As for "things we might do about it" -- I agree that punitive measures will only further distort this market. Essentially we've a) forgotten how to do urban retail by and large, b) goods and service delivery has changed a lot since the glory days of main streets, c) "financialization" of real estate into financial products instead of family businesses has fundamentally changed real estate. (honestly, I wish I better understood specifically how main street commercial buildings were financed back in the day).
To attack these problems, is about changing the way the whole real estate ecosystem works. I suspect you will need: many more smaller and medium sized developers who are based in the cities, towns, and neighborhoods where they work. They will still be profit driven entrepreneurs, but they will be more responsive to real buildings, streets, and people, than spreadsheet crunchers. Those developers will need to be trained in the arts of good place making. Not because it's hippy-shit, but because it will make them wealthier--"location" is just where people want to be. You can create that.
I think there's a durable demand for commercial space in cities and towns. We run about 350,000 square feet of it in Providence and we're 95%+ full. Everything from bars and restaurants, to shops, gyms, professional offices and corporate offices, warehouse and flex space, recording studios, and nonprofits, artist studios to indoor minigolf and breweries and distilleries. But this requires creativity and a hands on approach. It can't be outsourced from corporate to brokers. We work with nearly all non-credit tenants. In the end, grit and gumption and quality product will make a business successful. And those that fail can be re-tenanted in buildings that are well cared for.
Lastly, we will need to change the structure of real estate capital. Right now it's particularly hard to finance these kinds of deals. They are too small to interest the big pools of capital sloshing around than need to write $100+ million checks, but they are too weird for a lot of smaller investors and lenders (as compared to flipping houses or building townhouses or whatever). I have some ideas on what might work, but that's a longer story for another time.
If i could amend anything it would be to point out that this situation mostly pertains to professionally managed and financed buildings—which are the type of large urban infill with annoying vacancies that make people crazy, of vacant storefronts in very high price areas (where the deals are fully leveraged, etc)
I think the situation will prove to have different causes and effects in the probably larger world of mom and pop managed mixed use and storefront buildings. I alluded to this in a note, but a big cause here is properties that are fully depreciated with little or no debt, non professional owners typically want the cash flow and do not invest improvements or upgrades or frankly market their spaces very hard. They are already getting checks doing very little!
Sorry - one more additional piece of information. Commercial leases are often multi-year. Signing a lease changes the option value of a building. So in buildings that might be redeveloped or where starbucks might come next year, you're not going to be interested in signing long-term leases. And a tenant opening their own coffee shop is going to need enough term to pay-back the cost of buildout and getting set up. So we have different time preferences as well.
Unlike the typical home mortgage in the US, my understanding is that CRE loans also tend to be “recourse”, meaning the borrower is on the hook for whatever amount is left on the loan after the bank sells the building in case of foreclosure.
Someone pointed out in the comments of Matt's post that if a tenant rents and then fails after a year, that might overall lose money, especially if they got an allowance for renovation and maybe also struggled to pay rent. So that's a reason to keep the property vacant and hope Starbucks or a bank eventually moves in.
Also often the floor plates of retail space in new construction, especially new residential construction, are really big and thus harder to fill.
What would explain the success of certain street commercial retail areas in present day?
For example, Larchmont Avenue in Los Angeles right now is absolutely bustin'. It's got no present vacancies. And it has not always been that way. A few years ago, it had high vacancy rates. There are certain long commercial strips in LA that seem to continue on with minimal vacancies.
And there are other parts of the city that have been struggling for decades (Westwood Village) or started to struggle within the last decade and a half (Robertson Boulevard adjacent to West Hollywood which was an in-place for a time).
Thank you btw for this post. It's very informative and helpful.
Honestly, I don’t know LA, so I don’t know. Retail neighborhoods usually thrive when there’s a good mix of stores and good foot traffic. Vacancy can cause a vicious cycle where the street just doesn’t feel as good and so foot traffic drops and so the remaining tenants have a harder time. Conversely, one really successful business can attract a lot of foot traffic and help energize the entire corridor.
