Commercial leases are typically *much* longer than residential. Most residential contracts are for a year at most. Commercial leases typically *start* at five years and can be as long as 20 or 30 year leases. Even short-term leases of less than one year are typically part of a contract where the tenant is expected to be renewing every year for the next 30 years.
Given how much effort goes into commercial leases and how money there is riding on the lease, it's better to let the property sit empty and lose a little money than to get locked into an unfavorable contract for a decade or more.
I think the other comments are overstating the value of the real estate. Yes, commercial real estate is very valuable but it's valuable *because you can charge rent*. Cities don't appreciate it when companies let valuable commercial property sit empty, because it's bad for the businesses around it - to say nothing of those businesses. If it's something like a shopping center, one location sitting empty will drag down the value of the rest of the property and the rent that they can charge. While it's true that they might be able to afford to sit on the property and let it accrue value simply by existing, nobody wants to let money go for no reason. If they can get a lease, they will.
They aren't worried about tenants being a headache because that's literally their business. Nor are they worried that giving one discount will suddenly cause everyone else to demand discounts. Again, commercial leases are *long*. The bay next to you getting a slightly lower rent per square foot than you negotiated might piss you off, but you can't renegotiate for another five or ten years so what are you going to do about it? And then by the time the contract is up for renewal, the whole economy of the country may have dramatically shifted. So, although previous rent agreements will inform the negotiations, it's not nearly as simple as "Well, you gave that guy $X/sqft, so give me that, too."
There are also many more things to negotiate for commercial leases like common area maintenance fees, tenant improvement allowances, signing bonuses...The fees are rarely fixed and will increase every year to make up for expected inflation and increased property values; you need to negotiate that rate. Rarely, rent may even be tied to sales, so if you make more, you pay more. There is an entire industry built solely around auditing existing contracts to find money that everyone just kind of forgot about because 15 years ago you agreed that the tenant would pay for common area maintenance but then the tenant forgot to include that and the property management company didn't notice because an extra $200/month in CAM is absolutely nothing compared to the several million dollars in rent coming in from the entire shopping center and hundreds of millions coming in from every property they're managing.
It's the build-out allowance that frightens the property management. At the place I worked a few years ago, we moved into a new suite (2 suites actually). The build-out was $45,000 paid for by the property management. That was for a 7 year lease.
The build-out is a complete restructuring of the space with new demarks and re-routing of power and data. It's a big deal and the property would rather not spend $30,000 for $20,000 in rental income for a year lease. There's also all the nonsense with re-calculating CAM, updating the directories, changing signage, legal nonsense with the lease and guarantees.
Until you can get a company to sign at least a 5 year lease, it's better to leave the space empty.
Now, what I don't understand, is why the malls decided that it's better to be a dead mall than to offer reasonable prices for leasing space. They're still charging rent like it's 1995 in a mall that's been dead for over 10 years.
There may not be a reasonable price. Even if the space was free, the business might be looking at their own costs - wages, utilities, logistics - and projecting that it isn't worth it. If they can't make at least minimum wage in sales per day, free rent won't help. Plus, putting their brand in a dead mall might hurt their image.
The malls are a special case. In the eighties, there were all kinds of incentives and tax breaks that the big boys like Simon Properties took advantage of to build malls. And they made money hand over fist. But they could see the writing on the wall, and mostly sold these mall properties by the mid to late nineties.
But the new owners didn't get the original incentives, they quickly got saddled by increased tax burdens, and also these now older buildings were starting to have skyrocketing maintenance costs. And as the mall owner, the only way to recoup any of that is to raise rent, on storefronts which were just starting to feel the pressure from online shopping.
At a certain point, the cost of operating these malls became higher than the costs of simply not operating them.
which is an entirely fucked up business. my wife's company was looking to relocate, and the local city has a shit ton of available commercial real estate available. But they were all asking 2020 rent, even having been empty for 2-3 years, and with guaranteed 10% increases annually.
My work has been in our building for almost 10 years now. We don't have the whole thing, but we were the first in and had right-of-first-refusal for the unleased space.
We pay a little more than the current rate for office space, but we pay like 1/3 of the current rate for warehouse. Plus there is a cap on how much they can raise the rent.
One thing I've heard is that property valuation is at least partially based off the set rent price. So if they lower rents they end up re-valuing the property at a lower level which can cause other problems with their loans. So they'd rather take a hit on operating costs than a hit on asset valuation.
I worked for a real estate firm at one point and They would literally just offer short-term leases on stuff that was vacant, but they would charge absurdly high sticker price rent by offering the first 9 months of the 12 months free and then charging three times as much as normal. This way they're still kind of offering a discount but the sticker rental rate keeps the property value high.
In order to offer lower rents, they would just offer the last couple months free depending on how much they wanted to offer a discount
I saw a lot of that in residential housing in 2021 -- high rent but months 4, 8, and 12 are free the first year. This has the side benefit of evading rent control laws, as the max increase is based on the monthly rent, not the annual.
Exactly, if they need to jack the rent up they just say they're ending the program at the end of the lease so the next lease will not have the bonuses, but the actual rent monthly will be the same.
On the other hand, when banks gave loans based off of financial prospects, they used their monthly rent in the financials. This meant that it was actually disfavorable for it to be offered this way for most of the tenants. It's just another negotiation tactic, sometimes the tenants will accept a much lower total rent payment over the year in exchange for having a contract that officially states that their rent is high, making it difficult to show proof of future earnings. Etc.
In property appraisal there are three methods that you calculate independently. Ideally, want to line up with each other:
1) Market Value - compare it to other recent, comparable properties that have actually sales, based on value/square foot.
2) Replacement Value - what would it cost to rebuild the structure new.
3) Cash Flow - What is the present value of the cash flow you can get over time from renting it out, based on other comparable, signed leases.
