UAP 5234 Urban Economy and Public Policy Assignment #2 Market Failure: Lack of Small Local Retailers in Recent

t Major Developments in DC

In Washington, DC, recently completed projects with large retail components are overwhelmingly leased to major national chain retailers. This trend indicates that the market has failed to provide a proportional and equitable amount of new retail space suitable for small, local retailers. These local merchants often help define and maintain a neighborhoods character, stimulate the local economy through community reinvestment, and provide opportunities for local entrepreneurs. In DC, public policy measures should be taken to help ensure that these retailers are equitably provided for in the coming developments, which are posed to redefine many of the citys neighborhoods. The District is fortunate to have the economic vibrancy required to attract major national retailers to its inner city neighborhoods, and these national chains continue to play a catalytic roll in neighborhood redevelopment (see Table 1). However, the city must take measures support the local businesses that helped build the foundation for the thriving retail market that exists today. Major new developments will continue to be built across the city, reshaping and redefining the neighborhoods in which they locate. The Washington DC Economic Partnership currently lists 127 proposed new construction projects in the District representing more than seven million square-feet of new retail space (see Table 3). The city should create a voluntary incentive package to persuade developers to provide space reserved for small, local retailers as a policy measure aimed at correcting this market failure. The DC Office of Planning (OP) has included expand opportunities for small

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and local retailers as one of the explicit goals in their 2008 DC Retail Action Strategy, a goal that must be reflected in the citys future economic development policy. A survey of recent major developments demonstrates the leasing tendency towards major chain retailers. See Table 2 for a summary of twenty of the largest retail developments in DC since 2001. The current tenant mix of these twenty developments is approximately three quarters retailers which are not locally based. With the notable exception of Rhode Island Place, these major developments are not suburban style shopping centers; instead, they contain pedestrian-oriented street level retail. While this model of retail development is typically well suited for small local retailers, the leasing patterns indicate otherwise. The ratio of local-to-national retailers is further skewed if the mix is evaluated on a project square-foot basis. The current retailing trend is to design projects around major chain anchors that require extraordinary footprints and a very small percentage of the space is left for local businesses. These patterns are not endemic of Washington DC: since 1997, the average size of retail establishments for the top 50 inner cities has increased by 17 percent (Miara, 2007). If these market-based design and development trends persist, local businesses will continue to lose their market foothold and DC will face the negative repercussions associated with the loss. Currently, DC has 8.7 square-feet of retail per capita, far below the Washington metro area average of 25.1 square-feet, and the national average of 20.0 square-feet (Paul, 2009). This represents a real need for both chain and local retailers in the District of Columbia. New development in DC should be designed to help fill this retail gap.

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Major chains have played a critical roll in DCs recent retail developments (see Table 2). The Urban Land Institutes publication, Ten Principles for Rebuilding Neighborhood Retail (Beyard, Pawlukiewicz, Bond, 2003), notes the importance of these major retailers stating that major chains lend legitimacy to the location in the eyes of other retailers, and they have advertising clout that helps one-of-a-kind stores. In addition to this function, major chain retailers such as Target and Best Buy can help to curb the estimated one billion dollars of annual retail leakage that is lost from the District of Columbia each year (Social Compact, 2008). These major retailers offer an efficient option for consumers looking for cost effective, predictable goods of moderate quality. Further, the big box retailers lower consumer transaction costs by offering a single source for a wide variety of goods. In this capacity, major retailers, who benefit from large economies of scale, provide efficient and economical offerings to consumers of varying socioeconomic levels. It should be noted, however, these low costs are also sometimes achieved by paying low wages and by offering limited benefits to their employees (Houston, Oden, Spelman, 2004). Despite the market benefits of these major retailers, the aggregate effect of the growth of national chain retailers and loss of local unique businesses can have negative externalities that are detrimental to DCs competitive advantage. If the majority of the Districts future major retail and restaurant offerings are dominated by the ubiquitous chain establishments typical of the surrounding area, there will be very little incentive for suburban residents to come into the city for shopping or dining out. Like most major cities, the District of Columbias retail strength in the region comes from providing a variety of unique offerings. Encouraging new developments that strive to promote a

