A simple model for vertical mixed-use vacancy.

Matt Yglesias is all “gee, why do storefronts below new condos go unused?

Well, let’s see. There’s two things to understand here. The first is that at many businesses are not viable even at zero rent. Let’s say my uncle dies and wills me his panel van. I could sell donuts out of this van! Have my own business! So I read up and I see that Houston and Dallas are both large markets for donuts and I decide to park my van in a field halfway in between. Is this a viable business strategy?

No, it’s not. For one thing, it’s very likely I’m going to lose money on the donuts. Presuming that I purchase wholesale donuts from the baker at $X and sell retail donuts to the public at $Y, then every day I need to sell at least Z donuts, where Z is Y * (number of donuts purchased / X). Then there is the opportunity cost of spending all day in a relatively unprofitable donut truck. I just as easily could be delivering cupcakes for $10 an hour.

The second thing to understand is that Urban Planners really, really, really like vertical mixed-use. It provides clear visual rebellion against the earlier generation of planners who really, really, really liked single uses, preferably as well-separated as possible. In many places planners will give you a “bonus” for providing retail spaces under residential. Maybe extra height, extra FAR. In other places planners require that you add mixed-use. Dallas did this, and as a result they have some very pretty streets that provide actual, built examples of the sketches you see in planning documents about the “transformation” that will happen to a certain street after bike lanes are added.

Sometimes it works.

The problem is, if you provide a bunch of financial incentives for the construction of retail space, you’re going to get a lot of retail space. And if you get enough of that, eventually you’re going to drive prices so low that it’s only rentable to unsavory businesses. There is a reason why “low rent” and “unsavory” are often synonyms. Say you’re looking to open a new Banana Republic store. Certainly, you’d like to pay next-to-nothing for a lease. But the places where you can find a next-to-nothing lease aren’t generally the places where it would be profitable to operate a Banana Republic. Conversely, given the obscene markups in porn it would be quite possible for a store in the Galleria to be profitable, and indeed there’s one next door. But in general there’s no benefit to locating a porn store in a major mall, you’d just as soon pick some place cheap like Sharpstown or Tidwell and 45.

Now if you own a stripmall, this is not a problem. You lease to whoever’ll pay. Five years ago in the Montrose you had a leather shop on Westheimer at Stanford and then you had a porn store three blocks east at Mason. With rising rents those tenants left and have been replaced with yet another tattoo parlor and a booshy wine bar. In theory, the glut of commercial space in San Diego could follow the same trajectory. Except SD’s glut of commercial space isn’t in stripmalls, it’s in residential blocks. Any commercial use poses a nonzero externality to people who live on top of it. And if the Slate comments section is to be believed, the HOAs for the condo buildings largely control those spaces.

What you get is a curve that looks like this.

As the “market price” for the rental space declines, so too does the opportunity cost. A retail space which could go for a couple grand a month not leased is a couple grand a month out of your pocket; one that only goes for 500 is only 500 lost. Conversely, as demand for the space goes down, the externalities of potential tenants increase. The clothing store doesn’t impose many externalities, but bars do, and there’s only room for so many clothing stores in a given yuppie neighborhood. The intersection of the two curves is the point at which it’s “not worth it” to lease the space. For a condo board this would basically be the point at which a given commercial use causes sufficient distress to the residents to negate the rent it brings in.

How do you move these curves? Well, in this relatively simplistic model, you don’t. Rather, what you do is stop requiring developers to build vertical mixed-use. If I walk downstairs in my “single use” apartment block and round the corner to a “single use” commercial storefront, I have not gone any farther than if my apartment was on top of that storefront. But placing the uses on separate parcels simplifies building codes, insurance, ownership, and leasing.

Removing the financial incentives for ground-floor retail can raise “market rents” (the theoretical rent at which all the spaces could be filled) by causing less retail space to be built in the first place. And as market rents increase the quality of the tenants will naturally also increase so that the externality cost goes down. At some point supply will be reduced to the point that rents exceed externalities at which point all the space is leased.

In a city like Houston you have no financial incentive for mixed-use and in fact the relatively inflexible parking requirements tend to militate against mixed-use, and even then you have Post Midtown which is some very nicely developed VMU. But it is important to note that only a part of the Post Midtown street frontage is actually VMU; much if it is quite residential. And Post Midtown, in turn, is only a small portion of the total neighborhood housing stock. Camden has developed more units and is institutionally skeptical of vertical mixed-use. That can still yield some nice buildings, but it’s not the sort of “activated streetscape” that’s hot in urban planning right now.

