Wall Street & Markets

Why are commercial real estate markets so often gridlocked?

By Justin Fox | August 28, 2009 | +

I live in a very prosperous neighborhood of New York City, the Upper West Side, where the main thoroughfare, Broadway, is full of vacant storefronts. Except for a few recent restaurant closings, this isn’t a product of the recession—it was just as true a couple of years ago. I mainly blame the banks, which at the height of their expansionist frenzy were adding branches on every corner, driving out more useful neighborhood businesses and overpaying on rent, thus driving up the expectations of every commercial property owner in the neighborhood. That led to lots of shop and restaurant leases not being renewed, and lots of ground floor commercial space going unused because for all their expansionism the banks were never going to need all the commercial space on Broadway.

Now the banks are retrenching. I imagine rents will eventually sink far enough to reflect this new economic reality, and the storefronts of Broadway will fill up again. But it’s taking absurdly long, and millions (hundreds of millions? billions?) of dollars in economic value is going lost in the process. The Upper West Side commercial real estate market would seem to be spectacularly inefficient.

It’s not just the Upper West Side. Sometime Curious Capitalist commenter Marcus reports (in a lecture he gave last week) of trying to rent some commercial space in the depressed and vacancy-plagued central business district of Newcastle, an Australian coastal city north of Sydney:

I contacted 13 separate Commercial Real Estate Agents in Newcastle via email seeking information about potential properties to lease. I gave them a price range – at the medium to high end of the asking price for most Newcastle commercial property), preferred but flexible locations, specific indications of what i was looking for and multiple contact details.

I offered to pay for some capital improvements and said i was able to fly to Newcastle from Melbourne to inspect any properties that might be likely candidates. Given the incredibly dire state of the commercial property market in Newcastle i was actually worried that i might be a little run off my feet with phone calls.

The total number of properties i have been encouraged to look at was nil. The total number of phone calls received was nil. The total number of “thanks but we don’t have anything for you at the moment” emails was nil.

Marcus’s explanation:

[M]any of these buildings are worth more as losses, write offs and deductions that as going concerns. The potential rents are so low that few can actually be bothered renting them. The commission for real estate agents are negligible. Commercial leases are by default prohibitively long and often require property owners to meet expensive obligations.

That, and the cost of complying with regulation can make small businesses and small real estate transactions uneconomic. Marcus came up with a clever partial solution in Newcastle—starting an nonprofit called Renew Newcastle that persuades property owners to let it take over their vacant commercial space on a rolling 30-day basis and then cleans it up and rents it out for use as shops, galleries, studios and a tea house. I don’t know how you make that work in a neighborhood like mine that isn’t in obvious need of rejuvenating but does have a temporarily dysfunctional commercial real estate market (that is, I can’t imagine landlords along Broadway agreeing to participate in Renew Upper West Side). But the common theme—that commercial real estate is prone to market failure—is pretty striking.

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  • pneogy

    “But it’s taking absurdly long, and millions (hundreds of millions? billions?) of dollars in economic value is going lost in the process. The Upper West Side commercial real estate market would seem to be spectacularly inefficient.’

    I suppose the acolytes of Schumpeter will call this just the destructive phase of creative destruction. But you are exactly right, and it is time to question the old bromide. There’s got to be a point beyond which the amplitude of the boom-bust cycle threatens the viability of the process itself.

  • whatsmyteam

    Thanks for posting the link to my talk Justin. Perhaps it’s relevant or not but one of my little obsessions which was also addressed in passing in the same talk is what i call “the problem of scale” or the idea that the sheer scale of several decades of responding to global capital has produced inefficiencies at the small scale. It’s an idea i will probably get to fleshing out further over time but it is striking me as an obvious problem and at the core of this strategy.

    I’m not sure about the States but in Australia this has come from both the left and the right. The left through increasingly prohibitive regulation and compliance that actually requires large amounts of capital to resolve (in an attempt to “civilise global capital”) and from the right through all manner of incentives to consolidate, scale up, de-localise and make it easier for companies and capital to operate at a national or international level.

    The net effect on my old home town, Newcastle, is an old city centre full of small scale spaces (it’s a 200 year old city which is very old by Australian standards) while all the regulatory and financial structures really only work at the large scale capital intensive level and the paper value of the sites has become detached from their use. As we discoverd when we started the project there is no lack of new enterprise that might take root here but no mechanism for it to take root.

    As a result the argument in the city has become about bulldozing it or preserving an intact 100 year old streetscape that sits often empty it rather than strategies for using it. Our approach has been to try and create an intermediary (our not for profit company) that makes the small scale viable again in the expectation that a new dynamic might emerge — or it may not!

