Economy Blog #5: Are landlords greedy?
Original post made by stephen levy on May 5, 2009
What follows is my economist perspective on the question of property owners, tenants and rents. Although I will use Palo Alto examples, this post is not personal to Palo Alto residents or property owners.
These are difficult economic times and I guess it is human nature to search for blame when we don't like what is happening. Is it possible, even more reasonable often, to talk about outcomes that we don't like without assessing blame?
For example, a rent decision that you don't like could be the result of rational behavior by the property owner, lack of full information on his or her part, or wishful thinking. I guess it is possible to characterize wishful thinking that didn't work out as "greed" but what then would you say about homeowners in Palo Alto who keep their homes listed at yesterday's prices. Are they greedy?
There are two parts to every transaction and if you think of the downtown Palo Alto rental market in 2000 (we have rented downtown for 40 years), it is easy to see that it was renters and not property owners who caused the big spike in rents that CCSCE got presented along with other downtown renters. In 1999 and 2000 there was a surge in venture capital start ups that wanted to locate in downtown Palo Alto. Rents would not have gone up if they had not pushed rents up by aggressively bidding for what they considered a prime location.
I find it hard to understand why people blame property owners when a bunch of folks playing with venture capital money bid rents up nearly 100 percent in some cases. Yet no one on Town Square mentions the companies. What were property owners supposed to do? Say, "No I absolutely won't go over $3 a square foot no matter what you offer me and, oh, by the way, I don't like that you are a high-tech start up playing with free money, I would rather rent to another cafe"?
Rents are primarily a function of demand. And when demand fell as companies went bankrupt or the funders told the start ups, "You bozos have to stop paying $8 a square foot on my dime to be close to neat cafes -- we are trying to run a company here," then rents fell.
So our rent went roughly from $3 to $5 and back to $3.
And after 2000 another wave of high-tech firms bought or rented space downtown. For them and for me downtown is an exciting and convenient area to do business. Our continuing interest pushed rents up above what you would find on other downtown areas. I am sure property owners were delighted when downtown became the place to be but property owners can't force companies to pay any rent. It is always a two-way negotiation.
Now we are seeing the downside of markets and rents.
The deep recession is turning the balance of power toward tenants as vacancies continue to increase in Palo Alto, throughout California and across the nation. Prices are falling throughout the economy as the recession forces sellers to sweeten the terms to reach buyers.
Rents are prices and while there may be exceptions I expect rents to continue to fall throughout the economy. That won't change the fact that downtown Palo Alto is a relatively attractive location for many activities or the fact that the relatively high rents in places like downtown Palo Alto make it difficult for some types of businesses to locate there.
Many of the comments about greedy landlords came up recently in a Town Square thread called Down Times.
One of the bad parts of asserting blame is that it pushes all of us away from the realization that we are, indeed, in "down times" caused by forces and misjudgments that are much broader than Palo Alto people and events. We are struggling with the human tragedy of economic down times and I, too, miss stores that our family loved.
But I think "down times" is the better explanation compared to greedy landlords. After all Palo Alto had no outlets for Mervyns, Circuit City, Gottschalks and the hundreds of other stores and chains that have disappeared as a result of their being not enough customers to support previous levels of economic activity.
Here is a list of layoff notices in California since November 2008. Look at the breadth of the pain across industries and cities.
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Why is it that when we don't like the outcome, our instinct often is to look for blame rather than understanding? Can't bad outcomes just be, "That's the way it goes sometimes"?
So let's end with Palo Alto homeowners.
What are ethical homeowners supposed to do when they want to sell their houses? Is it wrong to think that homeowners who want to sell need the money for their family and future? Should they take $300,000 off the price because Palo Alto housing is so expensive? Should they ask potential buyers whether they own a "deserving small community-owned business" or work for a hedge fund and make their sales decisions this way?