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diverse mix of local, unique businesses in concert with major chains will grow the retail gravity of the District. Another negative externality associated with the increasing prevalence of chain retail in DCs new developments is a reduction in the Local Premium. The Local Premium comes from Civic Economics well publicized report, The Andersonville Study of Retail Economics, October 2004, which demonstrated that locally owned companies contribute more to the local economy than their national retail counterparts. This study found that for every $100 dollars in revenue, local businesses generated $68 of local economic activity, while chains only generated $43. Additionally, this study found that local retailers commit more of their revenue towards their payroll, and contribute more to local charities and fundraisers. This pattern of community reinvestment creates an efficient positively reinforced cycle in the local economy, helping it grow and demonstrating the fiscal benefits that local businesses have to offer. Simply put, local businesses give more back to the economy of the city. This cycle results in increased tax revenue for the District, which provides residents with better public services, and a more robust economy. The benefits to the local economy, in turn, give residents more employment and business opportunities. In this light, helping to sustain the market share of local businesses is in the public interest. The lack of suitable retail space in new developments at rents which are sustainable to local businesses is an equity issue as well. Small immigrant entrepreneurs play an increasingly important roll in urban economic growth (Dickler, 2007). By developing projects that do not provide new retail space which fits the needs of small

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businesses, these entrepreneurs face more challenges in starting their business. This additional challenge may limit their ability to succeed in business and live out the American Dream. Provisions that develop retail spaces aimed at these small start-up businesses will help to level the playing field for new entrepreneurs, U.S -born and immigrant alike, and give them a more equitable chance to succeed. As of 2007, Washington DC ranked 37th in terms of number of entrepreneurs per capita (Fortune, 2007). Creating development incentives that ensure space suitable for local retailers can increase the opportunity for entrepreneurs and help DC move up in the rankings. Some of the spillover effects associated with the revitalization and neighborhood legitimacy that national retailers bring are increased property taxes, and higher, marketbased rents. These externalities pose a threat to the stability of existing local, small businesses. As property values rise with the perceived improvement of the neighborhood, businesses will also see their property taxes rise incrementally. Wellfinanced national retailers are better positioned to afford these sometimes drastic tax increases. For a small business, this increased burden may be enough to push them into deficit operation. The presence of major chains in a retail trade area will lead to increased market rents (Pratt Center, 2009). If existing small retailers do not have lease provisions to combat these market adjustments, they may be priced out of the neighborhood and unable to renew their existing lease. Once rents have been raised to the national retailer level it is unlikely that the space will be afforded by few businesses other than a major chain. Major cities around the country have recognized what is at stake when the stability of their local businesses are threatened by this market failure and have taken a

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variety of measures to combat it. Much of the public policy currently in place or proposed nationally are defensive in nature. They aim to restrict the market from allowing major chains to locate in neighborhoods, instead of focusing on creating spaces dedicated to small businesses and improving small business skills. Examples of these defensive strategies include San Franciscos Formula Business restrictions, big box taxes, and store size caps. The basic premise for San Franciscos policy is that formula retailers must be reviewed by the Planning Commission and receive a special permit for their business (New Rules, 2009). The restrictions have caused many chain retailers to shy away from trying to locate in some of San Franciscos neighborhoods. This does achieve the citys goals, but it is leaving many inefficient empty storefronts with landlords bearing the brunt of the burden (Duxbury, 2009). Los Angeles and Chicago have looked into the use of an additional tax specifically for big box stores. These policies would shift the tax burdens as a way to address concerns about the negative impact on the local economy (New Rules, 2003; Baiman, Weiske, 2004). Another common technique is the creation of caps which restrict maximum store size. These are currently utilized in more than thirty American cities (Weiner, 2008). Clearly, the increasing presence of national chain retailers is a point of concern for major cities across the country. Washington, DCs current public policy for the stimulation and support of small businesses focuses around three basic tenants: technical support through the DC Department of Small and Local Business Development, targeted infrastructure and storefront improvements through reSTORE DCs DC Mainstreet Program, and Enterprise

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Zone (EZ) incentives. The EZ incentives include tax-exempt bond financing, capital gains tax exemption, and DC employment tax credits (District of Columbia, 2009). This package is aimed at supporting the retailer by reducing their tax burden, connecting them with government resources, increasing their business skills, and beautifying retail corridors. Additionally, the District has successfully used Tax Increment Financing (TIF) funds to help stimulate economic development in the city. This money has often been allocated towards projects that have major retail anchors and are seen as neighborhood revitalizers. DC USA and Gallery Place are prime examples of this. These projects collectively received over 120 million dollars in TIF funds, are anchored by multiple formula businesses, and have minor, if any, small local retail requirements (Washington DC Economic Partnership, 2009a). DC USA is required to provide 3%, or approximately 15,000 square feet, of retail at below market rates for qualified local retailers. City Center DC and the Southwest Waterfront are two examples of major proposed projects with local or unique retail requirements. Both are major projects which involve significant land transfers from the city and include TIF financing components. The creation of a voluntary incentive program would help create local retail leasing requirements in projects of all sizes, even those that are completed by-right on private land. In order to combat the market failure described above, the city should develop a program whereby willing property owners and developers can enter into a voluntary agreement to provide retail space that is dedicated to qualifying small local businesses. The primary tool which should be used is land-use regulation modifications. These