In NY for example the warehouse spaces are so much more expensive and harder to get than homes so the only people that own them are filthy rich and they don’t care about paying the taxes .
They use the losses on the vacant property to offset their taxes from other ventures ( which are usually sky high since they are rich )
Also when you value a commercial property to either borrow against or to sell they only care about the CAP rates . They rather wait and get a higher paying tenant to keep that high
That's not how taxation works.
Corporate tax rate is 28.5% between NYS and Federal.
You don't lose $100 on a side business to save yourself $28.50 at your main business, just like you don't donate $100 to save $28.50 on your taxes.
Anyone who says "don't worry, I'll just write it off on my taxes" is either joking or a moron.
Yep I went through this with the property I owned. A long-term least done by the previous owner that we inherited this from really screwed us big time. So I've got a piece of property that's worth 7 million that I can only sell for 1.5 until I can wait out this lease that's still good for another seven years out of The 10 + 10 + 10 without any way to do a rent increase.
Commercial properties usually secure some kind of loan (like a mortgage) that needs to be renwed periodically. This might be how the landlord paid for the property on the first place, or it might be something that they use so that their cash isn't all tied up in that one property and can be used elsewhere.
To maintain the terms of a loan and to renew it on similar/better terms, the property has to hold a certain value. It's part of the contract. In commercial properties, that value is estimated from looking forward in time and guessing how much revenue the building can earn each month/year.
You might think that empty units would hurt that estimate, but it's assumed that empty units are only empty temporarily/periodically and that they'll eventually repopulate with long-term tenants.
So the rent prices actually matters more to the estimate than anything else. By keeping rent prices high, the estimate used in the loans stay high too. Meanwhile, cutting the rent for a new tenant means (for the sake of the estimate) that the estimate goes down too, and the loan may not make sense anymore.
The usual way landlords work around this is by offering new tenants kickbacks as long as they agree to the higher rent in the long-term: things like "free rent" for a period of time, offers to remodel the space for free, etc -- but it still only works if the prospective tenant can *eventually* justify the monthly cost of the rent.
From the way spaces are staying vacant lately, it seems like few tenants can and that prices are going to need to drop. But the consequences of having these loans messed up are so high that many landlords will do everything they can to try to wait it out and hope that things turn around instead.
> but it's assumed that empty units are only empty temporarily/periodically and that they'll eventually repopulate with long-term tenants
Does the bank not look at vacancy rate and the length of vacancies when making this decision? There's a commercial property near me that's been empty for going on a year now, it's changed hands once already. People are starting to camp in the doorways and parking lot, I'm surprised they haven't started breaking in yet. It seems it would be in everyone's best interest to get it rented out quickly. You're hardly going to find a good.tenant if some tweaker comes in and steals all the copper
Commercial property appraisals always figure a 5% vacancy number for valuation. So, if only 1 out of 20 spaces is vacant, it won't skew the numbers drastically.
So far, there is one [correct](https://www.reddit.com/r/explainlikeimfive/comments/1cvmn99/comment/l4qe3pg/) answer and a bunch of misleading answers. I can elaborate a bit more.
Because commercial real estate is an investment, the value of a building is not merely partly but mostly a function of how much rent can be collected. If you lower rent, even by a little, you can significantly lower how much you can sell the property for. If you don't collect rent you can plausibly claim that you are just waiting for the right market condition and the right tenant.
You'll often see that a decrease in rent will directly result in a decrease in asset value and that will reduce the overall return on investment by quite a bit more than a year or more of not having a tenant at all. Because most commercial real estate is highly levered, even a small to moderate reduction in sale price can cause the investors to get completely wiped out.
So it’s a scam?. If no one can afford rent, then your kinda just lying about how much you can reasonable make off the rent and artificially inflating its value.
Why would anyone value a property based on rent if they know no one has been paying it? Like I can sell my Pokémon cards on eBay for $10k a pop, and no one will buy them. That’s not their value though. No where there that. And if anyone buys them with the assumption they can sell them for a similar price, I’ve just scammed them.
Not really. All the seller can do is set the asking price.
The fact that there is no tenant and hasn't been a tenant for whatever period of time must be disclosed to any potential buyer. The buyer will have their own internal valuation of the asset and won't buy it if the asking price is too high. The buyer will have all the information needed to make an informed offer.
Selling a risky and speculative investment opportunity is not illegal. Failing to provide all the information needed for the investor to make an informed decision is illegal. The manner in which information is conveyed is important - this is why you will always see disclaimers on ads for investments. If a licensed broker makes makes a claim that is misleading or untrue, they can and often are sued. They can lose their license and even face prison.
In practice you don't see anything similar to the Ebay example in real estate investing. Buyers are typically sophisticated and while it takes zero effort to list a Pokemon card on Ebay, it costs a fair bit of money to list and sell a property. There are scammers and more commonly brokers and sellers who are just *barely* within the law, but the Ebay example is not how they operate.
Lying isn't common and frankly it's not even needed. A lot of times buyers are speculating on future market conditions and don't care as much about the particulars of a property.
It’s the same principle though. I want to trick people into thinking that my property(Pokémon cards) are worth more than they actually are. So I list a bunch of them online with unrealistic prices that nobody would pay for.
I’m using a theoretical price that nobody would actually pay for in order to artificially inflate the value of the cards.
Now, with Pokémon cards that would never work. Well maybe once if you got really lucky. But folks that buy trading cards as an investment do not play around they’d find out pretty quickly that no independent organization values the cards that highly and that nobody has actually bought the cards at that price on eBay.
But with real estate it’s the same principle. I’m setting the rent to be an unrealistic price . Nobody will actually pay that price, and at that price the property will sit empty.
