Why do commercial spaces sit vacant?(archive.strongtowns.org)
archive.strongtowns.org
Why do commercial spaces sit vacant?
https://archive.strongtowns.org/journal/2025/5/21/why-do-commercial-spaces-sit-vacant
150 comments
I’d support a land value tax myself so don’t take this following comment as criticism, but you don’t even need a land value tax in the case of LA. You do need to repeal Prop 13 for investment properties. I wager most of those years-vacant properties have a generous Prop 13 assessment and so the owner can just sit on it because their carrying cost is closer to zero than what it would be in any other tax regime. Then all of us folks around them continue to make the adjacent area nicer and they just ride off into the sunset while the absurd delta between their taxable value and market value increases.
Prop 13 is like the anti land value tax. Makes places like Texas look downright progressive.
Prop 13 is like the anti land value tax. Makes places like Texas look downright progressive.
We were very close to repealing Prop 13 on commercial property a few years ago (via Prop 15).
One of the biggest objections to a straight repeal Prop 13 on commercial property is that most commercial leases are triple-net, meaning that the businesses directly pay the taxes. Which means that a bunch of small businesses that are just barely on the edge of profitability will shut down when they finally have to pay their fair share of property tax.
Agreed on the need to do it though (and also Texas typically has higher taxes for a normal person, with worse services than California). We might just want to pass a gradual phase in or a requirement that landowners pay it without increasing rent )and doing reach through to modify all those triple net leases... or something. Or we just let the businesses fail, but the public tends to not like lots of small businesses failing.
One of the biggest objections to a straight repeal Prop 13 on commercial property is that most commercial leases are triple-net, meaning that the businesses directly pay the taxes. Which means that a bunch of small businesses that are just barely on the edge of profitability will shut down when they finally have to pay their fair share of property tax.
Agreed on the need to do it though (and also Texas typically has higher taxes for a normal person, with worse services than California). We might just want to pass a gradual phase in or a requirement that landowners pay it without increasing rent )and doing reach through to modify all those triple net leases... or something. Or we just let the businesses fail, but the public tends to not like lots of small businesses failing.
The inability to pay a high tax increase constantly comes up in discussions on Prop 13, and it seems like a willful failure to find a solution.
For personal property, raise the taxes, and give the home owner the option to defer the raise as a lien against the property, accruing fair interest. Nobody gets kicked out of their home, and the taxes get paid when the home is sold. If it is inherited, then the inheritors will have to increase their taxes paid at least so that the lien amount no longer increases relative to the home value.
For commercial property, cap the property tax paid by the lease-holder to the historic rate + a several percent growth to gradually meet the current tax bill. The rest of the tax becomes a lien on the property to be paid on sale, with forced payment increases if the lien to value ratio becomes too large. It would be up to the property owner whether they pay the additional tax or take it as a lien. Ultimately, commercial prop 13 was a mistake, and businesses that can't compete on a level playing field need to be gradually pressured to improve profitability or make the space available to someone that can.
Edit: one more thing that people seem to forget is that if we repeal Prop 13, we can reduce the property tax rate and keep the same tax income. So the unpayable increase is much more affordable than a naive analysis would suggest.
For personal property, raise the taxes, and give the home owner the option to defer the raise as a lien against the property, accruing fair interest. Nobody gets kicked out of their home, and the taxes get paid when the home is sold. If it is inherited, then the inheritors will have to increase their taxes paid at least so that the lien amount no longer increases relative to the home value.
For commercial property, cap the property tax paid by the lease-holder to the historic rate + a several percent growth to gradually meet the current tax bill. The rest of the tax becomes a lien on the property to be paid on sale, with forced payment increases if the lien to value ratio becomes too large. It would be up to the property owner whether they pay the additional tax or take it as a lien. Ultimately, commercial prop 13 was a mistake, and businesses that can't compete on a level playing field need to be gradually pressured to improve profitability or make the space available to someone that can.
Edit: one more thing that people seem to forget is that if we repeal Prop 13, we can reduce the property tax rate and keep the same tax income. So the unpayable increase is much more affordable than a naive analysis would suggest.
Yeah, I feel like the yimby's are going to take another run at repealing it for investment properties (5+ units of multifamily and all of commercially-zoned property) and it stands a much greater chance of passing the next time because of how close it was last time. The messaging will be much sharper.
Re your NNN comment, would you mind sharing a source for that? My gut says it's not accurate, but happy to be proven wrong. If you meant total square footage of leased space, that would make more sense, but having a hard time believing most leases are NNN (and since your point was about businesses going under what I think matters is the number of leases because (a bit over-simplified) 1 lease = 1 business regardless of the square footage leased by the business.
The ironic thing about this whole topic of businesses going under is that there's no rent control, for the most part, for businesses and yet Prop 13 acts as rent control (i.e., carried cost control) for landlords. If the landlords only charged the market rent that was achievable at the time they bought the property with a nominal capped annual increase that'd be pretty good for operating businesses, just not for the landlord's real estate business.
P.s. I personally benefit from Prop 13 and would be happy to have its market-distorting bullshit eliminated!
Re your NNN comment, would you mind sharing a source for that? My gut says it's not accurate, but happy to be proven wrong. If you meant total square footage of leased space, that would make more sense, but having a hard time believing most leases are NNN (and since your point was about businesses going under what I think matters is the number of leases because (a bit over-simplified) 1 lease = 1 business regardless of the square footage leased by the business.
The ironic thing about this whole topic of businesses going under is that there's no rent control, for the most part, for businesses and yet Prop 13 acts as rent control (i.e., carried cost control) for landlords. If the landlords only charged the market rent that was achievable at the time they bought the property with a nominal capped annual increase that'd be pretty good for operating businesses, just not for the landlord's real estate business.
P.s. I personally benefit from Prop 13 and would be happy to have its market-distorting bullshit eliminated!
> We might just want to pass a gradual phase in
You could probably adjust the annual percentage increase and find a balance between pre-prop13 problems of rapidly increasing property tax and the post-prop13 problems of significant gap between capped assessment and actual value.
Probably also need to do something about transfers via holding companies as well, since there's a ton of commercial properties that have never had their assessment cap reset because of the way the beneficial holding rules apply to corporations. OTOH, if the capped assessment grows at something like 5% per year, maybe it can catch up soon enough anyway.
You could probably adjust the annual percentage increase and find a balance between pre-prop13 problems of rapidly increasing property tax and the post-prop13 problems of significant gap between capped assessment and actual value.
Probably also need to do something about transfers via holding companies as well, since there's a ton of commercial properties that have never had their assessment cap reset because of the way the beneficial holding rules apply to corporations. OTOH, if the capped assessment grows at something like 5% per year, maybe it can catch up soon enough anyway.
What is the limiting principle here?
You note that a bunch of small business just won't be viable if you up the taxes, but you agree on the need to do it. So do you just keep upping the taxes until nothing is profitable except giant soulless corporations (who will then probably subvert the tax system anyway)?
You note that a bunch of small business just won't be viable if you up the taxes, but you agree on the need to do it. So do you just keep upping the taxes until nothing is profitable except giant soulless corporations (who will then probably subvert the tax system anyway)?
Profitability doesn't only come from large corporations. And it's likely that many large corporations would shut down businesses too if it impacted them.
The limit is that if no other more profitable business exists, the landlord lowers rent until they get some one. But that's often a multi year discovery process. And it's very likely that person will be some other small business that wouldn't have had a chance if the same spot was occupied.
It's hard to overstate just how much the random subsidy is for Prop 13 taxes; there is literally a 20x difference purely based on when a property was purchased or a building was built. This leads to very poor and inefficient allocation of real estate to businesses.
The limit is that if no other more profitable business exists, the landlord lowers rent until they get some one. But that's often a multi year discovery process. And it's very likely that person will be some other small business that wouldn't have had a chance if the same spot was occupied.
It's hard to overstate just how much the random subsidy is for Prop 13 taxes; there is literally a 20x difference purely based on when a property was purchased or a building was built. This leads to very poor and inefficient allocation of real estate to businesses.
We need to repeal Prop 13 completely. The fact that my neighbors pay 1/10th the property tax that I do, despite being younger and less at risk of being forced out of their home due to going fixed income or some financial crisis, is absurd.
Doing that would be good policy but bad politics. The people it would hurt the worst are the ones who vote most (older people) and the people most responsible for cities being the way they are (people who have lived in one spot a long time). So it's unlikely to directly happen, for that reason.
Piecemeal reform is much easier to swallow. Especially if you start with something like commercial properties, and especially since the increased income that results can be used to create tangible community improvements.
So even if your ultimate goal is full repeal, the correct strategy to make that come about is piecemeal reform, and pushing for a full repeal is counterproductive to that happening.
Piecemeal reform is much easier to swallow. Especially if you start with something like commercial properties, and especially since the increased income that results can be used to create tangible community improvements.
So even if your ultimate goal is full repeal, the correct strategy to make that come about is piecemeal reform, and pushing for a full repeal is counterproductive to that happening.
Prop 13 passed originally as a taxpayer revolt against uncontrolled spending increases by local governments. I agree that reform is needed but I'll only support changes if they maintain some sort of reasonable revenue limits on local governments. Otherwise the money will just be wasted giving fat raises to public employees.
I'm a former (i.e. not irrelevant to the question) Californian who also thinks Prop 13 should be repealed, and am probably supportive of LVT;
Can you walk through the scenario that younger neighbors pay a tech of the property tax you do? Are they legacies and benefiting from some sort of inherited trust or something?
