Joel's Jambalaya #3: Neighborhood Retail & Institutional Decay

How do you stop gentrification?

Welcome Wonderful Subscribers!

Last week I mentioned that we had received preliminary approval for our first complete neighborhood in Florence, Alabama. In the coming issues I will provide more context on some of the design choices we’ve made for the site.

First up is a new class of business: Neighborhood Retail

What is Neighborhood Retail?

Neighborhood Retail is the kind of business within walking distance of your house. The kind you stop by at least once a week, or even every day. The kind where you know the owner.

It’s the cozy neighborhood grocery store, not the 30,000 square foot super market that’s a 15 minute drive away.

The neighborhood coffee shop, not Starbucks.

We are entering a new era for this kind of small, local businesses.

The pandemic and widespread remote work are giving individuals unprecedented choice to move out of hyper-dense & expensive labor markets to smaller towns and neighborhoods that better fit their desired quality of life.

Making Neighborhood Retail Work

This story, borrowed from Kevin Song of Withco, sums up the issue with this type of retail well:

My story is my family’s story.
And my family’s story is an American one.
Maybe you’ve heard it before.
It goes like this.

Immigrant parents leave home, in hopes of giving their kids a better one.
They land in New York to make a new life.
They start a small business built on big dreams.
They work relentlessly until they have regulars.
They sponsor little league and give young moms a little help when they’re in a pinch.
All these little things make a big difference on their block.
But their neighborhood changes fast. The rent changes faster.
The family puts up a fight, but it isn’t a fair one.
Their small grocery store is replaced by a bank chain.
And their big dreams are replaced by a new reality.

These neighborhood businesses are what make a neighborhood desirable. Once a neighborhood is desirable to live in, the only businesses that can afford to rent there are the ones that make a neighborhood undesirable: financial services, accountants, lawyers.

This is gentrification of the commercial side of a neighborhood in a nutshell. It is caused by misaligned incentives between the owner of the real estate (often an institution that owns large amounts of real estate like a REIT) and the user of the real estate, the small business.

Real estate owner incentives: maximize rents, all other factors (such as neighborhood vitality, or small business owner financial health) are not relevant.

Business owner incentives: continue to provide useful services to residents of the neighborhood and earn a living. This includes the explicit service the business performs - serving coffee, food, etc.- but also numerous other “soft” benefits like deterrence of crime, a place for residents to socialize, and so on.

So how do you solve this? The simplest solution is to change the ownership structure to better align the incentives.

“Show me the incentives and I’ll show you the outcome” - Charlie Munger

Small businesses work hard to serve their community. The “soft” benefits mentioned above bring tremendous value to a neighborhood. When a small business rents from a landlord, the landlord is the one capturing that value.

This model simply realigns the incentives so the small business owner benefits from all the value they bring to the neighborhood. Seems fair, right? So why is it not done?

There are two main reasons: 1. It is unusual and 2. It might require long term thinking.

The first point is simply that most real estate businesses and investors have a model that works, and they are very uncomfortable trying anything outside that model.

Second, true long-term thinking is rare. A 7 year time horizon is almost unheard of for any business, particularly publicly traded ones that report every 3 months! No matter your opinion of Jeff Bezos and Amazon, it’s this sort of long-term thinking that fueled the company’s dominance:

“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue. At Amazon we like things to work in five to seven years. We’re willing to plant seeds, let them grow—and we’re very stubborn.”

I believe the long-term health of the neighborhood should take precedence over short-term income, so our model explicitly targets giving ownership of the small business spaces to the business owners themselves.

I’ll be discussing the logistics of this more in future issues. If you or someone you know has or wants to start a neighborhood business, send me an email or reach out on Twitter.

Quote I’m Pondering

“Life, like a dramatic piece, should not only be conducted with regularity, but it should finish handsomely.” - Benjamin Franklin

If you don’t already know, I’m likely in the top 1% of Benjamin Franklin fans, so he will appear often in this newsletter.

