A view from outside a glass office tower at dusk of the workers inside.
Workers in an office tower in London's Canary Wharf at dusk. Toby Melville/Reuters

Vertical clustering—of certain high-status industries on the higher floors of buildings, for example—is an important part of urban agglomeration.

In today’s knowledge economy, the clustering of companies and talent is the key driver of innovation and economic growth. Such clustering is usually thought of as occurring horizontally on the flat plane of a map, across a geographic area with large concentrations of companies, highly educated workers, and capital. Even as our cities rise higher in the sky—and policy makers and urbanists call for increased densities—we have little understanding of the ways cities are organized vertically.

A new paper published in the Journal of Urban Economics takes a close look at the organization of economic activity in our increasingly vertical cities. Its authors, urban economists Crocker H. Liu, Stuart S. Rosenthal, and William C. Strange (my colleague at the University of Toronto’s Rotman School), examine the kinds of economic activities that cluster in tall buildings; the types of industries that concentrate on higher floors; the variation in rents in these vertical (as opposed to traditional horizontal) clusters; and the effects of such vertical clustering on city economies.

Their study uses data from three sources: a set of confidential offering memoranda, supplied to potential investors when a building is up for sale, with detailed information on rents and tenants; CompStak, a commercial real estate analytics startup; and Dun and Bradstreet, which has detailed data from credit reports on a wide range of business establishments. It quite literally adds a new dimension to the study of agglomeration in urban economics, one that will become increasingly important as cities grow taller and denser.

The key takeaway is this: Not only do rents rise by floor as tenants pay more for status, prestige, and view, but the rate at which rents increase, or the rent gradient, is higher than the price premium tenants pay for being in prime locations in the central business district. In other words, vertical clustering is a bigger deal than horizontal clustering, at least in terms of the premium on commercial rents that tenants are willing to pay.

A graph of rent for square footage and floor number
Commercial rents are high on the first floor because retail businesses want to be at street level. They then drop and make small climbs and dips before steadily rising at higher levels. The chart is based on a sample including only suites from buildings over 30 floors in height, and is restricted to suites from two floors below ground level up to floor 30. (Liu, Rosenthal, and Strange)

That said, the ground floor, on average, is the most expensive, because retail businesses are willing to pay a higher premium for being on the street. But starting at the second floor and moving up, rents gradually increase by floor, with bigger increases for higher floors. On average, rents increase by roughly 0.6 percent per floor.

Higher floors bring a bundle of attributes, including views (of course), reduced noise, and higher status and prestige. This is why the highest floors in residential towers are called penthouses and command a higher price. Also, higher floors in office towers are a way of “signaling” that a firm is high-status and performs important, well-remunerated services.

Rent differences by elevation represent a tradeoff between vertical transportation and vertical amenities, according to the study. The expense and inconvenience of a higher location are gradually outweighed by views and status.

Economic activity is also sorted vertically, with higher-profile and more profitable firms occupying higher building floors. Law offices are disproportionately represented on the highest floors, taking up more than a third of floor space above the 40th floor, compared to 12 percent of floor space between the second and 40th floors. Finance, insurance, and real estate take up roughly 20 percent of floor space above the 40th floor, compared to 23 percent between the second and 40th floors. Business services, engineering, and miscellaneous other industries are also more likely to take up more space below the 40th floor.

This panel summarizes the composition of tenants in buildings in the cleaned data. Measures are reported based on the share of establishments by industry and the share of space occupied by industry. (FIRE stands for fire, insurance, and real estate.) Law offices make up 24.3 percent of establishments above floor 40, but occupy 34.8 percent of the space (in the far right column). (Liu, Rosenthal, and Strange)

It’s not just horizontal clustering, but vertical clustering of economic activity in tall buildings that drives growth and innovation. Moving up one floor in a building has a similar effect on productivity and rents to adding 3,500 new workers to a neighborhood.

High-rise towers are an increasingly important element of our economic geography. As the back-to-the-city movement gains strength, our cities—and their urban cores and central business districts—are growing upward. Cranes dot the horizons in New York, Hong Kong, and Toronto, but even more so in the rapidly urbanizing cities of the developing world. Skyscrapers are like neighborhoods or even mini-cities unto themselves, with some housing 50,000 workers or more.

The reality is that cities grow in three dimensions, not two. Where economic activity happens on a map is just part of the story. Where it is located vertically in space—and which activities cluster high in the sky, and why—is an increasingly important part of urban economic geography. Mayors, urban leaders, and economic developers, as well as researchers, need to pay more attention to the vertical city.

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