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Musings Report 2019-29 7-20-19 Main Street Small Business on the Precipice
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Main Street Small Business on the Precipice
As a generality, I think it's fair to say the average employee (including the nation's punditry) has no real experience or understanding of what it takes to start and operate a small business in the U.S.
Government employees in the agencies that oversee and enforce regulations on small businesses also generally lack any experience in the businesses they regulate.
A third generality is the constantly promoted ethos of entrepreneurism cultivates the illusion that there is an essentially endless supply of entrepreneurs who are itching to start businesses and throw everything they have into the risky gamble.
The reality is very few people have the drive, risk appetite, capital and experience needed to start and operate a small business. Once this pool of people has been exhausted or bankrupted, the number of small business start-ups plummets and does not recover.
Another reality is a great many bricks-and-mortar Main Street businesses are on the precipice of closing.
There are two primary drivers of this systemic vulnerability:
1. Costs are rising far faster than enterprises' ability to raise prices for the goods and services they sell
2. Wages and salaries (earned income) has stagnated for the past 20 years for the lower 95% of households while costs of big-ticket expenses such as rent, healthcare, college, childcare and government services and taxes have risen sharply.
This leaves less discretionary income available to spend on non-essentials.
Simply put, small business expenses are rising while their customers' stagnating income means there is little leeway to raise prices. Small business is in a vise.
There's another dynamic in bricks-and-mortar businesses that must rent commercial space. The bubble in real estate valuations has spread to commercial real estate in many if not most urban areas, but certainly in every urban area with a vibrant job market--exactly the sort of place that attracts those willing to start a new business.
If a retail building was worth $1 million 20 years ago, and now it sells for $3 million, the new owners naturally expect rents to cover all expenses and yield a 5% return on their investment.
The new owners don't think of themselves as greedy; a 5% return on capital is conservative.
The higher price doesn't just increase the size of the mortgage and the monthly payments; it also increases the property taxes due. Since the fees for government services are soaring (business licenses, permits, etc.), these costs have also increased sharply.
For the investment to pencil out for the new owner who paid $3 million for the building, the rent for each space has to triple from $1,00 a month to $3,000 a month.
How many small businesses can afford a doubling or tripling of rent? Since wages, healthcare, licenses, permits, etc. have increased dramatically while the ability to raise prices has been constrained, many small businesses can't afford even a 50% increase in rent, never mind 200%.
(Note on interest rates: even if the interest rate on the commercial-property mortgages has declined a bit, that doesn't offset the much larger principal payment required since the mortgage tripled in size, nor does it reduce the property taxes or other fixed costs. In other words, the mortgage-interest part of the owners' monthly expenses is not the primary expense.)
Now let's factor in a recession or slowdown, a period of consumer belt-tightening that causes revenues to drop.
A great many Main Street businesses paying market rents are only making money in the very best of times. Any slowdown, however modest, pushes them into the red.
If they expect revenues to pick up in a month or two, small business owners will absorb losses, cut the hours of employees, work longer hours themselves, etc. But if the revenues don't recover while expenses click higher, the entrepreneur eventually has no choice: either close down now or go broke via the drip of monthly losses.
Once the slowdown is undeniable, no one with any moxie is going to step up and pay current market rent on the vacant space. The inexperienced souls who try their hand in the new space will be bankrupted in a matter of months by the high rent.
The building owners are loathe to drop the rent from $3,000 a month to $2,800, much less to $2,000 a month. Yet the reality is that no small business can afford more than $1,000 a month. As for corporate tenants: Corporate America is reducing its bricks-and-mortar outlets, not increasing them.
The owners are caught in their own vise: they need rents close to $3,000/month to cover their expenses,and so dropping rents to what small businesses can afford will result in horrendous monthly losses. But leaving the spaces vacant is causing losses, too.
The only way out is to default on the mortgage and abandon the building to the lender, who then faces enormous losses because the building is no longer worth $3 million since rents have crashed.
Neither the commercial building owners nor the small business tenants have any wiggle room. The only alternative to increasing losses each has is to close down the business / sell the building for a huge loss or default on the mortgage.
