Why Don’t Markets Clear in Urban Storefronts?
Vacant storefront on 1300 block of U Street; good place for a Wendy's? (cc photo by NCinDC)
One of the enduring mysteries of urban life is the prevalence of vacant storefronts. This is understandable in a truly depressed area where the whole local economy has broken down. But if you take someplace like U Street in Washington DC where there are tons of thriving businesses, it seems bizarre that there are also lots of vacant storefronts. Surely there’s something, at some rent, that could make a profit. And surely some rent would be better than no rent. But as Justin Fox writes, the markets seem not to clear even in super-prosperous areas like Broadway on the Upper West Side.
His theory, also endorsed by Felix Salmon is that the culprit is unduly long lease lengths:
If prevailing leases are low, or tenants hard to find, the developer will quite rationally choose to keep the property empty. Leasing at a low rate will lock in a loss, while keeping the property empty has significant option value: at some point in the future, rents might well rise, and the developer can at that point lock in a profit instead. This is why successful property developers generally need very deep pockets: anybody who needs immediate cashflow, in the form of rent today, is in an invidious bargaining position and is likely to lose out over the long term.
I buy this, but only to an extent. If you look at suburban strip malls, the same long lease dynamic applies, but widespread strip mall vacancies are normally a sign of specific economic distress. The current recession has less to a lot of them, but in normal economic times you tend not to see this. Instead, even depressed areas reach a low-rent equilibrium. Possibly this is because strip mall property is less speculative in nature than urban property. But I think the specifically urban nature of the problem probably has something to do with the level of regulatory uncertainty surrounding new retail endeavors in most American cities combined with the reluctance of many neighborhoods to play host to the sort of “uncool” national retail chains that could better manage the risks involved.
42 Responses to “Why Don’t Markets Clear in Urban Storefronts?”
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August 31st, 2009 at 4:05 pm
Well, no-one’s going to rent that place because they’ll want to paint over the Soviet-style mural on the outside wall, and the defenders of art will tie that up in court and before various boards for aeons, and… where’s the economic incentive in that?
August 31st, 2009 at 4:09 pm
The flip side, of course, is that if the lease is too short, a successful start-up business will add value to the space and quickly get priced out.
Unduly long terms might be a problem, but overly short ones would just open up a new can of worms. You might have lower rent businesses opening up at great locations, only to be forced into closing or moving right as they’ve established themselves.
August 31st, 2009 at 4:12 pm
Are lease lengths set by law?
August 31st, 2009 at 4:15 pm
Can localities impose some sort of ‘vacancy tax’ on properties like these?
I would imagine that increasing the cost of idling the properties might be a good way of getting revenue, encouraging business, or at the very least condemning vacant property.
August 31st, 2009 at 4:17 pm
The comparison to strip malls is useful, because most strip malls are filled with chain retail outlets that have a business model built around suburban strip malls. Certain chains will venture into storefronts like 1300 U Street, but many won’t.
The presumably higher rents and insurance costs, and lower supply of potential renters, would probably explain the disparity regardless of lease length.
August 31st, 2009 at 4:19 pm
I doubt suburban strip mall rents are subject to the same variance as urban core rents. I don’t think this post adds value.
August 31st, 2009 at 4:21 pm
and lower supply of potential renters
It’s not as if there is an unlimited supply of people who are looking to risk everything to realize their dream of opening a tea shop, dog bakery, organic parsnip dealership, etc.
August 31st, 2009 at 4:22 pm
“Can localities impose some sort of ‘vacancy tax’ on properties like these?”
Georgian Single Tax! http://en.wikipedia.org/wiki/Georgism
August 31st, 2009 at 4:30 pm
Many urban areas (notably South St. in Philly although there are others) have been giving out these spaces to art collectives for them to use as gallery/workshop space, with an agreement that the artists will clear out once a paying renter is found.
Keeps the storefront occupied, and adds a cultural presence to the neighborhood. Win-win.
August 31st, 2009 at 4:40 pm
One of the explanation for the rise of malls generally was their ability to internalize externalities. They would lower lease rates to traffic building stores such as department stores and movie theaters and raise them on the sun glass hut and Mrs. Fields. Similarly, one might expect that a strip mall owner, recognizing that a vacant store front threatens the lease income on his other properties will be much more willing to sign a cut-rate lease.
August 31st, 2009 at 4:43 pm
In my day job [which I am currently ignoring] I represent tenants in NYC. Up here, I can tell you, the problem with shorter-term leases for most commercial tenants is build-out costs. Most suburban strip mall spaces are one-size-fits-all vanilla boxes that are geared to pretty standard uses that, especially for retail, typically don’t cost a lot to prepare. Even many of the restaurant set-ups are pretty interchangeable.
