Beyond the Wage Premium

Why are firms willing to pay such high rents to locate in the very centres of large cities? The standard answer in urban economics is productivity: dense city centres allow firms to share inputs, match with specialised workers, and learn from nearby competitors. These agglomeration forces are usually measured through wages. Workers in larger or denser cities earn more, and this wage premium is interpreted as evidence of higher productivity.

In this paper, we argue that this perspective is incomplete. Firms do not only compete for workers; they also compete for floor space. In productive locations—especially central business districts (CBDs)—land is scarce and buildings cannot be expanded without rising costs. If productivity is truly higher in these places, firms should be willing to pay not only higher wages, but also higher rents. Ignoring this second channel risks understating the true strength of agglomeration economies.

Our contribution is to quantify how much of urban productivity is capitalised into commercial rents, rather than wages. To do so, we construct a new micro-geographic commercial rent index for Germany and use it to study how commercial rents vary within cities and across cities of different sizes. We show that commercial rents fall sharply with distance from the CBD and rise steeply with city size. Accounting for this rent capitalisation implies that agglomeration effects are substantially larger than wage-based estimates suggest—especially in large cities.

Three Facts About Commercial Rents

We begin by assembling a new dataset on commercial real estate in Germany, drawing on millions of listings over a 15-year period. Commercial rent data are typically sparse and unevenly distributed across space, which makes standard methods ill-suited. To address this, we develop a locally weighted approach that produces a continuous rent surface at a fine spatial scale, even in locations with few transactions. The result is a postcode-level panel of commercial rent indices that spans nearly all German local labour markets.

Using this index, we document several new stylised facts.

First, commercial rents are highly centralised. In large cities, rents decline by about 17 percent per kilometre as one moves away from the CBD. This gradient is even steeper than for residential rents, which fall by around 13 percent per kilometre. The difference reflects the stronger productivity advantages of central locations for firms compared to households.

Second, commercial rents scale strongly with city size. Rents in CBDs rise sharply with local labour market population. On average, the elasticity of CBD commercial rents with respect to city size is around 15 percent. The relationship is convex: the effect is modest for small and medium-sized cities, but becomes very large for the biggest urban centres.

Third, these patterns have proven remarkably stable over time. Despite discussions about the “death of the office” after COVID, we find little evidence of a sustained weakening of CBDs in large German cities. If anything, commercial rent gradients have become steeper, indicating a strengthening pull of central locations.

We then interpret these findings through a standard land-use framework in which productivity declines with distance from the CBD and increases with city size. In such a model, productivity advantages are capitalised into both wages and rents. Using our estimates, we show that commercial rent capitalisation alone implies an agglomeration elasticity of roughly 2 percent. Since wage-based estimates typically fall in the range of 2 to 4 percent, ignoring rents leads to an underestimation of total agglomeration effects by about one-third to one-half. For large cities, the bias is even greater.

Policy Implications

Our results have several important implications for policy and research.

First, they suggest that the productivity benefits of large cities are larger than commonly believed. Much of the existing evidence focuses on wages, implicitly assuming that land and floor space are passive inputs. In reality, competition for scarce commercial space absorbs a substantial share of productivity gains. From a policy perspective, this means that the social cost of restricting access to productive locations—through tight zoning, height limits, or slow permitting—is likely higher than wage-based calculations imply.

Second, our findings shed new light on land-use regulation and spatial misallocation. If agglomeration benefits are capitalised into rents, then policies that constrain the supply of commercial floor space in central locations do not merely redistribute rents; they limit firms’ access to productivity-enhancing environments. This is particularly relevant for “superstar” cities, where we find the strongest rent responses to city size.

Third, the results help explain why firms remain willing to pay extremely high rents in CBDs, even when remote work technologies improve. Higher rents are not necessarily a sign of inefficiency; they are the price firms pay to access dense networks, specialised labour pools, and knowledge spillovers. However, when rents rise faster than the supply of floor space, the burden falls disproportionately on young firms and new entrants, potentially dampening competition and innovation.

Finally, our commercial rent index opens up new avenues for research and policy analysis. By providing a fine-grained, publicly available measure of commercial rents across Germany, it allows researchers to better quantify productivity, amenities, and distortions in spatial equilibrium models. For policymakers, it offers a tool to monitor the health of CBDs, evaluate infrastructure investments, and assess how shocks—such as pandemics or changes in work practices—reshape the economic geography of cities.

In short, the price of productivity is not paid in wages alone. A large share is paid in rents. Recognising this fact leads to a richer and more accurate understanding of how cities work—and of what is at stake when we shape them through policy.