Can you think of how specifically Larchmont changed over the last few years? What might have helped create that positive atmosphere?
TIL: Banks are allowed to intentionally misrepresent the value of assets on their balance sheet.
Seems like pretty obvious fraud.
If you are looking for a simple fix, cracking down on this sort of fraud might be one of the first things to try.
Obviously banks have incentives to over value their properties. They would get access to cheaper capital, cheaper credit, great assets under management, bigger salaries for the top brass and bigger bonuses too. But like wtf this shouldn't be allowed! It pollutes the commons and defrauds others. There are rules against this sort of thing, at least I thought so. Maybe I've been missing a trick the whole time?
I understand that you don't like outcome -- I don't like it either -- but I don't think this is fraud, and it's certainly not intentional fraud / crime. Who is being defrauded? The participants in the project are the ones paying the price.
Rather I think this is a surprising side effect of *scale*. You may wish for the building to be operated like a local, individual owner/operator would if they owned the building outright. That's totally understandable. But most large scale commercial property couldn't even *exist* if it wasn't a financial product, because local individual owner/operators would not be able to bring together the massive amounts of money that it takes to build things like this.
Every loan starts out as a negotiation based on assumptions about the future. In this case, the building operator is making their best effort to forecast what will happen in the future, how many tenants they will have and what those tenants will be willing to pay. The operator, investors, and the bank are all putting millions of dollars of their own money at risk -- money they could use for other things instead! -- and taking a chance to build a building. And when it turns out they guessed wrong about the future, they pay a huge price! The operator is losing tons of money every year trying to buy time to avoid losing even *more* money.
Now, we could say we ought to *force* the banks to crack down on loans like this rather than give the operator more time, but remember that wipes out both the building owner *and* hurts the bank. If you think this is a moral hazard issue, how moral does that same line of thinking feel for other kinds of loans?
Lots of people owe more on their cars than the cars are worth -- should a bank be forced to repossess a car if the car loan is upside down, or is it okay to let the borrower keep making the payments? What if the market changed and the value of your house went upside down, as it did for millions of people during the Great Recession? If the homeowner wants to keep making payments and stay in their home, should the bank be forbidden from negotiating and forced to foreclose? Was the homeowner committing fraud when they unknowingly overpaid for their house, unable to see that a recession would come and turn the market downward?
It's easy to start from not liking the outcome and then imagining malicious intent that needs to be punished, but assuming bad intent often leads us astray. This isn't happening because people are evil. It's because they tried their best to guess the future, they invested a ton of money into that guess, they guessed wrong, and now they're just trying to recover without losing everything.
I'm still confused about why the banks need to foreclose when rent is lower than hoped/expected. Whose decision is it? Why wouldn't they prefer *some* income to foreclosure?
To be specific: If reality has proven a property can only make $700k per year, well, that is better than in reality the property only making $500k per year. So if you would need to foreclose in the $700k case, why do you not need to foreclose in the $500k case? And if you don't need to foreclose in the $500k case, why do you need to foreclose in the $700k case? This seems perfectly backwards to me.
Can the bank value the property at $14M without needing to foreclosure? If not, why not? This might be the detail I'm missing.
So, understand that the original loan is going to end, and the owner/operator will need to repay the entire outstanding $16M balance all at once. They almost certainly can’t do that, so they need a new loan. This is what triggers the problem.
With locked in lower rent, the bank can’t continue to value the building at $20M and offer a new term loan for $16M, they have to value the building at $14M and can only offer a new loan for $11.2M.
That gap between the old value and the new value, combined with the original loan coming due, is what creates the problem.
To avoid that, the operator and the bank need to keep trying to make the original model work, ie keep the rent where it was “supposed to be,” so they can continue to justify that the building “is going to be worth” the expected value of $20M.
