Why do commercial spaces sit vacant?

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.

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.

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.

Is it because of Prop 13 that commercial property owners aren't paying adequate property taxes that would act to encourage use?

Some businesses survive because they already own the property or have long time leases.

Don't underestimate how many businesses are supplementing their income with dirty money.

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?

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.

> 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.

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.

> 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.

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.

> 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.

A vacancy tax would work on areas with high demand, but it also punishes areas that are already struggling.

  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."

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).

That would just devalue the surrounding property even more. This is why "we should just do X" is almost always a bad idea.

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.

All you need is 20% annual returns and you're better off with the investment. ;D

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.

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.

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?

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.