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I’d be lying if I said I understood the full ramifications of the following on the macro economy, but commercial real estate in general is, in my opinion, a com

by xp84 2y ago

I’d be lying if I said I understood the full ramifications of the following on the macro economy, but commercial real estate in general is, in my opinion, a completely non-functioning market. Every one of us has seen countless retail and office spaces which sit empty for years or decades at a time, even in cities where space is at an absolute premium. They are empty not because literally no one would like to rent the space, but because the investors who own those properties simply ignore the market signals telling them they are priced wrong. I think maybe it has something to do with their financial games that they play, where if they cut the asking rent buy 75% to actually fill the space then whoever holds the mortgage for the building will decide they’re insolvent and foreclose? Whereas if it sits empty for six years at an absurd asking rent, theoretically the building still has the value it used to have when it actually brought in that amount of rent? Regardless of why it’s like this, I think I would prefer for the commercial real estate industry to die in a fire and return to system where prices are set according to supply and demand. Assuming that it wouldn’t cause a Great Depression, but it probably would.

AnthonyMouse 2y ago
> I think maybe it has something to do with their financial games that they play, where if they cut the asking rent buy 75% to actually fill the space then whoever holds the mortgage for the building will decide they’re insolvent and foreclose? A lot of this was low interest rates. Appreciation on the building, especially given artificial scarcity from captured zoning boards, meant you could make more than the interest on the loan just through increases in the price of the building without even renting it out. So they were asking crazy rents because if they could actually get someone to pay that it's pure profit and if not they're still making money. Now interest rates are higher and that doesn't work so well so the result should be a drastic decline in rental prices, but people are holding out in the hope that the fed is going to drop rates to zero again. Which would be stupid. > Assuming that it wouldn’t cause a Great Depression, but it probably would. Nah, we just "fixed it" the wrong way in 2008. We lowered interest rates so people would borrow money (bank loans create new money) and reinflated the housing bubble. But a bubble is bad. So what you do is you let it pop. This causes deflation, which is generally bad. But uh, maybe not actually so bad right now. And if there was too much deflation, that's all too easy to fix -- it intrinsically allows you to print money and send out stimulus checks, because in that case inflation to counteract the deflation is what you want. And since you don't need to buy a house to get a stimulus check, that stabilizes the overall economy instead of re-overheating the housing market like we did last time.
- from-nibly 2y ago
  We might be able to handle deflation, but the fed can not. That would cause them to default on their loans. They are already dangerously close to this happening IIRC.
  - AnimalMuppet 2y ago
    The Fed was never in any danger of defaulting on their loans. (Do they even have loans?) The Fed was worried about everybody else getting wiped out in a deflationary spiral.
    - AnthonyMouse 2y ago
      The Fed is both a bank and the part of the government that prints federal reserve notes (i.e. dollar bills). If it wants to buy government bonds or something else it will just credit your account (or your bank's account) at the federal reserve bank. The Fed then owes that other bank money, but banks are also required to keep reserves on deposit with the Fed in order to make loans, so they generally don't ask for the money, and when they do they generally don't actually want dollar bills, they want to transfer the money to a different bank, and then the Fed would just credit that bank's account. Occasionally other banks actually do want printed currency (e.g. to fill their ATMs), so then the Fed debits their account and gives them physical cash it has printed. The Fed is never in any danger of defaulting. If you want to transfer money it owes you to another bank, they're just changing the numbers in their computer. If you want it as cash, they're the thing that prints the cash. The only reason it can't just create an unlimited amount of money to use for whatever the government wants is that creating money causes inflation.
Animats 2y ago
That's called "extend (the loan term) and pretend (that the collateral has enough value)". Here's the real estate industry saying that's a good thing, [1] "saving the market from becoming flooded with devalued assets." [1] https://www.loopnet.com/learn/why-extend-and-pretend-may-be-prudent-for-both-lenders-and-borrowers/124625489/ https://www.loopnet.com/learn/why-extend-and-pretend-may-be-...
x0x0 2y ago
The explanation I read: banks lend against a percent of value, eg 90%, and require the owners to maintain 10% ownership (numbers just for example). They also calculate the value of the property via the rents. The commercial mortgages require the property owners to recollateralize the loan if they accept reduced rent, ie pay the loan down until the banks have only lent that 90% of value. Thus accepting reduced rent means the owners must immediately cut a check to the bank or negotiate with the bank to change the terms of the loan. Except the bank doesn't own the loan, it's been sold to investors as cmbs, and the language on the cmbs requires a high threshold (80% or more) to approve an alteration. So that's functionally impossible. Additionally, you can often add unpaid rent on to the end of the loan and extend the terms. If you expect valuations to rise over time, not being able to rent units at the value you promised the bank (and perhaps that value was inflated to make it easier to get the mortgage) is often much more easily dealt with by extending the loan rather than writing the bank a check to recollateralize.
- Animats 2y ago
  > Except the bank doesn't own the loan, it's been sold to investors as cmbs, and the language on the cmbs requires a high threshold (80% or more) to approve an alteration. So that's functionally impossible. Until somebody in the chain goes bankrupt and a bankruptcy court rewrites the terms.
  - x0x0 2y ago
    Indeed, though I suspect part of the value of the bankruptcy is it's finally a limited number of counterparties for the negotiation and they have to respond.
- xp84 2y ago
  Thanks for the full detail, that lines up with what I vaguely had a memory of hearing. It just sucks that it provides such a market distortion. Real estate has so many ways for “sellers” to ignore market price signals. Imagine if a retailer had a store where they hadn’t made a sale in 15 years yet they just kept dusting the racks and carrying the costs of that location on their books all that time. Only in commercial real estate can that happen. (Okay, probably in defense contracting somehow as well)

