9 ms·

This explanation seems very implausible to me. By lowering the rent by X%, and therefore reducing annual revenue by X%, you admit the building is worth X% less.

by jwarden 3mo ago

This explanation seems very implausible to me. By lowering the rent by X%, and therefore reducing annual revenue by X%, you admit the building is worth X% less. But by leaving the building X% vacant, also reducing the annual income stream by X%, you and the bank can somehow pretend the building is worth what it would be if full? I doubt owners and banks actually believe this. Is there some policy that forces this?

postepowanieadm 3mo ago
How do you asses the value? You use the x last transactions. No transactions, no data, the last value remains.
- arcza 3mo ago
  If a coffee shop is charging $25 for a latte and sells none, we don't say everything's fine because no sales data. The sales are $0 and it's not fine. There is no escaping the powers of supply and demand.
- AnthonyMouse 3mo ago
  "Last value" is pretty meaningless when it's stale though. Suppose there is a building that was built in 1970, last rented out in 1975 and then bought by a company that has used it as their own offices until now. The last transaction was in 1975, what's the value if they apply for a mortgage today? Surely they have some formula to use for this based on e.g. other buildings in the area. Moreover, "failure to find a tenant" is also a type of transaction. It's the landlord acting as the high bidder for the space, essentially the involuntary edition of imputed rent, and implies something negative about the financial prospects of the building when it continues for a significant period of time or large percentage of units. Ignoring that it is either incompetence or some kind of perverse incentive.
  - embedding-shape 3mo ago
    > "Last value" is pretty meaningless when it's stale though. For who and in what way though? Every entity involved wants to keep the price high, except the renter/new buyer, so with that in mind, "Last Value" seems optimal for achieving that. Maybe it's different in the US, but in Spain there is a ton of properties that sit completely empty and unused, even since earlier than 2008, just because the owners don't think the value is enough to sell yet, and they wouldn't earn enough renting it out, so everyone (except renters/new buyers) seems to prefer it just sits empty for decades.
    - AnthonyMouse 3mo ago
      > For who and in what way though? For anyone who wants an accurate accounting. Suppose the building is supposed to be worth $20M, has an existing $10M mortgage and is actually only worth $10M. The landlord comes to you and wants to borrow another $5M against the building. Pretty important to the lender at this point that they're not overvaluing it, right? Or the same if they go to a different bank trying to refinance an existing mortgage they're already underwater on when using an accurate accounting.
      - grebc 3mo ago
        Commercial borrowers have to pay for a valuation report by a bank approved valuer.
        AnthonyMouse 3mo ago
        Then why does anybody care if they rent out some of the units for a lower rent?
        grebc 3mo ago
        You keep asking the same question and the answer is the same in all these. You don’t like it. We get it. No one is doing anything illegal. If the bank thought a customer couldn’t pay, they’d get foreclosed, end of story.
        AnthonyMouse 3mo ago
        It's not a matter of whether I like it. It's a question of why the bank, unless required to do so by some kind of absurd perverse regulatory incentive, would do something which is not only harming others but also increasing the default risk for the bank by reducing the income of a borrower who, if they can't make the payments, will cause the bank to have to write off millions of dollars by foreclosing on an underwater building.
- lotsofpulp 3mo ago
  “You” require a continuous analysis of cash flow to continuously determine value, and proper management. A simple, and common, requirement in commercial lending called the debt service coverage ratio. https://www.investopedia.com/terms/d/dscr.asp https://www.investopedia.com/terms/d/dscr.asp Lower income for the building means lower numerator, which means being unable to meet the agreed upon DSCR, which means default. Whether or not the lender acts on this default is a separate matter, as they are usually loathe to get into the property management business, but renegotiation of terms and eventually foreclosure does happen.
makeitdouble 3mo ago
Here the bank cares less about annual income than future income. Keeping it vacant only impact current income, lowering rent impacts future forecasts.
- AnthonyMouse 3mo ago
