GoKawiilIn yesterday’s mailbag post, Matthew Yglesias responded to a question about why commercial spaces sometimes sit vacant for years at a time. Matthew’s answer started off on the right track, then veered off course. So, as one does, I quickly fired off a note in response.
That note went (and is still going) more viral than anything else I’ve written this year. Fun! There were a lot of questions for clarification, and a few asks for me to expand this into a post.
So here’s an expanded version of the note. For any email subscribers who didn’t see the note, I hope this is interesting. I have a feeling that a more complete explanation won’t be as viral as the short note, but for those who found the note compelling I hope you’ll share this article widely and give others something to bookmark.
To start, here’s the question that inspired this post:
Can you explain why it makes economic sense for landlords in high-priced metros to keep commercial real estate empty for years at a time? … I understand there's a lot of social pressure on landlords to keep rents high or face the wrath of their neighbors, but how can that pressure still work after ten years of losses?
The short answer is both simple and surprising: in many cases, lowering the rent on a building will force the bank to foreclose on it.
Foreclosure is very bad for both the bank and the operator, so both parties would rather “extend and pretend,” leaving the building vacant while they wait and hope for the market to change.
This seems absurd. Surely everyone would be better off it they just lowered the rent and got some use out of the building — getting some rent must be better than getting no rent, right?
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 buildings can make perfect sense for a financial product.
To understand this I’ll offer a simplified explanation of commercial real estate, and the “extend and pretend” dilemma.
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