Can you walk through the scenario that younger neighbors pay a tech of the property tax you do? Are they legacies and benefiting from some sort of inherited trust or something?
Not OP, but it's probably about inheritance rules. If you inherit a property then you inherit its tax basis. In fact, if I remember correctly, you inherit the tax basis, but the capital gains basis resets. You effectively inherit a property that has a low property tax, but face zero capital gains if you turn around and sell it.
All of this is subject to limits and rules and stuff. I think prop 19 made it so that you have to use it for your primary residence for the first year. And I think there's a cap on the difference between property value and tax basis of ~$1m.
All of this is subject to limits and rules and stuff. I think prop 19 made it so that you have to use it for your primary residence for the first year. And I think there's a cap on the difference between property value and tax basis of ~$1m.
That's a soft cap, you get the full benefit if the value difference is up to $1m (in 2021, adjusted biennally for inflation since) or less, and if its greater you get the amount of value increase beyond the limit is added at full value (but the amount below the limit is still waived) in setting the tax basis value at transfer.
As the parallel comment said, this is probably inheritance, and the low tax basis can be passed to children and grandchildren.
This was recently modified, due to Prop 19, so that only the first million of property value can escape fair taxation. Since it was passed, there have been two attempts to bring back the landed gentry aspect of Prop 13, and there is a third attempt under way:
https://www.mercurynews.com/2025/11/30/third-attempt-to-repe...
The example house used in the story was taxed at $1,300/year before inheritance, on a $2M home value. After inheritance, it's an annual $18,000 bill, discounted from something like $30k-$40k.
This was recently modified, due to Prop 19, so that only the first million of property value can escape fair taxation. Since it was passed, there have been two attempts to bring back the landed gentry aspect of Prop 13, and there is a third attempt under way:
https://www.mercurynews.com/2025/11/30/third-attempt-to-repe...
The example house used in the story was taxed at $1,300/year before inheritance, on a $2M home value. After inheritance, it's an annual $18,000 bill, discounted from something like $30k-$40k.
The article points that adding any more costs just costs the operator money and won't change their behavior unless the costs are so high that the bank is forced to foreclose. Maybe on some that level that is a good thing and clears the market but in the current situation the banks just won't make loans unless this happens.
It makes me think of the "poker game" model of nuclear power plant construction where the vendor is quoting a price lower than they know it will cost because otherwise they wouldn't make the sale. If commercial buildings were properly priced at the outset, banks would be financing fewer of them.
It makes me think of the "poker game" model of nuclear power plant construction where the vendor is quoting a price lower than they know it will cost because otherwise they wouldn't make the sale. If commercial buildings were properly priced at the outset, banks would be financing fewer of them.
Yes, the idea of a land value tax is to make it high enough to for banks to foreclose. The entire thing is about making sure land is used on the most socially benefiting way possible.
> The entire thing is about making sure land is used on the most socially benefiting way possible.
The idea of land value tax is to make the government effectively the universal landowner and everyone else renters, and renters paying a high enough rent that it is economically infeasible to use land for any but the most financially remunerative purpose.
Having it optimizing for social utility rather than maximizing negative externalities requires a finely optimized system of Pigovian taxes and subsidies, otherwise you are nailing the accelerator to the floor on the divergence between market incentives and social utility.
The idea of land value tax is to make the government effectively the universal landowner and everyone else renters, and renters paying a high enough rent that it is economically infeasible to use land for any but the most financially remunerative purpose.
Having it optimizing for social utility rather than maximizing negative externalities requires a finely optimized system of Pigovian taxes and subsidies, otherwise you are nailing the accelerator to the floor on the divergence between market incentives and social utility.
It would make sense to have those Pigouvian taxes no matter what. But having an LVT is orthogonal, and it doesn't make the bad economic incentives that much worse. Especially since most economic activity subject to pigouvian taxes will not be much affected by land value taxation.
> It would make sense to have those Pigouvian taxes no matter what. But having an LVT is orthogonal
It is absolutely not orthogonal; LVT by design makes doing things with property that are less financially remunerative unviable, it’s key selling point is eliminating “less productive” uses by that mechanism. This exacerbates any divergence between market incentives and social utility.
It is absolutely not orthogonal; LVT by design makes doing things with property that are less financially remunerative unviable, it’s key selling point is eliminating “less productive” uses by that mechanism. This exacerbates any divergence between market incentives and social utility.
Ok, good point.
If you optimize a lot, the social optimum is almost never the most profitable use for anything.
If you optimize a lot, the social optimum is almost never the most profitable use for anything.
> The article points that adding any more costs just costs the operator money and won't change their behavior unless the costs are so high that the bank is forced to foreclose.
That is assuming operators are roughly zero-IQ automatons who can't factor future costs into present decisions?
That is assuming operators are roughly zero-IQ automatons who can't factor future costs into present decisions?
And I don't even think it is controversial. People who squat on needed resources without using them are a drain on society, thus society should try to create an incentive structure for using spaces. A tax can be part of this.
What about incentivizing switching the building from commercial to residential? Given that commercial brick and mortar are generally on a downward trend, and the need for housing continues to increase, it would seem better to switch the property zoning in the long run. Since I'm clueless about the financial details of commercial real estate, I'm sure this proposal is full of holes, but, as a rule, I prefer incentives rather than penalties to motivate change.
Don't underestimate how many businesses are supplementing their income with dirty money.
Some businesses survive because they already own the property or have long time leases.
Sometimes the last lessee is still on the hook for the remainder of the lease due to landlord improvements for the tenant. Had a friend lease a retail storefront, his business failed, but he still was coughing up rent to the landlord until the space was leased again. He was a sole proprietor and had to personally guarantee the lease. It was in his best interests to pay it rather than take the hit to his credit by defaulting on the lease.
My guess is a already wealthy landlord would probably be motivated to ride out the remainder of an existing lease and write off any unpaid amount as a loss before lowering the price to attract another business into the space.
My guess is a already wealthy landlord would probably be motivated to ride out the remainder of an existing lease and write off any unpaid amount as a loss before lowering the price to attract another business into the space.
True. What I don’t get, is how is vacancy a good move for the landlord? Wouldn’t it make more sense to have a tenant during that time?
Commercial loans are not like residential mortgages and often the loan is based on a minimum rent. If you go below that then you are in default.
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How do they make mortgage payments without rent?
* own a portfolio of real estate, so losses in one area can be offset
* own a mixed use building, so an empty ground floor retail space can be offset by multiple floors of apartments
also, if the rise in equity outpaces the losses in rents it can still be net positive
* own a mixed use building, so an empty ground floor retail space can be offset by multiple floors of apartments
also, if the rise in equity outpaces the losses in rents it can still be net positive
I don't like just saying "read the article", but this is precisely what the article explains. In short: the rental rates are a condition of the property owner's loan.
Is it because of Prop 13 that commercial property owners aren't paying adequate property taxes that would act to encourage use?
How does land value tax change the scenario in the article? It plays out exactly the same way with and without land value tax.
Land value tax mainly helps with severely under-utilized properties like parking lots. Right now a parking lot is taxed far, far lower than a lot with a building, so the owner can keep it for parking when it would be better utilized as residential, commercial, or office space.
If it didn't pencil out to just site on empty land, we'd get better development.
If it didn't pencil out to just site on empty land, we'd get better development.
So it does not help with commercial property? How does that work? I don't understand the reasoning. Because this is of course not true unless it lowers the value of that land to below zero. And if it lowers the value of that land even just to zero, it'll just be undeveloped entirely ...
> So it does not help with commercial property?
The opposite: It does help with commercial property
> if it lowers the value of that land even just to zero, it'll just be undeveloped entirely
It's not that the value of the land is zero, but rather the price can drop to zero. The price is a factor of both the land value and the taxes on the land. For example, suppose you buy land for $50, and you wish to 10x your investment, and won't resell for less than $500 (which nobody will pay). Suppose further that the land value tax is $0/mo. You can sit on the land doing nothing, ruining the community, and it won't cost you much.
Now suppose the land value tax is raised/added to the tune of $1/mo. You would need to find some use for the land that raises more than $1/mo, or else you're losing money every month. Costing money every month means the land is now worth less, let's say $25. But what if you don't want to use the land, because you're a speculator, not a business owner? Well, you can choose to either keep losing money monthly, or sell the land for $25. Economically speaking, you might choose to sell the land if you would otherwise keep it empty for >25 months.
If you choose to sell the land, whether for $25 or $0, then I could buy it and run a business from there, and as long as the business makes more than $1, I stand a chance to profit. Thus, I win, and also the community wins, because the storefront that the original speculator kept empty gets filled with something useful.
In fact, in this scenario, everybody wins except the real estate speculator who was ruining the community by keeping storefronts empty, and that person deserves to lose and be punished. With any luck, the speculator realizes that what they're doing is both bad and unprofitable, and either finds a useful way to contribute to the community, or fucks off forever. Either way, the community wins!
The opposite: It does help with commercial property
> if it lowers the value of that land even just to zero, it'll just be undeveloped entirely
It's not that the value of the land is zero, but rather the price can drop to zero. The price is a factor of both the land value and the taxes on the land. For example, suppose you buy land for $50, and you wish to 10x your investment, and won't resell for less than $500 (which nobody will pay). Suppose further that the land value tax is $0/mo. You can sit on the land doing nothing, ruining the community, and it won't cost you much.
Now suppose the land value tax is raised/added to the tune of $1/mo. You would need to find some use for the land that raises more than $1/mo, or else you're losing money every month. Costing money every month means the land is now worth less, let's say $25. But what if you don't want to use the land, because you're a speculator, not a business owner? Well, you can choose to either keep losing money monthly, or sell the land for $25. Economically speaking, you might choose to sell the land if you would otherwise keep it empty for >25 months.
If you choose to sell the land, whether for $25 or $0, then I could buy it and run a business from there, and as long as the business makes more than $1, I stand a chance to profit. Thus, I win, and also the community wins, because the storefront that the original speculator kept empty gets filled with something useful.
In fact, in this scenario, everybody wins except the real estate speculator who was ruining the community by keeping storefronts empty, and that person deserves to lose and be punished. With any luck, the speculator realizes that what they're doing is both bad and unprofitable, and either finds a useful way to contribute to the community, or fucks off forever. Either way, the community wins!
But ... none of this affects this problem in a good way. The problem here is that it's cheaper to leave financed buildings empty, rather than fill them up at cheaper rents, eating the bigger loss. If anything land value tax makes the problem worse, as it would immediately become part of the financing, driving up the price. (the price, obviously, is the price the buyer paid. That the seller doesn't receive the money for the land value tax just sucks for them, it makes no difference)
Land value tax, in a world where buildings are financialized (ie. have a mortgage) and used for speculation will make things worse by making everything more expensive, hence making the big losses on underwater mortgages ... bigger. Which, you have my personal guarantee, won't affect the community in a good way at all.
Empty lots aren't empty because their owners hate you, it's because the land value is too low for the mortgage and needs to drop, but can't, they're unwilling or unable to eat the loss. The problem is investors prefer small yearly loss over eating the big loss now. Land value tax supposedly solves that ... by making everything more expensive? Of course it will do the reverse.
Land value tax, in a world where buildings are financialized (ie. have a mortgage) and used for speculation will make things worse by making everything more expensive, hence making the big losses on underwater mortgages ... bigger. Which, you have my personal guarantee, won't affect the community in a good way at all.
Empty lots aren't empty because their owners hate you, it's because the land value is too low for the mortgage and needs to drop, but can't, they're unwilling or unable to eat the loss. The problem is investors prefer small yearly loss over eating the big loss now. Land value tax supposedly solves that ... by making everything more expensive? Of course it will do the reverse.
> The problem here is that it's cheaper to leave financed buildings empty, rather than fill them up at cheaper rents
Exactly! So we make it more expensive to leave their building empty. Land value tax makes it more expensive to hold the land vacant, thus encouraging the speculator to either use the property (improving the community), or continue lowering rental/sale prices until it rents or sells, or pay higher taxes to the community they're ruining.
> Empty lots aren't empty because their owners hate you, it's because the land value is too low for the mortgage and needs to drop, but can't, they're unwilling or unable to eat the loss.
They're empty because the speculators are asking so much above market price for rent or sale that nobody can afford it. The solution is to institute forces which coerce them to either use it or sell it (potentially at a loss, but not as high a loss as holding it vacant).
> Land value tax supposedly solves that ... by making everything more expensive?
No, land value tax only makes it more expensive to leave the property empty. It doesn't make anything else more expensive. Indeed, it makes it cheaper for a business to buy up an unused property, because the seller would rather sell at a loss than incur a sufficiently larger loss (land value tax) over time.
Exactly! So we make it more expensive to leave their building empty. Land value tax makes it more expensive to hold the land vacant, thus encouraging the speculator to either use the property (improving the community), or continue lowering rental/sale prices until it rents or sells, or pay higher taxes to the community they're ruining.
> Empty lots aren't empty because their owners hate you, it's because the land value is too low for the mortgage and needs to drop, but can't, they're unwilling or unable to eat the loss.
They're empty because the speculators are asking so much above market price for rent or sale that nobody can afford it. The solution is to institute forces which coerce them to either use it or sell it (potentially at a loss, but not as high a loss as holding it vacant).
> Land value tax supposedly solves that ... by making everything more expensive?
No, land value tax only makes it more expensive to leave the property empty. It doesn't make anything else more expensive. Indeed, it makes it cheaper for a business to buy up an unused property, because the seller would rather sell at a loss than incur a sufficiently larger loss (land value tax) over time.
> No, land value tax only makes it more expensive to leave the property empty. It doesn't make anything else more expensive. Indeed, it makes it cheaper for a business to buy up an unused property, because the seller would rather sell at a loss than incur a sufficiently larger loss (land value tax) over time.
You're disregarding everything I said. The problem is that "selling at a loss" is a much, much higher loss than the tax over time, which is what's sustaining the bubble for 1.5 years now. Investors are showing the opposite behavior of what you claim, and you are unwilling to even consider the data.
There effectively a land value tax on commercial property. It's called a mortgage. It's just being paid to banks (and the money "destroyed") instead of going to government. It has the opposite effect of what you claim: it makes land values higher despite no development.
You are also totally not considering what happens if your "forced to sell" shit actually goes through. That money is people's pension money and money that is used for social security. If your tax results in those loans disappearing, yes, you may be able to buy the lot cheaply, but only at the cost of destroying a large amount of people's livelihoods.
You're disregarding everything I said. The problem is that "selling at a loss" is a much, much higher loss than the tax over time, which is what's sustaining the bubble for 1.5 years now. Investors are showing the opposite behavior of what you claim, and you are unwilling to even consider the data.
There effectively a land value tax on commercial property. It's called a mortgage. It's just being paid to banks (and the money "destroyed") instead of going to government. It has the opposite effect of what you claim: it makes land values higher despite no development.
You are also totally not considering what happens if your "forced to sell" shit actually goes through. That money is people's pension money and money that is used for social security. If your tax results in those loans disappearing, yes, you may be able to buy the lot cheaply, but only at the cost of destroying a large amount of people's livelihoods.
> The problem is that "selling at a loss" is a much, much higher loss than the tax over time
You don't know what the tax is, so there's no way that you can make that assumption. Like folks here are saying, we just make the tax enough that it's an even higher loss than that.
> There effectively a land value tax on commercial property
Commercial property isn't the issue here. We're talking about penalizing unused commercial property.
> That money is people's pension money
I didn't force people to put their pension money into Blackstone so Blackstone could ruin communities with their speculation. More importantly, communities being ruined here, and the people living in them, are more important than investors in speculation which ruins them. The livelihoods are already being destroyed by them.
You don't know what the tax is, so there's no way that you can make that assumption. Like folks here are saying, we just make the tax enough that it's an even higher loss than that.
> There effectively a land value tax on commercial property
Commercial property isn't the issue here. We're talking about penalizing unused commercial property.
> That money is people's pension money
I didn't force people to put their pension money into Blackstone so Blackstone could ruin communities with their speculation. More importantly, communities being ruined here, and the people living in them, are more important than investors in speculation which ruins them. The livelihoods are already being destroyed by them.
So that would be a yearly tax, higher than the sale value of the property? Oh great, then I don't need to explain to anyone what a horrible idea that is.
Unused commercial property is a subset of commercial property.
And you don't care that people lose their pensions. Ok. I think we're done here ...
Unused commercial property is a subset of commercial property.
And you don't care that people lose their pensions. Ok. I think we're done here ...
same thing happens in SF, often to businesses that have been a valued part of the local neighbourhood for years. it's infuriating.
Yep, this has wiped out my favorite deli, local cinemas, and bookstores in the east bay. Basically non-capital-intensive businesses seem to pay the price for the market signal falsification engaged in by landlords and banks. But nobody wants to bite the bullet and risk setting off a repeat of the 2008 financial crisis, so we've ended up with some kind of hypernormalization-style fake economy which is being 'run' by a former reality TV star and a bunch of TV personalities and political entrepreneurs.
Interesting, but It doesn't answer why a bank would hold a completely vacant building for 15 years.
I think we need Vacancy taxes that go up based on the percentage of time vacant over different spans of time. Anything that makes owning an empty building a bad investment in all circumstances. This needs to apply to all units in a multitenant building.
I think we need Vacancy taxes that go up based on the percentage of time vacant over different spans of time. Anything that makes owning an empty building a bad investment in all circumstances. This needs to apply to all units in a multitenant building.
> Interesting, but It doesn't answer why a bank would hold a completely vacant building for 15 years.
Lowering the rent to fill their building reduces the value of that building, which means when they sell it, they will recognize a loss that is likely larger than many years of operating loss from the empty building.
Additionally, lowering the rent for that building will also reduces the value of other nearby buildings that have that building as a comparable property. Then when those buildings come up for refinance, either the borrower will have to come up with more funds so that the loan to value max isn't exceeded or the borrower will default and the bank will lose the income stream and be holding another property where their investment is more than the value.
Borrowers usually don't want to come up with more funds on a property where they're underwater and banks don't want to foreclose on property where the bank will be underwater, so it's in the bank's interest to let things be vacant and keep the valuations based on the previous rent, rather than lowering the rent and facing the music. You'll also see promos like first several months free, rather than reducing the rent, so you can report it's rented at whatever the headline rate is, even if the tenant is effectively paying much less; of course, the tenant will be looking for somewhere else to rent come renewal.
This is far from the only case in banking where taking some action on an asset that would otherwise be reasonable won't be done, because it would trigger a mark to market on too many other assets. Ex: you can't sell realize a loss to sell treasury bonds to satisfy cash flow needs, because you'll have to mark to market all the similar bonds, and then you won't meet your reserve needs.