By contrast, many spaces in urban storefronts are oddly configured. In addition, the businesses tend to be more individualized, trading on their trendiness. On the Upper West Side you can’t just throw a bunch of merchandise racks into the space and announce that you’re open for business, at least not if you hope to succeed.
These factors combine to make build outs more elaborate and, in NYC’s high-priced, code-heavy construction market, very expensive. Even many of my small retail clients spend upwards of $100,000 outfitting a space for occupancy; small restaurant clients can spend several times that. After that kind of investment, you don’t want to risk getting booted out after 3 or 4 years. As such, most tenants won’t settle for less than a 10-year lease.
August 31st, 2009 at 4:51 pm
I guess if you start from the assumption of “Rational Markets”, and rent optimization it does not make sense.
But some times (and it happened in my home town) it might just be an elderly landlord, that doesn’t need any more money, and doesn’t sell the property simply because he doesn’t want to, since we are talking commercial urban areas, the property is appreciating enough just sitting there idle, if he ever needs money he’ll sell it.
Or as it happened in my town, when the old man kicked the bucket the grandchildren built parking decks, on properties that had been idle for at least 10 years.
August 31st, 2009 at 4:56 pm
Here’s why:
Retail tenants usually have to cover significant expenses in fixtures, equipment, finishes, signage and other aspects of brand identity before they open the door. Most retail leases cover a portion of these expenses with a “construction allowance” that is paid back gradually as part of the rent.
From a landlord’s perspective, the lease needs to be long enough to make financing a construction allowance worthwhile.
From the tenant’s perspective, too short of lease means that he would have to bear the cost of “fixturization” on his own and then be stuck in the space, with a lease that could be renegotiated to his disfavor very soon.
Tenants that are indifferent to brand identity tend to be undesirable and diminish the prestige of a building. Moreover, most retail leases have base rents that are increasedif monthly sales rise higher than an established threshold. So holding out for a better tenant promises higher rents down the road.
So with those dynamics in mind, retail vacancies in a vital neighborhood can be viewed not as a sign of decline, but as a sign that landlords are looking forward to a better future.
August 31st, 2009 at 4:58 pm
Matt needs to take some business courses. Even an empty rental property may have a benefit to the owner in terms of depreciation expense to deduct in taxes against the income from other operations or rentals if the landlord owns multiple properties. The benefit of the depreciation is one factor that has to be balanced in deciding whether to rent at below market rates.
August 31st, 2009 at 5:03 pm
I think a big difference is in an urban neighborhood their are many landlords while in a strip mall it’s basically one landlord. When there are many landlords each think perhaps the surrounding properties will lease out first, make the community more vibrant, and increase the potential rent they can charge for their space. Basically they hope if they wait it out a little longer they can benefit from externality.
August 31st, 2009 at 5:14 pm
In reference to the mural that someone mentioned in an earlier post. That used to be a bar called “The State of the Union”, which used to be one of my favorite places in my early 20s. It closed sometime after I moved to Baltimore in the late 90s, and it seems like it’s just wasting away. Darn shame.
August 31st, 2009 at 5:27 pm
I worked briefly in mall real estate and tyler is 100% correct. The exception is when spaces are already “built out” (suitable for a business) and the business is willing to operate a month to month deal in exchange for lower rent. That kind of deal isn’t great for a lot of retailers.
August 31st, 2009 at 5:33 pm
Administered Prices:
This message brought to you by Gardiner Means and Adolph Berle.
Oh…and Thorstein Veblen too.
And Symeon – you win a tip of the hat from me.
August 31st, 2009 at 5:34 pm
Inadequate floor-plate, structure is shot, floor needs reinforcement, non ADA compliant, no HVAC (yeah…you’re gonna need a new reinforced roof..), inadequate plumbing and electrical, no cable runs, no sprinklers… what’s not to love?
Plus the nearby availability of new or retrofitted buildings (including suburban style big box and strip malls).
This is a tear down waiting for the right offer.
August 31st, 2009 at 5:56 pm
Re scythia’s comment at 9 — if you are running your city worse than Philly is doing, you have major problems.
/ born at UPenn hospital
// go Eagles and Phillies.
August 31st, 2009 at 6:18 pm
I assume it’s because strip malls have spacious parking lots.
August 31st, 2009 at 6:39 pm
Why don’t the just have shorter-term leases when the price is low, so that they can raise the price easily when it goes back up?
August 31st, 2009 at 6:45 pm
Re scythia’s comment at 9 — if you are running your city worse than Philly is doing, you have major problems.
