I read an article the other day that mentioned one reason why so many storefronts/commercial spaces are empty is that banks prefer vacancies to lowered rent - but the article didn’t go on to explain a reason for this preference or even how the bank’s preference would affect rent. There are plenty of reasons I can understand why a landlord might prefer to leave a space empty rather than lowering the rent- but this article was specific about it being due to the bank. And I don’t understand why the bank would care about how much the theoretical rent was ( because remember, this is about vacant spaces ) rather than whether the mortgage was being paid or how much rent was actually being collected (if it’s refinancing or sale)
I believe commercial leases are usually long, like five or ten years, so if they accept a lower-than-normal rent, they’re locking in that income reduction for a good long time. Perhaps better to wait until market conditions improve?
That’s one of the reasons I thought of why a landlord might do it* - but it doesn’t really make sense to me for the bank to be concerned with that.
- Although I’ve seen more than one space stay empty for more than five years because of this.
If the landlord defaults and the bank forecloses on the property, it’s going to be much simpler for the bank to deal with selling an empty property. A good established tenant enhances the value of a commercial property. But if the landlord is defaulting, it’s unlikely to be a good situation with the tenant. And the bank is only concerned with getting back whatever fraction of the property value is outstanding on the loan, as quickly and easily as possible.
I think that “banks prefer empty storefronts” should be read as “banks will punish you if you lower the rent”. Most importantly, a lower rent directly implies a lower capital value, which means the security (mortgage) you provided for your property loan (on business terms) is worth less — which means your interest rate goes up or the bank makes a margin call.
Business relationships are full of “perverse incentives”. Which should come as no surprise, given that tax rates and family relationships are full of perverse incentives.
“Kid, did you just hit your little brother? Because if you tell the truth, I’m going to paddle you.”
If the landlord is paying the mortgage, the bank doesn’t care what the landlord is doing. The bank wants its loan repaid, period. The only situation this would arise is when the landlord has defaulted on the loan and is negotiating with the bank for a restructuring of the loan or a deferral of some payments. When that happens, the bank wants some assurance that the landlord has a viable plan to get the payments current at some point in the future.
On of the things that they don’t believe is a good plan is lowering rents. Many others have touched on the reasons why. To the bank it looks like a failing property for which the bank is simply delaying the inevitable foreclosure. Other long term tenants are going to want lower rents as well. Further, banks don’t have the expertise or the patience to continue being a de facto landlord for a long period of time. And it is probably not from simple stubbornness; they have seen in the past that vacant spaces means eventual default.
Best to cut and run now IF the only plan to become current is lowering rents.
For commercial leases here, the bank cares about the security, secured by a registered mortgage, which has contractual terms regarding the value of the mortgage, which may and sometimes do include trigger events for revaluing the security.
What ever happened to the sacred “whatever the market will bear”? Seems to me that if the rents are too high, there won’t be renters, so it should be natural to lower the rent rates until you get full occupancy.
I have never been a landlord or a bank, but as a general rule of thumb, if there is something in a financial deal that is perverse, look to the tax code first for reasons.
I am not sure, but I suspect that having an empty storefront “worth” a high rent is worth more to the profitable bank in tax write-offs than a lower rent. Logically it shouldn’t matter since the only thing the bank is concerned about is the mortgage payment not the rent, but where taxes are involved logic is not applicable. Someone with actual knowledge of the subject will hopefully correct me if I am wrong.
Back when I rented, I was in the rental office and overheard the manager telling one of teh staff that you NEVER offered a lower rent. You gave them a free month or two and pro-rated the monthly payments. Practically, it was a lower rate but officially it was still the higher rate.
Sure, but when the property is leveraged, a clean price discovery process might need to involve the landlord who owns the property losing all his equity, the bank foreclosing and selling to a new landlord at a lower price, with a new mortgage based on the lower property value and lower rents.
