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.