Modeling persistent storefront vacancies
Have you ever wondered why there are so many empty storefronts in Manhattan, and why they may stay empty for many months or even years? Erica Moszkowski and Daniel Stackman are working on this question:
Why do retail vacancies persist for more than a year in some of the world’s highest-rent retail districts? To explain why retail vacancies last so long (16 months on average), we construct and estimate a dynamic, two-sided model of storefront leasing in New York City. The model incorporates key features of the commercial real estate industry: tenant heterogeneity, long lease lengths, high move-in costs, search frictions, and aggregate uncertainty in downstream retail demand. Consistent with the market norm in New York City, we assume that landlords cannot evict tenants unilaterally before lease expiration. However, tenants can exit leases early at a low cost, and often do: nearly 55% of tenants with ten-year leases exit within five years. We estimate the model parameters using high-frequency data on storefront occupancy covering the near-universe of retail storefronts in Manhattan, combined with micro data on commercial leases. Move-in costs and heterogeneous tenant quality give rise to heterogeneity in match surplus, which generates option value for vacant landlords. Both features are necessary to explain longrun vacancy rates and the length of vacancy spells: in a counterfactual exercise, eliminating either move-in costs or tenant heterogeneity results in vacancy rates of close to zero. We then use the estimated model to quantify the impact of a retail vacancy tax on long-run vacancy rates, average rents, and social welfare. Vacancies would have to generate negative externalities of $29.68 per square foot per quarter (about half of average rents) to justify a 1% vacancy tax on assessed property values.
We identify a little-known contracting feature between retail landlord and their bankers that generates vacancies in the downstream market for retail space. Specifically, widespread covenants in commercial mortgage agreements impose rent floors for any new leases landlords may sign with tenants, short-circuiting the price mechanism in times of low demand for retail space.
I am pleased to see people working on the questions that puzzle me.