Back in 2000 I was looking for a couple thousand square feet of office space for a design center for the Fortune 500 company I was working for. Went to one newish building and looked at some vacant, unimproved space. It would have done nicely, so our real estate team tried to negotiate a lease. The landlord wouldn’t budge on the rent, which at $30/sq ft was substantially higher than comparable properties.
Fast forward six years. Lease on our office is running out, looking for a slightly larger space. Local agent takes me back to the building that wouldn’t negotiate. Looked at the same space, still vacant and unimproved, still overpriced.
I think they had about 33% occupancy in the building at the time, including the landlord’s offices.
A couple of years later they were finally to fill the building after converting it to medical offices. So eight years sitting empty rather than take $25/sq ft instead of the $30/sq ft they were asking.
Free? Sometimes you pay them money to take on the rent.
This is important to take note of. Banks don’t control rents unless they are the landlord. And then they are like any other landlord in that they don’t want to lower the value of their property by lowering the rent. Unlike other landlords they want to sell that property as soon as possible, and that is definitely complicated by having a property occupied, and at a lower rent that a potential buyer will use to value the property.
Two situations where the bank’s opinion becomes very important.
- Where the current landlord/owner is looking to refinance the loan.
- Where the current landlord/owner is looking to sell the place, and the potential purchasers are limited by the banks’ assessment of the property value.
As to why the bank would “prefer” vacant space, I would assume they don’t actually prefer it. But their algorithm for assessing property value is heavily based on the monthly rent roll. If the rent is lower, then using the same value/rent multiple produces a lower assessed value for the property, and they’re willing to lend less on that property. But if there is some vacant space, then it’s likely they’re willing to use the most recent monthly amount, or perhaps some estimated rent of their own, and this can produce a nominal rent amount which is higher then the requested reduction, which translates into a higher assessed value for the property, and a willingness to loan more money for a potential refi or purchase.
Underlining mine.
Not trying to pile on but here’s another wrinkle nobody has mentioned.
Even absent banks, underwater landlords, taxes and all the rest of the complicators, there’s no reason that the economically best outcome is to obtain full occupancy.
The landlord may make more total revenue with higher rents and 90% occupancy than they do with lower rents and 100% occupancy. There is some room to charge different tenants different rents/SF in the same building. But particularly in areas with weak demand, the landlord can only get away with so much price disparity between tenants. Pushing to fill the last space can gut margins on all the other spaces.
This might actually be the answer to my question if I’m understanding you correctly. So what you’re saying is that the banks don’t assess property based on the actual amount of rent that is collected - which would be zero for a vacant space. They base it on some estimate of what it could be rented for - which makes sense to me if the space has been vacant a few months ( but not so much if it’s been vacant a few years)
True for just a landlord, but remember that a bank is not interested in collecting any rent. They are involuntary landlords, they want to sell the property not collect rent.
Especially if the vacant space is still paying on it.
If you sign a lease, then you are responsible for fulfilling it. You may go out of business, but you still owe on it. Even if you aren’t paying, your landlord may still be charging you, with the theory of recovering that rent down the line, one way or the other. So, some of these vacant properties may still be under lease. If the landlord rents them out to new tenants, then the previous tenant is off the hook.
Recovering the rent is possible, the leaseholder could be a large chain that will pay off it’s leases. I think when possible sub-letting is done. In a lot of cases there is no chance of recovering all the rent but landlords may be at the top of the list of creditors who will get paid in a bankruptcy. And whether it’s through bankruptcy or just suing for payment having a new renter in place will complicate the matter. The rent collected from a new renter can’t be recovered as damages from the original leaseholder, and in bankruptcy may lower the priority of the landlord because they have recovered some losses while other creditors are still unpaid.
And again, big difference between a bank doing this and a conventional landlord. The bank figures it’s costs on the money lent and the normal administration of the loan. They aren’t interested in being landlords, dealing with renters or courts, they just want the landlord, old or new, to be paying off the loan without further involvement of their further involvement. Banks don’t prefer empty storefronts to lower rents, they prefer having their loans paid off over anything else.