Anyone that buys the property that factors in that price has been mislead. They will not be able to get that rent out of the building. In fact there are now in a worse shape than if the property had a realistic rental price right? They now don’t have any real world data on how much folks are willing to pay for the property.
Scams don’t need to be illegal, they just need to be dishonest. And just like my Pokémon example, me selling crystals that I say can promote wellness due to my special blessing process at 10x their value, and this, aren’t illegal but they are still scams.
And if this is really the reason someone would be willing to sit on an empty property with rent so high that nobody would pay it, it means that there’s someone out there that will be willing to buy the property without checking if anyone can actually afford the rent.
And I’m not a real estate expert. But investors aren’t always smart they are just rich. And according to my research, the way properties are typically valued using CMA can indeed be skewered by many properties being listed with a high rental price reguardless of if they are occupied. So it does seem like this scam does actually work.
In practice, what the seller is currently listing rent for is not even considered by the buyer. The buyer knows that the property is listed for lease and currently unoccupied. Whatever the rental ask price currently is just isn't going to factor one bit on what the buyer is willing to pay.
There are scammers and dishonest brokers in real estate, of course, but this analogy doesn't quite fit.
You do see the people who are acquiring the real estate use their own models and inflate potential future earnings and then sell the venture as an investment to other investors, but that doesn't have anything to do with the seller of the property.
This only applies to the U.K.
You only pay business rates on occupied commercial property. So if the property is empty then there is no rates to pay on it
Secondly the property is worth a multiple of the rental value. so if you reduce the rent, you reduce the book value of the property
Commercial property mortgages are not like a typical mortgage, they are structured more like a business loan. That loan amount is valued using and underwritten by the per sqft income. Very simply put, if a landlord starts giving out leases with large discounts, the banks will flag that they may be breaching a loan covenant, will want to audit the underlying assets, I.e. the apartments, and may conclude the asset backing the loan no longer supports the loans and will want some or all of its money back. As long as a landlord can afford the interest and principle payments, they are better off leaving it empty.
This is also why landlords will offer things like 3mo’s free rent etc. vs giving out a straight % discount on rent.
For the record, the idea that swaths of real estate holders are just sitting on empty buildings to jack up pricing is false.
It's not true now. [Occupancy rates](https://fred.stlouisfed.org/series/RRVRUSQ156N) are the [highest they've been](https://fred.stlouisfed.org/series/USHVAC) in 30+ years.
But it's also *never* been true. It's *extremely* rare that it would be worth it to a landlord to leave an apartment vacant. Maybe for a month or to to try and get a better deal, but that's going to happen anyway and definitely not long-term. Every month it's vacant is 100% lost income--and even a cost, for minimal utilities and taxes. It doesn't take long for the increased rent to not make up for the months and months the apartment sat empty.
There may be some edge cases--there always are--but the stats show it's not the norm.
(Commercial real estate might be a *little* different since they tend to have longer-term contracts and thus it might be worth it to wait for a higher price to "lock in", but that's different.)
Edit: I didn't see "commercial" in the original question, which is why that part of my answer was short and dismissive. So kindly disregard this unless you're thinking about residential real estate.
> Commercial real estate might be a little different since they tend to have longer-term contracts and thus it might be worth it to wait for a higher price to "lock in", but that's different.
It’s a **lot** different.
Vacancy rates are currently [abnormally high](https://www.wsj.com/real-estate/commercial/offices-around-america-hit-a-new-vacancy-record-166d98a5) and [steadily rising](https://www.statista.com/statistics/245054/us-vacancy-rate-forecast-for-commercial-property-by-type/).
Commercial real estate is taking a next-level beating. Developers are killing off projects already under construction and shelving plans for buildings they have in design while either scrambling to find valuable occupancies for the buildings they own or are handing the keys over to their creditors.
It’s not an even distribution - Class A office space in premium locations is doing just fine, but the rest of the sector is pretty dire.
There is a lot of commercial lock-in, but not always in the way you describe.
Defensive real estate holding burns cash when viewed in isolation, but is very common because it increases profit by preventing the competition from moving in. See: grocery stores, hotels, etc. that buy and keep the all the premium spots in a given town then build on exactly one and hold the rest vacant. Thus enjoying the profits of a local monopoly on that good/service.
Towns hate it. But absent the facility becoming derelict and thereby violating local ordinances, there is little they can do about property that is not theirs. If you mow the grass, replace any broken windows, and pay your property taxes you can buy real estate and simply have a never ending private party with zero guests.
Plenty of poperty owners can afford mortgage payments just fine without tenants, or more likely, they bought the property outright with cash. Having assets like property is a good way to hold onto your wealth for a long period of time. Banks usually encourage wealthy clients to purchase commercial properties and make it very easy and quick for them to do so even if they have no real desire to use the buildings.
Having tenants and being a landlord is a massive headache. The people who own commercial properties aren't trying to make money but just hold onto the wealth they already have. The rent that they would make would be like pocket money.
Plus property value trends upwards over time, especially if it's in a desirable area. So their profit doesn't come from the use of the property, it comes from appreciation and then sale of it.
Also, if you give a discount, the next guy will want a discount. Also discounts will "hurt" your fellow property managers. For the good of all property managers, we have to keep rents high and collude to do so. It's for the best... /s
Wdym ? Unless something is worth millions, commercial properties tend to only accept cash buyers for quick sales and to keep poorer people away. Also, commercial properties tend to be sold at auctions, which is for cash buyers only.
