The economics of shopping malls

By Felix Salmon
September 1, 2009
Matt Yglesias buys my argument that the phenomenon of empty storefronts is a function of long commercial leases, "but only to an extent":

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Matt Yglesias buys my argument that the phenomenon of empty storefronts is a function of long commercial leases, “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.

Karl Smith then cuts through all the wild guesses and nails the real real reason why strip malls don’t have empty storefronts:

The difference is that a mall has a single owner who internalizes all of the externalites associated with vacant storefronts (and trash and crime, etc). An ugly mall is a less popular mall and thus commands lower rents overall. Typically its worth for the mall owner to take a hit on one store if he can make it up in higher rents for the others. This, of course breaks down when demand for the whole mall declines.

If one landlord owned all the shops on Broadway, she could happily rent a few of them out to banks at high rents, while renting others out to high-prestige, low-profit artisanal shops at much lower rents, all in the interest of maximizing total rental revenue. (I’m reminded that at the Time Warner Center, the landlord actually paid a set of bold-face names like Thomas Keller and Jean-Georges Vongerichten to open up restaurants there: they would never have opened up in the middle of a shopping mall otherwise.) Those cross-subsidies can’t work when there’s a multiplicity of landlords.

So yes, one solution to the problem of empty storefronts would be for a single landlord to take over a large shopping area. But I don’t think many people want that: you invariably end up with something which feels like an outdoor mall.


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Whether or not a single-landlord development feels like an outdoor mall depends on the landlord. A forward-looking landlord can do development that fits well into an urban landscape– the classic example is Federal Realty’s Bethesda Row development.

The problem is that this kind of development is expensive, requires long-term commitment, and entails endless struggles with local zoning and regulatory bodies. The good news is that over that long term, you end up making a lot of money.

Posted by MattF | Report as abusive

Sounds like you’ve hit on the solution. Assuming empty storefronts do impose negative externalities on nearby businesses, those businesses should be willing to subsidize their neighbors to take lower rents. Landlords renting to the banks, CVS, etc. pay others to rent to restaurants and small shops. Win-win.

Posted by ab | Report as abusive

Wasn’t the business model of the (now bankrupt) Steve & Barry’s clothing stores built around getting large up front payments from owners of distressed malls?

Posted by bdbd | Report as abusive

Speaking from a great deal of experience, most landlords don’t want temporary tenants because that speaks of desperation and because temporary tenants don’t pay squat. It can be different on a street in a city than in a strip or shopping mall but what’s noted are the weird exceptions: restaurant / bar space, because the rule of thumb is that you never convert away from that use because getting that use approved and built the first time is so expensive. But in standard space, the belief, right or wrong, is that having a temporary tenant in place discourages longer term tenants from taking the space.

The notes about length of lease driving vacancy is largely correct. The other factor is financing cost and debt covenants. A commercial mortgage will have a debt service ratio and should have a key tenant list. Let’s say a key tenant moves out. You have a negotiated period of time to get a replacement and that can, depending on the situation, get extended pretty far out. Let’s say you have a 1.25 coverage ratio – and they vary – then as long as you hit your ratio, you really don’t have an incentive to give in and make a short deal. Remember, as long as your CAM leakage isn’t terrible – so you’re not paying too much out of pocket – then you still have cash flow of sorts.

Posted by jonathan | Report as abusive

Maybe I live in the bizzaro universe, but the notion that strip malls have lower vacancy rates seems wrong. I live and work in northwest Indiana, and I can attest, on the basis of driving to work this morning that vacancy rates of 1-out-of-6 storefronts (or higher) in strip malls can be common and long-lasting.

And, for some actual data, I present this for your amusement:

“For neighborhood and community centers, net absorption for the quarter amounted to negative 7.9 million square feet—greater than the negative absorption for all four quarters of 2008 combined. The figure was down only slightly from the 8.1 million square feet of negative absorption posted in the first quarter. The vacancy rate jumped to 10.0 percent—the highest level since 1992. Year over year effective rents are down 3.2 percent and effective rents dropped 1.1 percent between the first quarter and the second quarter…On the regional mall front, the vacancy rate hit 8.4 percent—the highest figure since Reis began tracking regional malls in 2000.” l-vacancy-rates-new-highs-0713/

So neighborhood and community shopping centers had *higher* vacancy rates than did regional malls…hmmmm.

Posted by Donald A. Coffin | Report as abusive

Jonathan has it right.

As someone who works in real estate (but more on the construction finance side) the debt coverage ratio is a major covenant, so banks’ want long term leases from major anchor tenants covering the bulk of the monthly payments.

Frankly we don’t care if Joe’s shoe store goes under since the strength of the anchors will draw business to the vacant space.

But if a formerly solid anchor goes under(i.e. grocery store chain, bank, national fast food co. etc.) you can kiss the mall goodbye

Posted by schooner | Report as abusive