So this is, at root, a failure of regulation. Except rather than planning and zoning regs that favor low-density suburban districts, it’s a reg that in theory favors walkable urban districts. And who knows, perhaps foot traffic in that part of San Diego will eventually rise to the point where those spaces become leasable to the type of tenants the residents want. However, in order for that to happen, more people will need to move to the neighborhood, and newer buildings will need to not include retail space. As long as more condos = more retail, the balance will never change, and that neighborhood will have a permanent glut of retail. Cities with this problem have no choice but to stop incentivizing it. Which is to say, they need to do it the way Houston does.

13 thoughts on “A simple model for vertical mixed-use vacancy.”

  1. The size of the development might also hurt a bit, assuming that the rental income is amortized across all residents but each bears the full cost of externalities.

  2. Yep. Even in very dense neighborhoods you can see that many buildings do not support ground level retail. Now you could look at that street scene, and note that many former ground level retail shops have been converted to apartments. Which is probably because the apartments above currently have 1-2 people living in them, instead of 10-20 like they did back in the good old tenement days. And even the amount of ground level retail supported in the North End today is only possible because there are so many tourists. That’s great for the North End, but it obviously can’t be repeated in every neighborhood in the city.

    Bottom line, you need very high density to support ground level retail all over the hood. Even places like Seoul aren’t mixed use if you drift off into the side streets.

    The thing I do find a little strange is that in a place like the North End, ground level retail will rent for about 5-10x what a ground level apartment rents for. You’d think at least some landlords would take a chance on it. Still, there’s no way it would work off the main streets.

  3. In Minneapolis, my experience is that the vacant retail space in new multi use buildings are the result of two primary factors: poorly designed for commercial use and priced too high relative for the users who it does attract.

    A lot of the mixed use buildings are housing over retail and as a result, are developed by housing developers who don’t know retail. They design it wrong and so many retail uses won’t locate there. So their market shrinks to the start up or less sophisticated retail operation. In Minneapolis, this is not usually undesirable businesses, as you suggest.

    Also complicating it is that the rent is usually too high for less than desirable space. In neighborhoods where retailers often have off street parking, they won’t pay rent for poorly designed space without customer parking, as is typically the case in the new buildings. So they sit empty.

    In 2003 Village Green built an apt building in Uptown Minneapolis and the city and community wanted retail. It sat vacant until 2011 pros because it was poorly laid out. They still have vacant space on the retail, yet the building sold a couple of years ago as a top housing transaction. The apartment rents more than made up for it. But had they built only apartments on this corner, it would have been a missed opportunity and not as good for the district. Downside is the city got crappy space but long term, this will likely become relatively more affordable retail space….an important amenity in a district that has seen increasingly more national brand stores and high rents.

  4. related.

    the thing that is confusing me as I walk around downtown San Diego(away from the conference), is how few people (appears to me) there are walking around the streets relative to the apparent residential density.

  5. Dennis is right about size. If I own a two-story “main street” commercial building and live on the second floor, I might accept a significant amount of nuisance from the storefront below in order to gain their rent money. If I own one of a hundred units in a condo building, even if the space rents for 2000/mo that’s only twenty bucks out of my pocket not to put up with it.

    1. But the commercial unit in that 100-unit building is most-likely not owned by anyone else in that building. It was likely created by the developer as its own condo tract and either retained by the developer or one of its investors or sold to a business or another investor. So in that case, the only financial benefit those 100 residential units receives from the commercial tenant is reduced Association Dues.

      But if it were a two story building that you reference, there is a low probability today that the business owner would live above the unit. I’ve been in the business association/district world for ten years and have yet to meet someone who lives in the building they work in. While I love the concept, it would take a monumental shift in our economy, our land use/transportation patterns, etc. to create the conditions necessary to encourage such an arrangement.

  6. Several of the comments in the Slate article suggested that in the San Diego buildings in question, the HOAs retain ownership of the commercial space and make leasing decisions. And I’m not sure where you got the live-work reference from – I was referring to the example of an owner-occupant who lives in the (2nd floor) residential space but leases the (1st floor) commercial space to a second party.

