PROTECTING SMALL BUSINESSES:
LESSONS FROM RESIDENTIAL PROTECTIONS
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Locally-owned small businesses are critical. To community members, they provide convenient access to critical goods and services like groceries and healthcare. To the economy, they contribute jobs and revenue, as money spent in local businesses multiplies throughout the community. And to neighborhoods, they serve as local institutions that define an area’s identity.
They are also in crisis. Commercial rents continue to skyrocket in cities across the U.S., fueling the displacement of established local businesses. More specifically, small businesses are suffering the consequences of commercial gentrification, a process that remains under-studied relative to its residential peer. When gentrification occurs in a neighborhood, displacement threatens not only residents, but also small businesses. The rise in land value leads commercial landlords to increase rents and the parallel growth of higher-income consumers attracts outside chain stores to the area. Small independent businesses become particularly vulnerable, and if they are priced out, “displacement usually means liquidation of the business,” because “relocation is either prohibitively expensive or the business is dependent upon its current location for its customers.” As local small businesses disappear, the community pays the price in multiple ways: a loss of diversity, a lengthening of commutes to essential services, a lower local multiplier effect and a fracturing of the neighborhood’s identity.
We must do more to protect independent small businesses in America’s communities. Policies mitigating commercial displacement have started to emerge in the last few decades, though few have been widely adopted. In contrast, city governments have implemented many policies to mitigate residential displacement over the past decades and the effectiveness of such policies is better understood. As such, policymakers and community members should look to successful residential anti-displacement strategies and evaluate which they can apply to small business protection efforts. Upon evaluation, three housing-inspired strategies emerge: stronger tenant protections, community ownership, and inclusionary zoning. Cities have already tested some of these strategies, though all warrant further exploration in the face of the current small business displacement crisis.
Literature on commercial gentrification remains relatively scarce with mixed findings. Researchers agree that commercial gentrification transforms a neighborhood’s identity and character, but diverge in their theses on how the process affects existing residents and businesses. For instance, Lance Freeman posits that an influx of new retail improves residents’ quality of life if the new establishments provide goods or services that were previously unavailable in the area. In contrast, Sharon Zukin argues that an increase in new commercial amenities attracts wealthier residents to the neighborhood and fuels a surge in property values, thereby leading to the displacement of small local businesses and residents. Relatedly, no consensus yet exists on whether commercial gentrification is the chronological predecessor to or the consequence of residential gentrification. Given gentrification as a whole is a complex and non-linear process, commercial gentrification could occur both as an instigator and a result of residential shifts.
On commercial displacement more specifically, research points to a multitude of factors fueling the displacement crisis, related to both supply and demand. On the demand side, researchers note that cities continue to gain popularity amongst larger national chain stores, driving up demand for the storefronts in walkable urban areas. On the supply side, it comes down to limited market availability of small storefronts; older buildings with the small-scale ground-floor retail spaces are being demolished to make way for new developments. Once built, the new developments typically contain ground-floor retail designed for one large chain tenant, rather than multiple small spaces suitable for local businesses. An irony exists in the story of commercial displacement, because it is often the case that for the local businesses who worked to make the neighborhood “vibrant and valuable through their own investment and labor,” the rent increases can be the most dramatic.
Studies also articulate why it is in our collective best interest to protect local small businesses from displacement. As one report details, “established neighborhoods with a mix of older, smaller buildings perform better than districts with larger, newer structures when tested against a range of economic, social, and environmental outcome measures.”
Accordingly, some communities have started implementing policies to protect local small businesses. For instance, San Francisco established the Legacy Business Program, which became the first legislation in the country to “recognize notable small businesses as historic assets and incentivize their preservation.” Through the program, small businesses that are 30 years or older apply to join the local Legacy Business Registry. Once part of the registry, business owners become eligible for grants, as do property owner who extend leases of Legacy Business tenants.
A handful of cities have also deployed size cap ordinances to combat the surge of larger chain stores. Square footage caps prohibit construction of retail stores larger than a certain size – 50,000 square feet on average. Amidst the shortage of suitably sized storefronts for small businesses, which typically require just 2,000 square feet, these size cap ordinances protect existing supply, regulate demand, and protect the character of the neighborhood. That said, neither of these strategies have been widely adopted, nor do they fully address the complexities of small business displacement.
The question remains: how can policymakers and community members best protect locally owned small businesses from displacement? Research on commercial gentrification lacks conclusive findings and policy responses are scarce. As such, it proves valuable to look for guidance elsewhere; more specifically, the robust policies addressing residential displacement provide key lessons. While residential policies might not translate directly to the commercial space, many of their frameworks do.
