Tuesday, June 12, 2007

Should the City treat demand for real estate as a scarce resource?

The Lawrence Journal World (“Downtown’s future looking up: Leaders may consider guidelines for vertical redevelopment”, June 12, 2007) reports that the City Commission is thinking about ways to help redevelop the downtown. This is a good and useful exercise. The article also reports that the City is considering ways to permit buildings taller than experienced in the past. Again, this is a useful exercise. What is missing in the article is recognition by the City that buildings, at any height, need tenants who want to fill them.

The demand for real estate is a function of the population, its income, and its spending habits, not the number or height of the buildings available. There is only a fixed amount of demand available to the various real estate markets of Lawrence. Creating more buildings will not create any more demand. It is a zero-sum game. There is some opportunity to import dollars from elsewhere through tourists, but the capacity to do this is very limited and often overstated. The various households and firms who operate here allocate the total demand for real estate across the City. If a market is overbuilt, attracting demand to any one area of town means that the demand is taken away from another area of town.

If the City wants all the built space to be occupied and viable, then it should not permit more space to be built than this finite amount of demand can support.

What has been our experience in the various sectors of the real estate market?

Retail Sector

The supply of retail space is growing at an annual rate of over 3 percent per year with demand for that space growing by less than 1 percent. This excessive pace of growth doomed the retail market to what we have today, a market with widespread vacancy and blight. The overall retail vacancy rate is over 8 percent and over 10 percent for general merchandise space, the type of space sought after for downtown. At its extreme, this empty and under-utilized space is blighting some districts such as North Lawrence where nearly one-half of the retail space is empty. But the problem is not peculiar to North Lawrence. Many other retail centers, in all parts of the City, in buildings of all ages and sizes, are experiencing high vacancy.

Yet, the developers want to build more.

A second Wal-Mart will have little direct impact on downtown. Its competitors will be such vendors as Dillon’s grocery and Ace Hardware. However, the proposed Bauer Farms, Northgate, and Mercato developments are direct competitors with downtown. If built, these three developments will add over 600,000 square feet, equivalent to over one-half of all the retail space downtown. The growth in retail demand is sufficient for the City to absorb only about 50,000 square feet of new retail space per year. Clearly, these three developments constitute many years of growth in retail demand. It is doubtful that any downtown redevelopment proposals can be successful if the City has already approved over a decade’s worth of additional retail space elsewhere.

There are too few vendors to fill all of this space as well as redevelop large parts of downtown. Letting the vendors and the developers decide where this space will be filled is not the best way to achieve the city we want. The citizens, working through their planning process, should decide.

Office Sector

The office sector is in even worse shape. The retail sector is so overbuilt that owners of empty malls have leased space to office tenants rather than let their space go empty. This can be seen in the old Tanger Mall, 10 Marketplace, and the Southern Hills Mall. This has not been a temporary problem. Had it been, the mall owners would have taken the more lucrative retail tenants at the first opportunity, but office uses have occupied this surplus retail space for many years.

Spreading the problems of an overbuilt retail market into the office market has repercussions for the City’s downtown redevelopment plans. Evidence is found in the office space in the Hobbs-Taylor development. The space built for lease has been empty for too long.

Can the City hope to succeed in its redevelopment plans if a high quality project like the Hobbs-Taylor building is unable to lease either its office or its retail space? Usually, the first project in a redevelopment plan captures the latent demand that has been unsatisfied for some time, while buildings built in subsequent phases of redevelopment are slow to be leased. Given the overbuilt markets in Lawrence, even this initial building is struggling to find commercial tenants.

Residential Sector

The stock of homes grew much faster than the growth in population throughout the 1990s. The net growth in the stock of housing (new units minus demolitions) was 27 percent from 1990 to 2000. The growth in population was only 22 percent during the same time period. In round numbers, this means that about 120 more housing units were built per year than were needed. This resulted n unneeded new subdivisions that pulled residents out of older neighborhoods. This fostered deterioration and blight in these older neighborhoods, when the City should be ensuring that these neighborhoods maintain their population and the level of investment in the homes. Of the 40 neighborhoods of Lawrence, 14 experienced a decline in population and/or housing during the 1990s. There is no need for this to happen a growing city. The growth is being squandered. The high level of vacancies and the slow pace of home sales suggest that the problems continue today.

Lessons to Learn

The City should treat demand for real estate as a scarce commodity.

The market does not do a good job of pacing the growth of supply with the growth of demand. Developers and builders generate more supply than is needed. This creates vacancies and blight in otherwise good markets. The City needs to bring discipline to the market, helping to keep the pace of growth in supply in check with the pace of growth in demand.

The City also needs to take the initiative to direct that growth where it can do the most good.

For the retail market, the City should not only help to redevelop the downtown, but it should prevent other developments, such as West 6th Street, from damaging the downtown redevelopment plans. There is not enough demand for two downtowns. Lawrence can support one on Massachusetts Street or one on West 6th Street; there is insufficient demand to support both. The City needs to recognize that Massachusetts Street is the core of its unique destination shopping district, a destination that can be imitated but not duplicated on West 6th Street. That core cannot survive if too much additional space is created elsewhere, diluting the demand. We need only look at the Hobbs-Taylor building downtown for evidence. Its retail space remains empty; the market is saturated, leaving very desirable projects such as the Hobbs-Taylor building hurting.

For the office market, the process is very similar. The growth of office space needs to reflect the growth in employment among firms in the finance, insurance, health care, and other sectors that occupy this type of space. It is in the City’s interest to keep this component of the commercial real estate market healthy. To the extent that any downtown redevelopment plans contain office space, the success of these plans depends upon new demand materializing. It is hard to foresee success in future office space when a new office building such the one in the 1800 block of Wakarusa Drive has stood empty for years.

For the residential market, the City needs to pace the growth of residential space so that it matches the pace of growth of the population. If the net growth in homes is any faster, older neighborhoods are harmed and redevelopment plans for these areas will be foiled. It will add to the City’s debt burden, as it must pay for the new roads, sewers, and other services needed to support this surplus space. A growing city does not need to experience decline in any neighborhood; a smart city manages its growth seeing to it that some amount of growth and investment is attracted to all neighborhoods.

Demand for real estate is a finite scarce resource. The amount available dictates the success of any development or redevelopment plan. Good design and location are important, but they are of little consequence if the supply is far in excess of the demand for that space. If the City wants to succeed in its redevelopment plans for downtown, it must do much more than debate the number of stories in the buildings. It must carefully gauge the available demand for new space, permitting no more space to be built throughout the City than can be supported. The City must also allocate that space to downtown and elsewhere with equal care so that the finished space is able to be occupied and remain financially viable.

No comments: