Comment by gspencley | Hacker News Reader

Comment by gspencley | Hacker News Reader

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What I don't understand is how it benefits the bank for the owner / borrower to leave a commercial property vacant, thus collecting NO rent, which could impact the borrower's ability to repay the loan even more. Possibly resulting in a default.

I guess the bank has the property as collateral. But liquidating the property is also expensive and risky. Generally if you want people to borrow money from you, you want those loans paid back with interest. It can't help business to have customers constantly defaulting and leaving you with physical assets and costly legal and liquidation proceedings.

The other thing the article mentioned was "credit tenants": big chains that will take out long leases and continue to rent even if they close the location and it appears vacant. But while clearly the banks would love these tenants, there wasn't a connection made in the article between "borrower is about to default because they can't find a tenant" and "credit tenant swoops in to save the borrower and bank." The only thing credit tenants seem to add to the story is that they are yet another reason there are so many vacant retail locations. A big chain opens a store, and then closes it because the under-performing location costs less to run out the lease than it does to keep it operating.

I'm clearly missing something.

AIUI valuation of commercial real estate is driven almost entirely by NPV of rents. The lender loans against a value derived from some expected $/ft rent. If the space is empty, but offered at or above that level, then the landlord (and maybe the bank) might have some issues making payments, but both their balance sheets are the right way up. If the landlord leases some of the space cheaper than the target, then cashflow improves, but the value of the building drops because the current lease sets expectations for future rents. If they lease cheap enough, the landlord and lender might end up underwater and undercollateralized, and be forced to sell at a loss, wipe out equity, etc.

All else equal, both sides prefer paper equity to hard cash, so lose money short term rather than mark the asset to market.

What I don't get is the endgame. When the lack of cashflow makes the landlord go bankrupt and the lender has to repossess, doesn't that look bad for them? If you try to sell me a property with the promise that it can bring in $100/sq foot, but nobody has wanted it at that rate for 3 years, and it's in a neighborhood full of other vacant storefronts, why would anyone believe you? There's gotta be some externality that I don't understand.

>There's gotta be some externality that I don't understand.

The banks are over-invested in commercial real estate, is my guess, and they're attempting to price fix to prevent the price from dropping too quickly and putting the banks themselves under water

If you're betting that the lull in demand is a temporary thing and in the not too distant future people will start paying the prices they did before, then it makes perfect sense.

On a larger scale, even if you know some locations are never going to see the demand they once did, so long as some fraction do recover, then it's an overall winning strategy. Where that breakeven point is exactly is tough to say, but I'm sure you can find a good number of people bullish on long term commercial real estate.

The endgame does not matter. Banks are publicly traded, and like every publicly traded company, the only timespan that matters is 1-4 quarters.

My takeaway (and perhaps I have it wrong too) is that:

1) The bank doesn't have a mortgage on the commercial property, that's the owner/landlord.

2) The bank can tell the owner, "You can't lease this place for less than $100 per square foot".

3) The benefits to the bank from having "this place goes for $100 per square foot" on their books (or, conversely, the negative consequences of not having that one their books) are strong enough to keep the bank locking that rate in place, even if doing so increases the chances of the landlord going bust.

4) Worst self-percieved case for the bank is: "We own a commercial property worth a lot on paper, because on paper it's worth $100 per square foot, which makes it easy to find another buyer."

Kinda smells to me like the banks are trying to engage in price-fixing to keep the commercial real estate market from plummeting too far in value too fast

I have made similar arguments elsewhere on the Internet.

I believe this is the right analysis because the best comeback they have is a straw-man along the lines of "why do you hate Capitalism/America/etc?"

I really can't wait until the Big Bank/Big Real Estate cartel gets busted over this; they almost did in 2008 during the crash and somehow wiggled out of it with minimal losses, while bankrupting Greece, almost bankrupting Spain, and setting back the US economy a decade.

That was touched on in the article and in the report linked in another comment. Basically the bet is as follows:

1) I lower the rent $X and lease to someone now. This has a life time value of lease months * X

2) I leave it vacant, and lease to someone later for a premium rent $Y which has a lifetime value of $0 * vacant_months + $Y * lease_months.

The bet is that #2 is more money. What the landlord fears is that because leases are hard to break, #1 will leave them "stuck" for 'n' years at the lower rent.

In the Bay area during lots of competition for space, one could finesse this, if you were able to move easily, by leasing just "month to month".

> if you were able to move easily

I find myself imagining a cyberpunk future: The local Megabuilding is ringed with empty sockets along its ground-floor, bays of various standardized sizes and utility-connections, each waiting for tenants--with their treaded "stores"--to drive along, buy a few weeks, and carefully back in before unfurling their colorful interface to the wallets of the public.

They have some interesting "pop up" stalls in downtown Atlanta. I have heard that the 'container village' in Las Vegas was kind of thinking of that too, based on a standard container, you just dropped it down and then moved it when needed.

Its always interesting seeing the somewhat regular pop-up markets with crowds in the parking lots of 2/3 vacant strip malls.

I already see that happening, except without the Megabuilding. For example, I see lots of semi-permanent food trucks — they park in the same spot every day, running off of bottled propane and a noisy little generator hanging off the hitch, doing brisk business in a busy pedestrian-heavy neighborhood with lots of empty storefronts. This can go on for literally years.

On occasion the food truck will become so permanent that it's up on blocks in a parking lot, has a permanent eating area built next to it, maybe even has a cord running into a neighboring business. But that neighboring business is invariably a small business in an old, single-story building.

I don't know the cause of this obvious inefficiency. I assume it's that commercial real estate companies don't want to waste their time with small tenants. They figure it's more profitable to leave a large space open for ten years in hopes of getting a bank branch or chain restaurant, rather than rent each 25-foot section out to a separate tenant with higher turnover. Maybe they're right. Nobody gets rich running fleamarkets.

Not necessarily from the perspective of the bank, but the borrower/owner, I've heard of the concept of `prevailing market rent` to be a driver of this.

If I rent out a space to A, they may have clauses that reference the rent/average rent for the building vs. their space. So it might be preferential for me to wait to fill a space at a higher price, financially.

In addition, renting out at a lower rate may end up turning up in surveys of rent in the area, leading to a lower average, meaning that future renters of space that is currently rented will try and negotiate downwards in the future.

if you're worried about rent surveys, wouldn't vacant units ($0 / sq foot) be the worst possible scenario?

For that explanation to work, the vacant spaces must somehow be excluded from the "prevailing rate" calculation. Perhaps by calculating their rent according to their asking price - which would, interestingly, give (large-scale, at least) landlords even more incentive to hold a few properties vacant - or perhaps by entirely removing them from the equation.

I don't know if GP's description is correct, but if it is then I agree with you (I assume) that $0-income spaces ought to be in some way included in the average.

Difference between building cost and leverage may cover that gap.

Let's say you buy a building with a 50 year mortgage for $50M. You're 10 years into the mortgage, so you've paid off $5M. But real estate in your area has done well, so the building is now worth $80M. If the bank forecloses on you then it's risky for them, but not as risky as it sounds.

They foreclose and fire sale the building for $60M (25% discount to make sure it moves). They get back the remaining $45M on the loan, and the owner gets $15M. Less than the $35M they'd have if they had sold it themselves.

The bank doesn't really care how much the building sells for as long as it's over what they are owed, because that's all they get out of the sale.

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