If a homeowner engages in wishful thinking and keeps his or her home on the market for months because it is priced $500,000 above the market, are they greedy or foolish or maybe making a rational decision that the market can recover?
Why blame one set of property owners but not another?
on May 6, 2009 at 11:22 am
Paul Losch is a registered user.
This is such a touchy subject. I think a distinction needs to be drawn between ground level retail businesses and places such as Facebook or the like which do not depend on foot traffic for their sales.
I am not sure how landlords in town view the differences between the two, but as my beagle and I roam University Avenue on our regular walks, it is pretty clear that something is not right with downtown retail in Palo Alto. I just saw this morning that Gleim Jewelers is vacating its location shortly! They have been there for dozens of years. There are storefronts that have sat empty literally for years in downtown, and several businesses that have opened up there have last just a few years before closing down (Windy's, Neibaum-Coppola to name but two.)
Retail operations of various shapes and stripes do not enjoy the sorts of profit margins than do businesses that do not depend on their location for their success. By contrast, Danger Inc. was downtown for a while, and now they are in a building on Park Blvd near Fry's. No reason for them to remain downtown, as also is the case with Facebook, which I understand is re-locating.
When rents are too high, a retailer has a difficult time achieving success. It typically is one of the biggest expenses such companies have. With so much vacant space downtown, it suggests to me that the current asking rates are out of line with the market. It also becomes a downward spiral, as fewer people will patronize downtown as the retail offerings diminish.
on May 6, 2009 at 11:44 am
Perspective is a registered user.
Every financial transaction is, essentially, a bet, driven by an assessment by each party of the transaction concerning the risks, costs and benefits of the transaction.
Rationality, informed or not, and emotion enter into the bet.
A renter bets that s/he will make enough money to have the life s/he wants in the rented home/business, and decides the benefits of living/working in the place are worth the costs and commitment. A landlord makes the bet that the rent being paid by the renter is going to be paid, and is going to make the landlord enough money to have the life s/he wants, and is worth the risk of having to pay the mortgages, taxes and upkeep.
Emotion and knowledge enter into determining the outcome.
To "blame" anyone for deciding NOT to rent a business or a home is, as you implied, silly. There are many reasons businesses are choosing not to rent in Palo Alto, and they are quite valid, ranging from oppressive policies and ever rising taxes, high rents relative to return in sales etc.
Landlords not lowering the rent have choices in front of them. FEW businesses are willing to take a rental for just a year. Most want at least 10 year leases. Landlords are making a bet that if they wait a year or two, they will be able to rent their property at the higher rent...and lock it in for the next 10 years. If they rent at a lower rate now for 10 years or more, they are stuck. It is a bet.
It is true that when rents are "too high", retailers have a hard time achieving success..however, business rents on El Camino in Mountain View have been comparable to Palo Alto El Camino rents..yet they are rented and ours are not. Therefore, it is not simply rent that is the problem.
on May 6, 2009 at 1:40 pm
stephen levy is a registered user.
I agree with Paul and Perspective that residents have strong feelings about the climate for business in Palo Alto. It is a separate but important issue from the discussion of property owner behavior and rent determination.
I can provide some data that do not provide an answer to the what should Palo Alto do questions but are interesting about downtown retail.
In the April 20th issue the Weekly on page 20 provided a table of retail sales in downtown. I have the statewide data and thought it would be informative to compare the growth rates.
In the 4th quarter of 2008 retail spending in downtown was down 16.4% from a year earlier while the statewide drop was 16.3%.
In every one of the previous 7 quarters the percent change in retail spending in downtown was greater than the statewide average--either more growth or smaller declines. I admit I was surprised.
Between Q1 of 2006 and Q4 of 2008 downtown retail sales were up 1.5% while statewide retail sales fell by 5.6%. I was even more surprised by these numbers. I don't know why the data are what they are or exactly what it means beyond the obvious point that downtown retail activity has not fallen off the planet compared to the rest of the state.