The two parties can’t and won’t always do this — commercial properties do go into foreclosure or go bankrupt. But, if the operator can afford to keep making the payments, then both parties may feel that “extend and pretend” is the best option, because they both expect that eventually they’ll find tenants, and the alternative is just really bad for everyone who put money in to buy (or build) the building.
Right. But a financial product with cash flow of $500k/year is worth less than a similar product with cash flow of $700k/year. So if you can value the $700k/year product at $14M, then surely any reasonable net present value calculation would value the $500k/year product even less. And as the $500k/year product is not worth as much, it is surely harder - not easier - to get the new loan.
If you are trying to pretend the income stream is $1M/year, the $700k/year product does a better job of this than the $500k/year product. The closer the cash flows to the projected values, the easier it should be to "make the model work".
I'm sorry to say that I still don't understand this extend-and-pretend explanation: Why would banks value smaller cash flows more than bigger cash flows when making these follow-on loans? And what financial model could justify this? I'm not sure what I'm missing; it still seems fairly backwards to me.
It's a question of how much the bank is willing to ignore. What about a city program that (1) rents the space at the original rent (thus giving the bank cover to make-believe the original valuation model), (2) sub-leases the space at the true lower market rates, and (3) is paid the difference by the landlord as a "vacancy service fee" or similar? Importantly, the fee paid by the landlord to the city could be slightly less than the city's cost, so the landlord saves a little money by participating, and the city could likely recoup that small difference through the increased taxes generated by the sub-lease activity. Further, the city's lease should be long-enough that when the market recovers, they can raise rents on their sub-leases and potentially recoup some additional value. If the bank can ignore the sub-lease rates, then everyone benefits.
I realize the answer to my question is probably "because this is the way it is" but I still don't understand why the value of the building isn't the amount the seller agreed to sell it for, and the buyer agreed to pay for it. Why wouldn't that system work?
Why do the banks and buyers do interest-only loans like this in the first place? Doesn’t it basically guarantee that at some point someone is left holding the bag on the real value of the building, since only that originally 20% down ever goes to “equity”?
Is the idea that they just keep kicking the loan down the road until the building depreciates and gets torn down and rebuilt, starting the whole process over again?
They don’t always do interest only, but they sometimes do, and it makes the example easier to understand. Keep in mind:
For the bank a building is an income stream, they want to make loans and receive payments on them, so they are happy to have a percentage of a building be debt indefinitely
But buildings are bought and sold, so, really what both the bank and the operator are expecting is that at some point in 5-20 years they’ll sell to another owner/operator and that’s how whatever debt is left on the property will get paid off
Finally, buildings generally appreciate over time, so even if the principal wasn’t being paid down the percentage of equity in the building would be expected to go up over time
To me the obvious answer is to write vacancy discounts into bank capital formulas. Nonperforming collateral with a performing loan should obviously be viewed as more risky than performing collateral with a nonperforming loan. You’d change some regulation in CMBS as well.
And to answer your question: free rent is very common in commercial especially in big footprint/quasi special purpose properties.
This was great - I think a lot of people’s intuitions about commercial real estate (including mine!) come from experiences with residential real estate (ie buying an owner-occupied property), which is apparently a really weird financial product.
@Andrew… is there any way to take out a long term bet that Extend & Pretend will eventually lead to widespread revaluations in some future financial crisis?
I’m wondering if there’s some sort of Big Short-like angle here.
I know this is super late here, but doesn't this whole analysis just ignore mark to market? The whole premise is that an economic loss has occurred. Who is going to show that on their accounting records?
The FV of the collateral underlying the commercial loan has deteriorated relative to the loan commitment and thus there's going to be credit loss on the lending decision *even if* payments are current.
Also, what about the loan loss that comes from a modification extending payment terms? That has a negative present value impact on the loan from the bank's perspective.
The landlord will have impairment loss eventually, too!
And even if accounting doesn't force recognition of reality, reality has a way of forcing recognition on market participants.
