Land is the great liver of the economy. After impurities and intoxicants have worked their way through all other elements of production – labor, capital and entrepreneurial coordination – they wind up lodged in the land.
The headline-grabbing Los Angeles City Council vote to blow out the minimum wage by 67 percent, from $9 to $15 an hour, will settle as long-term deadweight on the city’s land. If you’re expecting immediate doom, you will be disappointed. Fallout from the move, which includes annual inflation indexing forever after, will resemble more a malevolent tide than a tsunami. Here is how it will affect the land:
Ground leases imperiled: Chain retailers, from Chili’s to Walgreens, tend to be uninterested in land ownership, since they can finance construction through credit lines without placing loans against real estate. They tend to lease their sites from property owners for terms of between 55 to 99 years and then build stores on the leased land. This arrangement also allows them to expense depreciation and interest.
With ground leases, the lease payments and all “kickers” (escalations) are generally laid out for the entire term of the lease. For these property owners, the arrangement resembles investment in a bond. Owners of the land trade the low risk of these arrangements for a lower expected return. Retailers sign these long-term leases based on long-term projections of merchandise costs, markups and wages – in short, based on their business models.
With the City Council’s vote, the risk to thousands of ground leases across the city has been added overnight but without any commensurate reward. But don’t worry, the market will have the last say in this by changing the multiples at which such land trades.
Ebbing of capital improvements: The flow of capital will drop off as tenants and landlords eye the $15-an-hour phase-in period during lease negotiations. The phase-in, incidentally, is the length of many service-sector and retail leases – five years. Spaces will become less functional and less aesthetic over time as capital improvements are deferred.
More retail flotsam and jetsam: Small proprietor-run businesses, such as liquor stores and corner taquerias, will benefit, as will those businesses linked to the shadow economy – unlicensed contractors, tree trimmers, nail salons, domestic service firms and massage parlors – while national credit retailers and brand-name service providers in the city will face huge challenges. Land users with exceptional business plans that leverage high levels of automation will also thrive. But most service-sector businesses aren’t exceptional and depend on a mix of skilled and unskilled workers.
Doldrums for vocational schools: The new inflation-adjusted wage offered to unskilled workers will quickly resemble wages paid by traditional move-up jobs, such as medical assisting, welding, auto repair, bookkeeping and clerical work, so vocational schools and junior colleges will suffer. Unskilled jobs, such as those offered by the fast-food industry, will become as “sticky” as rent-controlled apartments in Manhattan. True, some of the added costs will be offset by savings from lower turnover and higher productivity. However, these gains will be offset by disincentives for workers to move up within organizations.
Back to the blight: Businesses that are now on the edge of profitability, many in disadvantaged parts of the city, will not be able to pass price increases on to their customer base. Long-term vacancies will increase. There will be higher youth unemployment as middle-age laborers cling to their low-skill jobs with greater tenacity. As a result, blight will increase, but this time around, the city has no redevelopment agency as the result of statewide changes several years ago.
As much as the city would like to legislate prosperity, which is a worthy goal if it were possible, the explosion in the minimum wage will become just another encumbrance on land, resulting in fewer market participants and a debasement of L.A.’s commercial dirt.
Successful cities are hotbeds of innovation and hold a cumulative attraction for unskilled and skilled workers, and professionals. The right distribution of these and market-based incentives to move up help boost employment opportunities and potential income, creating a virtuous circle. If prosperity could simply be established by decree, governments would have done so long ago.
The low wages prevalent in many parts of Los Angeles are an outgrowth of low educational attainment, lack of skills, poor language proficiency, the disappearance of manufacturing from the region and a booming shadow economy. Low wages aren’t the cause of these things but the effect.
Eventually, the land market in Los Angeles will find its equilibrium, as markets always do, leaving L.A.’s land less desirable, less valuable and less flexible. The malevolent tide has begun.
Jeremy Bagott is senior analyst for Integra Realty Resources in Encino.
