Spencer Heath MacCallum
We hear a lot of expressed concern about conserving the environment, but no one talks much about producing it. Why not manufacture it competitively and sell it in the free market like other goods and services—and even bundle it with product support? As a matter of fact, that is being done. It is a relatively new product, but its manufacturers stand behind it, and we will doubtless be seeing more of it in the future.
To explain this unlikely sounding proposition, I shall first analyze an incentive structure that is only now gaining explicit recognition in commercial real estate. Then I shall describe a two-hundred-year empirical trend to show how the above scenario is actually being played out. Finally, I shall explain why this is of more than mildly academic interest. In light of the incentives at play, the on-going historical trend has unexpected and important social implications.
It does not matter that the incentive structure I am about to describe is in its infancy, for as always it is the trend, rather than any given stage of development, that is significant. However, before tracing out the logic of these incentives, a key term calls for definition. For a moment, let us talk abstractly about land.
We tend to think of land as something physical: We describe it as clear, rocky, fertile, or barren. But those who deal in land say that three things give it value: location, location, location. It makes sense from an economic standpoint, therefore, to look at land not as anything physical, but as a special kind of location having to do only incidentally with geophysical coordinates. It is intangible, always changing, never fixed in supply. I am talking about location with respect to all of the things in the environs of a site, near or far, present or anticipated, that have any relevance for its intended use. This excludes features of the site itself, such as the presence or absence of valuable minerals,soil, water, or built improvements. We are interested in what surrounds the site, not what is on it. Admittedly, having said that, the physical attributes of a site do affect the probable use of the surrounding land, and to that extent its environment. But except for that, the physical features just named can be bought, sold, altered, or removed from a site without affecting its location in the sense described.
From this perspective, what landowners actually sell—that which commands value—is location with respect to a specific environment at the moment of consideration or anticipated for the future. A site merely defined by geophysical coordinates without reference to its surroundings has no ascertainable value; it comes into demand only as its environs have relevance for an activity that is to take place there. A prospective home site for a young family gains in desirability if there is a school nearby, or a mine site if there is a railroad accessible to transport its ores, or a retail site if there are residences nearby, not to mention parking spaces, utility grids, and many other things. When we buy or sell land, therefore, we are trading in what might be called positioning rights—rights to position ourselves and our activities strategically relative to other people and activities we consider significant.
For this discussion, therefore, “land” will mean economic location, or location that is potentially of use to somebody so that it commands a market value. It should be noted that “location,” in the sense described, and “environment” are correlative terms; each implies the other, and by itself has no meaning. While it is practical to define a land title in terms of the “metes and bounds” or geophysical coordinates of the site to which it pertains (because these are constant), the value of that title is always fluid, reflecting the changing location/environment of the site and the subjectivity and situation of the actors. Paul Birch puts it succinctly in economic terms: The site value of a property is simply the sum of the externalities directed to that property from all other properties
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Although the immediate advantage an owner can take of a parcel of land is to use it himself, as might a farmer or a homeowner, that is of no interest to us here. Our concern is with the incentives acquired by a landowner who brings his land into the market—that is to say, who sells or lets out its use to others. If he sells it, then he will be out of the picture and of no further interest for this particular discussion. But if he opts to lease it to others while retaining its ownership, he may be in the picture for a very long time. He will no longer be using the property himself, but will have made a specialty of its ownership and administration. Ownership and use will have separated. That is the situation we want to study—and the more so if he has multiple tenants. In the case of a single tenant, the discussion that follows may have little relevance, but with multiple tenants it begins to be consequential because a multi-tenant property begins to approach a community.
Where ownership and use have parted, and the owner no longer has the direct use of his land, what is his incentive with respect to it? How can he maximize his advantage from it over the long term? The only way he can do so is by making the site more valuable to its present or prospective tenants/users so that it will bring more rent. What does that entail?
As suggested above, the use anyone makes of a site is facilitated —indeed made possible—by the suitability of the site for the activity in question. That suitability depends on what people are doing elsewhere, and the proposed activity, or lack of one, in turn affects the value of sites elsewhere, creating a systemic process constantly changing with changing culture, people, and technology. By modifying the environment of a site (and, correspondingly, its economic location) in ways that make the site better suited for its intended range of uses, landowners make it more valuable to present or prospective tenants who are then willing to bid more for it.
