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Keeping it vacant only impact current income, lowering rent impacts future forecasts.
Does it though? Suppose you can't find a tenant right now because the market is soft but is predicted to improve in a few years. If you leave the unit vacant, you lose money right now. If you rent it out with e.g. a 3-year lease, you make more for the next 3 years than you would with a vacancy, and if the market price has increased by then you can increase the rent on the unit and either get it from the current occupant or the one you get to replace them in the high demand market when the higher rent causes the low-paying tenant to not renew the lease.
So taking a tenant now only improves prospects (you fill a current vacancy) with no negative impact on future returns. The only thing it does is imply that current rents are lower than before and future rents might be too, but a vacancy implies that even more strongly.
If my wife and I are at the airport, and the gate agent offers me (and only me) an upgrade on the flight, your logic says I should take it since that's strictly better than both of us flying economy.
Suppose there is a building that was built in 1970, last rented out in 1975 and then bought by a company that has used it as their own offices until now. The last transaction was in 1975, what's the value if they apply for a mortgage today? Surely they have some formula to use for this based on e.g. other buildings in the area.
Moreover, "failure to find a tenant" is also a type of transaction. It's the landlord acting as the high bidder for the space, essentially the involuntary edition of imputed rent, and implies something negative about the financial prospects of the building when it continues for a significant period of time or large percentage of units. Ignoring that it is either incompetence or some kind of perverse incentive.
For who and in what way though? Every entity involved wants to keep the price high, except the renter/new buyer, so with that in mind, "Last Value" seems optimal for achieving that.
Maybe it's different in the US, but in Spain there is a ton of properties that sit completely empty and unused, even since earlier than 2008, just because the owners don't think the value is enough to sell yet, and they wouldn't earn enough renting it out, so everyone (except renters/new buyers) seems to prefer it just sits empty for decades.
There is no escaping the powers of supply and demand.
https://www.investopedia.com/terms/d/dscr.asp
Lower income for the building means lower numerator, which means being unable to meet the agreed upon DSCR, which means default. Whether or not the lender acts on this default is a separate matter, as they are usually loathe to get into the property management business, but renegotiation of terms and eventually foreclosure does happen.
Also foreclosure generally isn't the only option: the borrower could, for example, agree to repay part of the loan early, or give extra collateral, both of which would increase the LTV (and this would be better for the bank).
I'm not saying the explanation is wrong, but I don't blame people for finding it difficult to understand. Other factors contributing to this are probably borrower relationships/negotiating strength and the high costs associated with foreclosing.
The question is, why would they actually do that? The premise is that the landlord has to take out a new mortgage every few years and then the bank won't give them a new one if they're underwater. But that's only true if it's a different bank.
Let's take the same example. Building was expected to be worth $20M, landlord pays $4M down and takes a $16M interest-only mortgage. The only thing the bank ever expected from this was to collect interest on the $16M until it's paid back, which could be never and that's fine as long as they get to keep collecting interest.
Then we find out the building is maybe really only worth $14M. But the landlord is still making the interest payments on the $16M, and over time it will likely become worth more than $16M again due to inflation if nothing else, so why does the bank need to foreclose? The risk that they could "lose $2M" is by that point a sunk cost. It's the thing that happens if they do foreclose (or fail to renew the loan). They'd be calling in the note against an LLC that owns nothing but a building which is now estimated to be worth less than the loan principal. So the obvious thing would be to keep renewing it as long as the landlord continues to make the interest payments.
This feels like some kind of regulatory inefficiency or accounting scam where the bank is listing the mortgage lien as an asset and would have to take a write off if they valued it accurately and therefore transfer their perverse incentive to the landlord to prevent that from happening.
Notice however that doing that also hurts the bank. The landlord is collecting $500k/year at half occupancy, then paying the bank $640k and losing $140k/year to try to avoid the total loss of their $4M initial investment. Maybe they can do that for a year or three but the longer it continues the higher the probability that they run out of money. Whereas if they were collecting the $700k/year from renting out the entire building at lower rents then they could keep paying the bank its $640k/year forever, regardless of whether they're technically underwater. And if the landlord runs out of money then the bank has to take the $2M write off because they get a $14M building instead of collecting interest on a $16M loan. So the bank is really shooting itself in the foot.
I suggest that like the dotcom/2008/AI bubbles, people will just keep dancing and making money until reality catches up and the music stops.
Actual commercial real estate professionals could give you many more reasons than I can
I am so tired of listening to people with little to no experience with commercial real estate try and explain the vacant storefront thing. Maybe this explanation in the article is correct, but it raises more questions than it answers, and it’s unclear why we should trust this person’s explanation.
As described, the landlord can't offer a traditional lease for the actual value of the space.
However, the landlord could offer essentially day rentals without creating a lease. There are systems for this already, such as Peerspace and their ilk, which I've used for small events. I believe these don't trigger the foreclosure clauses.
I think that a property management company managing deeply underwater buildings could play in this, reducing their cost structure by offering day rates. They've often already got a solid NFC entry system. Most of what you need is automated pricing, onboarding and offboarding, and figuring out how you avoid needing physical cleaning/setup/teardown overhead.