By the way: there is a wonderful Ken Burns documentary on PBS about Ben Franklin that Sophie and I have been watching. Also, did you know Ben Franklin killed Beethoven?

What I’m thinking about or reading this week:

I’m on part one of a two part series by Francis Fukuyama. The first is The Origins of Political Order: From Prehuman Times to the French Revolution.

What I’m interested in is: what is institutional decay and why does it happen?

Institutional Decay

Many of the problems societies face today have a common cause: Institutional decay.

There are certain problems in human society that repeat over and over. Humans create institutions to solve or manage these things the best we can: these are our political, social, and economic institutions.

Samuel P. Huntington writes in his 1968 book Political Order in Changing Societies:

“Political institutions are rules that ensure stability and predictability in human societies, and they also facilitate collection action. However, sometimes old political institutions do not adapt to new circumstances because of self-interest of insiders, cognitive inertia, or conformism”.

Huntington’s definition of institutions: “stable, valued, recurring patterns of behavior”.

The problem is, the world changes. Technology changes. When the world changes, institutions do not. They are sticky and change-averse. This is what creates friction: people don’t feel their needs are being served by the institutions that are supposed to serve them. Needs have changed, institutions haven’t.

Change is not only the norm today, it is accelerating. This means many of our 20th-century institutions decay at a faster rate (feels like there is some way to quantify this, but that is far above my pay grade)

Francis Fukuyama argues that while democracies can theoretically reform through electoral politics, they are also potentially subject to decay when institutions do not adapt.

I think most of us feel this, particularly at the municipal level. Election cycles are long. In theory it is possible to participate democratically. In practice, however, it is effectively impossible to have influence without devoting one’s entire life to politics. That feels very undemocratic.

Institutions, as a rule, do not change much throughout time. They develop in response to a particular set of circumstances and do not function well when those circumstances change. Fukuyama explains that although it is possible to reform through the democratic process, in practice it is usually futile to do so.

So where does that leave us? We know our institutions will continue to decay, likely at an increasing rate, and reformation of them is infeasible.

It’s up to all of us to create new institutions

Buckminster Fuller makes the same point, just swap “model” for “institution”:

You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete.

There was another famous thinker with some ideas on creating new institutions: Georg Hegel. I’ll turn things over to the School of Life and their summation of Hegel’s views on the role of institutions:

Hegel took a very positive view of institutions and of the power they can wield. The insight of an individual might be profound. But it will be ineffective and transient unless it gets embodied in an institution. Jesus’s ideas about suffering and compassion needed the Catholic Church to take them to the world. Freud’s ideas about the complexity of childhood didn’t become a properly constructive force until they got organised, extended and institutionalised at the Tavistock Clinic in London.

The point is for ideas to be active and effective in the world a lot more is needed than that they are correct. This was a point Hegel made again and again in different ways. In order for an idea to be important in a society it needs employees and buildings, training programmes and legal advisors, Institutions allow for the scale of time that big projects need – much longer than the maturity of one individual.

The essential function of an institution is to make the major truths powerful in society. (And an institution loses its way when it stops having a profound mission). So, as new needs of a society get recognised they should, ideally, lead to the formation of new institutions.

Nowadays, we might say we need major new institutions to focus on relationships, consumer education, career choice, mood management and how to bring up less damaged children.

I would add to the last point that we need new institutions to facilitate better daily living. This is the scale that affects us the most; the scale where we should spend nearly all of our time and attention.

In particular, the local political institutions that exist today evolved in circumstances 200-300 years ago:

"We are 21st-century citizens doing our very best to interact with 19th century-designed institutions built with an information technology of the 15th century. It is up to us to design the political and economic systems for the internet generation."

Pia Mancini - How to Upgrade Democracy for the Internet Era

Not only that, but our institutions must be designed with the expectation that the rate of change in the world will only continue to accelerate.

I spend a lot of time thinking about what these institutions might look like, so follow along for more thoughts on that.

Until next time,

Joel