What is significant in the broad social picture is that landlords—persons specialized in the ownership and administration of sites ratherthan in their use—singly and collectively have incentive to optimize the environment for present and prospective site users, in the process creating land value and harmonizing land uses community-wide. Landlords are, collectively, the natural market agency of community landuse coordination and planning. They are the true environmentalists.
The owner of a regional shopping mall, for example, is concerned about all of the things he has any control over within that mall that are environmentally significant for the individual leased sites, such as there being the right combination of stores to create maximum draw from the market area served—taking into account the income level, culture, and special needs of that particular market. He is also concerned that the managers of those stores make up an effective retailing team, each ready to cooperate in a hundred different ways—such as participating in joint promotions, referring customers, maintaining a good appearance, keeping regular hours, or alerting one another promptly in security matters. He is equally concerned about having adequate public parking and attractive landscaping of common areas.
But as a competent environmentalist, he is also concerned with a wide range of things outside his mall that affect each and every one of the sites he offers for lease within it. He is concerned about the obvious things, like convenient freeways and other transportation to the mall from his market area, but he also wants the community itself to be affluent, since that means a prosperous customer base for his mall merchants.
As within the mall itself, so in the surrounding community: One of the things that most affects the utility and value of land and thereby the affluence of inhabitants is the presence or absence of common services, such as the provision and maintenance of parks and well-placed streets, water and power and other utilities, sewerage, security, justice services, and the like. Just as a mall owner is concerned with the quality of management within his mall, so is he concerned with the quality of management in the rest of the community outside the mall, which is to say, the quality of local government. He is not alone in his concern. He is one among a growing constituency of commercial property owners, all of them concerned to see that municipal services are performed and performed well, whether that means monitoring, informally supervising, subsidizing, or actually providing the services, whatever it takes—alone or in collaboration.
A small landlord, leasing or renting to perhaps one tenant, has little hope of improving or rearranging the environment of that small parcel to make it more valuable to the tenant. He is almost as helpless as an individual owner who uses the land directly. He lets it for whatever use and level of use the existing surroundings permit, and has little control over how community infrastructure is provided. If he looks for any improvement at all, it is for municipal government to intervene on his behalf.
But as he enlarges his holding or combines with others to achieve a holding of more practical size, and begins to lease not to one but to multiple tenants, he gains leverage over the environment. He may now find it economically feasible and in his interest to build substantial physical infrastructure for tenants in a multi-tenant property. But even before that, he finds that he creates environment in the very act of leasing to multiple tenants, since each tenant becomes a factor in the environment of every other. This has been carried to high levels of sophistication in the selection and arrangement of tenants in shopping malls.
Returning to the example of the shopping mall landlord, he goes well beyond merely selecting and arranging particular land users for optimal synergy and then building physical infrastructure for them. By providing proactive leadership, and by creating, in the terms of his leases, rules that facilitate community living, he builds effective social infrastructure as well. He brings focused attention to the myriad environmental factors affecting land users in that place in order to facilitate a highly complex, interactive community of landlord and merchant tenants.
Just as environment is blind to property lines, so is the landlord’s concern on his tenants’ behalf. As he achieves success in building land value, he becomes economically more able to influence environmental factors well beyond his property boundaries, both directly and in cooperation with other landlords, each of whom has similar environmental concerns.
By virtue of this incentive, a distinctive entrepreneurial role for landowners in the market place has been building for more than two centuries. Instead of continuing like everyone else on his own plot as an environmental consumer, some owners have specialized and differentiated by administering their land to benefit others, who now have become their customers. In so doing, they are administering land as productive capital in the market. Their enterprise consists in the production and marketing of human environment. As this enterprise has grown, so has the accompanying know-how.
However unconscious and unplanned, the spread of this enterprise reveals the general outline of a new structure of incentives governing the production and distribution of community goods. Ever so quietly, little remarked upon by social commentators but with the seeming inevitability of a sea change, this new paradigm has made its appearance with the advent and growth of multi-tenant income properties in all areas of commercial real estate.
The multi-tenant income property is the application in an urban setting of a form of land tenure that for millennia characterized agrarian societies. It consists of holding the overall land title intact while parceling sites among land users by leasing. Site improvements, on the other hand, may be constructed and owned by anyone, depending on the particular circumstances. The multi-tenant income property is the antithesis of the subdivision, prominently exemplified by condominiums and planned unit developments, in which a tract of land is fragmented into many separate ownerships.
