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> Hedge funds and large corporations often seem like they have more power and often much more agility than governments. They don’t. Hedge funds and corporation

by User23 5y ago

> Hedge funds and large corporations often seem like they have more power and often much more agility than governments. They don’t. Hedge funds and corporations don’t have powers like eminent domain and men with guns authorized to use violence to enforce them. The vacancy rates actually are a second order effect of the banking industry. You’d think landlords would reduce rents because some income is better than none. However commercial property is valued as a function of the rent, so reducing rents 20% could reduce the value of the property 20% too, potentially leaving the commercial mortgage underwater. But leaving it empty with a rent the market can’t bear keeps that from happening. Therefore the correct solution is changing banking regulations to eliminate that perverse incentive, not to try an ad hoc fix at the city level which probably won’t work as intended.

sokoloff 5y ago
That provision is because commercial property is often valued by reference to a cap rate (essentially a net-operating-income multiplier to get to the property value). This is not a property of the banking system but of the market for commercial property. The banking angle is to ensure that loans on property aren't durably underwater, such that the bank has a high likelihood of ending up owning underwater property. (The bank is in the money business; anytime they get into the real estate business with a REO, someone screwed up.) Preventing banks from doing this is likely to lead to a lot more bank-owned properties (REOs), which is generally a bad sign for a real estate market.
- krisoft 5y ago
  You seems to be understanding this better than I do. I understand that if a commercial property gets rented out at 80% of its previous rent that causes a reduction in the valuation of the property. What I don't understand, shouldn't not-renting it out cause an even bigger dip? An 80% reduced property brings in 20% less income to the owner, but if the property is empty that means the owner has to pay for maintenance out of their pocket. (maintaining the roof, keeping the squatters away etc. However cheap these expenses are, it is clearly not zero dollar.) The property becomes from an asset to a liability. (in the colloquial sense at least, as you can hear I'm not well versed in economics.) How does that not decimate the valuation like crazy?
  - sokoloff 5y ago
    Commercial property as a category has some characteristic vacancy rate. (For office and retail, this can be around 10% under typical market conditions. It's not at all weird for "good" property to sit vacant for 18 months at a stretch.) The valuation is based* on looking forward multiple decades. If you think COVID (or recession or other short-term event) is a blip in the future prospects, you aren't overly concerned if a property sits vacant for a year or two, when you're looking at the overall income over the next 30 years. On the other hand, if you drop the rents 20% because you're feeling an urgent need to fill the property now, your fixed costs don't change (property tax may eventually go down slightly), you have 20% less income to cover them and leave a profit, and your next 10 years' of rental income outlook is now nerfed by about 20% (and profit by perhaps 30% or more). It's the reason that rent rebates are a thing. You don't drop the monthly rental rate; you instead credit free months of rent over the initial period of the lease, give larger allowances for landlord-paid improvements, or other "one time" credits. * - every market participant does something slightly different, of course, but they're all more or less looking over a multi-decade period to judge what the property is worth now.
- User23 5y ago
  As you say, it means the bank’s underwriting process failed. It makes more sense to me that they eat the loss caused by their error and auction off the property at a price the rental market will bear. Papering over bad underwriting with dishonest valuations doesn’t strike me as worth sacrificing cities’ commercial vibrancy for.
  - sokoloff 5y ago
    That's the thing the bank is (sort of) "trying to do" and the landlord is seeking to prevent them doing. If the landlord lowers the rent such that the property would now be in violation of the loan covenants, the bank has the option to foreclose on the loan and auction the property off. If the landlord does not lower the rent, they can avoid being in violation of the loan covenants and the bank does not have the right to foreclose and force an auction (provided the landlord keeps making the loan payments, of course). If the bank has a loan on the books that’s being paid-as-agreed and is in compliance with the agreed ratios, it's not at all clear to me that there's been an underwriting mistake and consequently I don't think that giving them the power to foreclose is in the public or borrower’s interests. (Giving them the option is technically always in the bank’s interests, but if the loan’s being paid, they’re not likely to exercise the option anyway.)
    - User23 5y ago
      > I f the bank has a loan on the books that’s being paid-as-agreed and is in compliance with the agreed ratios, it's not at all clear to me that there's been an underwriting mistake and consequently I don't think that giving them the power to foreclose is in the public or borrower’s interests. This view is implicitly premised on the notion that banks exist purely to make a profit. I take the view that banking licenses are issued by the government representing the public and that licensees should act in a way that benefits the community in which they are licensed to operate. Using a dishonest valuation scheme that blights urban commercial districts violates that public purpose. I have no strong opinion on how the lender and borrower ought to work out the costs of accepting reality, and I acknowledge that it probably needs to be handled with finer granularity than some blanket policy.