This is one of the clearest explanations I’ve seen,and it absolutely tracks with what I’ve experienced. The tragedy is that what looks like irrational vacancy is actually financially rational dysfunction.
The moment you realize the building isn’t real estate,it’s a debt wrapper around a projected income stream,it changes everything. The physical space becomes secondary to preserving the valuation narrative. That’s what kills flexibility, creativity, and ultimately, vitality.
One idea I’ve been thinking about: what if cities or quasi-public funds offered shared-risk TI pools or short-term partial lease guarantees, not to distort rents, but to bridge exactly these capital stack gaps without forcing write-downs? It wouldn’t fix overleverage, but it might restore movement without triggering systemic loss.
A few naive, interrelated questions from someone who knows nothing about real estate, if you're willing to entertain them:
-Why couldn't you just extend the life of the loan so the building operator compensates the bank for portion of its loss over the long term? Yes, that means the operator would be putting more money into an asset that costs less than they assumed at first. But in return they'd get to fill vacant space and make more rental income per month.
-And why couldn't regulators require banks in such situations to work with commercial building operators to come to new terms that would allow for lowering rents? Yes, I get that forcing banks to eat losses too suddenly can cause financial chaos in the short term, but such a change could be phased in slowly, and over the long term banks would surely adapt to a regulatory environment in which this sort of risk was priced into their commercial lending business. You don't have to end financialization, just use regulatory tools to make it work better for the common good.
-In general, banks and commercial real estate interests have a lot of money. Why can't the government make them "take a haircut" on an overly optimistic deal like you describe (perhaps with some minimal level of public money as a backstop) on terms that are better for everyone involved than simply letting units stay empty?
As for "things we might do about it" -- I agree that punitive measures will only further distort this market. Essentially we've a) forgotten how to do urban retail by and large, b) goods and service delivery has changed a lot since the glory days of main streets, c) "financialization" of real estate into financial products instead of family businesses has fundamentally changed real estate. (honestly, I wish I better understood specifically how main street commercial buildings were financed back in the day).
To attack these problems, is about changing the way the whole real estate ecosystem works. I suspect you will need: many more smaller and medium sized developers who are based in the cities, towns, and neighborhoods where they work. They will still be profit driven entrepreneurs, but they will be more responsive to real buildings, streets, and people, than spreadsheet crunchers. Those developers will need to be trained in the arts of good place making. Not because it's hippy-shit, but because it will make them wealthier--"location" is just where people want to be. You can create that.
I think there's a durable demand for commercial space in cities and towns. We run about 350,000 square feet of it in Providence and we're 95%+ full. Everything from bars and restaurants, to shops, gyms, professional offices and corporate offices, warehouse and flex space, recording studios, and nonprofits, artist studios to indoor minigolf and breweries and distilleries. But this requires creativity and a hands on approach. It can't be outsourced from corporate to brokers. We work with nearly all non-credit tenants. In the end, grit and gumption and quality product will make a business successful. And those that fail can be re-tenanted in buildings that are well cared for.
Lastly, we will need to change the structure of real estate capital. Right now it's particularly hard to finance these kinds of deals. They are too small to interest the big pools of capital sloshing around than need to write $100+ million checks, but they are too weird for a lot of smaller investors and lenders (as compared to flipping houses or building townhouses or whatever). I have some ideas on what might work, but that's a longer story for another time.
Well done Andrew.
If i could amend anything it would be to point out that this situation mostly pertains to professionally managed and financed buildings—which are the type of large urban infill with annoying vacancies that make people crazy, of vacant storefronts in very high price areas (where the deals are fully leveraged, etc)
I think the situation will prove to have different causes and effects in the probably larger world of mom and pop managed mixed use and storefront buildings. I alluded to this in a note, but a big cause here is properties that are fully depreciated with little or no debt, non professional owners typically want the cash flow and do not invest improvements or upgrades or frankly market their spaces very hard. They are already getting checks doing very little!