Although the principle is ancient and widespread, modern multitenant income properties stand out as an American phenomenon. From their first appearance in the second quarter of the nineteenth century, they grew along a rising trendline that steepened after World War II, when they began to expand dramatically in number, kind, size, and complexity.2 Entrepreneurs in this new line of business created myriad environments reflecting the specialized needs of a seemingly endless variety of clientele—merchants, travelers, manufacturers, residents, and professionals of every variety. Each new type of environment that met with success in the market defined an economic niche. In succession, we saw the rise of hotels, apartment buildings, office buildings (“skyscrapers”), luxury liners, camping grounds, commercial airports, shopping centers, recreational vehicle (RV) parks, mobilehome parks, coliseums, small-craft marinas, research parks, professional parks, medical clinics, theme parks, and land-lease manufactured-home communities, as well as, increasingly, integrations and combinations of these and others to form properties larger, more complex, and less narrowly specialized.
As these properties became more generalized through complementary mixed uses, they began approaching what we think of as communities. Some hotels today, for example, compare with a small but complex city. The MGM Grand in Las Vegas includes shopping malls, professional offices, convention facilities, restaurants and cafes, chapels, theaters and art galleries, medical services, a security force, a monorail station, and more. In terms of population, it is two to three times larger on any given day than the city of Boston at the time of the revolutionary war.
As entrepreneurial landowners learned how to build land value by optimizing environment for their tenants, a major segment of the business community in the United States abandoned the atomistic pattern of subdivided lots along Main Street, devoid of a unifying proprietary interest, and moved onto larger landholdings organized and managed under integrated ownership. Here the organized landowners—of whom there can be unlimited numbers through use of stock and other undivided interests—provide many of the services that once only governments provided, including streets and parking, sewerage, storm drainage, power distribution, policing, and landscaped public places. The sophistication of common goods now routinely provided in large multi-tenant income properties has far surpassed those of municipalities.
The growth of such environmental enterprise has been extraordinary. The shopping center at the close of World War II was small and experimental. Fewer than a dozen existed in the United States, and the name had yet to be coined. Today, shopping centers and malls in the United States number 47,000, accommodating half of the non-automotive retail activity of the nation.
Landlords have far transcended their traditional, stereotyped role. From being merely passive recipients of rents, they have become entrepreneurs. In each specialized type of multi-tenant property, they tailor their management style to the needs of their customers. A large mall, for example, requires a special commitment to leadership to forge a collection of merchant tenants into a strong retailing team. A team needs a coach, and in the shopping mall, the manager is it. His coaching role calls for keeping the peace and building morale among highly competitive merchants. The merchants in the mall recognize his unique qualifications for such a role. His concentrated entrepreneurial interest in the land confers on him qualities found nowhere else in the center. Unlike the tenants he serves, who are naturally partisan and inclined to exploit the center as a commons, he is both interested and disinterested. He has a direct personal and business interest in the entire center and, therefore, in the success of every proprietor on his team. This leadership presence in the shopping center is a major environmental asset for the community of merchants located there. Commentators in the retail trade literature have called it the whole premise of the shopping center.
The multi-tenant income property has a straightforward business rationale. As environmental entrepreneurs in the economic niche defined by their type of property compete to lower their asking rents, a field of prospective tenants, similarly competing, bid up the rents they are willing to pay. For owners and managers who succeed in offering attractive physical and social environment in this competitive market, land revenues return their costs and a profit besides.
Multi-tenant income properties are, essentially, communities. As such, they stand out against the tragic record of traditional, subdivided communities, which are unable to be run any way other than politically. Subdivisions are not market phenomena because they do not sell a product, nor have they any customers. Hence, they generate no income, but must subsist on assessments or tax levies. Multi-tenant income properties, on the other hand, are business enterprises. Because they serve customers, they earn an income. Producing a market revenue makes them self-supporting—and more than merely self-supporting. Not only do market revenues finance the current operation, they enable the accumulation of reserve funds from which to renovate as required, or even to completely rebuild to the same or another use to stay competitive with other locations being similarly administered in the market. This illustrates the immortality of productive capital.
