Sunday, March 25, 2012

Richard Epstein: City Planners Run Amok

The Upper West Side (UWS) of New York City operates in a moral and political universe different from my own. Currently, its confident progressive worldview has precipitated a major land use controversy. On the urging of the UWS “community” and its elected officials, the City’s Department of Planning has endorsed this modest proposal “for new or expanding establishments” on Broadway, Columbus, and Amsterdam avenues. These are major commercial streets, yet the proposal seeks to limit store frontage on them to forty feet for general retail and twenty-five feet for banks.

The proposal earns its “modest” label, because, as the Planning Department confidently notes, the rule would not limit the overall size of the business, the configuration of its interior space, or its kind of operations. Still, many businesses and banks currently exceed the proposal’s limit, often by multiples of four and five.

The locals insist that this regulation is needed to preserve the distinctive character of the neighborhood from large banks and major retail chains, which gobble up valuable frontage in ways that drive out small local businesses. The UWS is said to be “largely unique” because the space available for commercial use is limited relative to the population density, driving rents up. The supporters of the bill are determined to protect the “mom-and-pop” stores from unapologetic corporate behemoths. The local community board has unanimously approved this proposal over the vocal opposition of the City’s commercial real estate interests and passage now awaits approval by the City Council and then the Mayor. Let’s hope it doesn’t happen.

I begin with a cautionary note. It is too easy to treat “neighborhood character” as a loose and sentimental notion that should be excluded from urban planning deliberations. To do so would be to ignore what everyone knows: that the character of our surroundings makes a huge difference in how we live and organize our lives. The proper integration of public and private spaces is something people expect in deciding where to live and work. There is no question that private developers think about how to integrate aesthetics, access, and use into a harmonious whole; they know these amenities drive both the desirability and price of the units that they wish to sell. Ample evidence suggests that character also matters a great deal in public spaces.

But to stop there leaves the story incomplete, for it fails to address two questions: Will regulations, such as the ones discussed above, improve the “streetscape character,” as its supporters claim? If so, will it do so at an acceptable cost to all of the individuals and businesses that bear the brunt of the proposal?

On these tough questions, the UWS proposal lays a goose egg. The City’s planners have lulled themselves into minimizing the effect that this one constraint (the storefront limitations) has on everything else. Price controls, minimum wage laws, and rent stabilization regulations also impose “only” a single restraint each. But aggressively applied, each can, in short order, wreck agricultural, labor, and rental markets respectively by blocking key profit-making strategies. These frontage limitations are equally dangerous. Tuyukhey never operate in isolation. Retail establishments have to worry about how to meet this requirement when faced with a myriad of other legal and business constraints.

Take a simple hypothetical case: A tenant whose store has a hundred feet of frontage goes bankrupt for one reason or another. Immediately, the hapless landowner must divide that space into at least three separate establishments. But the frontage rule does not account for the fact that the internal configuration of the space may not allow all three new units to have desirable frontage.

Bulky support columns could be evenly spaced at thirty-three feet apart—too small to make retailing viable, but too large to meet the twenty-five foot restriction for a bank. Perhaps, the owner could claim a waiver from the regulation by showing the impossibility of complying with it—but through what procedures, and by what standards? Should the waiver be granted for a mom-and-pop store with large frontage, but not for a national chain?

What happens when the new city ordinance is enforced to the letter? Now each of the three new stores must guarantee proper wheelchair access to customers; each of the three will also need separate heating and ventilation systems; each will need additional plumbing and appliances for three separate restrooms; each will have to redo the electrical, alarm, phone, and cable systems as well. The construction bill could result in thousands of dollars of added expenditures, and similar amounts in lost rents.

Once that work is finished, just who will lease these new spaces? And for what rent? Real estate rental rates are commonly quoted in terms of square footage. But that conceals the critical dynamics of valuation. The first commandment of the retail rental market is that all space is not created equal. The well-lit window space is worth much more than the dark space at the rear. Limit the frontage for the business, and the retail operator has fewer displays to use to lure customers into the store.

At the same time, the interior floor space may become dreary as it fans out behind the smaller stores located in front. The new setup doesn’t bring in enough foot traffic to sustain the business. Jobs are lost as business slows. Rentals then drop, which leads the landlord to claim a reduction in real estate taxes, putting greater strains on public budgets.

