The Paradox of Empty Storefronts

http://meganmcardle.theatlantic.com/archives/2009/08/the_paradox_of_empty_storefron.php

by robg • 17 years ago

30 8 17 years ago

meganmcardle.theatlantic.com

ShabbyDoo2• 17 years ago

A Cleveland-area landlord was offering a year's free rent for a somewhat urban restaurant space (Shaker Square for the locals here). I presume a longer-term lease was required at the beginning of the deal. For the tenant, it was like some mix between venture capital and an option. If he fails, he can leave and not have spent as much compared to a normal lease deal. But, if he is successful, the landlord wins with a long-term tenant, and the tenant sticks around because of the signed lease and the switching costs of moving.

I don't know a lot about lease deals, but it seems that some additional complexity would make the market more efficient. The article repeated the question, "What restaurant would sign a one year lease?" I presume the restaurant owner was referring to a contract that offered no guarantees about renewability or the price at renewal time. Why not structure a lease as a combination of rent and an option on a future contract? At the end of a one-year lease, the restaurant could pay $X to get out or sign a similar contract for no more than $X/month. This is just one of many examples.

In general, markets are less efficient because parties stick to contractual terms that are standard for an industry rather than being creative for mutual benefit. Fear, stupidity, and irrational doubt lead to this. When I bought my house, I modified the contract (at an attorney's suggestion) to include a "liquidated damages clause" which limited both the liability of both sides to the amount of earnest money provided. And, I provided a significantly above average amount of earnest money to reduce the seller's risk of taking the home off the market. The seller's real estate agent did not understand the economics of the change and therefore did not help the seller understand the mutual benefits. So, the seller ended up hiring his own attorney to review the contract, and the deal was almost delayed.

netsp2• 17 years ago

I think the your second paragraph answers your first. In economics this tends to be called transaction costs, though I think that is typical economists avoidance of ever dealing with mess.

Standardised contracts allow buyers & sellers to compare, potential deals or other deals in their area.

A restaurant owner may not have trained his mind to value options or futures. He almost certainly can't see through the legalese. Besides the direct cost of having this explained to him by a lawyer (times how many contracts he has reviewed), I don't think it is preferable to hand over decision making power to a lawyer. They tend to undervalue upside.

Short answer: It's simpler.

ShabbyDoo2• 17 years ago

I agree that standardization reduces transaction costs, but the cost to the landlord of having a unit sit vacant for a year seems significantly higher. And, there are probably restaurant owners who are operating sub-optimally -- maybe they aren't remodeling because they are scared of what the terms of the next lease will be like.

budman• 17 years ago

I was actually just driving around Vegas the other day noticing and pointing to a friend just the ridiculous amount of "for lease" signs one sees.

jswinghammer• 17 years ago

There is a lot of empty retail space here in Boston as well. In one case though the owners tried to raise the rent of a local favorite restaurant/night club in my neighborhood and now the space sits empty. There's also an element of stupidity involved sometimes too :)

pbhjpbhj• 17 years ago

This is capitalism though - from the LL's point of view if they up the rent on a 5 year lease by 20% and it sits vacant for a year then they haven't lost anything (or little anyhow) they've just deferred receipt of the money.

I thought starting our own business would free me from working for "the man" - of course now I make the LL rich instead of the boss, the LL has a lot less to do (be rich) to get his money as well.

jibiki• 17 years ago

A hilarious comment:

"Real estate people don't think like you and me.

About 10 years ago I ran a small manufacturing company in the Midwest. We leased an office/warehouse suite in a complex of 7 other units. At the time there was a vast overcapacity in the market (still is) and 4 of the units were empty. Several months before our lease was to expire I contacted the landlord to sign a new lease. Rather than being overjoyed that we were staying, he stated that our rent needed to be increased by 15% to make up for the empty units! With other locations just blocks away heavily recruiting us, I said NFW. However, I was willing to continue at what we were paying due to the hassle factor of moving. No dice, he held firm. We moved.

For the next 4 years I drove past the old location on the way to work. It remained empty."

The Paradox of Empty Storefronts

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