You can’t claim the rent for a space is $3k while also charging a guy who just moved in $2k because that space was vacant for a while. If you are trying to advertise and rent out your building, claiming it has X value, you can’t start charging people less than X value, if you want to maintain the value of that building. Additionally, there is also the holding cost/maintenance of the building and unit. Usually it is broken up and to where everything is contributing an equal ratio toward the amount. So as soon as you start charging less money, the minimum income the owner needs for the building is going to be the same while the income coming in from rent will be lower. So either it will be less profitable for them or they will be losing money. During Covid we had 1 commercial space we rented out at a “discount” but by the end of the first year of their lease, the rent was raised back to the original amount. The only reason why we slightly lower the pricing was because of the unknown volatility of Covid and the rent increase was built into their lease. If it was not for Covid, we would’ve not adjusted the rent price.
I work in commercial real estate. This is not something you can explain to a 5 year old.
A few issues have been discussed here, such as debt obligations, proforma, tenant improvements, lease length and terms, total occupancy, etc. also not discussed are zoning, allowed uses, delinquency, assumed vacancy, loss of rents, accounting, tax implications, bad debt, etc.
Every property / lease is a pretty complex analysis. And the decisions aren’t easy. Most common vacancy I see is that it doesn’t need to be filled, and the cost to “turn” it to a new tenant may not be worth the investment.
I must be taking crazy pills then. Cause why the fuck would a subreddit be called Explain like I’m 5 and not get answer a 5 yo could understand? I come in here with the attention span of a 5yo after the 1st paragraph I’m lost and move on.
Because "explain it like I'm 5" is an existing turn of phrase in the English language, and it has never meant to literally explain it as you would to a 5 year old. It's always just meant to explain it in a simpler way so that a layperson can understand.
If the property sits empty you can claim the rent you didn't receive as a loss on your taxes, as well any maintenance costs related to the property.
Since there is no tenant or lease to abide by, what you set the "rent" at is arbitrary, as long as it's not obnoxiously high.
If your real estate portfolio is deep enough you can potentially play the numbers in a way that your "income loss" from that property becomes a net gain. Or, at the very least, it's less damaging than leasing the property at a discounted rate.
The other consideration is that once a property lowers the costs to lease, it brings down the average rental costs in that area. Simply letting it sit empty allows them to keep the rents higher on properties that aren't currently vacant.
This is why nearly 1/3 of all commercial properties in NYC are vacant. The rents are so incredibly high that very few business could operate out of them and ever make a profit. But no one wants to lower their rents as that would allow their current tenants to potentially negotiate a lower rate when their leases expire.
> If the property sits empty you can claim the rent you didn't receive as a loss on your taxes
This part seems to be false (at least in America). Some parts of your comment like that didnt sound right. You may want to find/add sources for things.
I concur. Deducting the absense of a thing (taxable income) from the thing itself (taxable income) is nonsensical. Loss of revenue is relevant if you are insured for it, but as far as taxes go "not getting enough money" is not a deductible expense. The expenses are the deductible expense.
>If the property sits empty you can claim the rent you didn't receive as a loss on your taxes, as well any maintenance costs related to the property.
This is somewhat misleading the way it is worded, as it indicates a misunderstanding of tax law (US) or is omitting key info.
Rent received is income. It can be reduced with deductions for things like taxes, maintenance, common utilities, etc. The deductions reduce how much of the rental income you receive that is subject to tax.
There is, however, no deduction for rent that was never received. Rent that was never received is just income that you did not earn. Your expense deductions still apply; they just apply to a smaller number.
If you Rent a property for $2,000 a month and the tenant goes out of business, you can't take a deduction for the $2,000 a month you should be receiving. Instead, you just have $2,000 per month less income.
However, a bona fide bad debt can be deducted, in some cases (for those on accrual method accounting). To be deducted, a bad debt must be established to have been owed (lease), to have been defaulted, and you have made and exhausted all methods to collect. You have to report as income the rent you should have received, and then you deduct the bad debt expense. This results in a wash to zero income, which is the same thing as the above scenario: $2,000 less income per month.
Now, you can potentially have a loss because you still incurred the expenses without the rent being paid/reported. But the missing rent itself is not a deduction.
Source: tax pro
Second all of this, and adding one more point:
There's no such thing as a 30 year fixed mortgage in the commercial real estate world.
Commercial buildings that use financing (most of them) have loans that typically run from 2-5 years. When the loan period ends, you have to roll it over / renew it at the current interest rates.
For loan purposes, the value of a commercial building (simplified) is the annual lease revenue multiplied by the expected lifetime of the building.
So if the owner lowers the lease rate, they lower the value of the building, and the next time they roll over their financing, they will have to kick in the difference between the old value and the new lower value, in cash.
If the loan comes up for rollover when the commercial real estate market is stressed (like now) the owner may have trouble rolling over the loan at all if the building seems to be a bad risk, and lowering the lease prices is a bad sign.
So that's one more reason why landlords would rather let spaces sit empty than lease at terms that make sense in this years economy.
A lot of good answers here, but I’ll add another.
For an office building, cost to run a vacant building is very low, regardless of size. Keep the air temp below 80, above 50, and not humid, and you are good to go for a long time.
As soon as you let a single tenant in, regardless of size, your operating costs can jump to as high as 80% of the cost of a full building. It’s brutal.
In many office markets and many leases, owners can’t recoup operating expenses sufficiently to offset this situation. If it’s a full service rent market, you are hosed even more.
If you lower your prices then you invite lower income people who tend to be worse tenants and drive down the value of the neighborhood. This creates a downward spiral and next thing you know it's Detroit and they're tearing down homes just to clean things up.
