Storefronts often remain empty for months or years at a time, even in some of the world’s highest-rent retail districts. Between 2015 and 2019, for example, empty storefronts in Manhattan remained vacant for 16 months and less than half of vacant units were filled after one year. Moreover, because neighborhoods with a variety of restaurants, cafés, shops, and other services are desirable places to live and work, the lack of retail activity has the potential to negatively affect the broader community and the value of housing in those communities. As a result, policymakers in New York State (and several other states and municipalities around the US) have, at times, proposed levying a vacancy tax on empty storefronts as a way to encourage more retail activity.

In our new working paper, “Option Value and Storefront Vacancy in New York City,” Daniel Stackman and I analyze why storefronts remain vacant for long periods of time and assess the consequences of a possible vacancy tax. We conclude that in the long run, a primary driver of retail vacancy in dense urban areas is the fact that landlords are willing to forgo rents today in order to preserve the option to lease their space to someone else (who might pay higher rents) tomorrow. We also find that while a vacancy tax similar to the one proposed in New York State would decrease the vacancy rate and rents, it would also lower tenant quality and lead to faster churn in the city’s storefronts.

Our analysis is based on data from the firm Live XYZ, whose team of “mappers” collect information on storefront occupancy and vacancy by physically walking around the city, and by scraping stores’ websites and social media pages. Storefronts were observed every few months between late 2015 and February 2020. This high-frequency data allows us to separately observe flows into and out of vacancy. We combine the Live XYZ data with a sample of lease contracts from CompStak, a platform that crowdsources real estate transaction data from brokers. These data show that there is a great deal of variation in rents even after accounting for specific locations and when leases were signed.

We explore the relative importance of two sources of “option value” (that is, the value of delaying the decision to lease out a property) in commercial real estate. One source is uncertainty over future demand: landlords might choose to leave their storefront vacant today if they expect market rents to increase tomorrow. Another source of option value for landlords is variation in the “match quality” they have with different potential tenants – that is, two different tenants may generate different profits in the same retail space, and the landlord wants to choose the one which will generate higher profits (and thus is willing to pay higher rents). This dispersion in match quality, plus the fact that tenants don’t all show up at the same time, incentivizes landlords to wait for tenants with an especially high willingness to pay for their particular storefront.

Our paper finds that, in the long run, vacancy rates are primarily driven by the latter form of option value. Landlords are willing to wait for a higher rent offer because signing a lease involves tying their hands for a long period of time. Indeed, because tenants need time to recoup the costs associated with renovating their space before moving in, retail leases are long relative to other sectors: 58 percent of the leases in our data have ten-year terms, while the average office lease is five to seven years in length and the average residential lease is one year.

The paper also evaluates New York City’s proposed vacancy tax. The stated goal of the tax is to reduce the long-run vacancy rate, thereby decreasing the total magnitude of externalities the vacancies create for residents and pedestrians. We show that a vacancy tax would decrease the vacancy rate and rents but would lower tenant quality and lead to faster churn. We also find that any vacancy externalities would need to be roughly $18.72 per square foot per quarter (about one-third of average rents) to justify the proposed tax.

These findings have important broader implications. Indeed, growth in urban retail amenities helped drive the resurgence of American cities in the last 30 years, a change that increased home prices and contributed to residential sorting. Although interdisciplinary literature finds that neighborhoods with a variety of retail amenities tend to be safer, healthier, and wealthier, this literature is nearly silent on how these retail amenities come to exist and thrive. In reality, physical retail amenities rely heavily on the built environment, which is mostly owned and managed by commercial landlords. Understanding the behavior of these landlords is key to drawing out the link between local amenities and home values, and developing effective urban policies.