Siting bank branches

Some ask where is a bank branch; I ask why is a bank branch.

The humble bank branch. You’ve probably been in one before. You might not realize that that forward deployment of banking capital represented a multi-million dollar commitment to almost a century of service. For an institution which touches most people, particularly in the middle class and above, they’re poorly understood.

As it turns out, my father Jim McKenzie spent most of his career doing real estate acquisitions in the Chicago area. I remembered many of the recurring characters in his dinner table stories to be bank branches, so I had a chat with him about it over my family vacation. He then replied with the sort of fatherly enthusiasm only possible when your son finally takes up the family business of negotiating curb cuts with the Illinois Department of Transportation for suburban Chicago bank branches.

The below is my understanding of his experience, with a bit of color from me on the inside-the-financial-industry point of view. All mistakes are, as always, my own. I work for Stripe, which does not endorse what I write for myself.

Bank branches as privately funded public financial infrastructure

A recurring theme of this column is that banks are privately funded public infrastructure. Bank branches continue this trend.

The typical bank branch, and for here we’ll concern ourselves mostly with full-service bank branches of large institutions since they dominate the amount of new branches in most years, is a complex outsourced real estate transaction followed by bespoke development, funded by both the bank and external investors. Let’s break this transaction into parts.

First, after the scale of community banks, branches are no longer one-off projects. Banks think in terms of branch networks, where the value of the network is greater than the sum of the parts, and then work backwards from that to a spreadsheet with rows for individual branches. The magic jargon word for this in real estate is footprint; this covers both the actual sites, their serviced areas, and the demographics and business opportunities in the relevant commute corridors. We’ll see those concepts return in a moment.

So when a large bank wants to expand its footprint in, without loss of generality, Chicago, they have exactly two options. One is to buy an existing bank with an existing branch footprint and local customer base, and indeed the large national banks grew to their current size by buying many smaller banks over the years. The second one is to kick off multiple parallel real estate acquisition and development projects.

Banks, like most large firms with brick-and-mortar presences, have real estate departments but lack the internal infrastructure to entirely acquire and develop properties. Few bank employees swing hammers or wire structures for a living. Instead, they work with local real estate developers to either identify sites or get sites pitched to the bank.

The ideal branch site

“The ideal branch is in an upper middle-class neighborhood on a corner of Main Street and Main Street”, said my dad. (About which, more later.)

Why on a corner? In commercial real estate (CRE), the world is split into destination locations—places you’d leave your house or office to go to—and Everywhere Else. Think of the last few times you made the decision to leave your house and what caused you to leave. Medical checkup? Grocery shopping? Fancy dinner with the spouse at that restaurant with rave reviews on Yelp? All of those are destinations.

Bank branches are not destinations. Like Starbucks and cell phone shops, they rely on capturing your day-to-day custom when you’re out and about. In the U.S., that mostly means being maximally accessible by cars. (In Japan, and other places with different transit behavior, bank branches are among the most likely user for large parcels directly adjacent to hub train stations, with smaller light branches and ATM-only locations being deployed close to far-from-station workplaces.)

The dominant understanding in the financial industry is that customers choose their main bank due to convenience, with convenience being defined as “close to home, close to work, or (ideally) on the commute corridor between the two.” If you work in commercial real estate, you develop a fascination with the SimCity-like logic of commute corridors and which corners collect what type of worker as the exit which neighborhoods. (A corner has twice as many roads fronting it as a non-corner property and therefore sees many approximately twice as many cars and many, many more slow cars than a non-corner on either of the two streets.)

Banks can substantiate, with voluminous data, that banking relationships are very sticky. I covered this previously and won't repeat it here.

The economics of banking suggest spending generously to capture sticky business, particularly sticky business that will grow. This is one reason they spend tens of billions of dollars a year on advertising. The branch network is an extension of advertising, sometimes extremely literally; there are branches which exist for no purpose other than “had a city-approved large billboard adjacent to a thoroughfare with hundreds of thousands of desirable commuters daily.” The bank built the branch and staffed it with about half a dozen professionals as the cost of being able to put their logo on the billboard for half a century.

Branches are expensive

In general, bank branches are new construction, because banks have functional requirements that few other businesses have.

You might think “Aha, they have security concerns and need a vault. How many commercial spaces have drill-proof rooms in them?”, and if you think that you are creative but not well-calibrated. Physical security drives surprisingly few decisions about bank branches; vaults have gone from the defining feature of a bank to a bit of an anachronism.

The things which a bank needs which are difficult to retrofit into a space that was previously a dentist office are numerous. One example is “a drive-through window with, ideally, a specialized pneumatic system for conveying cash and documents between the customer and the teller”, for many deployments. (You’d think that ATMs would have largely obviated the utility of these, but the businesses which build and service them remain extremely healthy.)