1 | Tenant Protections
Many cities have implemented policies to protect residential tenants and reduce the power imbalance between tenants and landlords. A similar need exists in the commercial space. Take Back NYC, a coalition aiming to protect the rights of New York City’s small business owners, cites the failure of the commercial lease renewal process as the number one reason that established small businesses close and notes it has been the number one reason for 30 years. This failure involves landlords demanding unfair lease terms, rent gouging, refusing to negotiate a lease renewal, and extorting business owners – particularly immigrants. It is time that policymakers do more to protect small business tenants from corrupt landlord practices and unfair lease demands. While protecting small business tenants is not yet commonplace, protecting residential tenants exists as policy in numerous forms. As such, we can look to the residential tenant protections for inspiration and lessons on how cities can best mitigate unjust displacement of small businesses.
Residential Policies & Practices
One key tenant protection that many cities have begun to institute is the right to counsel. According to Eviction Lab, there was “roughly 1 eviction filing for every 17 renter households between 2000 and 2016, and approximately 1 in 40 renter households were evicted over this period.” In simpler terms, 6,300 people are evicted every day in the United States. And importantly, evictions do not just occur due to a tenant’s inability to pay rent; in many cities, landlords don’t have to give a specific reason to evict a tenant. Legal representation for tenants is paramount to ensure just outcomes, but in most cases, tenants do not have access to counsel, while the landlords do. In Philadelphia, for example, data from 2017 revealed that only 8 percent of renters in eviction filings had access to some form of legal aid, while 81 percent of landlords had legal representation. Right to counsel for all tenants facing eviction would stop some evictions and ensure more favorable terms for those that cannot be stopped, such as keeping the red flag of eviction off tenants’ credit records. Several cities have put in place right to counsel policies, including Philadelphia, Baltimore, and New York City.
Vacancy taxes, also known as “empty house penalties," are another relevant policy that aims to create a fairer residential market, though they are more nascent. And, unlike policies ensuring a right to counsel, which empower tenants directly, vacancy taxes benefit tenants more indirectly. Essentially, vacancy taxes serve as a tool for ensuring that all available housing is used. According to the U.S. Census, 12 percent of all housing units were vacant as of late 2019; that said, little data exists detailing why the units are vacant. Advocates of vacancy taxes believe many are vacant because speculators are “sitting on properties until they can rent them for a higher rate, or sell them at a greater profit when prices inevitably increase.” Vancouver became one of the earliest adopters when they implemented a vacancy tax in 2017, designed such that properties that are empty for more than six months per year are subject to a tax of one percent of the property’s assessed taxable value. According to the Mayor, who believes “homes are for people, not speculation,” the program has been successful, as measured by empty homes being returned to the rental market. Revenues from the tax also benefit tenants, as all revenues collected go towards the city’s affordable housing programs.
Application to Commercial Spaces
Both policies serve as critical reference points in the development of protections for small business tenants. Regarding direct tenant protections, policymakers can leverage frameworks like residential right to counsel policies to level the similarly imbalanced playing field between small business tenants and their landlords. A retail legal assistance program analogous to residential right to counsel programs would equip small business tenants to manage an array of processes: lease renewal negotiation, tenant-landlord dispute negotiations, and initial lease reviews.
New York City launched one such program in 2018, the Commercial Lease Assistance Program, designed to provide an “avenue of defense for small businesses seeking to mitigate the costs of survival.” In its first two years, the program provided no-cost legal assistance to hundreds of small businesses in over 1,000 legal matters; in doing so, it has helped businesses arrive at more favorable lease terms and addressed unjust tax pass-throughs from landlords. However, free legal representation is not enough to protect small business owner tenants, who are typically at a significant disadvantage when confronted by commercial lease negotiations with their landlords.
Further protections and regulations are necessary, and a handful of cities are considering how to best address the need. In New York City, the Small Business Jobs Survival Act (SBJSA) remains in legislative limbo, but if passed, could provide direction for other cities to follow. Specifically, the SBJSA would “establish conditions and requirements for commercial lease renewal negotiations, including requirements for lease renewal terms, arbitration-triggering conditions, limits on security deposits, and prohibitions on landlord retaliation.” Take Back NYC, the coalition fighting for SBJSA’s passage, believes fairness in the commercial lease process would be pivotal in controlling the small business displacement crisis. It is time for New York City to prioritize the futures of small businesses by putting the bill to a vote, and time for other cities to consider similar protections.