The dislocations are not only borne by the hapless landlord. The character of the neighborhood is not likely to remain diverse and vibrant with this new restriction in place. The mandated renovations will require extensive down time. Reconstruction can idle stores, block streets, and reduce foot traffic, all of which will diminish the charm of the neighborhood and cut into the revenues of nearby businesses.

The problem gets compounded because small retail outlets typically free ride off of the larger anchor tenants, whose numbers will be thinned out under the ordinance. Redevelopment will lag because a sitting tenant that needs extensive frontage will not sell its rights in its current location since it will become a “new” business in its new location, where it can get at most forty feet of frontage.

The difficulties compound. Faltering tenants will receive rent concessions instead of eviction notices by landlords desperate to avoid the costs of subdivision. As overall property values decline, key owners will continue to shed jobs and to seek real estate tax reductions to reflect the physical devaluation of the space and the slowdown in sales.

The administrative complexities make the overall system more tenuous. It is easy for the City to announce that the ordinance applies only to new or expanding businesses. But these words quickly become terms of art. Suppose that a woman’s store decides to add a men’s line. Does that new use continue the old clothing business, or does the addition of the men’s line constitute the starting of a new business? Add a snack bar to a bookstore and you have the same question.

These will not be isolated incidents, because a healthy real estate market always has benefits from rapid, seamless, and gradual modifications in the use of existing facilities that reflect changes in market conditions. The long-term effect of the City’s frontage proposal will interfere with this process of adaptation. In so doing, it will affect the character of the neighborhood, yes, but only negatively. The same defensive protectionism that doesn’t work in international trade won’t work for local land use ordinances.

So why then has this dubious proposal gotten as far as it has? Why do planners ignore the potential downside? It’s because of the incentive structures under which they operate. There is one major reason why public deliberation so often leads to flawed results in the land use context. Scroll down through the Planner’s defense of the UWS plan, and the word “compensation”—as in compensation to those landlords affected by the burden of the proposal—will not be found.

The legal explanation is simple. The United States Supreme Court and the New York State Court of Appeals don’t care about property issues. In both places, the key cases hold that land use restrictions should be regarded as “regulatory” and not “physical” takings. While there is a near per se duty to compensate for the latter, “mere” regulations may be imposed on property owners without compensation, except in rare circumstances where the government acts in a bizarre and irrational way. Any proposal that goes through an intensive study, as the UWS plan did, will not flunk that last test. So compensation to the aggrieved landowners and tenants is off the table. The planners don’t have to pay property owners a dime for the loss in the value of their space and thus systematically downplay their predicament.

Their free ride, courtesy of the courts, drives the decisions of planning boards everywhere. Their first move will be to assure the “community” of their protected position to line up political support. Regulation is just like any other commodity. The less a community has to pay to get it, the more that community is willing to purchase it. Still, the indirect costs on the community itself remain. Indeed, for the UWS, those costs could come back to bite the supporters of the program. But that pushback will hardly guarantee repeal. The same community forces that backed the ordinance might relax the restrictions once the shoe pinches, but they won’t do away with them completely.

None of this would happen if federal or state constitutional law required the City to compensate landowners in full for the loss of their capital values. That compensation might be owed when the ordinance is put in place. Or it might only take effect once the particular owner has to renovate his premises to meet the legal requirements. For these purposes, it doesn’t much matter. Either way, city planners will understand the community’s potential financial burdens from adopting the ordinance. That looming liability means they have to budget for these potential condemnation costs. Faced with a positive price tag, the enthusiasts will have to explain to their fellow citizens just what they hope to gain from the regulation. Now, the deliberative process might nix the proposed ordinance once its costs are made explicit. If so, then the just compensation requirement has done its silent work. There is no need to calculate compensation in hard cases if the just compensation requirement leads to the defeat of these dubious schemes in the first place.

The current approach of regulatory takings means that that scenario will never play out. The only way for landlords to win under the current law is through an “as applied” challenge that shows that the regulation renders any use of this specific rental space economically unviable. Sometimes that happens. But most local governments prefer ad hoc waivers to stave off credible constitutional challenges—not withstanding the serious risks that government-by-waiver poses to the rule of law.

The larger issue of constitutional design goes far beyond the UWS. The current law distorts land use decisions everywhere. The only way to short-circuit this deadly cycle over public overregulation is for the courts to rethink the free pass that they have given to land use regulations.

Richard A. Epstein, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution, is the Laurence A. Tisch Professor of Law, New York University Law School, and a senior lecturer at the University of Chicago. 

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