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We need land value tax bad [1]
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.
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.
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.
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.
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?
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.
same thing happens in SF, often to businesses that have been a valued part of the local neighbourhood for years. it's infuriating.
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.
> 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.
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.
> 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.
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.
A vacancy tax would work on areas with high demand, but it also punishes areas that are already struggling.
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.
That would just devalue the surrounding property even more. This is why "we should just do X" is almost always a bad idea.
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).
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.
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.
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.
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.
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.
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!
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.
The world needs Someone with enormous chutzpah to try this.
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?
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?
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.
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.
> 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.
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.
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"?
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.
> 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."
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.
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"?
> a building is not a building but a financial product.
Are we cooked chat?
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.