Vacancy taxes can also be directly translated to the commercial realm. Just as some landlords sit on vacant residential units, landlords of commercial spaces do the same. San Francisco pointed to a few specific factors contributing to the high local retail vacancy rates: “absentee landlords, speculative rent increases, and failure to rehabilitate or improve commercial space to attract community-serving tenants.” In response, the City recently passed an ordinance that will charge landlords an annual tax on retail properties that remain empty for more than six months, with the tax growing over time. Given the COVID-19 pandemic, the City has delayed the ordinance’s implementation, and plans to launch it in 2022. As such, it is not yet possible to evaluate the potential success of a retail vacancy tax. However, retail vacancy taxes do hold promise, as they incentivize landlords to keep their commercial spaces occupied – potentially for lower rent -- rather than holding out for a higher-paying tenant, and contribute positively to the supply of small-scale retail spaces.
2 | Community Ownership
Local small businesses are critical community assets, both in terms of supplying critical goods and services and in their contribution to the character and identity of a neighborhood. However, communities do not control the small businesses in their area, - commercial landlords do. Naturally, the interests of communities and landlords differ, as communities focus on how the businesses serve its needs, while landlords generally focus on their own bottom line. Furthermore, landlords and developers often prefer less financially risky leases, a preference that manifests as leases to national chains over locally-owned small businesses. As such, the question emerges: how can a community take more control over its commercial spaces? Once again, turning to housing programs, specifically community land trusts, provides useful guidance.
Residential Policies & Practices
Community Land Trusts (CLT) serve as a community-based mechanism for maintaining and increasing a community’s stock of affordable housing. The CLT model has evolved over time, but the typical set-up involves a non-profit organization owning land and leasing it to people who reside in houses on the land, thereby separating home ownership by individuals from land owned by the community. In essence, a CLT holds land for “what it conceives to be the public interest” and contributes to sustained affordability of housing, partially through agreements limiting the amount of appreciation that goes to the homeowner. Members – the residents – still build wealth through homeownership, and can oftentimes receive assistance from CLTs for down payments. The community also plays a direct role in governance of CLTs, as homeowners serve on the CLT’s Board of Directors, alongside general community members and local representatives from the non-profit sector, government, and funding agencies. There are currently between 225 and 280 CLTs in the country, and their ability to deliver permanently affordable housing makes them a powerful community-led tool and a model worth applying to the commercial realm.
Application to Commercial Spaces
Communities seeking more direct control of their commercial corridors can look to CLTs or to similar models, such as real estate investment cooperatives. The use of land trusts to provide land specifically for permanently affordable commercial spaces is a newer concept, and few existing CLTs have commercial spaces as part of their portfolio. In the few existing instances, the CLT acts as the master lessor, owning the commercial space and renting it out to small businesses at below-market rates. One key difference between residential and commercial CLTs would be how tenants build wealth. Businesses are less likely to be interested in ownership and would instead build wealth through their business - and their rent savings.
Real Estate Investment Cooperatives (REICs) are a similar model that hold promise for successful community-driven commercial development. REICs have been implemented in a handful of cities across the country and allow communities to own and develop their commercial spaces. Residents come together and invest financially to collectively buy, rehabilitate, and manage properties – all for the betterment and stability of their own community. The first commercial property investment cooperative in the country was established in 2012 in Minneapolis, when neighbors in Northeast Minneapolis came together to form the Northeast Investment Cooperative (NEIC). Residents join the cooperative for $1,000 and can invest further through purchases of non-voting stock. Within its first three years of operation, NEIC had completed its first project, a multi-tenant commercial property, and turned a profit. NEIC then passed along the profits to its members – local community members – as a four percent return on membership A-shares. This served as a proof of concept for the model, which aims to achieve “sustainable economic development, local ownership of community assets, and a modest return on members’ investment.”
The local ownership is crucial. While typical developers are more likely to lease commercial space to retail chains, REICs prioritize leasing space - at affordable rates - to locally-owned, community-serving small businesses and are invested in supporting the businesses’ growth. In the past five years, other communities have started building similar REICs, including New York City. While the REIC and commercial CLT models require further testing, both are tools that more communities should look to as they fight to protect the small businesses in their area.
3 | Inclusionary Zoning
Supply constraints exist both in the residential market and in the commercial market, particularly for affordable units. In the commercial market, the supply of small storefronts falls as old buildings are razed and new developments go up in their place. Given it is less financially risky for developers to secure one larger chain tenant for the ground floor retail space rather than numerous locally owned businesses, new developments typically design large-scale commercial units on the ground floor and lease them early in the development process – typically to national chains like CVS, Starbucks, or Target. Banks reinforce this practice; their aversion to risk makes them hesitant to finance real estate projects underpinned by small businesses. To a typical bank, small businesses are simply “non-credit” tenants – tenants who are “a potential risk of not paying their rent because of a lack of corporate strength or rental history.”