All the increasing costs are famously sticky: wages don't go down, healthcare costs don't go down, city fees don't go down, and rent goes down only grudgingly, in increments too small to save small businesses operating in the red.
And since the pool of experienced entrepreneurs is small (and shrinking as people burn out, go bankrupt, retire, etc.), the empty storefronts will stay empty for a long, long time--until rents drop back to levels that enable small businesses to make a profit in recessionary times.
Nobody wants to see building valuations decline by 2/3 or more: cities, lenders and investors all want valuations to notch higher or at least remain stable. But bubble-era valuations lead to rents that are completely unaffordable, so small businesses will close, resulting in the rental income dropping to $0 per month.
Since all the costs are sticky and expectations are wildly unrealistic, there is no painless way forward.
Small businesses on the precipice need only one small shove to go over the edge, and there won't be replacements filling the fast-multiplying empty storefronts.
Highlights of the Blog This Past Week
The Planetary Insanity of Eternal Economic Growth 7/19/19
The Three Ds of Doom: Debt, Default, Depression 7/17/19
Epstein and the Explosive Crisis of the Deep State 7/15/19
Best Thing That Happened To Me This Week
6 a.m. breakfast with GFB, friend for almost 50 years.
Musings on the Economy: Do Global Capital Flows Favor the U.S.?
Martin Armstrong, among others, believes private-sector assets such as stocks and real estate in the U.S. will continue lofting higher--much higher--as capital flees the troubled economies of the EU, China, Japan, et al. and seeks the relative safety of the U.S. dollar and U.S. assets.
Armstrong says that as these economies weaken and the risks increase, the owners/managers of large-scale capital will increasingly want to secure capital rather than worry about a yield.
In other words, the key driver of investment decisions will be "hoarding liquidity," i.e. being able to invest $100 in an asset and being able to sell the asset later and getting the $100 returned in full.
This may be part of why precious metals are soaring: if money managers care more about preserving capital than earning a high yield, they pull money out of risky assets and seek liquid safe-haven assets.
This would also explain why the yields on U.S. Treasuries has plummeted: demand for Treasuries has been strong enough to push yields lower.
But there are cross-currents in this story. WSJ.com reported that Foreign Buying of U.S. Homes Suffers Record Drop.
Some governments (China for example) are already imposing capital controls to restrict the flow of capital out of their economies.
The extraordinary expansion of global money and credit has created a pool of $300 trillion in financial assets, all of which are seeking low-risk returns and/or safe liquidity havens. Where this pool of capital sloshing around ends up will eventually matter.
From Left Field
A Long & Undeclared Emergency: Prakash’s book is the latest to clarify that many of India’s political and social pathologies...
I Help People Cheat Their Way to Getting PhDs: I've written dozens of papers, including dissertations, for people with fancy titles in prestigious fields. One reason why the entire world is over-credentialed....
The Fall and Rise of Racket Capitalism -- revisiting Ricardo
Burned out? You’re not alone. And the world is finally paying attention.
Requiem For The ‘Living Dead’: Ten Years After 7-5: July 5, 2009, is a date that forever changed the course of Xinjiang history. The lives of Uyghurs in China have never been the same.
$5.5 Million Homes in New York, Illinois and Missouri. -- all overpriced...
The Disillusion and Frustration of a New Generation is Fueling Hong Kong’s Protests
I Used Google Ads for Social Engineering. It Worked. (via Mark J.) Ad campaigns that manipulate searchers’ behavior are frighteningly easy for anyone to run.
Organic Growth Dead, Growth Now A Centrally Engineered Synthetic.
Going on vacation won’t cure your burnout. -- it might even increase it....
How Jeffrey Epstein Made His Money: Four Wild Theories -- blackmail seems plausible....
While Westminster bluffs and blusters, a UK recession looms -- sharp-tongued critique....
"To think is easy. To act is hard. But the hardest thing in the world is to act in accordance with your thinking." Johann Wolfgang von Goethe
Thanks for reading--
charles |
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