A natural question arises regarding the growth and spread of multitenant income properties. Why, with the major exception of apartments and hotels, has nothing comparable happened in the housing field? Instead, we have subdivisions with homeowners’ associations, which David Friedman describes as government like any other. The anomaly may be due to a combination of factors. A partial explanation may be that innovations often first appear in the business world, where competition drives innovation and efficiency, and later make their way into the consumer market.
A different explanation is cultural—the longstanding ideological bias in America favoring home ownership over renting or leasing that traces to colonial times and the repudiation of the last vestiges of feudalism in Europe. Still another explanation is public policy. Detached, single-family subdivision housing has been aggressively promoted since the 1930s by a close involvement of the federal government with the corporate building industry.
In addition, federal income tax policy discriminates against renting or leasing for residential use. The federal government also directly subsidizes homeownership through its various federal mortgage insurance programs. The fact that such insurance only covers homes in a subdivision with a qualifying homeowners’ association in effect mandates subdivision housing, since most builders feel their product must qualify for federal insurance if they are to remain competitive in the industry.
Added to these various federal requirements, the taxing of dividends at substantially higher rates than capital gains (at top rates the difference is 39.5 percent versus 20 percent) encourages short-term venturing for capital gain, as in subdivision housing, over conservative, long-term investment for income.
Certainly all of these factors play a role, but understanding how they are to be weighed against one another awaits empirical and historical study. The public policy factor is so great as to suggest that the ubiquity of subdivision over land leasing in residential housing may be a matter of market distortion more than of consumer preference. To the extent that the explanation is cultural and psychological, we do know from the abrupt shift of New York City apartment living from disrepute to respectability in the mid-nineteenth century that such change can happen rapidly.
It is important to recognize that, however they may be provided, common services and amenities like streets, utilities, parks, and public safety pertain to sites rather than to individuals as such; individuals derive benefit from them only as occupants of a place. Thus, when landowners sell or lease sites for price or rent, they are, in fact, acting as the market purveyor of the public services and other environmental amenities attaching to that place.
With that in mind, we can readily imagine a scenario forecast by Spencer Heath in 1936.10 Pointing out that communities have owners, albeit unorganized, he forecast that the growing class of entrepreneurial landlords, representing broad segments of the investing public, would organize and begin to monitor the provision of public services. In so doing, they would become thoroughly aware of the fact that they are merchandisers of the environmental amenities of their combined sites and that, prominent among these, are the public services of the host community. In a strict sense, therefore, he argued, public employees are the acting agents of the owners of the land of the community, even if the latter do not fully pay or supervise them.
Today, Heath continued, the unorganized owners of a community might be likened to a hotel’s owners who have allowed their staff to be chosen by public shout and, without any supervision, to finance themselves and the operation as they see fit or feasible by picking the pockets of the guests. But as enterprising landowners come to recognize their relation to the provision of public goods—how they themselves fit into the larger societal picture—it will only remain for a sufficient number to organize to assume full responsibility for servicing the community, now become an enterprise. First, they will voluntarily assume full fiscal responsibility, thereby realizing in a practical way the Georgist dream of the “single tax,” followed in due course by administrative responsibility. This will come about as a matter of good business. Commercial landowners will see their opportunity to enhance land values dramatically by providing effective community services while relieving site users of the harassment and burden on their productivity that taxation and bureaucratic regulation now entail. The provision of common goods then will become a truly competitive market enterprise.
In his classic book The Quest for Community, Robert Nisbet described the importance, for the preservation of freedom, of many kinds of “intermediate associations”—familial, religious, economic, professional, recreational, academic—acting as buffers between individuals and political government. Because of their immature development when he was writing toward the close of World War II, it did not occur to him to specify multi-tenant income properties as a prime example of intermediate associations. He later acknowledged the omission, observing that they “assuredly fit the category of intermediate associations and perhaps also communities.”
The manager of a shopping center in a small California city volunteered how multi-tenant income properties provide the kind of buffering Nisbet described. A large part of his role as manager, he said, was running interference between the local city government and his merchants so that they could devote more of their time to operating their businesses—to their own profit and that of the center as a whole. He said he participated widely in civic organizations in the community “to make friends for the center” and knew “the right people to go to to get something done, as long as it’s fair.” He cited examples of the center’s cooperation with civic clubs, schools, and the Boy Scouts, and counted among his personal friends the mayor, city manager, chief of police, and fire chief.
