Saving Small Businesses and Local Supply Chains

Three City Blocks

I want to tell you a story from my experience developing commercial real estate in the city of Detroit. Starting back in 2014, my partner and I purchased 12 buildings across three continuous blocks in an important and historically significant neighborhood in the city of Detroit called Milwaukee Junction. The area was once home to the Ford Piquette Plant where the first assembly line for the Model T was built. We owned more than 250,000 square feet of beautiful light industrial property that was originally built to serve the automobile industry. We viewed the buildings as much more than four walls and a roof, we viewed them as living organisms that help to organize and support society in important ways.?

Prior to investing in Detroit real estate, my partner and I were both very active in the city for years and had founded several successful initiatives and programs focused on attracting and retaining young talent to the city of Detroit. By the time we bought our first building we were embedded in the community and had built an extensive network of people in the city who were also dedicated to the economic development of Detroit.

We were not aspiring to be, “real estate guys” and focus on buying and renting boxes. It was about creating something with a long-lasting impact on the city of Detroit that would be felt for generations to come. It was a unique opportunity to develop a largely vacant neighborhood from the ground up and create a blueprint for local economies around the country. Rather than trying to convert the buildings into fancy lofts and high-end restaurants, we were focused on what we believed Detroit needed most - small businesses. The vision was to create a, “Craft District,” a neighborhood largely consisting of companies that design and manufacture digital and physical products that both businesses and consumers use on a daily basis. Items like chairs, drinking glasses, soap, office furniture, lamps, and food-related products. From a real estate perspective this meant developing relatively affordable workspace for small businesses. The goal was for these companies to:

? create jobs with career ladders for local Detroiters; and?

? build more localized supply chains for products that are consumed daily.?

This concept made sense in this location for many reasons, but the main one being in the same neighborhood as Shinola’s headquarters and The College for Creative Studies (CCS), an internationally recognized design school. We had strong conviction that this was the type of neighborhood development that both Detroit and other communities across the country and world need in an effort to build stronger, more localized supply chains and economies.

It All Starts with Real Estate

We knew that in order to build a strong cluster of small businesses in Detroit it all started with real estate. If we did not own the buildings, there was no realistic way to develop a concept with enough scale. If you do not have affordable and stable space for these companies to operate out of, it is not possible to build an ecosystem to create jobs and develop more localized supply chains. In 2014 the property was extremely cheap, which created an interesting investment opportunity. The market conditions allowed us to try something different and still have the opportunity to make outsized returns for investors and ourselves. I guess many would call this impact investment, but I just refer to it as investing with a higher purpose than simply making money. It is the way I believe all investing and businesses should operate.??

Our vision was inspired by the Brooklyn Navy Yard (https://brooklynnavyyard.org/), a 300-acre, $1 billion redevelopment project in Brooklyn, NY focused on developing workspace for manufacturing and design businesses. As of the end of 2019, the development consisted of more than 2 million square feet of space and created more than 10,000 jobs. What we learned from studying the Brooklyn Navy Yard was it was largely owned and managed by a non-profit development organization. This ownership structure created long-term stability for the district as they had a mission beyond maximizing profit.??

I also knew, based on how the real estate market works, that it is not possible for the private sector to develop this type of district and space for small businesses at scale. The main reason is the cost to buy and improve the real estate is too expensive based on the rents these types of companies can afford. It would not be profitable. If a for-profit developer even cared enough to develop a concept like this and bought the real estate cheap enough, they would have to eventually raise rents to make the buildings profitable for their investors.?

The Pratt Center for Community Development and Urban Manufacturing Alliance published a very good report and toolkit here that breaks down how the economics work for developing stable, affordable design and manufacturing space for small businesses. I have found the numbers and analysis to be fairly accurate.

What was unique about our approach as for-profit developers was we took on all of the early risk alongside our investors in an effort to put the vision together. This was possible because we were able to buy the real estate at insanely cheap prices. But, we knew that this opportunity was time-based and that over time market forces take over. We would eventually have the pressure of delivering returns to investors, which would force us to bypass the affordability threshold for the small businesses we wanted to attract. In order to create a long-term, sustainable district, public and philanthropic subsidy and support was essential.?