    It’s an interesting experiment to run and the initial results seem positive. We’ve got 36 new initiaitves open (creative enterprises, arts and community projects are our focus for a range of reasons) in what was dead zone and are waiting to see what takes root.

    The project outline and results are at http://www.renewnewcastle.org if any if your readers are interested to take a look.

  • http://www.marcuswestbury.net/2009/08/29/time-is-on-my-side-and-wired-too/ TIME is on my side (and WIRED too)

    [...] something of an exageration. But Justin Fox, the business and economics columnist for TIME magazine has written a little piece about Renew Newcastle in TIME’s The Curious Capitalist economics bl…. I like Justin’s work and have been known to leave the odd comment on his blog at [...]

  • tomlind

    I like the article but can you substantiate the claim that the banks were overpaying?

  • jfnjfn

    The banks were only one species of “feeding” consumer in the real estate area discussed. They sought access to the large number of people in the area to perform transactions benefical to their profits (feeding).

    In theory, if the entire economy was functioning (that is to say other species of consumers felt they had the “control” to make profits or “eat”) the spaces would have been taken by that species in short order. The number of people living in that real estate area has not gone down drastically.

    It is not the banks but rather the lack of “control in the hunt for profits” that the individual consumers perceive that they do not have at this time.

    The panic of 2009 has caused this effect not the weak species know as our “commeical banks”

  • http://yglesias.thinkprogress.org/archives/2009/08/why-dont-markets-clear-in-urban-storefronts.php Matthew Yglesias » Why Don’t Markets Clear in Urban Storefronts?

    [...] 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. [...]

  • http://twitter.com/justinmicklefox Justin Fox

    “overpaying” is probably the wrong word. The banks simply came into the neighborhood a few years back with a great desire for corner properties and a willingness to pay a premium for them—and lots of landlords along Broadway have been waiting in vain ever since for somebody else willing to pay that much.

  • http://modeledbehavior.com/2009/08/31/why-dont-strip-malls-have-vacant-storefronts/ Why Don’t Strip Malls Have Vacant Storefronts «  Modeled Behavior

    [...] ~ August 31st, 2009 in Economics, Urbanism Several bloggers have pondered the question of vacant urban [...]

  • http://aroundthesphere.wordpress.com/2009/09/01/malls-stores-and-distress-what-does-an-empty-store-mean/ Malls, Stores And Distress: What Does An Empty Store Mean? « Around The Sphere

    [...] Justin Fox in Time: I live in a very prosperous neighborhood of New York City, the Upper West Side, where the main thoroughfare, Broadway, is full of vacant storefronts. Except for a few recent restaurant closings, this isn’t a product of the recession—it was just as true a couple of years ago. I mainly blame the banks, which at the height of their expansionist frenzy were adding branches on every corner, driving out more useful neighborhood businesses and overpaying on rent, thus driving up the expectations of every commercial property owner in the neighborhood. That led to lots of shop and restaurant leases not being renewed, and lots of ground floor commercial space going unused because for all their expansionism the banks were never going to need all the commercial space on Broadway. [...]

  • http://www.marcuswestbury.net/2009/09/02/renew-newcastle-on-the-blogs-at-reuters-the-atlantic-and-the-bbc/ Renew Newcastle on the blogs at Reuters, The Atlantic and the BBC

    [...] in case you missed it. The discussion started with Justin Fox at TIME magazine. It was picked up by Felix Salmon at Reuters, before being continued by Megan McCardle at The [...]

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  • nonsense2

    It’s not only in Newcastle NSW Australia. A very similar problem seems to be happening here in Hervey Bay Qld Australia as well.

    Walking down the Esplanade one could throw a bowling ball and not hit anyone Mon-Fri but the place comes alive on weekends, and school holidays.

    I feel so sorry for so many of those retailers as some of them have a lot of money tied up in stock just sitting on shelves while the shop two doors up from them is empty.

    I believe as this second dip hits the world financial markets, many towns and cities around the world will realise the importance of having a firm foundation based on small business enterprises.

  • http://www.marcuswestbury.net/2010/10/09/renew-newcastles-coming-to-america-tour/ Renew Newcastle’s coming to America tour | marcus westbury

    [...] Harvard Business Review Group and formerly of Time magazine described the Renew Newcastle model as a “clever partial solution” for the failures of dysfunctional commercial real estate mar… while  Felix Salmon of Reuters – also reflecting on the failure of commercial real estate [...]

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