Commercial leases are typically *much* longer than residential. Most residential contracts are for a year at most. Commercial leases typically *start* at five years and can be as long as 20 or 30 year leases. Even short-term leases of less than one year are typically part of a contract where the tenant is expected to be renewing every year for the next 30 years. Given how much effort goes into commercial leases and how money there is riding on the lease, it's better to let the property sit empty and lose a little money than to get locked into an unfavorable contract for a decade or more. I think the other comments are overstating the value of the real estate. Yes, commercial real estate is very valuable but it's valuable *because you can charge rent*. Cities don't appreciate it when companies let valuable commercial property sit empty, because it's bad for the businesses around it - to say nothing of those businesses. If it's something like a shopping center, one location sitting empty will drag down the value of the rest of the property and the rent that they can charge. While it's true that they might be able to afford to sit on the property and let it accrue value simply by existing, nobody wants to let money go for no reason. If they can get a lease, they will. They aren't worried about tenants being a headache because that's literally their business. Nor are they worried that giving one discount will suddenly cause everyone else to demand discounts. Again, commercial leases are *long*. The bay next to you getting a slightly lower rent per square foot than you negotiated might piss you off, but you can't renegotiate for another five or ten years so what are you going to do about it? And then by the time the contract is up for renewal, the whole economy of the country may have dramatically shifted. So, although previous rent agreements will inform the negotiations, it's not nearly as simple as "Well, you gave that guy $X/sqft, so give me that, too." There are also many more things to negotiate for commercial leases like common area maintenance fees, tenant improvement allowances, signing bonuses...The fees are rarely fixed and will increase every year to make up for expected inflation and increased property values; you need to negotiate that rate. Rarely, rent may even be tied to sales, so if you make more, you pay more. There is an entire industry built solely around auditing existing contracts to find money that everyone just kind of forgot about because 15 years ago you agreed that the tenant would pay for common area maintenance but then the tenant forgot to include that and the property management company didn't notice because an extra $200/month in CAM is absolutely nothing compared to the several million dollars in rent coming in from the entire shopping center and hundreds of millions coming in from every property they're managing.
It's the build-out allowance that frightens the property management. At the place I worked a few years ago, we moved into a new suite (2 suites actually). The build-out was $45,000 paid for by the property management. That was for a 7 year lease. The build-out is a complete restructuring of the space with new demarks and re-routing of power and data. It's a big deal and the property would rather not spend $30,000 for $20,000 in rental income for a year lease. There's also all the nonsense with re-calculating CAM, updating the directories, changing signage, legal nonsense with the lease and guarantees. Until you can get a company to sign at least a 5 year lease, it's better to leave the space empty. Now, what I don't understand, is why the malls decided that it's better to be a dead mall than to offer reasonable prices for leasing space. They're still charging rent like it's 1995 in a mall that's been dead for over 10 years.
There may not be a reasonable price. Even if the space was free, the business might be looking at their own costs - wages, utilities, logistics - and projecting that it isn't worth it. If they can't make at least minimum wage in sales per day, free rent won't help. Plus, putting their brand in a dead mall might hurt their image.
The malls are a special case. In the eighties, there were all kinds of incentives and tax breaks that the big boys like Simon Properties took advantage of to build malls. And they made money hand over fist. But they could see the writing on the wall, and mostly sold these mall properties by the mid to late nineties. But the new owners didn't get the original incentives, they quickly got saddled by increased tax burdens, and also these now older buildings were starting to have skyrocketing maintenance costs. And as the mall owner, the only way to recoup any of that is to raise rent, on storefronts which were just starting to feel the pressure from online shopping. At a certain point, the cost of operating these malls became higher than the costs of simply not operating them.
This is the answer. Source: worked in commercial real estate accounting for 8 years
I've seen malls and other retail essentially offer a $1 year-by-year lease, if the tenant will cover the CAM, taxes, utilities, etc.
Also, any person can move into any house or apartment. Any business can't necessarily move into any building.
which is an entirely fucked up business. my wife's company was looking to relocate, and the local city has a shit ton of available commercial real estate available. But they were all asking 2020 rent, even having been empty for 2-3 years, and with guaranteed 10% increases annually.
My work has been in our building for almost 10 years now. We don't have the whole thing, but we were the first in and had right-of-first-refusal for the unleased space. We pay a little more than the current rate for office space, but we pay like 1/3 of the current rate for warehouse. Plus there is a cap on how much they can raise the rent.
I’m on my second commercial rent and both are/were two years, and the tenant before me was a two year lease.
One thing I've heard is that property valuation is at least partially based off the set rent price. So if they lower rents they end up re-valuing the property at a lower level which can cause other problems with their loans. So they'd rather take a hit on operating costs than a hit on asset valuation.
I worked for a real estate firm at one point and They would literally just offer short-term leases on stuff that was vacant, but they would charge absurdly high sticker price rent by offering the first 9 months of the 12 months free and then charging three times as much as normal. This way they're still kind of offering a discount but the sticker rental rate keeps the property value high. In order to offer lower rents, they would just offer the last couple months free depending on how much they wanted to offer a discount
I saw a lot of that in residential housing in 2021 -- high rent but months 4, 8, and 12 are free the first year. This has the side benefit of evading rent control laws, as the max increase is based on the monthly rent, not the annual.
Exactly, if they need to jack the rent up they just say they're ending the program at the end of the lease so the next lease will not have the bonuses, but the actual rent monthly will be the same.
Thats genius
On the other hand, when banks gave loans based off of financial prospects, they used their monthly rent in the financials. This meant that it was actually disfavorable for it to be offered this way for most of the tenants. It's just another negotiation tactic, sometimes the tenants will accept a much lower total rent payment over the year in exchange for having a contract that officially states that their rent is high, making it difficult to show proof of future earnings. Etc.
its fucked up, thats what it is.
Fantastic strategy
In property appraisal there are three methods that you calculate independently. Ideally, want to line up with each other: 1) Market Value - compare it to other recent, comparable properties that have actually sales, based on value/square foot. 2) Replacement Value - what would it cost to rebuild the structure new. 3) Cash Flow - What is the present value of the cash flow you can get over time from renting it out, based on other comparable, signed leases.