No comment on the state of political/civic affairs in Philly, last time I checked the state of Pennsylvania wasn’t a Soviet republic. These are private developers and private real estate agents making this call. Art galleries increase foot traffic, which increases the desirability of the location, as well boosting the sales of other tenants on the block the landlord may have. Plus, galleries can adapt to the space they’re given without having to incur the initial structural costs mentioned by other commenters above.
August 31st, 2009 at 7:06 pm
Re scythia’s comment at 9 — if you are running your city worse than Philly is doing, you have major problems.
Well, Killadelphia.
Well, no-one’s going to rent that place because they’ll want to paint over the Soviet-style mural on the outside wall, and the defenders of art will tie that up in court and before various boards for aeons, and… where’s the economic incentive in that?
Yep. I love how this was probably the worst illustration possible for the urban-storefront problem. They’ve got a fucking socialist-realism mural on that wall that developers probably have no expedient legal recourse of erasing, and you wonder why that particular slice of the market doesn’t clear?
August 31st, 2009 at 8:25 pm
@ Chide Myles
Well I was being snarktastic about the mural. I don’t think anyone really cares that its “socialist realism.” Its just ugly, is all.
Nevertheless, Childe Myles we need to mark this as a red letter day: Its is the first time we have ever agreed on anything – even if its for the wrong reason.
August 31st, 2009 at 8:26 pm
In Pittsburgh you have a couple of places where the existing tenant was *kicked out*, yet stood empty for years (8 years and 15 years for the two I know of). I think looking for an economic explanation in some cases is futile – there were probably personality conflicts combined with overoptimism on the part of the landlord about finding new tenants.
The relevant buildings are the old Beehive in Oakland (which did finally find a tenant), and St Elmos (previously used books) on the South Side. Both of these are good locations with lots of foot traffic.
August 31st, 2009 at 9:29 pm
[...] Matt Yglesias doesn’t buy that answer If you look at suburban strip malls, the same long lease dynamic applies, but widespread strip mall vacancies are normally a sign of specific economic distress. The current recession has less to a lot of them, but in normal economic times you tend not to see this. Instead, even depressed areas reach a low-rent equilibrium. [...]
August 31st, 2009 at 10:38 pm
Well I was being snarktastic about the mural. I don’t think anyone really cares that its “socialist realism.” Its just ugly, is all.
I am just being precise, that’s all. It dminishes the word’s potency, really, when the word ‘Soviet’ is casually thrown around. Sort of like a synonym for anything that’s ugly.
Nitpicking, of course. But yes, I am actually curious, why have those sort of murals not yet come down? It is hideous and hideously dated.
Although not as preposterous as Diego Reviera, whose reputedly high artistic talent I never quite had the pleasure of appreciating. Back to the Renoir and Sargent and Klimt and Caspar Friedrich and Fra Filippo and Botticelli for me, I suppose.
August 31st, 2009 at 11:53 pm
#14 is correct: there are important tax and depreciation advantages to letting a store lay vacant for even years, until rents rise again (or liquidation, whichever is most responsive to market conditions at that time). The point is, a vacant store is not a dead loss for the landlord.
second point, the comparison to malls is entirely INapt: in fact malls have been taking huge hits the last couple of years.
http://money.cnn.com/2009/04/10/news/economy/retail_malls/index.htm
According to Reis, mall vacancies are higher and rising faster than at any time in two decades.
the difference is that urban storefronts are right there at the street/sidewalk level, positioned quite purposely to be as visible as possible. to witness–or count–mall vacancies, you have to seek them out. they are not visible unless looked for.
retail–in and out of malls–is in the toilet, and has been trending down more and more sharply for most of three years. that is why the recent rebate program for appliances should have been ten times as big, and should have covered furniture, books, hardware, and other labor-intensive, recession-fighting products.
[you'll notice i didn't mention clothing, since we can't get away with 'buy American' clauses in these things (and that's only right). but we can choose not to subsidize entire industries if they are actively part of our problem rather than part of our solution.]
anyway, we need more consumer-directed stimulus $. Retail, I don’t hope we need reminding, is a big employer, and especially of the young and under-skilled.
September 1st, 2009 at 12:14 am
2 issues – 1, the people who are all asshatty about the mural on the wall of the building must not spend much time in cities. Heck, there’s a restaurant in Bucktown in Chicago that specifically commissioned a mural with a slew of images of socialist/communist leaders. A very successful, relatively pricey restaurant (meal for 2, without drinks, probably runs about $80).
I very much doubt that a prospective tenant is going to care much about the mural, and a creative tenant would find a use for it.
2. This seems to be based on Matt’s experience in DC, which I would assert is not common in many other cities. There are plenty of cities without the problem Matt describes in all but the economically worst off areas. The only cities that I’ve seen with large problems with empty storefronts are those with major economic problems.