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modifications will allow for a project which provides retail space specifically designed for small local retailers to be developed at an enhanced density. Other tools, such as TIF packages and tax abatements, can be used for projects where land-use modifications are not appropriate. By entering into an agreement with the city, developers would be granted height limit relief or an increased Floor Area Ratio (FAR). The limits of these zoning modifications would vary based on location, existing adjacent land uses, and base zoning. This method would mimic techniques being used for mandatory inclusionary zoning (MIZ) for affordable housing. MIZ gives additional density is given to residential projects for providing affordable and workforce housing units. However, unlike MIZ, this voluntary program would work to create dedicated retail space and should be analyzed on a case-by-case basis. Creating retail space designed and reserved exclusively for small local retailers through density incentives is an efficient policy which will not require the temporary loss of any tax revenue for the District through TIF bond repayment or tax abatements. In fact, it will create more residential or office space in the city which can further spur revitalization and increase the citys tax base. To enact these changes, the developer and the city must work together to reach an agreement in the early planning stages of a project. This will allow the design to efficiently incorporate the revised land-use regulations. The increased tax revenue from the density bonus and the Local Premium associated with the local retailers should exceed the additional costs of administration borne by the District.

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In order to structure this voluntary program, the Office of Planning (OP) should create an overlay zoning map that gives easy-to-understand, basic parameters for the extent of the permissible land-use modifications. Focusing maximum additional density increases along predetermined growth corridors, in developing areas such as NoMa and the Southwest Waterfront, and in underserved neighborhoods, will allow OP to create a voluntary incentives system that will result in the creation of dedicated local retailers in the areas which need it most. These guidelines would give developers a framework to work within, allowing the projects to be developed as if it were a standard by-right development and not open to additional requirements or reviews. Basic guidelines regarding required leasing terms should also be provided. Long leases with flexible renewal terms should be encouraged in the program to help stimulate neighborhood stabilization and to give local retailers the latitude to grow as needed. The increases in FAR or height should be tied to the percentage of the buildingfootprint dedicated to small local retailers. In setting the standards this way, small projects are equally encouraged to participate in the program. Additionally, the bonus FAR calculations should be use-specific. The economics of a density increase vary from office to hotel to residential; this should be accounted for when determining the proper density bonus rate. The guidelines should be crafted with significant input for area developers and groups such as the DCBIA. Crafting the guidelines in a vacuum will be detrimental to the success, understanding, and voluntary acceptance of the program. A collaborative public-private effort in crafting the policy will help to ensure that both sectors concerns are addressed.

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Strict timeframes should be applied to this review and approval process to increase the dependability of the process. This will help limit uncertainty about the risk of financial loss or prolonged delay due to untimely rulings by the city. Providing a system that is fair, predictable, and expeditious is vital to enticing private developers to voluntarily enter into agreements with the city. As a complement to this program, the DC Department of Small and Local Businesses Development (DSLBD) should create a streamlined certification process for retailers that wish to be considered as potential tenants for the dedicated retail space. To organize these qualified tenants, DSLBD should maintain a database that is accessible to the public. The DSLBD should prequalify retailers and provide certification as a standard component of the business licensing process. The database should be an active tool for developers and retailers looking to match spaces with services. Qualification for certified small local retailer status should be based upon number of existing stores and primary business location. Creating a development environment where it is profitable for developers to provide appropriately sized spaces to local retailers will create more equitable development patterns which, in turn, help to support local entrepreneurs and stimulate the citys economy. Additionally, this influx of local retail options will help maintain and develop the individual character of the neighborhoods and develop the citys competitive advantage as a center for unique specialized retail options. The requirement to lease space to local qualified tenants will necessitate rates that are sustainable to local retailers. This will help local businesses to compete with major chains in terms of prices, while still providing living wages for their employees.