Lowering the rent to fill their building reduces the value of that building, which means when they sell it, they will recognize a loss that is likely larger than many years of operating loss from the empty building.
Additionally, lowering the rent for that building will also reduces the value of other nearby buildings that have that building as a comparable property. Then when those buildings come up for refinance, either the borrower will have to come up with more funds so that the loan to value max isn't exceeded or the borrower will default and the bank will lose the income stream and be holding another property where their investment is more than the value.
Borrowers usually don't want to come up with more funds on a property where they're underwater and banks don't want to foreclose on property where the bank will be underwater, so it's in the bank's interest to let things be vacant and keep the valuations based on the previous rent, rather than lowering the rent and facing the music. You'll also see promos like first several months free, rather than reducing the rent, so you can report it's rented at whatever the headline rate is, even if the tenant is effectively paying much less; of course, the tenant will be looking for somewhere else to rent come renewal.
This is far from the only case in banking where taking some action on an asset that would otherwise be reasonable won't be done, because it would trigger a mark to market on too many other assets. Ex: you can't sell realize a loss to sell treasury bonds to satisfy cash flow needs, because you'll have to mark to market all the similar bonds, and then you won't meet your reserve needs.
> Lowering the rent to fill their building reduces the value of that building
> Additionally, lowering the rent for that building will also reduces the value of other nearby buildings that have that building as a comparable property
> it's in the bank's interest to let things be vacant and keep the valuations based on the previous rent, rather than lowering the rent and facing the music.
This just seems like everyone involved is playing make-believe about the actual value of their property. A tax on vacant land that increases exponentially year after year might help to correct this behavior, because at some point, it costs less to realize the loss than it does to pay the ever-increasing vacant land tax.
> Additionally, lowering the rent for that building will also reduces the value of other nearby buildings that have that building as a comparable property
> it's in the bank's interest to let things be vacant and keep the valuations based on the previous rent, rather than lowering the rent and facing the music.
This just seems like everyone involved is playing make-believe about the actual value of their property. A tax on vacant land that increases exponentially year after year might help to correct this behavior, because at some point, it costs less to realize the loss than it does to pay the ever-increasing vacant land tax.
The behavior with a lot of commercial real estate loans atm is literally called “extend and pretend”
> This just seems like everyone involved is playing make-believe about the actual value of their property.
That's precisely what's going on.
It's a common theme among wealthy individuals/organizations to treat property as having value X for some purposes and Y for others - e.g., like pretending stock holdings are worth X for the sake of taxation while being able to secure loans by representing the stock valuation as Y.
That's precisely what's going on.
It's a common theme among wealthy individuals/organizations to treat property as having value X for some purposes and Y for others - e.g., like pretending stock holdings are worth X for the sake of taxation while being able to secure loans by representing the stock valuation as Y.
Other than some of the residents who don’t want to see empty storefronts, who is incentivized to push for a correction in this case? It’s a “everybody loses” scenario, this everyone pretends to believe the numbers.
Other than some of the residents who don’t want to see empty storefronts, who is incentivized to push for a correction in this case?
That is a tad dismissive. Instead of not wanting to see empty storefronts, consider residents who would like to start a local business, but can not because the rent on commercial properties is prohibitively expensive. Then remember that there are residents who would like more jobs in the area.
That is a tad dismissive. Instead of not wanting to see empty storefronts, consider residents who would like to start a local business, but can not because the rent on commercial properties is prohibitively expensive. Then remember that there are residents who would like more jobs in the area.
But residents understand that if that property value goes down, their own property value will go down as well, no? Unless they're a renter, which is the minority of the population. So, even if they'd want to open a business, they'd need to be ok with the devaluation of their environment as well.
Everyone but current holders of property and loans. Lower property values are good thing. As that means lower rents, meaning lower overheads. Leading to cheaper goods and services for everyone. Overall property values closer to reality is good for everyone including current owners.
But supermajority of the US (and almost majority of the world, I guess?) are property owners in their respective countries. So, by that logic, most people wouldn't want that, no?
By the way, I am very supportive of lower property values. I've just mostly given up on this issue, since from my conversations with random people all around the world, most people don't really want that to happen. Like, they want the property values to go down, but they don't want THEIR property to go down.
By the way, I am very supportive of lower property values. I've just mostly given up on this issue, since from my conversations with random people all around the world, most people don't really want that to happen. Like, they want the property values to go down, but they don't want THEIR property to go down.
> who is incentivized to push for a correction in this case?
Well, the government at the very least. From the article:
> Banks are highly regulated, so they can’t just loan whatever they want. The government insists that banks keep high margins of safety in their portfolio, and commercial loans are risky, so the terms they can offer are designed to limit risk. […] Second, the bank must keep a strict loan-to-value (LTV) ratio — so they won’t lend more than 80% of the value of the building (and often less than that).
The government says banks can’t loan more than 80% of the value of the building because it’s too risky. But what banks have done is instead maintained an inflated value of the property so they can loan out a higher percentage, which has led to the country being full of empty, overvalued property. Ie, a high risk of collapse—which is just what the regulation was intending to prevent. Lying about the value of an object to get around regulations is often considered fraud.
Well, the government at the very least. From the article:
> Banks are highly regulated, so they can’t just loan whatever they want. The government insists that banks keep high margins of safety in their portfolio, and commercial loans are risky, so the terms they can offer are designed to limit risk. […] Second, the bank must keep a strict loan-to-value (LTV) ratio — so they won’t lend more than 80% of the value of the building (and often less than that).
The government says banks can’t loan more than 80% of the value of the building because it’s too risky. But what banks have done is instead maintained an inflated value of the property so they can loan out a higher percentage, which has led to the country being full of empty, overvalued property. Ie, a high risk of collapse—which is just what the regulation was intending to prevent. Lying about the value of an object to get around regulations is often considered fraud.
Looking from the perspective that government is a representative and reflection a the general population (yes, i understand it's not the case everywhere and so on), doesn't it mean people don't want this to be enforced, as it would lead to declining property values, which would devalue majority of population's assets?
Well, fundamentally no, I don’t think it reflects the will of the general population, since I don’t think they’re aware that this is how it works. At least, I wasn’t before reading this.
And beyond that: people’s assets are mostly residential real estate, not commercial real estate. So I don’t know that people will get that worked up about commercial real estate devaluing.
And beyond that: people’s assets are mostly residential real estate, not commercial real estate. So I don’t know that people will get that worked up about commercial real estate devaluing.
They are, value is relative. If the local government did that, it would discourage investors and future growth. They would go somewhere with less risk
> Lowering the rent to fill their building reduces the value of that building
This must just indicate that the model used to value the building is wrong, right?
I'd think insofar the value of the building is tied to the rental price, that value should naturally be a function of the revenue that the building can be expected to generate, which in turn is be a function not only of the chosen rent price but the likelihood of someone renting at that price. Why would a building that offers its units at $N per unit but can only fill half of them at that price be worth more than the same building filling all of its units at $N/2 per unit?
I suppose there's some wiggle room to account for the relative uncertainty in those two cases. But fundamentally the rental price is a choice whereas the value of the building is (or ought to be) based on a combination of the qualities of the property itself and what the market is willing to bear.
This must just indicate that the model used to value the building is wrong, right?
I'd think insofar the value of the building is tied to the rental price, that value should naturally be a function of the revenue that the building can be expected to generate, which in turn is be a function not only of the chosen rent price but the likelihood of someone renting at that price. Why would a building that offers its units at $N per unit but can only fill half of them at that price be worth more than the same building filling all of its units at $N/2 per unit?
I suppose there's some wiggle room to account for the relative uncertainty in those two cases. But fundamentally the rental price is a choice whereas the value of the building is (or ought to be) based on a combination of the qualities of the property itself and what the market is willing to bear.
Since you brought up treasury bonds, during the 2023 Banking Crisis, the Federal Reserve created the Bank Term Funding Program[1] that let banks borrow against the par value of bonds, rather than the market value.
I thought it was a really elegant solution, and has made me wonder if a similar program could be used for vacant Commercial Real Estate in the cast of a national vacancy tax, land value tax, or similar value-lowering event.
1: https://en.wikipedia.org/wiki/Bank_Term_Funding_Program#Prog...
I thought it was a really elegant solution, and has made me wonder if a similar program could be used for vacant Commercial Real Estate in the cast of a national vacancy tax, land value tax, or similar value-lowering event.
1: https://en.wikipedia.org/wiki/Bank_Term_Funding_Program#Prog...
Lowering the rent to fill their building reduces the value of that building, which means when they sell it, they will recognize a loss that is likely larger than many years of operating loss from the empty building.
The specific buildings I was thinking about have paid more in taxes alone than their asking price.
The specific buildings I was thinking about have paid more in taxes alone than their asking price.
> first several months free, rather than reducing the rent
Doesn't this only indicate that the algorithm is shite? They can give first 1000 months free but rent is $1T, also we need 1st and last.
Doesn't this only indicate that the algorithm is shite? They can give first 1000 months free but rent is $1T, also we need 1st and last.
This doesn't happen because the owners of commercial property are very rich people. Adding these rules would essentially devalue commercial property all over the US, and we know how congress would never allow this to happen.
A property tax is intended to be this, I think. You pay for owning an expensive commercial plot. If you are making enough money with it to pay the tax, great. If not, sell it or lose money.
I suppose the model sucks because the community is highly benefited by a low profit cozy coffee shop or book store, which might not be able to afford the property tax rate needed to discourage the "keep it vacant" strategy.