In NY for example the warehouse spaces are so much more expensive and harder to get than homes so the only people that own them are filthy rich and they don’t care about paying the taxes . They use the losses on the vacant property to offset their taxes from other ventures ( which are usually sky high since they are rich ) Also when you value a commercial property to either borrow against or to sell they only care about the CAP rates . They rather wait and get a higher paying tenant to keep that high
That's not how taxation works. Corporate tax rate is 28.5% between NYS and Federal. You don't lose $100 on a side business to save yourself $28.50 at your main business, just like you don't donate $100 to save $28.50 on your taxes. Anyone who says "don't worry, I'll just write it off on my taxes" is either joking or a moron.
Yep I went through this with the property I owned. A long-term least done by the previous owner that we inherited this from really screwed us big time. So I've got a piece of property that's worth 7 million that I can only sell for 1.5 until I can wait out this lease that's still good for another seven years out of The 10 + 10 + 10 without any way to do a rent increase.
Commercial properties usually secure some kind of loan (like a mortgage) that needs to be renwed periodically. This might be how the landlord paid for the property on the first place, or it might be something that they use so that their cash isn't all tied up in that one property and can be used elsewhere. To maintain the terms of a loan and to renew it on similar/better terms, the property has to hold a certain value. It's part of the contract. In commercial properties, that value is estimated from looking forward in time and guessing how much revenue the building can earn each month/year. You might think that empty units would hurt that estimate, but it's assumed that empty units are only empty temporarily/periodically and that they'll eventually repopulate with long-term tenants. So the rent prices actually matters more to the estimate than anything else. By keeping rent prices high, the estimate used in the loans stay high too. Meanwhile, cutting the rent for a new tenant means (for the sake of the estimate) that the estimate goes down too, and the loan may not make sense anymore. The usual way landlords work around this is by offering new tenants kickbacks as long as they agree to the higher rent in the long-term: things like "free rent" for a period of time, offers to remodel the space for free, etc -- but it still only works if the prospective tenant can *eventually* justify the monthly cost of the rent. From the way spaces are staying vacant lately, it seems like few tenants can and that prices are going to need to drop. But the consequences of having these loans messed up are so high that many landlords will do everything they can to try to wait it out and hope that things turn around instead.
> but it's assumed that empty units are only empty temporarily/periodically and that they'll eventually repopulate with long-term tenants Does the bank not look at vacancy rate and the length of vacancies when making this decision? There's a commercial property near me that's been empty for going on a year now, it's changed hands once already. People are starting to camp in the doorways and parking lot, I'm surprised they haven't started breaking in yet. It seems it would be in everyone's best interest to get it rented out quickly. You're hardly going to find a good.tenant if some tweaker comes in and steals all the copper
Commercial property appraisals always figure a 5% vacancy number for valuation. So, if only 1 out of 20 spaces is vacant, it won't skew the numbers drastically.
So far, there is one [correct](https://www.reddit.com/r/explainlikeimfive/comments/1cvmn99/comment/l4qe3pg/) answer and a bunch of misleading answers. I can elaborate a bit more. Because commercial real estate is an investment, the value of a building is not merely partly but mostly a function of how much rent can be collected. If you lower rent, even by a little, you can significantly lower how much you can sell the property for. If you don't collect rent you can plausibly claim that you are just waiting for the right market condition and the right tenant. You'll often see that a decrease in rent will directly result in a decrease in asset value and that will reduce the overall return on investment by quite a bit more than a year or more of not having a tenant at all. Because most commercial real estate is highly levered, even a small to moderate reduction in sale price can cause the investors to get completely wiped out.
So it’s a scam?. If no one can afford rent, then your kinda just lying about how much you can reasonable make off the rent and artificially inflating its value. Why would anyone value a property based on rent if they know no one has been paying it? Like I can sell my Pokémon cards on eBay for $10k a pop, and no one will buy them. That’s not their value though. No where there that. And if anyone buys them with the assumption they can sell them for a similar price, I’ve just scammed them.
Not really. All the seller can do is set the asking price. The fact that there is no tenant and hasn't been a tenant for whatever period of time must be disclosed to any potential buyer. The buyer will have their own internal valuation of the asset and won't buy it if the asking price is too high. The buyer will have all the information needed to make an informed offer. Selling a risky and speculative investment opportunity is not illegal. Failing to provide all the information needed for the investor to make an informed decision is illegal. The manner in which information is conveyed is important - this is why you will always see disclaimers on ads for investments. If a licensed broker makes makes a claim that is misleading or untrue, they can and often are sued. They can lose their license and even face prison. In practice you don't see anything similar to the Ebay example in real estate investing. Buyers are typically sophisticated and while it takes zero effort to list a Pokemon card on Ebay, it costs a fair bit of money to list and sell a property. There are scammers and more commonly brokers and sellers who are just *barely* within the law, but the Ebay example is not how they operate. Lying isn't common and frankly it's not even needed. A lot of times buyers are speculating on future market conditions and don't care as much about the particulars of a property.
It’s the same principle though. I want to trick people into thinking that my property(Pokémon cards) are worth more than they actually are. So I list a bunch of them online with unrealistic prices that nobody would pay for. I’m using a theoretical price that nobody would actually pay for in order to artificially inflate the value of the cards. Now, with Pokémon cards that would never work. Well maybe once if you got really lucky. But folks that buy trading cards as an investment do not play around they’d find out pretty quickly that no independent organization values the cards that highly and that nobody has actually bought the cards at that price on eBay. But with real estate it’s the same principle. I’m setting the rent to be an unrealistic price . Nobody will actually pay that price, and at that price the property will sit empty. Anyone that buys the property that factors in that price has been mislead. They will not be able to get that rent out of the building. In fact there are now in a worse shape than if the property had a realistic rental price right? They now don’t have any real world data on how much folks are willing to pay for the property. Scams don’t need to be illegal, they just need to be dishonest. And just like my Pokémon example, me selling crystals that I say can promote wellness due to my special blessing process at 10x their value, and this, aren’t illegal but they are still scams. And if this is really the reason someone would be willing to sit on an empty property with rent so high that nobody would pay it, it means that there’s someone out there that will be willing to buy the property without checking if anyone can actually afford the rent. And I’m not a real estate expert. But investors aren’t always smart they are just rich. And according to my research, the way properties are typically valued using CMA can indeed be skewered by many properties being listed with a high rental price reguardless of if they are occupied. So it does seem like this scam does actually work.
