Developer size and development patterns

Earlier this week I attended an Urban Land Institute event about DC’s new development, The Yards on the Anacostia waterfront. This is a 42-acre area which was formerly a manufacturing center for the Navy. In 2003, Forest City Washington purchased the site from the General Services Administration for residential, retail, and office redevelopment. Generally I don’t have strong architectural preferences, but some of the former factories that now have glass curtain walls are looking very cool.

During the presentation, I was reminded of Ronald Coase’s 1937 paper, “The Nature of the Firm.” This paper is about knowledge problems, within and outside of the firm. He explains that firms exist, rather than each worker serving as his own contractor, because firms reduce the transaction costs of contracting for individual projects. However, firms face knowledge problems similar to those that government bureaucracies face:

In economic theory we find that the allocation of factors of production between different uses is determined by the price mechanism. The price of factor A becomes higher in X than in Y. As a result, A moves from Y to X until the difference between the prices in X and Y, except if so far as it compensates for other differential advantages, disappears. Yet in the real world, we find that there are many areas where this does not apply. If a workman moves from department Y to department X, he does not go because of a change in relative prices, but because he is ordered to do so. Those who object to economic planning on the grounds that the problem is solved by price movements can be answered by pointing out that there is planning within our economic system which is quite different from the individual planning mentioned above and which is akin to what is normally called economic planning.

In the case of The Yard, this means that Forest City Washington is saving money on development expenses, likely in large part on negotiations with the city and federal government, and giving up the price system which would better direct firms developing individual parcels to know what their customer want. This tradeoff is represented below. Firms will increase in size until the cost of not being able to rely on the price system is equal to the transaction costs of contracting work out:

During her presentation, Deborah Ratner Salzberg stressed her firm’s objective of creating a “complete neighborhood” with a balance of residential development and a mix of retail to serve tenants, including restaurants,  a grocery store, and soft retail. By one firm developing this entire small neighborhood, they had the advantages of knowing which tenants were likely to sign leases in which buildings and to control the vision for development within one company. However, they were not bidding against other developers to determine the highest-value buildings for each parcel, meaning that planning, rather than the price mechanism, shaped the definition of a “complete neighborhood.”

In a free market, we would expect firms that remain in existence for long periods to do a good job of weighing these tradeoffs, but of course development in DC is not a free market. The entitlement process favors large firms who have the ability to spend the money and time necessary for approvals. In this specific case, the federal government was selling right to develop 5-million square feet as a package, excluding firms who couldn’t make the investment to purchase the entire area.

Perhaps one of the largest drawbacks of large developments is that they tend to take advantage of their ability to lower transaction costs by working with brokers who represent many large tenants, resulting in repetitive development featuring, for example, Chipotle adjacent to Noodles and Co. In the case of The Yards, however, Forest City Washington made an effort to sign leases with local chains such as Vida Fitness and Sweet Green. Do you think it’s easy to recognize when one developer has planned a neighborhood rather than many small developers directed by the invisible hand? Has the entitlement bias toward large firms hurt the creation of complete neighborhoods?