Maybe I changed my mind, and "vacant and/or not being used for its zoning purpose" needs a separate, additional fee.
I suppose the model sucks because the community is highly benefited by a low profit cozy coffee shop or book store, which might not be able to afford the property tax rate needed to discourage the "keep it vacant" strategy.
Maybe I changed my mind, and "vacant and/or not being used for its zoning purpose" needs a separate, additional fee.
Property tax is intended to fund the local government. It doesn't care if the land is just being held as a hedge against inflation, or if a foreign investor is using the land to hide assets from their own government.
I suspect the claim of community benefit from stores, such as a bookstore or a coffee shop, is highly overstated. There's a drugstore within walking distance from my thousand-person neighborhood. It closed recently. Granted, it was a Walgreens, but the number of clients was so low the Muzak was crickets.
I think the only viable businesses left in the neighborhood are a sub shop and a liquor store. Even the gas station is pretty low traffic.
There's a lovely little coffee shop within a couple of miles away, close to the city center. It has nice events in the evening, such as trivia nights, contest nights, etc. Plenty of parking. But do I really want to go to where almost everybody is on their phone when I can stay at home and pet my cats? I think that's one of the major competitors' stores have, especially small, targeted-audience stores. Home is much more comfortable and rewarding than going out, especially if you have a cat or a dog.
I think the only viable businesses left in the neighborhood are a sub shop and a liquor store. Even the gas station is pretty low traffic.
There's a lovely little coffee shop within a couple of miles away, close to the city center. It has nice events in the evening, such as trivia nights, contest nights, etc. Plenty of parking. But do I really want to go to where almost everybody is on their phone when I can stay at home and pet my cats? I think that's one of the major competitors' stores have, especially small, targeted-audience stores. Home is much more comfortable and rewarding than going out, especially if you have a cat or a dog.
> Anything that makes owning an empty building a bad investment in all circumstances
But empty buildings aren't a bad idea under all circumstances. Eg, It might be prudent to have empty living space in a tourist or student area to deal with annual surges in demand. Or maybe someone has a warehouse full of facemasks because they think the price will 10x in the next pandemic. We'd have the same crowd complaining about empty buildings saying they were just doing it to hide the fact that the building is empty when in fact that is a pretty reasonable strategy that would be socially beneficial.
But empty buildings aren't a bad idea under all circumstances. Eg, It might be prudent to have empty living space in a tourist or student area to deal with annual surges in demand. Or maybe someone has a warehouse full of facemasks because they think the price will 10x in the next pandemic. We'd have the same crowd complaining about empty buildings saying they were just doing it to hide the fact that the building is empty when in fact that is a pretty reasonable strategy that would be socially beneficial.
That would be true in a normal economy where supply and demand dominated. See an empty storefront/building, hustle up a few bucks and turn it into an art studio or entertainment space or whatever. But if you start using a building you have to pay rent, and if you pay rent that goes on the books, and if it goes on the books then the mortgage on the property gets reevaluated and the then the merry-go-round comes to a screeching halt, because most commercial property is mortgaged up to the eyeballs.
> and if it goes on the books then the mortgage on the property gets reevaluated and the then the merry-go-round comes to a screeching halt, because most commercial property is mortgaged up to the eyeballs.
No, the leverage isn't the problem. The article is very explicit about this: the bank makes a $16M loan at interest of $640K / year, and the building operator is so good for that loan that he pays it off indefinitely out of his personal funds. The operator doesn't want to be foreclosed on, because that leaves him worse off (assuming the market eventually picks back up), and the bank doesn't want to foreclose, because that leaves it much worse off (whether the market picks back up or not).
The reason for the pretense is that lowering the rent legally requires the bank to foreclose despite foreclosure being terrible for the bank.
No, the leverage isn't the problem. The article is very explicit about this: the bank makes a $16M loan at interest of $640K / year, and the building operator is so good for that loan that he pays it off indefinitely out of his personal funds. The operator doesn't want to be foreclosed on, because that leaves him worse off (assuming the market eventually picks back up), and the bank doesn't want to foreclose, because that leaves it much worse off (whether the market picks back up or not).
The reason for the pretense is that lowering the rent legally requires the bank to foreclose despite foreclosure being terrible for the bank.
A warehouse full of things is not an empty buulding.
why a bank would hold a completely vacant building for 15 years.
By leasing for cheaper they effectively capitulate and sell at a loss which will hammer their funding ability. It's land speculation similar to tech speculation. Inflate valuations, get a longer runway from lenders, etc.
At some point it has to come back to reality, but as the saying goes: "The market (land owners) can remain irrational longer than you (businesses) can remain solvent."
> Interesting, but It doesn't answer why a bank would hold a completely vacant building for 15 years.
I had the exact same question before I fully read the article.
This is answered in the article in the "Extend and Pretend" section.
> "And so long as the operator can afford to keep losing $140k per year on the building… they can!"
> [...]
> "The only sticking point here is that the building operator is still losing $140k per year. But remember that, if he gives up, he loses the $4 million he’s already put into the building. Even if he ended up paying $140k per year for 10 years before things turned around, losing $1.4 million is still better than losing $4 million."
Extending the article's example to a scenario where the building was vacant for 15 years, it means the operator was willing to lose $140K per year. In the 15 year scenario, the operator lost $2.1 million ($140K * 15 years) which is still better than losing the $4 million if the operator walked away from the investment.
> Anything that makes owning an empty building a bad investment in all circumstances.
In the final section "This Sucks, What Could We Do About It?", it mentions how adding a vacant store font tax would end up creating more foreclosures. This is the side effect of the financialization of real estate.
I had the exact same question before I fully read the article.
This is answered in the article in the "Extend and Pretend" section.
> "And so long as the operator can afford to keep losing $140k per year on the building… they can!"
> [...]
> "The only sticking point here is that the building operator is still losing $140k per year. But remember that, if he gives up, he loses the $4 million he’s already put into the building. Even if he ended up paying $140k per year for 10 years before things turned around, losing $1.4 million is still better than losing $4 million."
Extending the article's example to a scenario where the building was vacant for 15 years, it means the operator was willing to lose $140K per year. In the 15 year scenario, the operator lost $2.1 million ($140K * 15 years) which is still better than losing the $4 million if the operator walked away from the investment.
> Anything that makes owning an empty building a bad investment in all circumstances.
In the final section "This Sucks, What Could We Do About It?", it mentions how adding a vacant store font tax would end up creating more foreclosures. This is the side effect of the financialization of real estate.
Interestingly, the article presents a very clear theory of what causes the problem, and then doesn't even mention it in the section on "what could we do about it?".
Usually, if you have a problem and you know why, you'd consider doing something about the cause of the problem.
Usually, if you have a problem and you know why, you'd consider doing something about the cause of the problem.
[deleted]
A vacancy tax would work on areas with high demand, but it also punishes areas that are already struggling.
Why is that? It would devalue property but renters want that. It would only hurt the rent seekers and speculators, no?
Imagine a half empty mall where there simply isn't enough demand for any more stores. If you add a vacancy tax that bankrupts the mall owners, then the mall shuts down and the renters lose out as well.
A problem is that the externalities of leaving a space vacant are not priced in. Having a bunch of storefront vacant in an area makes it much less appealing and devalues all the other properties surrounding it. It does seem like a vacant storefront tax, which is briefly mentioned at the end of the article, could address this, if partially.
This whole extend and pretend deal seems like it's simply accumulating risk hoping this will pass, while risking an even bigger, potentially systemic crash. Though I honestly don't know that much about the commercial finance world.
This whole extend and pretend deal seems like it's simply accumulating risk hoping this will pass, while risking an even bigger, potentially systemic crash. Though I honestly don't know that much about the commercial finance world.
That would just devalue the surrounding property even more. This is why "we should just do X" is almost always a bad idea.
> That would just devalue the surrounding property even more.
Why do you think that's the case? I'm sure it would make the entire city seem like a riskier investment at first, but it seems like in the medium term it would help address the situation described in the article.
Why do you think that's the case? I'm sure it would make the entire city seem like a riskier investment at first, but it seems like in the medium term it would help address the situation described in the article.
By "devalue" you mean "lower the price of" which... seems fine? Useful assets being cheaper is a good thing.
As long as you're not the owner of said asset.
Does your house stop being a house if the price goes down?
Does your car drive worse if no one will buy it?
I'm not saying it doesn't suck to overpay for something, but you can't expect too much pity when you lose money speculating.
Does your car drive worse if no one will buy it?
I'm not saying it doesn't suck to overpay for something, but you can't expect too much pity when you lose money speculating.
yes, this entire discussion is about a policy which might be good for communities but not necessarily for real estate speculators who keep storefronts in those communities empty
Still doesn't matter to you unless you're trying to sell it.
Or you think the best way to deal with people getting scammed, is to make sure everyone gets scammed, to avoid being unfair to the initial victims of the scam. For example if Billy put $200 in a Ponzi scheme we should tax everyone else $200 to make it fair.
Or you think the best way to deal with people getting scammed, is to make sure everyone gets scammed, to avoid being unfair to the initial victims of the scam. For example if Billy put $200 in a Ponzi scheme we should tax everyone else $200 to make it fair.
A "vacant storefront tax" would easily be circumvented by a legal entity with a vending machine business or the "owner" themselves putting one of their "offices" there (a table).
Any realistic vacant land tax with teeth would obviously need to define vacancy such that silly tricks like this wouldn't work.