  > Keeping it vacant only impact current income, lowering rent impacts future forecasts. Does it though? Suppose you can't find a tenant right now because the market is soft but is predicted to improve in a few years. If you leave the unit vacant, you lose money right now. If you rent it out with e.g. a 3-year lease, you make more for the next 3 years than you would with a vacancy, and if the market price has increased by then you can increase the rent on the unit and either get it from the current occupant or the one you get to replace them in the high demand market when the higher rent causes the low-paying tenant to not renew the lease. So taking a tenant now only improves prospects (you fill a current vacancy) with no negative impact on future returns. The only thing it does is imply that current rents are lower than before and future rents might be too, but a vacancy implies that even more strongly.
  - bandrami 3mo ago
    Humans are not Pareto efficient. If my wife and I are at the airport, and the gate agent offers me (and only me) an upgrade on the flight, your logic says I should take it since that's strictly better than both of us flying economy.
    - schlipity 3mo ago
      You should take it and then switch seats with your wife. Happy wife, happy life.
      - makeitdouble 3mo ago
        > Happy wife, happy life. Why wouldn't that happy cycle work with the husband ?
senordevnyc 3mo ago
Agreed. From the article: Actual commercial real estate professionals could give you many more reasons than I can I am so tired of listening to people with little to no experience with commercial real estate try and explain the vacant storefront thing. Maybe this explanation in the article is correct, but it raises more questions than it answers, and it’s unclear why we should trust this person’s explanation.
- em-bee 3mo ago
  do you have a better explanation?
  - probably_wrong 3mo ago
    It's on the person who willingly took the public stage to prove that their ideas have merit. I don't know much about microbiology, but that shouldn't stop me from asking someone who "did their own research" to shut up and let the experts talk.
    - em-bee 3mo ago
      they already gave their explanation. if you disagree then it is on you to provide a counter argument otherwise anyone could just shoot down any argument by claiming that it has no merit. at best you could say that you do not find the argument convincing, but even then you should explain why. you are not even claiming that the argument in question is wrong, you are only questioning the credentials of the author. that's appeal to authority, and therefore not a valid argument. https://youtu.be/N5k4yUSPHI8 https://youtu.be/N5k4yUSPHI8 I don't know much about microbiology, but that shouldn't stop me from asking someone who "did their own research" to shut up and let the experts talk. yes it should, unless you can provide a convincing argument that the person is wrong, expert or not. on the internet anyone can claim to be an expert and nobody can prove it.
      - senordevnyc 3mo ago
        I’m agreeing with the person I first responded to about why I don’t find this explanation credible. I don’t feel the need to reiterate what they said. AND I’m also saying I’m tired of non-experts giving their theories on this particular phenomenon, since they never make much sense.
zipy124 3mo ago
The policy is spelled out in the article? Banks have strict regulations that mean they have to have a certain amount of capital backing loans, and by revaluing a building you lower the capital that backs the loan, thus raising its risk, and thus leading you to break the regulation around capital requirements.
alper 3mo ago
The whole goal is not to write off the value of the property which you have to do if you rent it for less money than initially planned. That's not that difficult to understand is it?
- NoboruWataya 3mo ago
  I mean, it's highly unintuitive, which I would say makes it difficult to understand. The main weirdness is that lowering the rent would force a revaluation whereas letting the building sit vacant for an extended period of time apparently would not. If this is truly driven by regulatory capital requirements, then it seems like a gap in the regulations. Also foreclosure generally isn't the only option: the borrower could, for example, agree to repay part of the loan early, or give extra collateral, both of which would increase the LTV (and this would be better for the bank). I'm not saying the explanation is wrong, but I don't blame people for finding it difficult to understand. Other factors contributing to this are probably borrower relationships/negotiating strength and the high costs associated with foreclosing.
  - grebc 3mo ago
    Banks care that you pay their loan first and foremost, how you do that as the borrower is up to you. They care about the regulatory requirements in so far as you either meet it, or you don’t at the time of writing a loan. And maybe you get a yearly review. Also people are looking at this in a very isolated view. Just because a building is vacant doesn’t mean the owner has no other option than just lower the rent. Typically owners of commercial property own multiple properties and various other types of assets. Vacancy rates are also built into calculations.
    - bombcar 3mo ago