Sorry - one more additional piece of information. Commercial leases are often multi-year. Signing a lease changes the option value of a building. So in buildings that might be redeveloped or where starbucks might come next year, you're not going to be interested in signing long-term leases. And a tenant opening their own coffee shop is going to need enough term to pay-back the cost of buildout and getting set up. So we have different time preferences as well.
Unlike the typical home mortgage in the US, my understanding is that CRE loans also tend to be “recourse”, meaning the borrower is on the hook for whatever amount is left on the loan after the bank sells the building in case of foreclosure.
Why would that be?
Someone pointed out in the comments of Matt's post that if a tenant rents and then fails after a year, that might overall lose money, especially if they got an allowance for renovation and maybe also struggled to pay rent. So that's a reason to keep the property vacant and hope Starbucks or a bank eventually moves in.
Also often the floor plates of retail space in new construction, especially new residential construction, are really big and thus harder to fill.
What would explain the success of certain street commercial retail areas in present day?
For example, Larchmont Avenue in Los Angeles right now is absolutely bustin'. It's got no present vacancies. And it has not always been that way. A few years ago, it had high vacancy rates. There are certain long commercial strips in LA that seem to continue on with minimal vacancies.
And there are other parts of the city that have been struggling for decades (Westwood Village) or started to struggle within the last decade and a half (Robertson Boulevard adjacent to West Hollywood which was an in-place for a time).
Thank you btw for this post. It's very informative and helpful.
Honestly, I don’t know LA, so I don’t know. Retail neighborhoods usually thrive when there’s a good mix of stores and good foot traffic. Vacancy can cause a vicious cycle where the street just doesn’t feel as good and so foot traffic drops and so the remaining tenants have a harder time. Conversely, one really successful business can attract a lot of foot traffic and help energize the entire corridor.
Can you think of how specifically Larchmont changed over the last few years? What might have helped create that positive atmosphere?
TIL: Banks are allowed to intentionally misrepresent the value of assets on their balance sheet.
Seems like pretty obvious fraud.
If you are looking for a simple fix, cracking down on this sort of fraud might be one of the first things to try.
Obviously banks have incentives to over value their properties. They would get access to cheaper capital, cheaper credit, great assets under management, bigger salaries for the top brass and bigger bonuses too. But like wtf this shouldn't be allowed! It pollutes the commons and defrauds others. There are rules against this sort of thing, at least I thought so. Maybe I've been missing a trick the whole time?
I understand that you don't like outcome -- I don't like it either -- but I don't think this is fraud, and it's certainly not intentional fraud / crime. Who is being defrauded? The participants in the project are the ones paying the price.
Rather I think this is a surprising side effect of *scale*. You may wish for the building to be operated like a local, individual owner/operator would if they owned the building outright. That's totally understandable. But most large scale commercial property couldn't even *exist* if it wasn't a financial product, because local individual owner/operators would not be able to bring together the massive amounts of money that it takes to build things like this.
Every loan starts out as a negotiation based on assumptions about the future. In this case, the building operator is making their best effort to forecast what will happen in the future, how many tenants they will have and what those tenants will be willing to pay. The operator, investors, and the bank are all putting millions of dollars of their own money at risk -- money they could use for other things instead! -- and taking a chance to build a building. And when it turns out they guessed wrong about the future, they pay a huge price! The operator is losing tons of money every year trying to buy time to avoid losing even *more* money.
Now, we could say we ought to *force* the banks to crack down on loans like this rather than give the operator more time, but remember that wipes out both the building owner *and* hurts the bank. If you think this is a moral hazard issue, how moral does that same line of thinking feel for other kinds of loans?
Lots of people owe more on their cars than the cars are worth -- should a bank be forced to repossess a car if the car loan is upside down, or is it okay to let the borrower keep making the payments? What if the market changed and the value of your house went upside down, as it did for millions of people during the Great Recession? If the homeowner wants to keep making payments and stay in their home, should the bank be forbidden from negotiating and forced to foreclose? Was the homeowner committing fraud when they unknowingly overpaid for their house, unable to see that a recession would come and turn the market downward?
