LOWER MANHATTAN’S DENSITY:

THE ECONOMIC FORCES WHICH SHAPE THE SKYLINE


By Alex McCauley

It is often unnerving to observe the degree to which abstract economic mechanisms shape the physical space that surrounds us. Nowhere is that influence more obvious in daily life than in lower Manhattan. While the shape of the skyline can certainly be admired from an aesthetic perspective, its shape and the shapes of the buildings that compose it are determined almost exclusively by economic forces. When building the skyscrapers that characterize the skyline of New York City, the plans of the architect yielded to the primal economic forces of their time: generally speaking, in the twentieth century, New York had to rise higher towards the center of the financial district (located around Liberty Street, Broadway, and Wall Street) to provide as much space as possible close to the Federal Reserve, the New York Stock Exchange, and the New York Clearing House (Figure 1).

For most of the twentieth century, proximity to the financial nexus (composed of the Federal Reserve, New York Stock Exchange, the Clearing House, depositories, as well as telephone and telegraph networks and the offices of major depositors) was crucial for the ability of financial firms to do business effectively.[i] Before the advent of ubiquitous and instantaneous electronic communication, securities trades which occur in real time required proximity in order to clear. As financial firms are often very profitable, or at least hold great potential for profitability, they are willing to pay dearly for this ability to transact efficiently, and there is great competition to compete in the limited space available. As we know from geometry, the area of available land at any given distance from a central point increases exponentially as the distance from that point increases; consequently, the supply of land closer to key points is proportionally scarcer than the supply of land further from them. Given those two facts in isolation – that there are many wealthy buyers competing for increasingly scarce and increasingly desirable land as that land gets closer to the nexus of the financial district – we should expect land values to rapidly increase as the location approaches the nexus, and to rapidly decrease as it moves away from it. And of course, that is exactly what we see in Figure 2, from 2006, and Figure 3, from 1903.

Another dynamic, which, together with the one just described, explains the massing of tall buildings in the financial district, is the formula which calculates the ideal building height for a project: marginal cost equals marginal revenue, written MC=MR. The construction of an additional floor is said to be “at the margin,” meaning it is important primarily to evaluate the difference that floor will make to the total cost and total revenue of the project. Each additional floor is more expensive than to build the one below it, which economists call “increasing marginal cost.”[2] Increasing marginal cost translates to decreasing marginal returns (because the same amount of money buys a developer less floor space, or the same floor space costs more money), so the optimal height of a building is determined by the famous law of diminishing marginal returns. The value of office space in lower Manhattan is derived primarily from its location, due to the importance of proximity to key financial institutions. It follows that rent per square foot is relatively fixed for a building site; therefore, it is sufficient to calculate the discounted rent roll for each square foot, then determine the point at which the cost of constructing an additional square foot of rentable space exceeds the discounted rent roll for the standard square foot.[3]

The possibility of building tall buildings on a plot of land, thus multiplying the high rental rates one can receive on a site, greatly increases the value of that land. This more expensive land in turn provides an incentive to build higher. The cost of buying the land for the first floor is the same as the cost of buying the land for as many floors as it is possible to build. Consequently, where land is expensive, the average cost per square foot (taking into account the cost of land as well as construction) actually falls at first as a building rises. No developer trying to maximize profit would build lower than the height at which cost per square foot is minimized. I will call that height the minimum economic height for a given plot of land. This minimum economic height is greatest where land is most expensive; in the case of lower Manhattan throughout the twentieth century, this means that the minimum economic height for development increases the closer one gets to Liberty Street, Wall Street, and Broadway. Note that the optimal height (where MC=MR) must be greater than the minimum economic height by definition, because if the land costs were so high as a proportion of the rent roll that it would be uneconomical to build at any height, there would be no potential buyers, forcing a decline in the price of land.

It is no mystery, accounting for the needs of the financial sector in lower Manhattan, why the skyline is so tall and so concentrated. In order to make a profit, developers must stretch skyward to fit the most possible office space in the most expensive areas. The bias toward centralization around the key financial institutions at Liberty Street, Broadway, and Wall Street explains the shape of the skyline. Fortunately, this bias creates a massing that is often considered beautiful. Perhaps we can appreciate images of the massed buildings such as figure 4 even more because we understand the underlying mechanisms that caused the buildings to mass there.

[1] Armstrong and Hoyt, Decentralization in New York City, 125.

[2] Willis, Form Follows Finance, 46.

[3] In practice, it is usually not practical to construct only one additional square foot of space. The decision is made regarding the marginal unit of an entire floor or a portion of a floor rather than a single square foot.