The Storefront Vacancy Crisis (Part 2 of 2): Vacancy Taxes Don't Pay

For Part 1, click here.

With so many “For Lease” signs these days, it can be sad to walk the streets of major cities.

What can be done? One idea that’s gaining traction among policymakers is a so-called vacancy tax, in which landlords would be assessed a fee on retail space that remains empty for a set period of time. The thinking is that this tax could motivate landlords to lease their storefronts more quickly.

Will this help to reverse the high vacancy? San Francisco voters will give their answer on March 3, when they weigh in on the proposed vacancy tax called Proposition D; Washington, D.C., and Oakland. Calif., have already said yes.

I, however, say no. 

Vacancy taxes are grounded in the notion that landlords are either holding out to lease to higher-paying chains or stand to gain from leaving their spaces unoccupied.

There are – theoretically, at least – limited instances in which a property owner might benefit from keeping storefronts vacant. And, as mentioned above, facing a penalty could conceivably deter a landlord from leaving a retail space unused.

The overall impact likely would be minimal, though. 

That’s because, for most landlords, the logic is counterintuitive: after all, would you reject a higher salary because you would have to pay more in income taxes? 

A vacancy tax would also fail to address the other causes of high vacancy outlined in my previous post, “"Superstar Cities and Their Ghost Towns", which loom far larger. Indeed, with one iconic brand after another declaring bankruptcy, property owners are not getting as much interest from large chains these days. The biggest space eaters of the 2000’s -- banks and large-format drug stores -- have been either slowing expansion or shuttering locations in recent years.

Proponents might argue that even if a vacancy tax does not solve everything, it can still play a key role as part of a larger package of initiatives. However, this ignores the risk that it would also set in motion unintended consequences, which would negate any modest benefit. 

A landlord might, for instance, avoid the tax by filling an empty space with a “nuisance” use even more objectionable than a vacancy, like, say, a down-market liquor store.

Additionally, investors and lenders might become even more hesitant to take chances on higher-risk buildings or projects if they could face vacancy taxes later. This possibility seems particularly relevant along streets filled with one- and two-story structures, where the ground floor accounts for at least a large chunk of the revenue as well as pass-through expenses, which the landlord must absorb when the space is empty. 

A vacancy tax, then, could prove quite damaging to neighborhood commercial districts in struggling areas, where mom-and-pop landlords might be tempted to lease their spaces for nuisance uses or to default on their properties. At the same time, it would not necessarily do much to alter behavior in the downtowns, where big multi-story buildings generate most of their cash flow from upper-floor tenants like office users, apartment dwellers and hotel guests.

This also points to the broader danger of misapplication, as other communities in still weaker markets could emulate the big city approach and attempt a vacancy tax, with potentially disastrous consequences. 

Even in the healthiest of cities, the tax presupposes that the local economy will remain forever robust. But what happens during a recession? Who decides if and when the tax should be lifted, or when “hardship” exemptions should be given?

Ultimately, market forces are more effective than a vacancy tax in dealing with empty storefronts because, for all their flaws, they are independent of the whims, subjectivities, misapprehensions and incapacities of human beings. They might not work as quickly as some might like, but are more likely to work in the end. 

Indeed, even in the absence of a vacancy tax, landlords have been dropping rents and offering more concessions in recent years along Manhattan shopping streets and in other major urban retail areas struggling with high vacancy. Market discipline is doing its job. 

While no one likes empty storefronts, a vacancy tax isn’t the answer. Adopting one will make the situation worse, especially in places that can least afford it. 

Researcher: Mohnish Narlanka