      That's the missing link on these - the owner is making payments either way - the bank is getting their money. They don't want to disrupt the flow or trigger contract clauses, so they cover the missing cashflow from elsewhere.
ReptileMan 3mo ago
Think of it that way - until you haven't climbed on the scale, you haven't gained weight, even if your pants are bursting at the seams.
- GJim 3mo ago
  At some point, you don't need to stand on the scales for it to be obvious you are a fat bastard. Ditto, it's obvious to all that commercial property has lost a huge amount of value. I suggest that like the dotcom/2008/AI bubbles, people will just keep dancing and making money until reality catches up and the music stops.
AnthonyMouse 3mo ago
The argument the article makes is that the bank doesn't want to admit the property is worth less than the mortgage because then they would "have to" foreclose. The question is, why would they actually do that? The premise is that the landlord has to take out a new mortgage every few years and then the bank won't give them a new one if they're underwater. But that's only true if it's a different bank. Let's take the same example. Building was expected to be worth $20M, landlord pays $4M down and takes a $16M interest-only mortgage. The only thing the bank ever expected from this was to collect interest on the $16M until it's paid back, which could be never and that's fine as long as they get to keep collecting interest. Then we find out the building is maybe really only worth $14M. But the landlord is still making the interest payments on the $16M, and over time it will likely become worth more than $16M again due to inflation if nothing else, so why does the bank need to foreclose? The risk that they could "lose $2M" is by that point a sunk cost. It's the thing that happens if they do foreclose (or fail to renew the loan). They'd be calling in the note against an LLC that owns nothing but a building which is now estimated to be worth less than the loan principal. So the obvious thing would be to keep renewing it as long as the landlord continues to make the interest payments. This feels like some kind of regulatory inefficiency or accounting scam where the bank is listing the mortgage lien as an asset and would have to take a write off if they valued it accurately and therefore transfer their perverse incentive to the landlord to prevent that from happening. Notice however that doing that also hurts the bank. The landlord is collecting $500k/year at half occupancy, then paying the bank $640k and losing $140k/year to try to avoid the total loss of their $4M initial investment. Maybe they can do that for a year or three but the longer it continues the higher the probability that they run out of money. Whereas if they were collecting the $700k/year from renting out the entire building at lower rents then they could keep paying the bank its $640k/year forever, regardless of whether they're technically underwater. And if the landlord runs out of money then the bank has to take the $2M write off because they get a $14M building instead of collecting interest on a $16M loan. So the bank is really shooting itself in the foot.
- shaftway 3mo ago
  Not if the economy actually does recover, or at least "looks" like it recovered on paper. Inflation helps with that. The average inflation over the last 10 years has been just north of 3%. If you have tenants today that are paying $500k/year, in 10 years they should be paying almost $700k/year with 50% occupancy. If you can string the bank along for another loan then your valuation is $28M instead of $20M. As the owner you can effectively take money out in this scenario. If the bank won't refinance at that rate, then you could lower your rents by a bit in the last year. If you lowered your rates back down to $500k/year then you invite a bunch of new tenants, and now you can show high occupancy again.
laughing_man 3mo ago
It's not a question of what the banks believe, but rather what they believe officially. As long as they keep pretending the loss doesn't need to get accounted for.
pweaver 3mo ago
What is being missed is that most commercial leases are much longer term than residential leases. Businesses will want to renovate the space and sign a 10 or 20 year lease. So if you lower the rent by 30% you will really be reducing the income of the building over the long term and face those consequences when refinancing. Landlords will frequently try to rent out unused space to temporary tenants like popups or non profits that they can move in without renovation and kick our on shorter notice to generate some cash-flow and keep the storefront occupied.
- Sohcahtoa82 3mo ago
  > Landlords will frequently try to rent out unused space to temporary tenants like popups and Spirit Halloween.
nmfisher 3mo ago
> I doubt owners and banks actually believe this. I worked for a commercial property company before, and yes this is exactly how it works, and yes it's just as stupid as it sounds. Margin Call nailed it perfectly: "It's just money. It's made up. Pieces of papers with pictures on it so we don't have to kill each other just to get something to eat".