by xp84 2y ago

AnthonyMouse 2y ago

> I think maybe it has something to do with their financial games that they play, where if they cut the asking rent buy 75% to actually fill the space then whoever holds the mortgage for the building will decide they’re insolvent and foreclose? A lot of this was low interest rates. Appreciation on the building, especially given artificial scarcity from captured zoning boards, meant you could make more than the interest on the loan just through increases in the price of the building without even renting it out. So they were asking crazy rents because if they could actually get someone to pay that it's pure profit and if not they're still making money. Now interest rates are higher and that doesn't work so well so the result should be a drastic decline in rental prices, but people are holding out in the hope that the fed is going to drop rates to zero again. Which would be stupid. > Assuming that it wouldn’t cause a Great Depression, but it probably would. Nah, we just "fixed it" the wrong way in 2008. We lowered interest rates so people would borrow money (bank loans create new money) and reinflated the housing bubble. But a bubble is bad. So what you do is you let it pop. This causes deflation, which is generally bad. But uh, maybe not actually so bad right now. And if there was too much deflation, that's all too easy to fix -- it intrinsically allows you to print money and send out stimulus checks, because in that case inflation to counteract the deflation is what you want. And since you don't need to buy a house to get a stimulus check, that stabilizes the overall economy instead of re-overheating the housing market like we did last time.

from-nibly 2y ago
We might be able to handle deflation, but the fed can not. That would cause them to default on their loans. They are already dangerously close to this happening IIRC.
- AnimalMuppet 2y ago
  The Fed was never in any danger of defaulting on their loans. (Do they even have loans?) The Fed was worried about everybody else getting wiped out in a deflationary spiral.
  - AnthonyMouse 2y ago
    The Fed is both a bank and the part of the government that prints federal reserve notes (i.e. dollar bills). If it wants to buy government bonds or something else it will just credit your account (or your bank's account) at the federal reserve bank. The Fed then owes that other bank money, but banks are also required to keep reserves on deposit with the Fed in order to make loans, so they generally don't ask for the money, and when they do they generally don't actually want dollar bills, they want to transfer the money to a different bank, and then the Fed would just credit that bank's account. Occasionally other banks actually do want printed currency (e.g. to fill their ATMs), so then the Fed debits their account and gives them physical cash it has printed. The Fed is never in any danger of defaulting. If you want to transfer money it owes you to another bank, they're just changing the numbers in their computer. If you want it as cash, they're the thing that prints the cash. The only reason it can't just create an unlimited amount of money to use for whatever the government wants is that creating money causes inflation.

Animats 2y ago

That's called "extend (the loan term) and pretend (that the collateral has enough value)". Here's the real estate industry saying that's a good thing, [1] "saving the market from becoming flooded with devalued assets." [1] https://www.loopnet.com/learn/why-extend-and-pretend-may-be-prudent-for-both-lenders-and-borrowers/124625489/ https://www.loopnet.com/learn/why-extend-and-pretend-may-be-...

x0x0 2y ago

The explanation I read: banks lend against a percent of value, eg 90%, and require the owners to maintain 10% ownership (numbers just for example). They also calculate the value of the property via the rents. The commercial mortgages require the property owners to recollateralize the loan if they accept reduced rent, ie pay the loan down until the banks have only lent that 90% of value. Thus accepting reduced rent means the owners must immediately cut a check to the bank or negotiate with the bank to change the terms of the loan. Except the bank doesn't own the loan, it's been sold to investors as cmbs, and the language on the cmbs requires a high threshold (80% or more) to approve an alteration. So that's functionally impossible. Additionally, you can often add unpaid rent on to the end of the loan and extend the terms. If you expect valuations to rise over time, not being able to rent units at the value you promised the bank (and perhaps that value was inflated to make it easier to get the mortgage) is often much more easily dealt with by extending the loan rather than writing the bank a check to recollateralize.

Animats 2y ago
> Except the bank doesn't own the loan, it's been sold to investors as cmbs, and the language on the cmbs requires a high threshold (80% or more) to approve an alteration. So that's functionally impossible. Until somebody in the chain goes bankrupt and a bankruptcy court rewrites the terms.
- x0x0 2y ago
  Indeed, though I suspect part of the value of the bankruptcy is it's finally a limited number of counterparties for the negotiation and they have to respond.
xp84 2y ago
Thanks for the full detail, that lines up with what I vaguely had a memory of hearing. It just sucks that it provides such a market distortion. Real estate has so many ways for “sellers” to ignore market price signals. Imagine if a retailer had a store where they hadn’t made a sale in 15 years yet they just kept dusting the racks and carrying the costs of that location on their books all that time. Only in commercial real estate can that happen. (Okay, probably in defense contracting somehow as well)