And in response, owners would do something slightly less silly - just enough to technically fall within the rules, and so not be subject to the tax.
Then fix those technicalities, too. People act as though laws are etched permanently into clay tablets. Lawmakers should keep iterating until the bugs are worked out and the letter of the law more closely approaches the spirit of the law.
We shouldn't just always default to doing nothing because someone, somewhere is going to try to rules-lawyer their way out of it.
We shouldn't just always default to doing nothing because someone, somewhere is going to try to rules-lawyer their way out of it.
That's called "intervention spiral" where you need to put even more regulations on top of existing regulations because market forces are always leaking through. They should fix the underlying reason which is too restrictive zoning.
No no no .. snails!
https://www.bbc.co.uk/news/articles/c9v1rjlekpeo
https://www.bbc.co.uk/news/articles/c9v1rjlekpeo
It always bothered me that certain things are not marked to market. It's pretty much the point of financializing the economy, that you can then get a current value for things, instead of being able to pretend everything is fine.
The problem is that if you don't update values continuously, you are surprised when you finally are forced to. Some stock on the public market that isn't doing well goes from 100 to 90, 80, 70... etc, and people thinking about the stock have to make decisions accordingly.
A private loan against that business can sit at 100 until the company decides it can't pay, and suddenly the loan is worth 20.
The problem is that if you don't update values continuously, you are surprised when you finally are forced to. Some stock on the public market that isn't doing well goes from 100 to 90, 80, 70... etc, and people thinking about the stock have to make decisions accordingly.
A private loan against that business can sit at 100 until the company decides it can't pay, and suddenly the loan is worth 20.
Mark-to-market can create liquidity crises when coupled with capitalization requirements, though. This can happen in, e.g., bond markets.
Say a bank is sitting on a pile of very safe bonds. If the interest rate suddenly increases, the mark-to-market value of the bonds goes way down. The bank would still expect to get the full value of all the bonds at maturity. But if the bank has to mark-to-market, the current value may be low enough that capitalization requirements force the bank to sell all the bonds in a fire sale. So even though the bank in theory could have held onto the assets and gotten exactly what it had expected from the start, it instead ends up taking a big loss.
Say a bank is sitting on a pile of very safe bonds. If the interest rate suddenly increases, the mark-to-market value of the bonds goes way down. The bank would still expect to get the full value of all the bonds at maturity. But if the bank has to mark-to-market, the current value may be low enough that capitalization requirements force the bank to sell all the bonds in a fire sale. So even though the bank in theory could have held onto the assets and gotten exactly what it had expected from the start, it instead ends up taking a big loss.
I think that's almost what happened to Silicon Valley Bank, except that they weren't required to recapitalize, but all of their customers read their financial disclosures, assumed a mark-to-market loss was an actual loss, and withdrew their money, running the bank.
TFA seems to claim that the benefits of "nice buildings" outweigh the externalities of desolate, character-less street levels in cities. It doesn't seem very on brand for Strong Towns.
This phenomenon is going on in the downtown of my city - decreased foot traffic leads to tenants leaving, and the cycle continues. It's a miserable place to live or work that basically becomes a ghost town at 5pm. They're trying to do some office-to-residential conversions, but they're not very desirable because the entire neighborhood feels hollow and abandoned.
Instead of delaying these defaults and accumulating systemic risk until there's a massive correction, someone should be enforcing accounting that marks to market the actual rental value. That would force banks to be honest about the real level of risk on their balance sheets.
This phenomenon is going on in the downtown of my city - decreased foot traffic leads to tenants leaving, and the cycle continues. It's a miserable place to live or work that basically becomes a ghost town at 5pm. They're trying to do some office-to-residential conversions, but they're not very desirable because the entire neighborhood feels hollow and abandoned.
Instead of delaying these defaults and accumulating systemic risk until there's a massive correction, someone should be enforcing accounting that marks to market the actual rental value. That would force banks to be honest about the real level of risk on their balance sheets.
Something that's not addressed is how this situation plays out for 5-over-1 development[1] that's becoming the norm (or other mixed-use buildings).
Basically, the buildings cashflow solely on the residential, but the commercial space is/was valued optimistically (especially leading up to the 2020 pandemic). So a building's owner isn't in a financial bind, and if they were to lower rent on the commercial space, even if they didn't lose the building, it would be much harder to refinance the next time their loan matured. (Commercial loans are frequently "balloon" loans that have payments like they're amortizing over 30 years, but they mature before then, meaning the borrower either has to pay the remaining amount of the loan, or refinance.)
Possible Solution:
I've been thinking about a cumulative vacancy tax that increases every year a space is vacant (and decreases for every year it's occupied). So a building owner or loan underwriter could project when a vacancy would become more costly than lowering rent.
You could charge the tax on the assessed value of the vacant space. Increase it by 100 basis points for every year that a space is vacant. Decrease it by 200 basis points for every year that it's rented.
1: https://en.wikipedia.org/wiki/5-over-1
Basically, the buildings cashflow solely on the residential, but the commercial space is/was valued optimistically (especially leading up to the 2020 pandemic). So a building's owner isn't in a financial bind, and if they were to lower rent on the commercial space, even if they didn't lose the building, it would be much harder to refinance the next time their loan matured. (Commercial loans are frequently "balloon" loans that have payments like they're amortizing over 30 years, but they mature before then, meaning the borrower either has to pay the remaining amount of the loan, or refinance.)
Possible Solution:
I've been thinking about a cumulative vacancy tax that increases every year a space is vacant (and decreases for every year it's occupied). So a building owner or loan underwriter could project when a vacancy would become more costly than lowering rent.
You could charge the tax on the assessed value of the vacant space. Increase it by 100 basis points for every year that a space is vacant. Decrease it by 200 basis points for every year that it's rented.
1: https://en.wikipedia.org/wiki/5-over-1
If you can pretend that 50% occupancy @ $500k per year total rent is a temporary market slump, why can't you also pretend that 100% occupancy at $700k in rent is also a temporary market slump?
This also confused me, especially since we know that over time rents would be raised so maybe in a few years you do hit the target of a million?
Empty unit? The right tenant is coming any day now.
Rented unit? Can't be rented to imaginary rich/stupid people.
> Rented unit? Can't be rented to imaginary rich/stupid people.
No, but you can raise the rents. Best case scenario, they pay the higher price. Worse case scenario they leave—which leaves you exactly where you were before, with some extra money in your pocket.
No, but you can raise the rents. Best case scenario, they pay the higher price. Worse case scenario they leave—which leaves you exactly where you were before, with some extra money in your pocket.
Startup Idea: My company will lease your space for whatever price you want. Then we sub-lease your building at the market rate. We charge the different between the market rate for your building and what you want to charge + a small fee. That way your property retains it's "original" value, but actually gets rented out.
Everyone (especially us) wins!
Everyone (especially us) wins!
Sounds great! I'll charge you $100 per sqft, and you can sublease it at the current market rate, which is $5 per sq ft.
Perfect. That'll be $96 + tip.
The world needs Someone with enormous chutzpah to try this.
That's unbelievably stupid. But then again, so is not renting out the space at the market rate so you can pretend it's worth more than it really is. So... good luck, I guess?
that's the joke.gif
This doesn't make sense to me, why is lowering rent by 30% any more "proof" that the building is not worth what's stated on the bill than having a 30% vacancy rate at the expected value? Aren't both subject to the same "market conditions" argument?
It's all about contract/loan assumptions.
If the space is vacant, and the last known rent was $X, the assumption is that borrower is bad at advertising space, but a successor would be able to get it rented again at that rate.
OTOH, if the space is rented at 0.7 times $X, the tenants may have a long term lease that fixes that price for a significant time and even a savvy successor would have a hard time raising rents, so the valuation needs to be calculated based on current rent.
If the space is vacant, and the last known rent was $X, the assumption is that borrower is bad at advertising space, but a successor would be able to get it rented again at that rate.
OTOH, if the space is rented at 0.7 times $X, the tenants may have a long term lease that fixes that price for a significant time and even a savvy successor would have a hard time raising rents, so the valuation needs to be calculated based on current rent.
This seems like an assumption that over time would come to bite the banks that overexpose themselves to lending in this manner.
Wouldn't banks want to accurately assess these valuations so these types of "bad loans in actuality, good loans on paper" don't become a large portion of their balance sheet?
Maybe not all at once, but over time it seems like banks would want more accuracy on this.
Wouldn't banks want to accurately assess these valuations so these types of "bad loans in actuality, good loans on paper" don't become a large portion of their balance sheet?
Maybe not all at once, but over time it seems like banks would want more accuracy on this.
In a normal world yes. But banks are incentivized to mark up the value of these properties, so they continue to do that.
I think the argument is that the building was able to generate such income stream, in this case the stream comes from the owner. The owner is betting the investment will pay-off at some point, so is taking temporary loses (you could say that the owner is paying the rent for the vacant places).
I believe the argument is not about value itself, but about gaming certain ways to estimate value. For example a certain bank might have a policy that value is a certain multiple of rent.
Agreed. I’ve always been skeptical of this argument, because it assumes the counterparty to these valuation models is consistently an idiot.
I've always assumed the counterparty is a computer. You have say 100 Billion of 401k moneys to invest. How are you going to invest it into real estate with a expense ratio of 0.05 and also check all of the properties in the portfolio?
Counter party is either stupid, careless, on it or forced. I think often there is intermediaries involved. Say real estate investment fund. For which on paper in short term numbers looking good is enough. And in past environment as long as there was enough money coming in the ponzi could continue to run.