Private Sector Can Not Do It Alone

We spent several million dollars developing affordable workspace at a couple of our properties before seeking any public and philanthropic support. It was important for us to create a track record and demonstrate our ability to execute. It was only after the heavy lifting that we told the story and discussed the opportunity with the public and philanthropic sectors.?

Once we approached the public and philanthropic sectors we were greeted enthusiastically. We were approved for substantial rent subsidies, but the money never came. We were approached to create a public/private ownership structure of the buildings that would allow us to pay back the original investors and create long-term stability for the companies and neighborhoods. But, the final proposal never came.?

We were managing several million dollars of investor money and could no longer trust the stakeholders to keep their word and provide support for the Craft District. I could not continue doing the work I believed in and be successful in this type of market. The opportunity to develop something different around job creation and building more localized supply chains was fading away as the financial pressure on my partner and me mounted. After several years of living, eating, breathing work I truly believed in and taking a tremendous amount of risk, I had to be honest with myself. I did not have a strong interest in owning and renting boxes. This was not why I woke up everyday. Further, I was a fiduciary to other people’s money who took a big risk on us and the vision. At the time the Detroit real estate market was changing rapidly - property values appreciated substantially and we were in a very sought after area of town. This specific portfolio of property increased more than 4x what we paid for it in less than four years. We ended up selling the majority of the portfolio to a couple of our small business tenants and other young developers with a strong connection to the city of Detroit.?

How to Sustain A Small Businesses Ecosystem

The first step to building a local small business ecosystem is having cost affordable and stable space for these companies to operate in. Once the real estate becomes too expensive, the opportunity for the private sector to develop this type of real estate is gone. My Detroit experience combined with studying different markets around the country led me to the stark conclusion - real estate prices and rental rates have bypassed this affordability threshold for small businesses in the vast number of our neighborhoods and communities. I unpack many of the root causes of why this is happening in other essays, but a main driver is the explosion of private equity funds over the past 10 years that are now investing in real estate. These funds, often backed by large institutions like pensions and endowments, are gobbling up smaller properties at an unprecedented rate. These private equity groups are not necessarily bad people and may have the right intentions, but the problem is with the mechanics of how the average private equity fund is structured. It incentivizes the fund manager to have a short term mindset centered on profit maximization. Further, these private equity funds often hire several other firms to handle the day to day operations and management of the buildings. These fund managers may not even know specific buildings they own as they view them as numbers on a spreadsheet. These underlying mechanics of the marketplace combine to create a misaligned incentive structure between real estate owners who have no connection to the neighborhoods where the property is located. With our current system, these investors’ lack of connection to the local communities where they invest is going to continue to hollow out what is left of our small business ecosystems and there are no signs that this is slowing down.?

We only have two realistic options to change course:

Work Within the Current System: we have to experience a major economic downturn that results in distressed property values. This is when there is a window of opportunity to look at real estate differently. But, once this happens we have to be ready and proactive to create the following formula:

• Developers with the right value sets →?developers must have a long-term investment horizon, commitment, and connection to the community where the property is located.?
• Cheap real estate → developers must be able to buy and develop property cheap enough where they can charge reasonable rents and still deliver returns to investors. Another option is to develop publicly owned property as they did with the Brooklyn Navy Yard.
• Public/Philanthropic support → financial subsidy and support is required to both control costs and create ownership structures that prohibit private market forces taking over to a level where the small businesses can no longer afford the rent.?

If you get the first part right (like we did in Detroit), and other items do not come together, market forces will take over, real estate prices become too expensive, and the opportunity to change the current system is gone.?

Create new systems: We will need both policy changes and forward-thinking collaborations between the public and private sectors, similar to the Brooklyn Navy Yard, to develop stable, affordable space for small businesses at scale.?

But, if we sit around and wait for local governments to make these changes it is never going to happen. It is up to us as the people who make up the fabric of our communities to push this movement forward and rebuild more localized economies.

