetings are here to stay. 

“Technology can help and such platforms are beneficial,” Price says. “But a virtual experience isn’t a perfect substitute for a real experience.” 

In light of the pandemic, some companies are likely to allow employees to work from home more often but will still need enough square-footage at their offices to allow for social distancing. 

“You’re essentially just rotating people in and out of the home and office,” Price says. “So you don’t totally lose those benefits of crossing paths at the water cooler or the elevator.” 

As for commercial space in the retail sector, that market was already depressed. For some time now, brick-and-mortar stores have been losing business to e-commerce such as Amazon. The trend has been accelerated by the pandemic and may cause more big retail names to file for bankruptcy, Price says. 

“Over the past few months in the retail space, it’s common for shopping center owners to only have collected only 50% of the rent,” he says. 

As retail stores decline and e-commerce continues to grow, we’re seeing an increase in industrial spaces, such as warehouses and distribution facilities. 

Still, Price isn’t ready to write off the allure of in-person shopping. 

“Some people go so far as to say brick-and-mortar shopping is going to go away,” he says. “I think that’s also extreme and not likely to happen. There’s enough people out there who want that retail experience. You don’t get it when you buy stuff online.” 

Story by Margie Peterson
Image by John W. Tomac

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