The Unintended Consequences of Commercial Rent Control
Adelaide Polsinelli July 15, 2015, 11:05 a.m.
The idea of commercial and retail rent regulation has been bouncing around City Hall for 30 years. Once again this is being propped up and tweaked as if it’s a new concept to save “mom and pop” retail stores. Despite its good intentions to protect small businesses, the legislation hasn’t passed in all these years.
Why? Because it’s a bad idea.
But now that it has resurfaced—besides being challenged as discriminating and unconstitutional—the new bill will have several unintended consequences, harming new business expansion, consumers, building owners and the city at large.
The legislation pending in the City Council’s Committee on Small Business would restrict commercial rent increases by sending rent disputes to arbitration. So even if an existing tenant is struggling with its business model, the tenant can effectively break its lease and insist upon arbitration.
But even under these conditions the tenant can still reject the new rent levels set by the arbitrator, and the building owner cannot summarily evict the tenant. Instead, before signing a new tenant, the landlord would be forced to offer the existing tenant the same new agreement, as a right of first refusal.
Both the New York City Bar Association and Real Estate Board of New York have determined that the City Council doesn’t have the authority to impose commercial rent control, and if the legislation is approved it would be subject to legal challenges.
On a larger scale, our city’s economy depends on productivity and growth.
Rather than being forced to innovate its business model, or, if necessary, fold its business, the tenant would be empowered to bypass the standard Darwinian principals of adaptation to market conditions and impose undue control over the landlord, even though the tenant has in actuality violated the original lease agreement.
In addition, if a successful retailer with a thriving business model is restricted from expanding or effectively relocating because other spaces are being artificially controlled, their natural growth will be stifled.
As a result, new and creative business expansion would be discouraged, threatening the vitality and economy of New York City and the future of its worldwide stature of being the retail capital of the world. Instead of patronizing cutting-edge and vibrant stores and restaurants, consumers would be stuck with dinosaurs like the local DVD store or typewriter repair shop.
The landlord, who in many cases is also a smaller, mom-and-pop-type owner, most likely wouldn’t be able to raise the rent for these spaces and attract a startup or growing business that would better serve its building—and the local community.
To be clear, no one is attacking “mom and pop” retailers—rather, all this column is doing is making a call for an efficient, free-market system that rewards profitable, well-run businesses.
Plus, there’s another dubious side to the proposed legislation where the potential for profit would exist for the tenant, but not for the building’s owner. If a video store isn’t profitable, and the tenant can’t make rent payments, the tenant could sublet its space, profiting from the shadow market at the landlord’s expense.
Meanwhile, these same tenants could enjoy a windfall because they would be able sell their businesses for a much higher value—since they enjoy artificially low rents—providing buyers with substantial growth potential.
Additionally, if building owners aren’t permitted to attract the highest rent and best use for their properties, their ability to pay real estate taxes—which make up nearly 40 percent of the city’s entire tax base—will be impeded as will their ability to maintain, renovate and reinvest in their buildings.
Another point to consider: If, for example, a major retail chain (which is not a tenant that proponents of this bill would like to see protected) is in possession of a space that it has outgrown or no longer works financially, it will have no incentive to relocate or close if it is protected at the lower rent.
Consequently, even a well-run “mom and pop” retailer under the same conditions would likely become stymied, if not crippled, as it would be unable to draw from a pool of corporate funds designed to assist the larger business model.
In the end, (fairness issues aside) using commercial rent regulations as a tool to protect unprofitable businesses would harm those it was intended to protect. Once again, and as many before have concluded, this is still a bad idea.
Adelaide Polisinelli is a principal and senior managing director at Eastern Consolidated.