By Al Davis
In cities as diverse as Seattle, Spokane, Portland and even Austin, Texas, retail rents and those for manufacturing and warehouse spaces have increased by double digit percentages over the last year alone. As such costs rise, neighborhoods which have long provided the kind of favorable environments in which entrepreneurs thrive are becoming increasingly inhospitable to them. Independent businesses which serve the everyday needs of their communities are being forced out and replaced by national chains that can negotiate better rents or can afford to subsidize a high-visibility location.
The cost of commercial space is spiking upward, driven both by run-away real estate speculation and the growing popularity of urbanism. As a new generation discovers the appeal of walkable and mixed-use neighborhoods, demand for small commercial spaces in those neighborhoods is far outpacing supply, and rents are rising to match. Locally owned enterprises, which thrive in these areas, are increasingly threatened with displacement from the neighborhoods that they’ve made vibrant, and getting replaced by national chains that can negotiate better rents or afford to subsidize a high-visibility location.
As high rents shutter longtime businesses, they also create an ever-higher barrier to entry for new entrepreneurs, stunting opportunity and leading to a scarcity of start-ups in cities once known for their dynamic business environments. In one Seattle neighborhood, located near the residence of a Revitalization Partners Principal, a number of restaurants and a gym often frequented by his family are closing due to rent increases which are proving to be non-negotiable with landlords.
A Crisis of Identity. When once-thriving blocks become taken over by generic national brands, local business owners lose. So, too, do the cities and the people who live in them. Typical businesses at risk include grocers and hardware stores, neighborhood-friendly enterprises selling everyday goods with little padding on their margins. When these businesses get displaced, residents lose the ability to walk to the store for their shopping, to bump into neighbors, and to chat with the business owners, many of whom who contribute time and money to community needs that go well beyond making sales.
“We’ve been priced out of a ZIP code that we’ve been in for the past 18 years,” commented a local retailer in Austin participating in a survey of independent businesses. “I don’t mean rents slowly creeping up; I mean we would be paying more than double.” The business owner isn’t an outlier. In at least one survey, 59 percent of retailers reported being worried about the increasing cost of rent, and one in four described it as a top challenge.
Behind these rising rents are a complex constellation of causes which span new urbanism and global capital. On the demand side, cities are booming, and there’s an increased demand for the small-scale, walkable storefronts in which independent businesses thrive. National chains, too, are entering the hunt for space in cities, drawn by rising populations and having saturated the suburbs, seeking new markets. On the supply side, as older buildings — which were generally designed to have small-scale, ground-level retail space — are getting razed for new development, those new projects often don’t replace them, instead containing commercial space that’s larger-format and designed for a national chain.
Hitting the “Easy” Button. For the real estate developers behind these projects, securing a single large ground-floor tenant makes a project easier. A name-brand tenant is a faster ticket to financing for a project, especially within a banking system that’s increasingly national and international in scope. “The way that projects are financed, they go to a safe way of doing development and they have large tenant spaces that make the banks happy that are lending to them,” says Ken Takahashi, in the Seattle Office of Economic Development.
This bias toward large spaces in new construction further skews the built environment in favor of bigger companies and compounds the issue of rising rents. “In a lot of places, the spaces are not the right size for smaller businesses that really only need a fraction of what’s available, and they can’t afford to pay rent on a much larger space,” Takahashi says. Another challenge is that real estate developers and the brokers they hire are often themselves national in scale. They lack knowledge of the local businesses in the market, but already have ongoing relationships with many national brands.
Illusory Effects. Similar incentives, driven by how buildings are financed, also lead property owners to favor chains. While there is a perception that national chains pay higher rents, that’s not necessarily true. In some cases, it’s local businesses that have to pay higher rents in order to prove themselves, while national chains are given a discount for their perceived stability and creditworthiness.
“A formula retail tenant may not be paying more per square foot, but it adds some creditworthiness to the balance sheet for the landlord, and it makes your bank happy,” says Rodney Fong, president of Fong Real Estate Company in San Francisco and a member of the San Francisco Planning Commission. Banks and other lenders often provide lower interest rates or better terms if a building owner has signed a national brand. When property owners and investors can get better terms by leasing to a business like a Target, Fong explains, “Target will win every day.”
Structural incentives and geographic biases like these are further distorting the commercial real estate market for locally owned businesses, making it difficult for them to compete on their own merits. At the same time, property values are soaring, for reasons that include financial speculation and real estate’s becoming an increasingly popular place for global investors to park their capital.
Combined, these factors are creating rent increases that local businesses simply can’t absorb. Many of them face the expense and challenge of relocating their business or closing altogether. In one survey of businesses operating along Magazine Street in New Orleans, 76 percent of local business owners feared that soaring rents would force them off the street. Similarly, a March 2016 report from the city of Boston that addressed gaps in its small business ecosystem stated, “Some gaps, such as a lack of available, affordable real estate, are pervasive and affect most small businesses in the city.”
Sadly, that gap is wider today, forcing owners to look at alternative solutions to survive.
Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether the requirement is Interim Management, a Business Assessment, Revitalization and Reengineering, a State Receivership or Bankruptcy Support, the firm is known for finding the best resolution in the fastest time with the highest possible return.