by jwarden 3mo ago

postepowanieadm 3mo ago

How do you asses the value? You use the x last transactions. No transactions, no data, the last value remains.

arcza 3mo ago
If a coffee shop is charging $25 for a latte and sells none, we don't say everything's fine because no sales data. The sales are $0 and it's not fine. There is no escaping the powers of supply and demand.
AnthonyMouse 3mo ago
"Last value" is pretty meaningless when it's stale though. Suppose there is a building that was built in 1970, last rented out in 1975 and then bought by a company that has used it as their own offices until now. The last transaction was in 1975, what's the value if they apply for a mortgage today? Surely they have some formula to use for this based on e.g. other buildings in the area. Moreover, "failure to find a tenant" is also a type of transaction. It's the landlord acting as the high bidder for the space, essentially the involuntary edition of imputed rent, and implies something negative about the financial prospects of the building when it continues for a significant period of time or large percentage of units. Ignoring that it is either incompetence or some kind of perverse incentive.
- embedding-shape 3mo ago
  > "Last value" is pretty meaningless when it's stale though. For who and in what way though? Every entity involved wants to keep the price high, except the renter/new buyer, so with that in mind, "Last Value" seems optimal for achieving that. Maybe it's different in the US, but in Spain there is a ton of properties that sit completely empty and unused, even since earlier than 2008, just because the owners don't think the value is enough to sell yet, and they wouldn't earn enough renting it out, so everyone (except renters/new buyers) seems to prefer it just sits empty for decades.
  - AnthonyMouse 3mo ago
    > For who and in what way though? For anyone who wants an accurate accounting. Suppose the building is supposed to be worth $20M, has an existing $10M mortgage and is actually only worth $10M. The landlord comes to you and wants to borrow another $5M against the building. Pretty important to the lender at this point that they're not overvaluing it, right? Or the same if they go to a different bank trying to refinance an existing mortgage they're already underwater on when using an accurate accounting.
    - grebc 3mo ago
      Commercial borrowers have to pay for a valuation report by a bank approved valuer.
      - AnthonyMouse 3mo ago
        Then why does anybody care if they rent out some of the units for a lower rent?
        grebc 3mo ago
        You keep asking the same question and the answer is the same in all these. You don’t like it. We get it. No one is doing anything illegal. If the bank thought a customer couldn’t pay, they’d get foreclosed, end of story.
        AnthonyMouse 3mo ago
        It's not a matter of whether I like it. It's a question of why the bank, unless required to do so by some kind of absurd perverse regulatory incentive, would do something which is not only harming others but also increasing the default risk for the bank by reducing the income of a borrower who, if they can't make the payments, will cause the bank to have to write off millions of dollars by foreclosing on an underwater building.
lotsofpulp 3mo ago
“You” require a continuous analysis of cash flow to continuously determine value, and proper management. A simple, and common, requirement in commercial lending called the debt service coverage ratio. https://www.investopedia.com/terms/d/dscr.asp https://www.investopedia.com/terms/d/dscr.asp Lower income for the building means lower numerator, which means being unable to meet the agreed upon DSCR, which means default. Whether or not the lender acts on this default is a separate matter, as they are usually loathe to get into the property management business, but renegotiation of terms and eventually foreclosure does happen.

makeitdouble 3mo ago

Here the bank cares less about annual income than future income. Keeping it vacant only impact current income, lowering rent impacts future forecasts.