It's easy to start from not liking the outcome and then imagining malicious intent that needs to be punished, but assuming bad intent often leads us astray. This isn't happening because people are evil. It's because they tried their best to guess the future, they invested a ton of money into that guess, they guessed wrong, and now they're just trying to recover without losing everything.
I'm still confused about why the banks need to foreclose when rent is lower than hoped/expected. Whose decision is it? Why wouldn't they prefer *some* income to foreclosure?
To be specific: If reality has proven a property can only make $700k per year, well, that is better than in reality the property only making $500k per year. So if you would need to foreclose in the $700k case, why do you not need to foreclose in the $500k case? And if you don't need to foreclose in the $500k case, why do you need to foreclose in the $700k case? This seems perfectly backwards to me.
Can the bank value the property at $14M without needing to foreclosure? If not, why not? This might be the detail I'm missing.
So, understand that the original loan is going to end, and the owner/operator will need to repay the entire outstanding $16M balance all at once. They almost certainly can’t do that, so they need a new loan. This is what triggers the problem.
With locked in lower rent, the bank can’t continue to value the building at $20M and offer a new term loan for $16M, they have to value the building at $14M and can only offer a new loan for $11.2M.
That gap between the old value and the new value, combined with the original loan coming due, is what creates the problem.
To avoid that, the operator and the bank need to keep trying to make the original model work, ie keep the rent where it was “supposed to be,” so they can continue to justify that the building “is going to be worth” the expected value of $20M.
The two parties can’t and won’t always do this — commercial properties do go into foreclosure or go bankrupt. But, if the operator can afford to keep making the payments, then both parties may feel that “extend and pretend” is the best option, because they both expect that eventually they’ll find tenants, and the alternative is just really bad for everyone who put money in to buy (or build) the building.
Right. But a financial product with cash flow of $500k/year is worth less than a similar product with cash flow of $700k/year. So if you can value the $700k/year product at $14M, then surely any reasonable net present value calculation would value the $500k/year product even less. And as the $500k/year product is not worth as much, it is surely harder - not easier - to get the new loan.
If you are trying to pretend the income stream is $1M/year, the $700k/year product does a better job of this than the $500k/year product. The closer the cash flows to the projected values, the easier it should be to "make the model work".
I'm sorry to say that I still don't understand this extend-and-pretend explanation: Why would banks value smaller cash flows more than bigger cash flows when making these follow-on loans? And what financial model could justify this? I'm not sure what I'm missing; it still seems fairly backwards to me.
It's a question of how much the bank is willing to ignore. What about a city program that (1) rents the space at the original rent (thus giving the bank cover to make-believe the original valuation model), (2) sub-leases the space at the true lower market rates, and (3) is paid the difference by the landlord as a "vacancy service fee" or similar? Importantly, the fee paid by the landlord to the city could be slightly less than the city's cost, so the landlord saves a little money by participating, and the city could likely recoup that small difference through the increased taxes generated by the sub-lease activity. Further, the city's lease should be long-enough that when the market recovers, they can raise rents on their sub-leases and potentially recoup some additional value. If the bank can ignore the sub-lease rates, then everyone benefits.
I realize the answer to my question is probably "because this is the way it is" but I still don't understand why the value of the building isn't the amount the seller agreed to sell it for, and the buyer agreed to pay for it. Why wouldn't that system work?
Because a commercial buyer would value the building using this exact same approach, as a multiple of the rent, and arrive at the same value.
Made an account specifically to ask this too. Why doesn't the seller's price factor into the valuation?
Because a commercial buyer would value the building using this exact same approach, as a multiple of the rent, and arrive at the same value.
Made an account specifically to ask this too. Why doesn't the seller's price factor into the valuation?