by User23 5y ago

sokoloff 5y ago

That provision is because commercial property is often valued by reference to a cap rate (essentially a net-operating-income multiplier to get to the property value). This is not a property of the banking system but of the market for commercial property. The banking angle is to ensure that loans on property aren't durably underwater, such that the bank has a high likelihood of ending up owning underwater property. (The bank is in the money business; anytime they get into the real estate business with a REO, someone screwed up.) Preventing banks from doing this is likely to lead to a lot more bank-owned properties (REOs), which is generally a bad sign for a real estate market.

krisoft 5y ago
You seems to be understanding this better than I do. I understand that if a commercial property gets rented out at 80% of its previous rent that causes a reduction in the valuation of the property. What I don't understand, shouldn't not-renting it out cause an even bigger dip? An 80% reduced property brings in 20% less income to the owner, but if the property is empty that means the owner has to pay for maintenance out of their pocket. (maintaining the roof, keeping the squatters away etc. However cheap these expenses are, it is clearly not zero dollar.) The property becomes from an asset to a liability. (in the colloquial sense at least, as you can hear I'm not well versed in economics.) How does that not decimate the valuation like crazy?
- sokoloff 5y ago
  Commercial property as a category has some characteristic vacancy rate. (For office and retail, this can be around 10% under typical market conditions. It's not at all weird for "good" property to sit vacant for 18 months at a stretch.) The valuation is based* on looking forward multiple decades. If you think COVID (or recession or other short-term event) is a blip in the future prospects, you aren't overly concerned if a property sits vacant for a year or two, when you're looking at the overall income over the next 30 years. On the other hand, if you drop the rents 20% because you're feeling an urgent need to fill the property now, your fixed costs don't change (property tax may eventually go down slightly), you have 20% less income to cover them and leave a profit, and your next 10 years' of rental income outlook is now nerfed by about 20% (and profit by perhaps 30% or more). It's the reason that rent rebates are a thing. You don't drop the monthly rental rate; you instead credit free months of rent over the initial period of the lease, give larger allowances for landlord-paid improvements, or other "one time" credits. * - every market participant does something slightly different, of course, but they're all more or less looking over a multi-decade period to judge what the property is worth now.
User23 5y ago
As you say, it means the bank’s underwriting process failed. It makes more sense to me that they eat the loss caused by their error and auction off the property at a price the rental market will bear. Papering over bad underwriting with dishonest valuations doesn’t strike me as worth sacrificing cities’ commercial vibrancy for.
- sokoloff 5y ago
  That's the thing the bank is (sort of) "trying to do" and the landlord is seeking to prevent them doing. If the landlord lowers the rent such that the property would now be in violation of the loan covenants, the bank has the option to foreclose on the loan and auction the property off. If the landlord does not lower the rent, they can avoid being in violation of the loan covenants and the bank does not have the right to foreclose and force an auction (provided the landlord keeps making the loan payments, of course). If the bank has a loan on the books that’s being paid-as-agreed and is in compliance with the agreed ratios, it's not at all clear to me that there's been an underwriting mistake and consequently I don't think that giving them the power to foreclose is in the public or borrower’s interests. (Giving them the option is technically always in the bank’s interests, but if the loan’s being paid, they’re not likely to exercise the option anyway.)
  - User23 5y ago
    > I f the bank has a loan on the books that’s being paid-as-agreed and is in compliance with the agreed ratios, it's not at all clear to me that there's been an underwriting mistake and consequently I don't think that giving them the power to foreclose is in the public or borrower’s interests. This view is implicitly premised on the notion that banks exist purely to make a profit. I take the view that banking licenses are issued by the government representing the public and that licensees should act in a way that benefits the community in which they are licensed to operate. Using a dishonest valuation scheme that blights urban commercial districts violates that public purpose. I have no strong opinion on how the lender and borrower ought to work out the costs of accepting reality, and I acknowledge that it probably needs to be handled with finer granularity than some blanket policy.