AnthonyMouse 3mo ago
> Keeping it vacant only impact current income, lowering rent impacts future forecasts. Does it though? Suppose you can't find a tenant right now because the market is soft but is predicted to improve in a few years. If you leave the unit vacant, you lose money right now. If you rent it out with e.g. a 3-year lease, you make more for the next 3 years than you would with a vacancy, and if the market price has increased by then you can increase the rent on the unit and either get it from the current occupant or the one you get to replace them in the high demand market when the higher rent causes the low-paying tenant to not renew the lease. So taking a tenant now only improves prospects (you fill a current vacancy) with no negative impact on future returns. The only thing it does is imply that current rents are lower than before and future rents might be too, but a vacancy implies that even more strongly.
- bandrami 3mo ago
  Humans are not Pareto efficient. If my wife and I are at the airport, and the gate agent offers me (and only me) an upgrade on the flight, your logic says I should take it since that's strictly better than both of us flying economy.
  - schlipity 3mo ago
    You should take it and then switch seats with your wife. Happy wife, happy life.
    - makeitdouble 3mo ago
      > Happy wife, happy life. Why wouldn't that happy cycle work with the husband ?

senordevnyc 3mo ago

Agreed. From the article: Actual commercial real estate professionals could give you many more reasons than I can I am so tired of listening to people with little to no experience with commercial real estate try and explain the vacant storefront thing. Maybe this explanation in the article is correct, but it raises more questions than it answers, and it’s unclear why we should trust this person’s explanation.

em-bee 3mo ago
do you have a better explanation?
- probably_wrong 3mo ago
  It's on the person who willingly took the public stage to prove that their ideas have merit. I don't know much about microbiology, but that shouldn't stop me from asking someone who "did their own research" to shut up and let the experts talk.
  - em-bee 3mo ago
    they already gave their explanation. if you disagree then it is on you to provide a counter argument otherwise anyone could just shoot down any argument by claiming that it has no merit. at best you could say that you do not find the argument convincing, but even then you should explain why. you are not even claiming that the argument in question is wrong, you are only questioning the credentials of the author. that's appeal to authority, and therefore not a valid argument. https://youtu.be/N5k4yUSPHI8 https://youtu.be/N5k4yUSPHI8 I don't know much about microbiology, but that shouldn't stop me from asking someone who "did their own research" to shut up and let the experts talk. yes it should, unless you can provide a convincing argument that the person is wrong, expert or not. on the internet anyone can claim to be an expert and nobody can prove it.
    - senordevnyc 3mo ago
      I’m agreeing with the person I first responded to about why I don’t find this explanation credible. I don’t feel the need to reiterate what they said. AND I’m also saying I’m tired of non-experts giving their theories on this particular phenomenon, since they never make much sense.

zipy124 3mo ago

The policy is spelled out in the article? Banks have strict regulations that mean they have to have a certain amount of capital backing loans, and by revaluing a building you lower the capital that backs the loan, thus raising its risk, and thus leading you to break the regulation around capital requirements.

alper 3mo ago

The whole goal is not to write off the value of the property which you have to do if you rent it for less money than initially planned. That's not that difficult to understand is it?

NoboruWataya 3mo ago
I mean, it's highly unintuitive, which I would say makes it difficult to understand. The main weirdness is that lowering the rent would force a revaluation whereas letting the building sit vacant for an extended period of time apparently would not. If this is truly driven by regulatory capital requirements, then it seems like a gap in the regulations. Also foreclosure generally isn't the only option: the borrower could, for example, agree to repay part of the loan early, or give extra collateral, both of which would increase the LTV (and this would be better for the bank). I'm not saying the explanation is wrong, but I don't blame people for finding it difficult to understand. Other factors contributing to this are probably borrower relationships/negotiating strength and the high costs associated with foreclosing.
- grebc 3mo ago
  Banks care that you pay their loan first and foremost, how you do that as the borrower is up to you. They care about the regulatory requirements in so far as you either meet it, or you don’t at the time of writing a loan. And maybe you get a yearly review. Also people are looking at this in a very isolated view. Just because a building is vacant doesn’t mean the owner has no other option than just lower the rent. Typically owners of commercial property own multiple properties and various other types of assets. Vacancy rates are also built into calculations.
  - bombcar 3mo ago
    That's the missing link on these - the owner is making payments either way - the bank is getting their money. They don't want to disrupt the flow or trigger contract clauses, so they cover the missing cashflow from elsewhere.