Why do the banks and buyers do interest-only loans like this in the first place? Doesn’t it basically guarantee that at some point someone is left holding the bag on the real value of the building, since only that originally 20% down ever goes to “equity”?
Is the idea that they just keep kicking the loan down the road until the building depreciates and gets torn down and rebuilt, starting the whole process over again?
They don’t always do interest only, but they sometimes do, and it makes the example easier to understand. Keep in mind:
For the bank a building is an income stream, they want to make loans and receive payments on them, so they are happy to have a percentage of a building be debt indefinitely
But buildings are bought and sold, so, really what both the bank and the operator are expecting is that at some point in 5-20 years they’ll sell to another owner/operator and that’s how whatever debt is left on the property will get paid off
Finally, buildings generally appreciate over time, so even if the principal wasn’t being paid down the percentage of equity in the building would be expected to go up over time
Thanks, appreciate the extra detail!
To me the obvious answer is to write vacancy discounts into bank capital formulas. Nonperforming collateral with a performing loan should obviously be viewed as more risky than performing collateral with a nonperforming loan. You’d change some regulation in CMBS as well.
And to answer your question: free rent is very common in commercial especially in big footprint/quasi special purpose properties.
This was great - I think a lot of people’s intuitions about commercial real estate (including mine!) come from experiences with residential real estate (ie buying an owner-occupied property), which is apparently a really weird financial product.
@Andrew… is there any way to take out a long term bet that Extend & Pretend will eventually lead to widespread revaluations in some future financial crisis?
I’m wondering if there’s some sort of Big Short-like angle here.
Not that I know of, but I also haven’t tried to figure out how to do it. 🤷♂️
I know this is super late here, but doesn't this whole analysis just ignore mark to market? The whole premise is that an economic loss has occurred. Who is going to show that on their accounting records?
The FV of the collateral underlying the commercial loan has deteriorated relative to the loan commitment and thus there's going to be credit loss on the lending decision *even if* payments are current.
Also, what about the loan loss that comes from a modification extending payment terms? That has a negative present value impact on the loan from the bank's perspective.
The landlord will have impairment loss eventually, too!
And even if accounting doesn't force recognition of reality, reality has a way of forcing recognition on market participants.
I love footnote 3, such a good example of the frustration I experienced repeatedly throughout my educational experience.
This is one of the clearest explanations I’ve seen,and it absolutely tracks with what I’ve experienced. The tragedy is that what looks like irrational vacancy is actually financially rational dysfunction.
The moment you realize the building isn’t real estate,it’s a debt wrapper around a projected income stream,it changes everything. The physical space becomes secondary to preserving the valuation narrative. That’s what kills flexibility, creativity, and ultimately, vitality.
One idea I’ve been thinking about: what if cities or quasi-public funds offered shared-risk TI pools or short-term partial lease guarantees, not to distort rents, but to bridge exactly these capital stack gaps without forcing write-downs? It wouldn’t fix overleverage, but it might restore movement without triggering systemic loss.
A few naive, interrelated questions from someone who knows nothing about real estate, if you're willing to entertain them:
-Why couldn't you just extend the life of the loan so the building operator compensates the bank for portion of its loss over the long term? Yes, that means the operator would be putting more money into an asset that costs less than they assumed at first. But in return they'd get to fill vacant space and make more rental income per month.
-And why couldn't regulators require banks in such situations to work with commercial building operators to come to new terms that would allow for lowering rents? Yes, I get that forcing banks to eat losses too suddenly can cause financial chaos in the short term, but such a change could be phased in slowly, and over the long term banks would surely adapt to a regulatory environment in which this sort of risk was priced into their commercial lending business. You don't have to end financialization, just use regulatory tools to make it work better for the common good.
-In general, banks and commercial real estate interests have a lot of money. Why can't the government make them "take a haircut" on an overly optimistic deal like you describe (perhaps with some minimal level of public money as a backstop) on terms that are better for everyone involved than simply letting units stay empty?