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The use of development incentives that are flexible enough to allow for major retailers to locate in the District, while still providing for small local retailers, will avoid the negative repercussions associated with formula business restrictions and store size caps used elsewhere. This aspect of the voluntary agreement program will help curb retail leakage, and keep sales tax revenue in the city. Increasing the density of projects in focused areas of the city will help bring more residents and employees to parts of the city that are not developed to their maximum potential. The increased population in neighborhoods has positive spillover effects of enhanced vibrancy and safety. One of the major challenges associated with the provision of retail space reserved for local small businesses is the connection of small retailers with the developers. The DSLBD database would be key in helping to connect the respective parties, while also serving as the basic tool used by the city to ensure developer compliance. Developers will be required to keep the city apprised of all changes to the retail mix and prove that the terms of the agreement are being met. Sunset Clause provisions should be incorporated into the agreements to help curb developer concerns about extended periods of vacancy in the event of a lack of qualified tenants. This clause would provide temporary relief from the agreed requirements if a developer can prove that they have actively marketed the retail space, with reasonable lease terms, and have been unable to find a qualified tenant for the space. This clause provides an important safety net for property owners. An additional challenge associated with the provision of increased density in exchange for the development of dedicated retail space is the fact that not all areas which would benefit from an influx of local retailers are architecturally appropriate for

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increased density. Historic districts and primarily residential areas are an example of places where increased density may not be suitable. In these areas, the city should consider the utilization of TIF financing and tax abatements as incentives to entice developers and property owners to voluntarily enter into agreements with the city. These methods will not impact the physical massing of the projects but will detract from the citys tax roll. Success for these policy measures can be determined based on the number of developments that enter into the voluntary agreements as well and the vacancy rate of the dedicated components. If successful, this voluntary program will provide more equitable and competitive market for local retailers, create increased local and national retailing options for consumers, stimulate further economic development, minimize the loss of local community character, create an environment of success for local entrepreneurs, reduce the amount of retail leakage from DC, and help keep more money in the local economy. New developments will continue to change the neighborhoods of the District of Columbia. It is vital that the local-to-national retail disparity exhibited in recent developments does not become the sole model of development for new retail in DC. A carefully crafted voluntary program, which offers increased density in exchange for dedicated space for local retailers, is an efficient public policy measure that can help to correct this market failure by steering future developments down a more locally sustainable and equitable path that increases the citys competitive advantage in the region.

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Table 2 (1 of 3)

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Table 2, continued (2 of 3).

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Table 2, continued (3 of 3).

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Table 3

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References

Baiman, R., Weiske, D. (2004). The Estimated Economic Impact of a Chicago Big Box Living Wage Ordinance. UIC Center for Urban Economic Development. Retrieved from: www.uic.edu/cuppa/uicued Beyard, M.D., Pawlukiewicz, M., Bond, A. (2003). Ten Principles for Rebuilding Neighborhood Retail. Washington, DC: ULI the Urban Land Institute Civic Economics. (2005). The Andersonville Study of Retail Economics. Retrieved from: www.andersonvillestudy.com/ Dickler, J. (2007). Immigrant Entrepreneurs Ignite Economy. CNN Money. Retrieved from: http://money.cnn.com/ District of Columbia Deputy Mayor for Planning & Economic Development. (2009). Retail Incentives. Retrieved from: http://dcbiz.dc.gov/ District of Columbia Office of Planning. (2008). 2008 DC Retail Action Strategy. Retrieved from: www.planning.dc.gov Duxbury, S. (2009). Chain-store Rule Rattles San Francisco Retailing. San Francisco Business Times, June 29th, 2009. San Francisco, CA Fortune Magazine. (2007). Everybody Wants In, 2007. CNN Money/Fortune Magazine Retrieved from: http://money.cnn.com/ Houston, D., Oden, M., Spelman, W. (2004). Big Box Retail and Austin: An Independent Review Civic Economics/UT-Austin. Retrieved from: http://www.liveablecity.org Miara, Jim. (2007). Retail in Inner Cities. Urban Land Magazine, January 2007 Retrieved from: http://www.icic.org/

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New Rules Project. (2003). Los Angeles May Require Big Boxes to Pay Higher Wages Retrieved from: www.newrules.org New Rules Project. (2009). Formula Business Restrictions San Francisco, CA. Retrieved from: www.newrules.org Paul, Sandy. (2009). The State of Retail in DC, April 24, 2009. Delta Associates. Retrieved from: www.wdcep.com Pratt Center for Community Development. (2009). Saving Independent Retail: Policy Measures to Keep Neighborhoods Thriving. Retrieved from: www.prattcenter.net Social Compact. (2008). Washington, DC Neighborhood Market DrillDown Retrieved from: http://www.socialcompact.org/ Washington DC Economic Partnership. (2009a). DC Development Report 2008/2009 Edition. Retrieved from: www.wdcep.com Washington DC Economic Partnership. (2009b). Development Activity. Retrieved from: www.wdecp.com/development/search Weiner, Vicki. (2008). Preserving Local Retail: Issues & Strategies, Presentation for the APA Metro Chapter Zoning Committee. Pratt Center for Community Development. Retrieved from www.prattcenter.net

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