Another example is parking. Banks have extremely weird behaviors by the standards of parking engineers; the typical user behavior is to stop in for only a few minutes but the behavior the bank wants to optimize for, new account opening, can take half an hour to several hours. Through what turns out to be a simple result of queuing theory, bank branches end up with a lot of parking that appears mostly underutilized almost all of the time, and this is close to optimal.

Most retail users don't have this characteristic and so don't calibrate their parking in this fashion. A sitdown restauraunt will want their parking almost saturated on Saturday night (or cars are outcompeting tables). A dry cleaner with hundreds of weekly customers might only need two or three parking spaces.

A physical location that has been a bank branch is poorly calibrated for other users and vice versa.

Bank branches are expensive; the construction of a full-service branch, though it will vary based on size and location, runs roughly $20 million. They also represent an enormous future commitment, because banks largely lease rather than own.

Financing branches

The typical bank branch sits on land the bank has leased from a real estate developer, and the most typical terms are a 20 year lease with a combined 75 year option. This means, decoding from CREease, that the bank is obligated to pay for 20 years of rent and then gets to extend the period it can use a site up to 55 years after that. There is substantial variability in contracts and terms beyond those two.

Why don’t banks own branches? In part, this is part of optimizing the bank’s capital stack. If banks owned branches outright, this would tend to increase the amount of not-directly-productive assets they require to operate a given level of business; this would need to be financed with the bank’s cost of capital. Whether CRE operators or banks have a lower cost of capital is an interesting deep dive which depends heavily on, among other things, marginal regulatory guidance on funding sources.

A larger reason is that, because banks intentionally site branches in neighborhoods that they think are on the up-and-up, and because real estate represents an essentially permanent revenue stream of rents, current owners of up-and-coming land do not generally want to sell it to banks at prices that the banks would accept. A lease represents a trade; the bank believes that this parcel is a great branch on a 20-to-75 year timescale but also that the current owner overvalues it over the 76th through infinite years.

As a result, when you dig into bank filings, you’ll often see the properties they actually own have been in the business for (sometimes) centuries, represent flagship locations like headquarters, or had interesting quirks in the deals which resulted in them coming under bank ownership. The typical branch you’d walk into in Chicago has the land, and more rarely the building, owned by a real estate firm you’ve never heard of.

Prices are prices and are difficult to generalize about, but the right ballpark to think of for the price of leasing a full-service bank branch in Chicago (and many American metropolitan areas) is about $1 million per year. This is on top of $20 million or so in build-out costs.

Value add in commercial real estate development

What value do real estate firms bring to the table? Because bank branches are economic infrastructure and because banks are incentivized to predict (and influence!) the future trajectory of neighborhoods, they are often deployed in advance of a neighborhood or site being “ready” to host a high-traffic commercial location. This implies a diverse range of skill sets.

One of them is micropolitical action. The politics of zoning in America would fill several books, and they are often intensely local. Banks lack the block-by-block context of characters at village meetings and key decisionmakers, particularly for areas which are newly coming into their footprint. They also are extremely sensitive to the dynamics of banks interacting directly with public servants to get their preferred commercial outcomes.

Thus developers end up doing this. Part of the political action is as simple as showing up to the process; real estate developers attend village meetings about zoning decisions more frequently than almost any other profession. It is, after all, literally their job.

Part is about making arguments to stakeholders about land use policy. “If you approved the addition of a bank at this corner, the village would get a steady stream of taxes guaranteed for 20 to 75 years, where many other commercial tenants might or might not survive a shorter lease. Do you have any infrastructure improvements you want guaranteed funding of?”

Part is outsourced project management. The product a bank is buying is a colorful candy shell to conduct the business of banking in; everything outside that shell is someone else’s job. A fascinating detail about this is that your corner location in prime real estate requires curb cuts.

A curb cut is authority granted to you by the owner of the road (often the state government) to make a physical change to your property and the road to allow customers access. Curb cuts alter the properties of traffic management at a block-by-block engineering level. More cuts along a particular road tends to decrease the rate at which traffic flows through it; this ripples through the network and is therefore often very intentionally designed. The (without loss of generality) Illinois Department of Transportation has engineers who are responsible for individually reviewing and potentially approving curb cuts.

These decisions are some mix of the deterministic engineer-applies-written-rules-designed-to-ensure-even-application-of-the-law and politics at its most concrete and raw. The engineer making a decision on a curb cut has a boss, who has a boss, who has a boss, who eventually depends on the good graces of various elected officials. A bank branch is dead on arrival—it cannot be made—without approved high-quality curb cuts. (What makes a high quality versus a low quality curb cut? It comes down to everything from whether the angle a customer would need to turn at is subjectively an easy one to do at speed to factors like “is the physical cut large enough to accommodate the typical vehicle for this branch’s customer base.” I love the fractal nature of detail here; every detail about the built world was a painstakingly made decision at some point.)

Sometimes getting a high quality curb cut means identifying political leaders in, without loss of generality, Springfield and engaging with lobbyists with the intent of having those leaders make a quick call to the Department of Transportation to suggest that a senior official have a quick call with an engineer and suggest they review plans again with a more… persuadable eye.