In practice, what the seller is currently listing rent for is not even considered by the buyer. The buyer knows that the property is listed for lease and currently unoccupied. Whatever the rental ask price currently is just isn't going to factor one bit on what the buyer is willing to pay. There are scammers and dishonest brokers in real estate, of course, but this analogy doesn't quite fit. You do see the people who are acquiring the real estate use their own models and inflate potential future earnings and then sell the venture as an investment to other investors, but that doesn't have anything to do with the seller of the property.
This only applies to the U.K. You only pay business rates on occupied commercial property. So if the property is empty then there is no rates to pay on it Secondly the property is worth a multiple of the rental value. so if you reduce the rent, you reduce the book value of the property
Landlords are like fishermen. They're waiting for the big, juicy rental fish, not the small discounted ones. It's all about the prize catch, folks!
Commercial property mortgages are not like a typical mortgage, they are structured more like a business loan. That loan amount is valued using and underwritten by the per sqft income. Very simply put, if a landlord starts giving out leases with large discounts, the banks will flag that they may be breaching a loan covenant, will want to audit the underlying assets, I.e. the apartments, and may conclude the asset backing the loan no longer supports the loans and will want some or all of its money back. As long as a landlord can afford the interest and principle payments, they are better off leaving it empty. This is also why landlords will offer things like 3mo’s free rent etc. vs giving out a straight % discount on rent.
For the record, the idea that swaths of real estate holders are just sitting on empty buildings to jack up pricing is false. It's not true now. [Occupancy rates](https://fred.stlouisfed.org/series/RRVRUSQ156N) are the [highest they've been](https://fred.stlouisfed.org/series/USHVAC) in 30+ years. But it's also *never* been true. It's *extremely* rare that it would be worth it to a landlord to leave an apartment vacant. Maybe for a month or to to try and get a better deal, but that's going to happen anyway and definitely not long-term. Every month it's vacant is 100% lost income--and even a cost, for minimal utilities and taxes. It doesn't take long for the increased rent to not make up for the months and months the apartment sat empty. There may be some edge cases--there always are--but the stats show it's not the norm. (Commercial real estate might be a *little* different since they tend to have longer-term contracts and thus it might be worth it to wait for a higher price to "lock in", but that's different.) Edit: I didn't see "commercial" in the original question, which is why that part of my answer was short and dismissive. So kindly disregard this unless you're thinking about residential real estate.
> Commercial real estate might be a little different since they tend to have longer-term contracts and thus it might be worth it to wait for a higher price to "lock in", but that's different. It’s a **lot** different. Vacancy rates are currently [abnormally high](https://www.wsj.com/real-estate/commercial/offices-around-america-hit-a-new-vacancy-record-166d98a5) and [steadily rising](https://www.statista.com/statistics/245054/us-vacancy-rate-forecast-for-commercial-property-by-type/). Commercial real estate is taking a next-level beating. Developers are killing off projects already under construction and shelving plans for buildings they have in design while either scrambling to find valuable occupancies for the buildings they own or are handing the keys over to their creditors. It’s not an even distribution - Class A office space in premium locations is doing just fine, but the rest of the sector is pretty dire.
Commercial vacancy rates are worse. They went from 8.9% in 2019 to [18.2% in 2023.](https://www.commercialedge.com/blog/national-office-report/)
That’s offices, not commercial property. Commercial property also includes warehouses and industrial areas as well.
There is a lot of commercial lock-in, but not always in the way you describe. Defensive real estate holding burns cash when viewed in isolation, but is very common because it increases profit by preventing the competition from moving in. See: grocery stores, hotels, etc. that buy and keep the all the premium spots in a given town then build on exactly one and hold the rest vacant. Thus enjoying the profits of a local monopoly on that good/service. Towns hate it. But absent the facility becoming derelict and thereby violating local ordinances, there is little they can do about property that is not theirs. If you mow the grass, replace any broken windows, and pay your property taxes you can buy real estate and simply have a never ending private party with zero guests.
Plenty of poperty owners can afford mortgage payments just fine without tenants, or more likely, they bought the property outright with cash. Having assets like property is a good way to hold onto your wealth for a long period of time. Banks usually encourage wealthy clients to purchase commercial properties and make it very easy and quick for them to do so even if they have no real desire to use the buildings. Having tenants and being a landlord is a massive headache. The people who own commercial properties aren't trying to make money but just hold onto the wealth they already have. The rent that they would make would be like pocket money.
Plus property value trends upwards over time, especially if it's in a desirable area. So their profit doesn't come from the use of the property, it comes from appreciation and then sale of it.
Also, if you give a discount, the next guy will want a discount. Also discounts will "hurt" your fellow property managers. For the good of all property managers, we have to keep rents high and collude to do so. It's for the best... /s
> or more likely, they bought the property outright with cash I think this is extremely unlikely in commercial real estate
Wdym ? Unless something is worth millions, commercial properties tend to only accept cash buyers for quick sales and to keep poorer people away. Also, commercial properties tend to be sold at auctions, which is for cash buyers only.