  7. Meanwhile, down the street in College Station, some councilman had the brilliant idea of browbeating a developer into constructing a student apartment complex into a mixed-use development here: http://goo.gl/maps/Eipnl (The Lofts at Wolf Pen Creek). Even since it’s been completed, the only tenant that has stuck around in the commercial space is a pay-by-weight frozen yogurt establishment (Red Mango). A Honeybaked Ham Cafe has come and gone (now filled with some sort of low-rent boutique). The storefront of an Italian restaurant/marketplace that was way too big for its space has been closed for a couple years with the sign still there. The problems with the location are numerous. Among them, the development isn’t near existing traffic, being stuck in the corner of a largely residential area with the only incidental traffic being people heading to the back entrance of the nearby mall. Also, there is virtually no non-resident parking in the area, so any business would have to come from people in the area who would walk there (almost entirely students).

  8. I was about to comment on that. The Lofts have a number of problems. First off, I don’t know what Sabi Boutique is like, but I think it’s a bit more than “low rent” since it’s been an online operation for some time.

    The rent was generally way too high even for the market, as well, and the other major problem was that the city thought they could construct a type of “riverwalk” with restaurants and shops along Wolf Pen Creek, which never ended up happening. The recession didn’t help, but it was compounded by the fact that Holleman never had the traffic needed to make it become a success. It merely provides back access to the mall and dead-ends at the highway. The other massive problem is that the neighborhood isn’t very dense. There’s a smattering of apartments beyond it, but nothing to drive foot traffic there besides a somewhat popular park, which still wouldn’t give it the popularity it needs.

  9. I agree that incentives for vertically mixed uses results in a lot of vacant retail in locations where it may never be supported.. That’s not generally desirable.

    However, I can somewhat see the case for a requirement (no incentives) to put ground level retail spaces on certain streets. Cities may tend to apply these requirements much too broadly, but they do serve a purpose.

    I believe that it might be useful for planners to designate certain streets as retail districts. Perhaps one such district is up-and-coming, densifying, and has some retail on the main drag but is not not yet dense enough to support much more. Planners envision this main drag as a retail street.

    Because this main street is the most visible, developers are likely to build on this street first, but do not want to include retail sine there is no demand for it (yet.) A requirement for retail on the street might push developers to either go ahead and build retail on the street anyway even though there’s no demand, figuring that there will eventually be demand, or else build residential-only buildings on side streets, rather than building stuff with no retail on the main drag.

    With the tendency of buildings these days to take up entire blocks which can be 400 feet long or more, 400 feet of no retail would be a pretty huge gap on a street that has the potential to be a retail district.

    The question then becomes how do you make sure that you don’t require retail in too many places? The solution is to use the requirements sparingly.

  10. In reference to orulz’s suggestion: there’s still a problem here in the assumption that the planners know what the city is going to look like in 30, 50, 100 years. For example, take these buildings on former tidal flats in South Boston. They were built as warehouses, then became cheap office space, and are now turning into fancy lofts with ground level retail. I defy you to show me any point in the history of these buildings when someone accurately knew what was going to be happening here 30 years hence. The important thing is that we let developers put up buildings, and then make it easy to change the uses in response to market demand.

    KHH’s reply is spot-on for how suburban development happens today. It often leads to safety concerns if you’re designing something – that uncontrolled access point on the 4-lane arterial should probably be right-in, right-out only, but the developer won’t like that because it will lead to less business. Of course, urbanist types are going to say that they don’t want this kind of development anyway.

    Part of the solution that would make multi-level buildings w/ flexible first floor uses more practical is getting rid of zoning and minimum parking requirements that get in the way. But there’s also a whole private infrastructure of banks, insurers, etc. that also gets in the way. Your city might get rid of minimum parking and see developer propose a building with no parking, only to see the bank making the construction loan require the parking. That’s an area that CDCs, local banks and credit unions, and local governments need to look at.

  11. The problem with what orulz suggests is that retail which is constructed as a “checkbox,” to satisfy some planning requirement for an otherwise residential development, is much more likely to be poorly designed.

    Whereas the guys who are developing strip centers or office buildings or big box or what have you are laser-focused on accessibility, visibility, parking, that sort of thing. You propose moving a driveway entrance 100 feet to comply with some traffic engineering standard and they’re on your desk with 27 reasons why you shouldn’t, so you file for a variance or a “design exception” or whatever your jurisdiction calls it (hey, more work for you).

    More specifically I think a lot of planners and some developers don’t “get” that you absolutely, absolutely need parallel or angle parking for streetfronting retail to work. Retail on “transit malls” dies. Retail on “plazas” dies unless there’s parking 100 feet away. UH managed to pull off single-story retail without parallel parking but that’s because it’s underneath a garage in addition to being within a 3-minute walk of the school of business, the hotel, the gym, etc.

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