And the downside is loads of reasonably successful decent small shops in the UK now have to close after 12-24 months when the rents get jacked-up from sensible to astronomical levels. None of them become permeant tenants unless they are a front for money laundering (hence the explosion of nail bars and barbers on the UK high street) or illegal goods (dodgy vape shops).
https://www.bbc.co.uk/news/articles/cqj1rkqqrgro
Your local press (if yours still exists) will also be full of such stories.
I've seen companies provide some moveable furniture in a space like this - some desks, some extension cords - but it has to be up to the temporary user to configure and put things away when they're done.
I don’t enjoy dealing with property management or the fees they charge.
>> If the system allows you to pretend that the vacancy is temporary, why doesn’t it allow you to lower rents on the pretense that lower rents are also temporary?
> This does happen sometimes: it’s packaged as “incentive offers,” like 50% off the first 12 or 24 months rent, or 6 months without rent, etc, that lower the average rent over the life of the lease without lowering the “list price.” That’s common in residential leases, and I know it happens sometimes in commercial leases, but I don’t know how prevalent it is.
So as a blind guess, it probably depends on how legal incentive offers are. The axis being optimised here will be what the regulatory bodies can tolerate before they start handing out fines and punishments.
Could the situation be improved then if financial regulators started treating both versions ("temporary" vacancy / "temporarily" lowered rent) equally? Tolerate both or crack down on both.
> The obvious thing cities could try is to put more pressure on building operators to fill their spaces, but the building operators are already under a ton of pressure — they’re losing a bunch of money! So, cities could do something like put a vacant storefront tax and… make them lose even more money? If that “worked,” the mechanism would be to force a lot of commercial property to default, which could put a lot of new space on the market at lower prices, which should lower the commercial rent. But it would also hurt the banks a lot, which has a history of leading to bad consequences and subsequent bailouts.
I agree that this is the obvious remedy. I don't know if it's exactly the right answer, but it's the natural place to start the conversation, and I think it's at least in the ballpark of the right solution. It's the city (and bigger) government's job to create policies that incentivize the right behaviors for the benefit of the community. There clearly has been an oversight here, if extremely valuable commercial properties are literally just sitting unused for no good reason. In my opinion we'd all be better off if the market did correct itself, at least getting us all on the same page about what these properties are actually worth, rather than the current situation.
The city stepping in also helps put the fuckup back in the right place, in the hands of the property owners and lenders who seem to have made these bad bets, rather than externalized to the residents and business owners of the city, who haven't done anything wrong. The article suggests that this leads to "bad consequences" and even bank bailouts, but I'm pretty unconvinced that the problem is widespread enough that the federal government would literally need to start bailing out banks. From what I've seen, it's really bad in a few specific metro areas and not so much in others.
It also does look like San Francisco has a vacant storefront tax although the penalties are fairly light.
https://abc7news.com/post/remember-vacant-storefront-tax-san...
The "solution" is that you should have to pay tax on what you claim the rent is after a small grace period (Less than 24 months certainly. Probably less than 12 or at least prorated starting before that.).
If your financial agreement requires and claims that the rent is $5000, no problem! Then the tax authority should expect to receive the tax revenue they would expect if someone was actually paying $5,000 in rent to you. If you want to leave the space vacant even after paying the tax on the revenue--have a blast.
That would short circuit all the financialization shenanigans.
For example, "Big Pink" is an office tower in downtown Portland. It's last sale was for about $370 million. Out of desperation in a saturated market, the owners sold it last year for about $45 million. No one - the owners, the city, or the citizens - wants to have the vicious downturn of values, and there is no easy solution. Adding a vacancy tax just exacerbates the problem.
So it's a choice between honesty and profit towards investors ...
Oh and obviously the "solution" is waiting for inflation to change the price of the rent effectively. So the real fix is for government to take the initiative and start paying people (by now, a lot) more.
> Half empty, the building is only generating $500k per year in net income instead of $1M.
> Let’s imagine the owner lowers the rent by 30% to fill the building.
> Now, reality has proven the operator can only make $700k per year.
No. When the building sat half empty, reality had already proven that it could not generate what they thought it could.
This is the insane fallacy driving this whole thing, and no amount of explanations about commercial mortgages will prove anything other than that a larger number of people than we thought are participating in the same delusion. If you cannot rent the space for what you thought it could rent for, your building is already worth less than you thought, and it is sheer folly to think that you can alter that fact by pretending you are waiting for higher rent later.
> So, cities could do something like put a vacant storefront tax and… make them lose even more money? If that “worked,” the mechanism would be to force a lot of commercial property to default, which could put a lot of new space on the market at lower prices, which should lower the commercial rent. But it would also hurt the banks a lot, which has a history of leading to bad consequences and subsequent bailouts.
There is another problem. What we need is to dig deeper into that theory and push harder and harder for solutions where all the financial loss gets pushed onto the people at the top who have a lot of money. If the banks are making money off this kind of nonsense then they should fail.
> I’ll give this some more thought, but if any actual commercial real estate professionals have ideas I’d love to hear from you in the comments!
No! Commercial real estate professionals are mostly just more people buying into these same fallacies! What we need is more people outside that self-deluding system saying "this is nuts, I'm taking $100 million from you" and resetting the entire system.
Congratulations, you have just described high finance.
https://mises.org/mises-daily/children-and-rights