The Gentrification Paradox

Why is it that you see so many vacant storefronts in urban areas that are clearly becoming more prosperous? Surely the space would be worth renting out at some price, and just about any non-zero rent would be preferable to owning a vacant storefront.

Lydia DePillis sees a bubble mentality at work:

It’s a strange sort of boom. While Nelson at least keeps her store vibrant, other H Street properties sit vacant, in seeming defiance of the corridor’s boomtown press. Few properties are for sale. City records show that not much has changed hands in the last few years, which you might expect from a neighborhood in transition. What’s going on?

Well, lots of things. Many of the spaces are too small for some businesses. Few could be leased without extensive renovations. But mostly, the scene reflects the same logic Thelma Nelson is using: Hang on as long as possible, because values will keep going up. And if you want to sell, no price is too high.

“People are too unreasonable now. They believe they got a gold mine,” says developer Italo Rodriguez of IS Enterprises, which does renovation work on the strip. “People own lots, they are trying to sell the lots, but they are asking astronomic prices.”

Perhaps a more economist-y way of putting it is that with this kind of urban real estate you have a very non-generic, non-commodity product. So search costs are high, information is deeply imperfect, and you have a lot of market inefficiency. Thanks to optimism bias on the part of owners, that inefficiency manifests itself as systematic under-pricing and under-occupancy, which is a very bad outcome from a social point of view.