And other parties further can be say pension funds, which on paper are forced to search for anything that make their goals look good enough. Thus not doing enough due diligence.
Everything is fine until it is not. And this has been seen time after time.
And other parties further can be say pension funds, which on paper are forced to search for anything that make their goals look good enough. Thus not doing enough due diligence.
Everything is fine until it is not. And this has been seen time after time.
I've seen in here a couple people saying that Land Tax is the answer. But...
Let's say I have a building that's sitting vacant. Under the current system, I pay property tax, which is based on the land plus the improvements (the building). So it costs me to hold the building vacant.
If we switch to a land tax, then that would be taxed on the value of the land only (though presumably at a higher rate). But if moving to a land tax is revenue neutral, then the tax on vacant land would be higher than it was before, and the tax on improved land would be lower.
The net effect of a land tax, then, would be to lower the tax on this unoccupied building. How is that supposed to fix the situation?
Let's say I have a building that's sitting vacant. Under the current system, I pay property tax, which is based on the land plus the improvements (the building). So it costs me to hold the building vacant.
If we switch to a land tax, then that would be taxed on the value of the land only (though presumably at a higher rate). But if moving to a land tax is revenue neutral, then the tax on vacant land would be higher than it was before, and the tax on improved land would be lower.
The net effect of a land tax, then, would be to lower the tax on this unoccupied building. How is that supposed to fix the situation?
Your scenario seems to imply that for your empty building (and for every other empty building), there is an identical plot of land that is vacant, that will pay the same land value tax.
Your tax would go up in the following situations. Maybe there is very little, or no vacant land. Maybe every other land plot has a 30-story mixed use office tower/apartment building that is currently paying many multiples of your property tax.
The discussion about land value taxes often involve dense areas where these situations are more likely.
Your tax would go up in the following situations. Maybe there is very little, or no vacant land. Maybe every other land plot has a 30-story mixed use office tower/apartment building that is currently paying many multiples of your property tax.
The discussion about land value taxes often involve dense areas where these situations are more likely.
Living in SoCal, I almost always prefer to order online. Most local businesses are losing to their e-commerce competitors; no wonder commercial spaces are empty.
I have a side business of a small e-commerce shop. I would consider having physical space just for the sake of luxury, but now I would rather spend that monthly rent on marketing online rather than paying for physical space.
IMHO, that's what is happening. Bank problems or anything else are secondary; if it were profitable to be at the physical location for the businesses, other factors would vanish.
I have a side business of a small e-commerce shop. I would consider having physical space just for the sake of luxury, but now I would rather spend that monthly rent on marketing online rather than paying for physical space.
IMHO, that's what is happening. Bank problems or anything else are secondary; if it were profitable to be at the physical location for the businesses, other factors would vanish.
The article applies to all kinds of loans for property though.
Apartment complexes could also be 50% vacant and still "worth" their original value if the asking rents remain high.
Office buildings that got cleared out after covid, same thing.
Brick and mortar retail are the same.
The article is more of a criticism of how asset values are calculated and loans are managed to avoid foreclosure. Which results in financially valid buildings/loans that are underutilized because the other option is creating economic equilibrium at the cost of lenders and debt holders.
Apartment complexes could also be 50% vacant and still "worth" their original value if the asking rents remain high.
Office buildings that got cleared out after covid, same thing.
Brick and mortar retail are the same.
The article is more of a criticism of how asset values are calculated and loans are managed to avoid foreclosure. Which results in financially valid buildings/loans that are underutilized because the other option is creating economic equilibrium at the cost of lenders and debt holders.
In the current world isn’t the “downtown parking lot” situation more common? Where the value of the asset is increasing so quickly year over year, that locking in a contract right now for x years mean forfeiting the increases of future years - meaning the value of your asset is more when vacant than when rented/built on? IE why sell my parking lot this year for $5M when I’m 2 years it will be worth $7M, so I’m better off waiting and taking no income for the next two years as opposed to taking $5M and investing it.
All you need is 20% annual returns and you're better off with the investment. ;D
> If [a vacant storefront tax] “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.
Sounds like the right trade-off to me. Let the banks get hurt for the pain that's coming to them for making a loan on an asset that declined in value, let's see if it actually causes bank bankruptcy, then let's consider bailouts. Because letting balance sheets express a lie about financial health is preferable somehow? Letting pressure continue to build until commercial property owners can't cover interest payments is preferable?
Ideally, commercial development would be done by publicly-owned companies. Instead of renting, sell the storefront for a pittance to a mom-and-pop owner operator, conditioned on occupancy and using it for primary income. If occupancy is forfeited, then sell it to a new mom-and-pop.
Selling instead of renting means there are no rent increases. You go back to having local stores that have been open for 40+ years that have a real relationship with the surrounding community. You make it possible for young chefs to get a restaurant space to prove their mettle without needing to cozy up to some wealthy financier who then sucks away most of the income. You make it possible for young people to start new independent businesses without a mortgage on their future, which helps them invest further in their surrounding community. Being able to buy cheap storefront space is what made the American Dream possible for so many immigrants to America and built the largest middle class in the world.
Sounds like the right trade-off to me. Let the banks get hurt for the pain that's coming to them for making a loan on an asset that declined in value, let's see if it actually causes bank bankruptcy, then let's consider bailouts. Because letting balance sheets express a lie about financial health is preferable somehow? Letting pressure continue to build until commercial property owners can't cover interest payments is preferable?
Ideally, commercial development would be done by publicly-owned companies. Instead of renting, sell the storefront for a pittance to a mom-and-pop owner operator, conditioned on occupancy and using it for primary income. If occupancy is forfeited, then sell it to a new mom-and-pop.
Selling instead of renting means there are no rent increases. You go back to having local stores that have been open for 40+ years that have a real relationship with the surrounding community. You make it possible for young chefs to get a restaurant space to prove their mettle without needing to cozy up to some wealthy financier who then sucks away most of the income. You make it possible for young people to start new independent businesses without a mortgage on their future, which helps them invest further in their surrounding community. Being able to buy cheap storefront space is what made the American Dream possible for so many immigrants to America and built the largest middle class in the world.
Unmentioned in this article is the spread of small business pretend as a lifestyle, where someone signs a lease for the space, pays the rent, and never opens it or only after years of futzing around. They can do this because they have some other source of income, and it is just another aspect of wealth inequality that pretenders can outbid sincere small business operators. In my neighborhood we had a prominent corner store that was apparently vacant but actually had been leased by a restaurant that then spent 7 years intermittently remodeling the interior. Of course all the local NIMBYs spent the entire 7 years shouting about developers, but it wasn't their fault really.
Okay, the problem is ultimately that banks are constrained in the Loan-To-Value ratio they can have, but the value is something they can arbitrarily determine. They're incentivised to make the loan, and the person buying the property is also incentivised to do this, so they use the lever they have: they make up the value such that the loan can be made.
Perhaps if we split off commercial lending arms, allowed them unbounded LTVs, and then allowed them to fail we would get better performance?
It does seem like a pretty complicated problem. We want banks to be reliable, we don't have a pricing mechanism because the market is illiquid, and we have incentives to keep the Potemkin story alive.
Perhaps if we split off commercial lending arms, allowed them unbounded LTVs, and then allowed them to fail we would get better performance?
It does seem like a pretty complicated problem. We want banks to be reliable, we don't have a pricing mechanism because the market is illiquid, and we have incentives to keep the Potemkin story alive.
So the problem here is the banks wrote their loans stupidly and both the bank and the property owner's willing and able to burn money to keep those chickens from coming home to roost, which has an enormous social cost on small business owners, citizens, and other businesses in the area, but the article concludes we can't really do anything about it because it might make the banks sad and cause the renegotiation of a bunch of those shitty contracts.
Since when did "taking a loss" get written out of the definition of "investing"?
Since when did "taking a loss" get written out of the definition of "investing"?
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Pricing something based on what you project to make over 20 years seems like an insane way to go about it. Nobody can predict that far in the future.
It's a no-lose scenario for banks though, which is why it's done that way I guess.
It's a no-lose scenario for banks though, which is why it's done that way I guess.
Everything is priced that way, basically. In the world of finance, everything is priced according to the future income it can generate -- not just real estate, but stocks, bonds, etc. There's nothing insane about it. To the contrary, it's the only rational way of doing things.
You're right that nobody can predict correctly that far in the future, but ultimately you have to choose whether you think a business decision will be profitable or not, so you have to predict anyways or else you could never do anything. People build lots of models to try to predict better. And market prices reflect a middle point between the pessimists and the optimists.
Also, it's not no-lose for banks. If the owner walks and the property is re-sold for less than it was originally bought for minus the down payment, the bank very much loses. That's a major point of the article, why the bank would prefer the space to continue vacant for a few years than take that loss.
You're right that nobody can predict correctly that far in the future, but ultimately you have to choose whether you think a business decision will be profitable or not, so you have to predict anyways or else you could never do anything. People build lots of models to try to predict better. And market prices reflect a middle point between the pessimists and the optimists.
Also, it's not no-lose for banks. If the owner walks and the property is re-sold for less than it was originally bought for minus the down payment, the bank very much loses. That's a major point of the article, why the bank would prefer the space to continue vacant for a few years than take that loss.
> Everything is priced that way, basically. In the world of finance, everything is priced according to the future income it can generate -- not just real estate, but stocks, bonds, etc. There's nothing insane about it. To the contrary, it's the only rational way of doing things.