Phrased like this, the process can sometimes sound corrupt, and a lifetime of hearing about retail politics conducted in Chicago makes it difficult for me to entirely deny that. But for the record, sometimes lobbying means bringing local knowledge to the attention of people who are poised to make decisions based on it. For example, you could tell a political leader that a particular neighborhood with their constituency in it is underserved by the financial industry and that you are one curb cut away from improving that.

Bank siting is not a free choice

McDonalds has almost free reign under capitalism to site new McDonalds franchises at any corner they want to. Banks do not.

Because banks are expected from society to operate as public infrastructure in addition to operating as profit-seeking businesses, in return for privileges society grants to them that are not available to other businesses, regulators and lawmakers care a lot about where bank branches are and aren’t. Branches serve neighborhoods; neighborhoods without branches lack access to credit and other valuable banking services.

One formal lever for this is the Community Reinvestment Act, but less formal pressure from state or federal banking regulators also heavily informs siting decisions. If a large bank consistently applies only for permission to open branches in upper middle-class neighborhoods, which is often optimal for the bank, they will draw negative attention from their regulators.

The culture that is branch banking

Because access to bank branches brings cash management and credit availability into a community, society cares a great deal about whether that access is available. But how does one measure access?

One way, often used regarding so-called food deserts, is to drop pins on the map representing consequential retail locations, draw a circle around them, and count who is and is not within one of the circles using census data. This is fairly naive and therefore is much beloved of social scientists, who can get grad students to do it for them.

Some people in society have to actually be right about what they publish, and they have developed an important novel insight into human behavior: people cannot fly. And so banks long ago supplemented the radius method with painstaking work looking at road networks to see whether someone is within e.g. 1 mile of a bank branch using available and convenient transportation routes, and to calculate the expected catchment areas of candidate sites for new branches.

All models are wrong; some are useful. It turns out that this is a better approximation for user behavior, but people do not strictly optimize for distance in banking, even though industry often believed convenience trumped most other considerations.

A man named John Melaniphy, since deceased, did some groundbreaking work that industry would call user research and that academia might call ethnography. He and his team interviewed thousands of people about how they actually chose which bank branches to drive to.

They found out that there are truths evident on maps which distances do not full capture which influence customer behavior. One, extremely relevant in Chicagoland and having no rational explanation, is that users prefer not to drive through forest preserves on the way to their bank branch; they’ll go substantially out of their way to avoid mixing greenery with their money.

Another is that bank customers feel a strong sense of identification with neighborhoods. Bank branches are, by law and practice, open to the general public. While there are occasionally residency restrictions in whether they’ll open an account for you, typically a bank branch will allow you to open an account if you live anywhere inside the bank’s footprint, at a county-by-county or metro-by-metro level of resolution. I, for example, easily opened a bank account in San Francisco with an address in Chicago just by walking into the local instance of a large national bank; that wasn’t even odd for them.

Bank customers do not feel this is true. They will avoid using a bank branch a block away from their house or workplace if it crosses a neighborhood boundary. People familiar with the microgeography of Chicago can probably guess individual roads where there are somewhat rational and somewhat unfortunate reasons for that reluctance, but this turns out to generalize even between neighborhoods that are very similar in character/demographics/etc.

And of course, the community boundaries that live in people’s heads are not always the ones which are drawn on maps. This complicates Seeing Like A Financial Institution (or regulator), because bureaucratic processes often assume that the map is in fact the territory. One of the reasons large banks with national presences tap local real estate firms is specifically to understand available but opaque local knowledge.

What’s an example of this sort of knowledge? To use one from my current stomping grounds in Tokyo, Aobadai and Nakameguro are adjacent to each other but since Aobadai doesn’t have a train station people living in it frequently identify with Nakameguro (which does) but perhaps counterintuitively not with Daikanyama. Daikanyama station is almost the same distance but the hill up to it is a steep walk or bike ride. You would (mostly correctly) predict that the (generally well-off) people who live in Aobadai bank in Nakameguro and not in Daikanyama, but it would be difficult to guess that from most non-topographic maps of Tokyo.

Now imagine how fun this gets when you mix in factors like “Some customers in Chicago are acutely sensitive to what parish they are in”, “This community has substantial oral lore about a turf war between two gangs which no longer exist and people still avoid crossing that imaginary undeclared illicit boundary if they can avoid it”, and similar.

Does this even matter?

Many technically inclined people would say that this is interesting historical context but that banking happens on phones these days. The financial industry would, as discussed previously, fire back that many account services happen on phones (and they are enthusiastically in favor of transitioning more towards mobile and web channels) but that a large portion of their depositors and an even larger fraction of their deposited dollars are acutely sensitive to the availability of their local branch.

We’ll talk later about some of the fascinating hybridization of service which the industry has experimented with, which received a major accelerant when many branches were forced to temporarily close or limit services during the global pandemic.