ReptileMan 3mo ago

Think of it that way - until you haven't climbed on the scale, you haven't gained weight, even if your pants are bursting at the seams.

GJim 3mo ago
At some point, you don't need to stand on the scales for it to be obvious you are a fat bastard. Ditto, it's obvious to all that commercial property has lost a huge amount of value. I suggest that like the dotcom/2008/AI bubbles, people will just keep dancing and making money until reality catches up and the music stops.

AnthonyMouse 3mo ago

The argument the article makes is that the bank doesn't want to admit the property is worth less than the mortgage because then they would "have to" foreclose. The question is, why would they actually do that? The premise is that the landlord has to take out a new mortgage every few years and then the bank won't give them a new one if they're underwater. But that's only true if it's a different bank. Let's take the same example. Building was expected to be worth $20M, landlord pays $4M down and takes a $16M interest-only mortgage. The only thing the bank ever expected from this was to collect interest on the $16M until it's paid back, which could be never and that's fine as long as they get to keep collecting interest. Then we find out the building is maybe really only worth $14M. But the landlord is still making the interest payments on the $16M, and over time it will likely become worth more than $16M again due to inflation if nothing else, so why does the bank need to foreclose? The risk that they could "lose $2M" is by that point a sunk cost. It's the thing that happens if they do foreclose (or fail to renew the loan). They'd be calling in the note against an LLC that owns nothing but a building which is now estimated to be worth less than the loan principal. So the obvious thing would be to keep renewing it as long as the landlord continues to make the interest payments. This feels like some kind of regulatory inefficiency or accounting scam where the bank is listing the mortgage lien as an asset and would have to take a write off if they valued it accurately and therefore transfer their perverse incentive to the landlord to prevent that from happening. Notice however that doing that also hurts the bank. The landlord is collecting $500k/year at half occupancy, then paying the bank $640k and losing $140k/year to try to avoid the total loss of their $4M initial investment. Maybe they can do that for a year or three but the longer it continues the higher the probability that they run out of money. Whereas if they were collecting the $700k/year from renting out the entire building at lower rents then they could keep paying the bank its $640k/year forever, regardless of whether they're technically underwater. And if the landlord runs out of money then the bank has to take the $2M write off because they get a $14M building instead of collecting interest on a $16M loan. So the bank is really shooting itself in the foot.

shaftway 3mo ago
Not if the economy actually does recover, or at least "looks" like it recovered on paper. Inflation helps with that. The average inflation over the last 10 years has been just north of 3%. If you have tenants today that are paying $500k/year, in 10 years they should be paying almost $700k/year with 50% occupancy. If you can string the bank along for another loan then your valuation is $28M instead of $20M. As the owner you can effectively take money out in this scenario. If the bank won't refinance at that rate, then you could lower your rents by a bit in the last year. If you lowered your rates back down to $500k/year then you invite a bunch of new tenants, and now you can show high occupancy again.

laughing_man 3mo ago

It's not a question of what the banks believe, but rather what they believe officially. As long as they keep pretending the loss doesn't need to get accounted for.

pweaver 3mo ago

What is being missed is that most commercial leases are much longer term than residential leases. Businesses will want to renovate the space and sign a 10 or 20 year lease. So if you lower the rent by 30% you will really be reducing the income of the building over the long term and face those consequences when refinancing. Landlords will frequently try to rent out unused space to temporary tenants like popups or non profits that they can move in without renovation and kick our on shorter notice to generate some cash-flow and keep the storefront occupied.

Sohcahtoa82 3mo ago
> Landlords will frequently try to rent out unused space to temporary tenants like popups and Spirit Halloween.

nmfisher 3mo ago

> I doubt owners and banks actually believe this. I worked for a commercial property company before, and yes this is exactly how it works, and yes it's just as stupid as it sounds. Margin Call nailed it perfectly: "It's just money. It's made up. Pieces of papers with pictures on it so we don't have to kill each other just to get something to eat".