The only rational way of doing things is to turn every part of our economy into a bubble? Well, that at least explains why it’s all collapsing.
The only rational way of doing things is to turn every part of our economy into a bubble? Well, that at least explains why it’s all collapsing.
I don't have the slightest idea how you got to that conclusion from my comment.
This article probably omitted it for simplicity, but you would discount the income stream over time. Projected income at the 20 year mark is valued much less than income next year. That helps to account for the uncertainty.
> Intuition fails because normal people think of a building as a building, when in the majority of cases, a building is not a building but a financial product. Behavior that makes no sense for a building can make perfect sense for a financial product.
And it is precisely why a lot of people hate capitalism.
Adam Smith himself would would disapprove: "As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce."
And it is precisely why a lot of people hate capitalism.
Adam Smith himself would would disapprove: "As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce."
My day job is a Director level role at a large commercial real estate firm. Our primary segments are brokerage, management, and development management. I've been doing this for 11 years.
>The story starts with a building operator and a bank deciding what a building is worth. To figure this out, the operator is going to make a financial model that projects the income that a building will generate.
We're going by existing leases at the property, and take into account their expirations and rent escalations. Mostly, we're looking at current income. If a building is valued at $20M because of a $1,000,000 NOI at a 5% cap, that's because it literally has $1,000,000 of yearly income NOW and some seriously high grade tenants to justify that cap. Also, if there are no tenants in the building, we value it by things like construction value. If we're talking about new developments, we usually pre-lease and borrow based on the signed leases.
>You may wonder how the cap rate is determined. The simple answer is the owner and the bank negotiate and agree on a number.
This is disingenuous. We don't pull a cap rate out of thin air. We go by market caps on comparable properties and also factor in the credit of the existing tenants and their lease terms. There is a tiny bit of back and forth on the cap if the buyer and the bank disagree but this a matter of tenths of a percent.
All of that said, I have never known a property owner who refused to lower rents in a game of chicken with the bank and most would certainly rather fill a space with someone than keep rents elevated. If a space is empty, it's generating zero income, your NOI is therefore lower, and the building value has already decreased. The bank isn't pretending it's worth more than it is because you're advertising a certain rate. They're just giving you more time to lease the space so it doesn't have to go into receivership, which is a loss for everyone.
Beyond that, most leases are signed at or below asking rent unless the area is extremely high demand. They may not be advertising a rate drop, but anyone in this business knows that asking rents are a point to be negotiated during the leasing process.
>The story starts with a building operator and a bank deciding what a building is worth. To figure this out, the operator is going to make a financial model that projects the income that a building will generate.
We're going by existing leases at the property, and take into account their expirations and rent escalations. Mostly, we're looking at current income. If a building is valued at $20M because of a $1,000,000 NOI at a 5% cap, that's because it literally has $1,000,000 of yearly income NOW and some seriously high grade tenants to justify that cap. Also, if there are no tenants in the building, we value it by things like construction value. If we're talking about new developments, we usually pre-lease and borrow based on the signed leases.
>You may wonder how the cap rate is determined. The simple answer is the owner and the bank negotiate and agree on a number.
This is disingenuous. We don't pull a cap rate out of thin air. We go by market caps on comparable properties and also factor in the credit of the existing tenants and their lease terms. There is a tiny bit of back and forth on the cap if the buyer and the bank disagree but this a matter of tenths of a percent.
All of that said, I have never known a property owner who refused to lower rents in a game of chicken with the bank and most would certainly rather fill a space with someone than keep rents elevated. If a space is empty, it's generating zero income, your NOI is therefore lower, and the building value has already decreased. The bank isn't pretending it's worth more than it is because you're advertising a certain rate. They're just giving you more time to lease the space so it doesn't have to go into receivership, which is a loss for everyone.
Beyond that, most leases are signed at or below asking rent unless the area is extremely high demand. They may not be advertising a rate drop, but anyone in this business knows that asking rents are a point to be negotiated during the leasing process.
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Why can you bullshit about an empty building but not a temporarily low rent building? Why doesn't this just lead to "Month-to-month and Pretend"?
Because rent on the books is dollars and cents. If you (a landlord) pretend to rent a building to me at $1m/year but give me a $500k 'rebate' that's arguably a fraud on the bank and/or tax fraud. Doing it month-to-month might be a workaround but any commercial operation will want to write off the rent against tax, which makes it official again.
You could probably make this work by donating office space to nonprofit organizations while maintaining high nominal rent (and maybe this already happens) but it's not as practical for storefronts etc.
You could probably make this work by donating office space to nonprofit organizations while maintaining high nominal rent (and maybe this already happens) but it's not as practical for storefronts etc.
This still doesn't quite explain why vacant is excusable but under priced isn't also excusable.
Said another way why isn't a vacant space treated as renting it for $0? I can see why you wouldn't want to lock in a long-term low rate but why isn't a short-term rate as excusable as a vacancy?
Said another way why isn't a vacant space treated as renting it for $0? I can see why you wouldn't want to lock in a long-term low rate but why isn't a short-term rate as excusable as a vacancy?
Because once it's on the books, the bank has a fiduciary duty (to its shareholders) to take note of it - effectively marking the value of the building to a multiple of market rents - and if the rent indicates that the building is worth much less than it was financed for the bank has to reduce its exposure by law.
While the income is $0, the landlord can say they're actively seeking tenants, and the bank can pretend to believe this and exercise its right of forbearance. Lower actual rent payments break the illusion of how much the property is worth, and both the landlord and the bank have to put that unpleasant reality on the books.
Real world example: the fanciest mall in downtown San Francisco was valued at $1.2 billion a few years back. Great location, great building design, a nice place to shop for many years. Things started to go bad after COVID, and after 2 years of no rent the banks pulled the plug and foreclosed. They ended up buying the deed for $133 million. This would be a great deal, except that they'd loaned $566 million. So they are not the proud owners of an empty mall, which is only worth about 25% of the money they initially invested, and they have to tell their shareholders that they lost $433 million. Now that the cat is out of the bag they could start renting out retail units at affordable prices, but a bank does not want to be a landlord/property manager.
https://www.sfgate.com/local/article/2-buyers-scoop-former-s...
While the income is $0, the landlord can say they're actively seeking tenants, and the bank can pretend to believe this and exercise its right of forbearance. Lower actual rent payments break the illusion of how much the property is worth, and both the landlord and the bank have to put that unpleasant reality on the books.
Real world example: the fanciest mall in downtown San Francisco was valued at $1.2 billion a few years back. Great location, great building design, a nice place to shop for many years. Things started to go bad after COVID, and after 2 years of no rent the banks pulled the plug and foreclosed. They ended up buying the deed for $133 million. This would be a great deal, except that they'd loaned $566 million. So they are not the proud owners of an empty mall, which is only worth about 25% of the money they initially invested, and they have to tell their shareholders that they lost $433 million. Now that the cat is out of the bag they could start renting out retail units at affordable prices, but a bank does not want to be a landlord/property manager.
https://www.sfgate.com/local/article/2-buyers-scoop-former-s...
The article touches on this briefly: they do do this, in the form of "five year lease, first year free as an incentive!". This lowers the actual rent by 20%, but they can still use the (pretend) full rent when calculating asset value.
> a building is not a building but a financial product.
Are we cooked chat?
Are we cooked chat?
Your house and the 30-year fixed-rate mortgage on it is a financial product too, and a fairly complex and risky one at that. This fact is just well-hidden from you by nested layers of government subsidies.
There is basically no way for real estate to not be a complex financial product, because almost no one can pay cash-up-front for it. If it wasn't financialized, nobody could ever afford to own anything and we'd all be feudal serfs renting from a couple landlords.
There is basically no way for real estate to not be a complex financial product, because almost no one can pay cash-up-front for it. If it wasn't financialized, nobody could ever afford to own anything and we'd all be feudal serfs renting from a couple landlords.
One "Simple Fix" for cities, albeit with limited scope: Force your Planning Commission, Zoning Board, etc. to keep track of the vacancy rates for commercial space. Then use their powers to strongly discourage the construction of yet more vacant commercial space. And/or renovation of such space to other uses.
EDIT:
- Please do not assume some trivial straw-man implementation of this idea. That includes City organization being hopelessly corrupt or incompetent.
EDIT:
- Please do not assume some trivial straw-man implementation of this idea. That includes City organization being hopelessly corrupt or incompetent.
How would this help? If the existing operators refuse to lower rents and leave their spaces vacant then under this scheme no one else can build new spaces which rent at lower rates. You would just be stuck with vacant properties at above-market rates.
This policy would backfire greatly. For one, if I want to keep a competitor from expanding into my town, I'll just lease some commercial space and keep it vacant. That way they cannot build in my town.
That is a bad answer because it invites too much power to those commissions/boards. They already have a lot of power which they abuse (in places) to not allow things they don't like that would be good for the community.
Just charge a fine for poorly maintained space that degrades the community. They do this for homeowners.
No, Just Tax Land (TM)
In Los Angeles I’ve watched business after business close because their rent was increased by their commercial landlord only for the property to sit vacant in some cases (no exaggeration) for over 5 years!
Thats absurd. Also as a business owner who would like some space to work out of your only options are endless swaths of vacant industrial buildings that are tens of thousands in rent a month. I don’t quite get how anyone runs a brick and mortar or has space to do anything profitable.
[1] https://en.wikipedia.org/wiki/Land_value_tax