It Goes Beyond Real Estate

Ok, so let’s say we figure out the real estate thing, we still have an uphill battle. We all know Amazon and e-commerce has disrupted the bricks and mortar world and this has been further accelerated because of COVID-19. As technology becomes even more ubiquitous in our on-demand society, there is no doubt we are going to continue to experience a shift towards e-commerce. This will only intensify the pressure and challenges bricks and mortar businesses face. If these small businesses do not understand these trends and adapt by using readily available digital tools to connect with their customers, they do not stand a chance. But, people still want the bricks and mortar experience. In 2020, offline retail still accounts for about 80% of all retail sales in the US market (even after the surge of e-commerce due to COVID-19). This is still a large industry, but it is no doubt under siege.?

While this is a challenge, I believe this explosion of technology and connectivity in our everyday lives is a net positive. As buyers of products and services, we need to get our priorities in order and figure out how to harness this technology to build stronger local economies. Although the importance and economic impact of shopping local is widely-known it is still not commonly-practiced. As consumers we must walk the walk with our pocketbooks and consume from these local and regional businesses if we want them to continue to service our neighborhoods. This is the only way we can create stronger, more resilient economies and communities. And frankly, I believe this will lead to more happiness in our daily lives. But, it is up to us to determine the type of future we want for this country and future generations. We can either choose a one-click, emotionless approach to the products and services we consume where convenience reigns supreme or we can utilize technology to become more connected to the things we buy. We can understand where they come from, who makes them, and how it works.?

It’s About Our Happiness

Coffee shops, bakeries, restaurants, gyms, grocery stores, pubs, home furnishings, hardware stores, and hair salons.?These are some of the places that we often go, sometimes several times a week, to get the staples and items we need or want in our daily lives. These businesses make up the bedrock of our neighborhoods and communities. Their livelihoods are largely based on the local population stopping in to buy their products or services. Unfortunately, in many neighborhoods or communities we do not even have the choice. But, if we do, how are you choosing to live? Are you visiting the locally owned hardware store or the nearest Home Depot? Do you choose to eat at the family-owned restaurants where the taste and smells remind of your grandma’s house or are you grabbing a bite at Applebees or a burrito at Chipotle? Do you have meaningful daily interactions where you shop or are you checking Instagram and your Facebook feed while waiting in line because you do not know anyone in the store??

Local businesses play a key role in creating true community and developing meaningful relationships and overall happiness in our lives. I often think about the introduction to Malcom Gladwell’s best-selling book Outliers where he tells a very interesting story of the people of Roseto, Pennsylvania that dates back to the 1960s.?

The village was made up of citizens who came from the village of Roseto Valfortore in Italy. What was fascinating about the small town was that they had an extremely low incidence of disease, including no coronary artery disease in anyone younger than 55. A team of medical researchers dedicated themselves to studying the Roseto phenomenon and the results were shocking. The people of Roseto did not follow a healthy diet and obesity was prevalent, they did not exercise, and nearly everyone was a smoker. Their relatives living elsewhere had a high incidence of disease, ruling out a genetic explanation. Nearby towns had an incidence of heart disease three times that of Roseto. With no answers offered by the medical research team, they consulted with social scientists who described a unique sharing of experiences that defined the town’s social structure. Gladwell quotes one of the researchers in his book, “I remember going to Roseto for the first time, and you’d see three-generational family meals, all the bakeries, the people walking up and down the street, sitting on their porches talking to each other…” The researchers discovered a feeling of trust and security in Roseto because the people of the town always had someone they knew and who knew them to turn to for support. They concluded that the extraordinary health of this unique population could only be explained in terms of “extended family” and “community.”

Meaningful, daily interactions brings happiness to our lives. These daily interactions are what lead to meaningful relationships with others, people we can trust and support. These relationships are the building blocks of our neighborhoods and communities. Real estate is where the vast majority of these interactions take place and our current system is eliminating the viability for small businesses to operate. I learned from my real estate experience that there is no quick fix. We first have to change the way we look at real estate from assets on a page to the infrastructure of our lives. These buildings support the basic needs of society and should be treated as the essential resources that they are. If we do not collectively work together to build stable small business ecosystems in local real estate markets everywhere, we are heading down a dark and lonely path.?

Be great,

Jordan

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