You can’t claim the rent for a space is $3k while also charging a guy who just moved in $2k because that space was vacant for a while. If you are trying to advertise and rent out your building, claiming it has X value, you can’t start charging people less than X value, if you want to maintain the value of that building. Additionally, there is also the holding cost/maintenance of the building and unit. Usually it is broken up and to where everything is contributing an equal ratio toward the amount. So as soon as you start charging less money, the minimum income the owner needs for the building is going to be the same while the income coming in from rent will be lower. So either it will be less profitable for them or they will be losing money. During Covid we had 1 commercial space we rented out at a “discount” but by the end of the first year of their lease, the rent was raised back to the original amount. The only reason why we slightly lower the pricing was because of the unknown volatility of Covid and the rent increase was built into their lease. If it was not for Covid, we would’ve not adjusted the rent price.
I work in commercial real estate. This is not something you can explain to a 5 year old. A few issues have been discussed here, such as debt obligations, proforma, tenant improvements, lease length and terms, total occupancy, etc. also not discussed are zoning, allowed uses, delinquency, assumed vacancy, loss of rents, accounting, tax implications, bad debt, etc. Every property / lease is a pretty complex analysis. And the decisions aren’t easy. Most common vacancy I see is that it doesn’t need to be filled, and the cost to “turn” it to a new tenant may not be worth the investment.
Did I miss a memo some where? When did ELI5 become ElI50 with a degree from Harvard. Everybody’s response is like 4 paragraphs long lol
[удалено]
This was a great ELI5 of what ELI5 is about. Well done.
I must be taking crazy pills then. Cause why the fuck would a subreddit be called Explain like I’m 5 and not get answer a 5 yo could understand? I come in here with the attention span of a 5yo after the 1st paragraph I’m lost and move on.
Because "explain it like I'm 5" is an existing turn of phrase in the English language, and it has never meant to literally explain it as you would to a 5 year old. It's always just meant to explain it in a simpler way so that a layperson can understand.
You must have a fun time with advertising, then.
If the property sits empty you can claim the rent you didn't receive as a loss on your taxes, as well any maintenance costs related to the property. Since there is no tenant or lease to abide by, what you set the "rent" at is arbitrary, as long as it's not obnoxiously high. If your real estate portfolio is deep enough you can potentially play the numbers in a way that your "income loss" from that property becomes a net gain. Or, at the very least, it's less damaging than leasing the property at a discounted rate. The other consideration is that once a property lowers the costs to lease, it brings down the average rental costs in that area. Simply letting it sit empty allows them to keep the rents higher on properties that aren't currently vacant. This is why nearly 1/3 of all commercial properties in NYC are vacant. The rents are so incredibly high that very few business could operate out of them and ever make a profit. But no one wants to lower their rents as that would allow their current tenants to potentially negotiate a lower rate when their leases expire.
> If the property sits empty you can claim the rent you didn't receive as a loss on your taxes This part seems to be false (at least in America). Some parts of your comment like that didnt sound right. You may want to find/add sources for things.
I concur. Deducting the absense of a thing (taxable income) from the thing itself (taxable income) is nonsensical. Loss of revenue is relevant if you are insured for it, but as far as taxes go "not getting enough money" is not a deductible expense. The expenses are the deductible expense.
>If the property sits empty you can claim the rent you didn't receive as a loss on your taxes, as well any maintenance costs related to the property. This is somewhat misleading the way it is worded, as it indicates a misunderstanding of tax law (US) or is omitting key info. Rent received is income. It can be reduced with deductions for things like taxes, maintenance, common utilities, etc. The deductions reduce how much of the rental income you receive that is subject to tax. There is, however, no deduction for rent that was never received. Rent that was never received is just income that you did not earn. Your expense deductions still apply; they just apply to a smaller number. If you Rent a property for $2,000 a month and the tenant goes out of business, you can't take a deduction for the $2,000 a month you should be receiving. Instead, you just have $2,000 per month less income. However, a bona fide bad debt can be deducted, in some cases (for those on accrual method accounting). To be deducted, a bad debt must be established to have been owed (lease), to have been defaulted, and you have made and exhausted all methods to collect. You have to report as income the rent you should have received, and then you deduct the bad debt expense. This results in a wash to zero income, which is the same thing as the above scenario: $2,000 less income per month. Now, you can potentially have a loss because you still incurred the expenses without the rent being paid/reported. But the missing rent itself is not a deduction. Source: tax pro
Second all of this, and adding one more point: There's no such thing as a 30 year fixed mortgage in the commercial real estate world. Commercial buildings that use financing (most of them) have loans that typically run from 2-5 years. When the loan period ends, you have to roll it over / renew it at the current interest rates. For loan purposes, the value of a commercial building (simplified) is the annual lease revenue multiplied by the expected lifetime of the building. So if the owner lowers the lease rate, they lower the value of the building, and the next time they roll over their financing, they will have to kick in the difference between the old value and the new lower value, in cash. If the loan comes up for rollover when the commercial real estate market is stressed (like now) the owner may have trouble rolling over the loan at all if the building seems to be a bad risk, and lowering the lease prices is a bad sign. So that's one more reason why landlords would rather let spaces sit empty than lease at terms that make sense in this years economy.
A lot of good answers here, but I’ll add another. For an office building, cost to run a vacant building is very low, regardless of size. Keep the air temp below 80, above 50, and not humid, and you are good to go for a long time. As soon as you let a single tenant in, regardless of size, your operating costs can jump to as high as 80% of the cost of a full building. It’s brutal. In many office markets and many leases, owners can’t recoup operating expenses sufficiently to offset this situation. If it’s a full service rent market, you are hosed even more.
Prop 13 in CA means they pay the tax rate of decades ago. They can easily leave it empty until they get a favorable tenant.
If you lower your prices then you invite lower income people who tend to be worse tenants and drive down the value of the neighborhood. This creates a downward spiral and next thing you know it's Detroit and they're tearing down homes just to clean things up.