I live in Chicago, I’ve lived in areas ranging from the upper end (gold coast) to higher crime, gang and drug infested areas (Humboldt Park).
There weren’t any significant problems in any of those neighborhoods with a large number of vacant storefronts. Maybe the odd persistently vacant storefront, or the rotating storefront, but not persistently vacant. Same goes in parts of neighborhoods I frequently visit like Lakeview, Lincoln Park, Rogers Park, Hyde Park, Wicker Park, Bucktown, Logan Square, West Town, etc.
So, this may be a problem more unique to DC than a common problem that persists in many places.
Or, maybe the market has cleared in DC, and theres just an excess supply of storefronts. Maybe DC needs more people to create more demand for storefronts.
I would assert that DC is underpopulated. Lift the height restrictions and let some high rises go up and increase the population density.
September 1st, 2009 at 12:17 am
I’ve always thought that there’s a business opportunity here for a business willing to grab these spaces under cheap, short leases. You’d need the ability to cheaply “remodel” the space, and a product that isn’t dependent on the location remaining constant.
Wireless stores strike me as a one good example, since they seem to open and close more or less at random anyway. I could imagine a small brand like Virgin Wireless running their entire retail operation this way — saving a ton of money.
September 1st, 2009 at 2:13 am
To see the malls emptying out, visit the Dead Malls website.
http://www.deadmalls.com/
September 1st, 2009 at 3:40 am
A very successful, relatively pricey restaurant (meal for 2, without drinks, probably runs about $80).
That’s mid-market, and from what I can tell from the description, probably more a mid-priced getaway for bobos more than anything.
September 1st, 2009 at 7:10 am
Why Don’t Markets Clear Instantaneously in Urban Storefronts?
There, I fixed the headline
September 1st, 2009 at 9:50 am
> Why Don’t Markets Clear Instantaneously in
> Urban Storefronts?
>
> There, I fixed the headline
Uh, no. The phenomenon MY describes persists for long periods of time, certainly longer than the 3-5 year period of most commercial leases; often for 20 years or until the former commercial strip crumbles into dust.
Cranky
September 1st, 2009 at 10:45 am
[...] I wondered why, if the long length of commercial leases makes it hard for the market in urban retail storefronts to clear, you so rarely see vacant [...]
September 1st, 2009 at 11:55 am
[...] Matthew Yglesias: If you look at suburban strip malls, the same long lease dynamic applies, but widespread strip mall vacancies are normally a sign of specific economic distress. The current recession has less to a lot of them, but in normal economic times you tend not to see this. Instead, even depressed areas reach a low-rent equilibrium. Possibly this is because strip mall property is less speculative in nature than urban property. But I think the specifically urban nature of the problem probably has something to do with the level of regulatory uncertainty surrounding new retail endeavors in most American cities combined with the reluctance of many neighborhoods to play host to the sort of “uncool” national retail chains that could better manage the risks involved. [...]
September 1st, 2009 at 12:45 pm
I question the whole question. Do you have any real numbers?
The idea that it is a matter of long-leases is, if I am not being harsh, a bit weird.
September 1st, 2009 at 5:41 pm
A simple measure, wise for dozens of reasons, would be for localities to shift their taxes off buildings and onto land value.
If landlords were faced with higher carrying costs, they’d be less willing to hold out for higher rents, and more content to accept what the market is offering.
If landlords weren’t penalized for improving their buildings, and NOT rewarded for not improving them, we’d have a healthier local economy.
And the filled storefronts would be good for all the tenants.
Why does rent rise? Generally for reasons which have nothing to do with the activity or inactivity of the individual landlord, and plenty to do with the health of the local economy and the amount and quality of local public investment, not to mention effective pork spending. Why do we let landlords treat that value as if they’d personally created it? Their windfall doesn’t come out of thin air.
Check out Harrisburg, Pennsylvania’s experience with land value taxation. They’ve used it since 1982, and their vacant storefronts have gone way down. And they keep re-electing their mayor, who credits LVT with much of the city’s progress.
September 1st, 2009 at 5:52 pm
[...] week, some prominent bloggers—Felix Salmon, Megan McArdle, Matt Yglesias, DCist’s Sommer Mathis —are hammering at a curious urban quandry: why some [...]
September 1st, 2009 at 7:26 pm
that joints been like that since ‘97-’98… its probably a disaster inside… half a step from condemnation… and that art dates from ‘95 or so, so i doubt thats a factor, big ups to the SIME piece under the fake-me-out soviet thing…
September 2nd, 2009 at 8:33 am
[...] Yglesias wonders why (DCist, too) empty storefronts persist on busy thoroughfares, like U Street; WCP reporter Ruth [...]