If we make the single assumption that the historic trend toward the business-like administration of land as productive capital will continue as it has in the past, then it seems inevitable from the logic of the situation that the growing numbers of owners of multi-tenant income properties will associate to further their common interests, and that at the top of the list will be the shared desire to enhance communitywide services while relieving land users of taxation and its abuses and reducing bureaucratic regulation. Historically, being small and divided, landowners had little power to effect any significant improvements outside their own small parcel. The increase in the number and size of their commercial holdings, however, and the growing involvement of the investing public, is changing that picture.
As such trade associations develop, their membership will come to include not only larger landowning interests but also owners of small multi-tenant and single-tenant properties and even owner-occupiers, as the recognition grows that these associations offer a more promising avenue to improvements than does city hall. For the first time ever, we will see major trade groups endowed with very substantial resources dedicated to promoting the public interest. The special interest of their founding member firms will be the prosperity and well-being of their tenants and properties, which they will see as interconnected with and dependent upon that of the environing community.
As it continues to grow and develop, and as communities prosper from the success of local real estate associations, the environmental industry will inevitably organize on state and regional levels and take on correspondingly broader responsibilities for the environment, both physical and social. Associations will concern themselves with regional security, public parklands, and communications, even as shopping malls today on a small scale are known to build public roads and other common facilities, prorating the costs among them.
Fully a half-century before the beginning of modern multi-tenant income properties in the United States, Adam Smith described the congruence he saw between the landed interest and the general public interest. In ways he could not have foreseen, the present discussion bears out his statement of broad principle:
The interest [of landowners] is strictly and inseparably connected with the general interests of the society. Whatever either promotes or obstructs the one, necessarily promotes or obstructs the other. When the public deliberates concerning any regulation of commerce or police, the proprietors of land never can mislead it, with a view to promote the interest of their own particular order; at least, if they have any tolerable knowledge of that interest.
As we saw, land utility and value is a function of environment. Accordingly, an individual who gives up the direct use of his land and instead administers it as productive capital by letting its use to others acquires an economic interest in creating environment that will be conducive to the well-being of his tenants. His concern extends, albeit indirectly, to the whole population, since it comprises the environment, and the well-being it enjoys or the adversity it suffers will reflect back upon his tenants. This is the explanation for the alignment of the landed interest with the interests of land users.
Others have also called attention to the nexus between land, rent and public goods. Much of this literature has been brought together by Fred Foldvary in Public Goods and Private Communities
. He observes that it is a common failing of economists who argue market failure that they consider provision of public goods in a vacuum, whereas the very nature of public goods requires that they be considered in the context of a place.16
It is noteworthy that Spencer Heath, more than a half-century ago, was not so much proposing a social reform as he was merely predicting a future course of events, extrapolating from the market process as he understood it from events happening around him. If the scenario he forecast is correct, the commercial real estate industry will find it in its business interest to voluntarily assume the full provision of public services locally and regionally. Not the least of these services will be to untax land users and relieve them of the manifold burdens of political government. In this way will the industry promote general prosperity while building land values for its investors throughout the population. Through local and regional realty associations, neighborhood will compete with neighborhood, community with community, and region with region. On all of these levels, the competitive provision of common goods will be among the most highly profitable of all enterprises.
At the beginning of this article, I stated the unlikely sounding proposition that human environment, both social and physical, resembles any other good or service in that it is amenable to being manufactured, marketed, and maintained through the competitive processes of the market. I then did three things. I analyzed how this works in theory, described how it has evolved in practice, and showed the unexpected and significant result toward which that practice must logically lead.
That is to say, I first analyzed an incentive structure that was not present while land was mainly owned for consumption or speculation, but that came about with the emergence of land ownership as a capital enterprise. Second, I showed how that pattern has been unfolding historically in the gradual emergence and proliferation of modern multitenant income properties. Finally, I extrapolated from that established trend in real estate to forecast an unexpected and significant result.
The unexpected result logically implied by this real estate trend is nothing less than the qualitative transformation of government. Most interestingly, this qualitative transformation will come about not by taxation and the marching and marshalling of armies or the deliberations of legislative bodies, but by the quiet emergence of the enterprise of community as an almost incidental consequence of the continued normal development of the market process.