As such, it is imperative that cities establish mechanisms for incentivizing development of affordable small-scale retail space. To build a framework on how to do so, policymakers can look to the residential practice of inclusionary zoning.
Residential Policies & Practices
Residential inclusionary zoning policies require or encourage developers to build a certain percentage of affordable housing in market-rate projects. The practice has gained momentum in recent decades, in part because it doesn’t require direct public subsidy, which is crucial given the decline in federal subsidies and parallel increase in demand for housing that is affordable to low- and moderate-income households. The design of inclusionary housing programs varies by jurisdiction; for instance, some are mandatory while some are optional, and some cities offer incentives to developers while others do not. A particularly popular incentive is a density bonus. For example, the City of Cambridge, Massachusetts has a mandatory inclusionary zoning ordinance, requiring any new development of more than ten units to make 15 percent of the units affordable. In exchange for incorporating the affordable units, developers can receive a density bonus of up to 30 percent – as measured by the allowable floor area ratio (FAR). A critical element of inclusionary housing programs is defining “affordable” and “low-moderate income.” In Cambridge, households are eligible to apply for affordable units if they earn less than 80 percent of the area median income (AMI).
Application to Commercial Spaces
A similar model of inclusionary retail programs could work to support the development of smaller scale retail spaces that serve community interests. No such program yet exists in the country, likely due to the complexities of designing and implementing such a policy. Nevertheless, it is worthwhile to consider how policymakers could translate the design of inclusionary zoning to the commercial realm. At a basic level, an inclusionary retail program could require developers to designate a certain percentage of total retail floor area as smaller-scale stores rentable or sellable only to qualified commercial establishments. Determining which establishments qualify would be difficult; criteria could include local ownership and community-oriented goods and services (e.g., childcare, grocers providing healthy food). One researcher, Andres Sevtsuk, suggests another option for systematizing this process: an inclusionary business registry, analogous to the Legacy Business Registry that San Francisco established.
Ideally, these smaller-scale stores would also be affordable. For residential inclusionary zoning, affordability is defined as ensuring that residents do not pay more than 30 percent of their household income on their rent or mortgage. A similar threshold could be put in place for retail, based on occupancy costs as a percentage of total sales revenue, also known as the occupancy cost ratio (OCR). Paying no more than five to 10 percent of total sales revenue on occupancy costs is the most sustainable for small businesses. Accordingly, policymakers could require that for the smaller scale units that developers set aside, the lease terms must include a maximum OCR of 10 percent. Lastly, the policy could be mandatory for mixed use developments of certain types or encouraged by policymakers through incentives such as tax abatements.
Policies that partially align with the framework of a formal inclusionary retail program have started to emerge in cities across the country. For instance, New York City passed a law early this year requiring developers to “set aside affordable retail space for non-chain retailers within large City-funded affordable housing developments.” The law aims to protect local retailers from displacement, which is crucial, given that occupancy cost ratios for local retailers in the City are as high as 20 percent. As part of the program, the Department of Housing Preservation and Development will assess community needs to determine which types of retailers can apply for the affordable space. While limited to City-funded projects and certain types of developments, the law marks a significant step towards more robust commercial inclusionary policies. Ultimately, if done successfully, inclusionary retail programs will be pivotal tools for ensuring retail affordability and incentivizing the development of additional supply.
The success and survival of locally owned small businesses is paramount for the health and wealth of communities across the country, and policymakers must do more to mitigate their displacement. Given the dearth of existing policies in the commercial realm, policymakers should look towards the many residential anti-displacement policies. To better protect small business tenants from unjust lease terms and corrupt commercial landlord practices, policymakers should implement a retail legal assistance program inspired by the anti-eviction right to counsel policies, and could even tax landlords for deliberately leaving commercial properties vacant. To contribute to the supply of affordable commercial spaces suitable for small businesses, policymakers should design a retail inclusionary zoning program. And for communities that do not want to wait for policymakers or developers to step in, CLTs and REICs could be effective models for community control of commercial properties. Given none of the above strategies will be a panacea for the crisis of small business displacement, policymakers and communities should develop multiple policies in tandem. Small businesses are critical community assets, and it is time to better protect them.
By Julia Verbrugge
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