Felix Salmon

Empty storefronts

By Felix Salmon
August 31, 2009

Justin Fox has a very good post on the broken state of the commercial real estate, pointing to empty spaces on Broadway and in Newcastle, Australia. I could easily add my own street, Avenue B, which has an inordinate number of empty storefronts, or could point to Centre Point, in London, a skyscraper which stood empty from its completion, in 1966, until 1979.

Justin is absolutely right about the corrosive effect of bank rents on New York rental rates: all landlords want the kind of rents that only banks can afford, but of course not all landlords can have a bank as a renter. But the bigger picture is that commercial real estate in general often stays empty for extremely long periods of time — something which harms neighborhoods and lets huge amounts of economic value go to waste.

Why is this? I think the answer lies in the fact that commercial leases tend to be very long-term things — so long term, in fact, that the discounted cashflow from any given lease is likely, in a normal (non-bubbly) property market, to be more or less the same as the value of the commercial property itself. Looked at this way, a developer spends a certain amount of money on putting up (or simply buying) a building, and then sells that building, in lease form, for a profit.

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.

Marcus Westbury has manged, in Newcastle, to implement the obvious solution to this problem: short-dated leases, often just 30 days long, which roll over so long as the landlord hasn’t found a permanent tenant. That’s good for the neighborhood, and helps drive up prevailing rents, so everybody wins — except, of course, for the commercial real estate agents, who are disintermediated and who in any case are never going to make any money brokering 30-day deals. But many businesses are never going to find that kind of deal acceptable, even if they’re already in the space in question — remember that Kenny Shopsin, for instance, refused to extend his lease on the space he had occupied for years in the West Village by one year. “A one-year lease,” explained Calvin Trillin with no further elucidation, “is obviously not practical for a restaurant”. Yet somehow a brand-new teahouse in Newcastle manages to operate on a shorter lease yet.

My feeling is that commercial real estate in general has always operated on extremely long timescales, which can seem ridiculous to those of us not in the business. And it always will. Occasionally someone like Marcus Westbury will come along and shake things up. But more generally, many empty storefronts are likely to remain empty for years on end: it’s just how the business works.

5 comments so far | RSS Comments RSS

What you’re missing is the substantial upfront capital investment required of the tenant and/or the landlord. The lease needs to be long enough for the parties to amortize that upfront investment. A residential lease can be for one year notwithstanding the initial cost to build or renovate because replacement tenants will predictably rent the same exact space, perhaps with a new coat of paint. The next retail tenant might be a restaurant, or a florist, or a clothing store. Even for the same general use, like a restaurant, the space would typically need to be rebuilt, and the lease term would need to account for that cost. A short-term extension can be similarly problematic. If Kenny Shopsin needed new kitchen equipment, he wouldn’t pay to have it installed in a space where he might be leaving it after only a year.

The Newcastle space was already built out as a juice bar and could therefore be reused easily. They’re “hoping to make it a bit more welcoming”, but I assume that means bringing in some decoration they can easily take with them when they’re terminated, and maybe some volunteer labor to paint. Anything that can’t open for use with that little work just isn’t a candidate for a month-to-month lease.

Posted by matt m | Report as abusive

You’re wrong about the numbers, too. I think most people in the business would agree that a reasonable non-bubble valuation for a high street retail asset would be an 8-10% yield (cap rate). If you own one building with a 10-year in-place lease and sell it at a 10 cap, the buyer certainly isn’t going to recover his investment on a present value basis without giving any value to a sale at the end of the lease period.

I’d suggest that the reason that you see a lot of retail vacancy right now is that not too many retailers want to or can invest in opening new stores in the middle of the current huge recession.

Posted by SC | Report as abusive

It’s advocates do sometimes overegg the case, but surely this is exactly the problem a land value tax would solve?

Posted by Matthew | Report as abusive

Avenue B’s issues are as much the Community Board as the landlords. It seems they believe that empty storfronts are preferable to potentially loud resturaunts and bars. Not sure if they are right about that or not, but it may not be the purest form of tenant/landlord market data.

Posted by Ledbury | Report as abusive

I’ve been noticing this in Manhattan for the past few years as well. Go to midtown, 34th and 5th and you’ll see dozens of boarded up street level shops.


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