Commercial realestate seem to be a key example of a free market failure.
Everyone just accepts that rents are nowhere near the market clearing price and that buildings are left abandoned. There are many factors at play: covenants, GRM, LTV, properties trading for tax loss value and depreciation rather than usage.
I'm generally a fan of free markets but in this case it absolutely seems to make sense for the city to step in and do something about it. Is there a way to solve this in general, specifically change policy such that commercial real-estate rent more quickly reflects the market-clearing price?
The general case is hard, because ideally you want some level of vacancy, to keep availability high. It's probably better for the city to have overbuilt than under, and attempts to discourage vacancy are likely to discourage new construction. One approach I could see would be a carrot-stick approach, where the city subsidizes new construction by way of offering low-interest loans, but with the caveat that the loan can get called in if vacancy numbers rise by some amount for some amount of time, or perhaps a stipulation that requires the building be converted into residential if there's not enough commercial business (on threat of the loan being called in).
Ultimately, regulation would require a clear distinction between 4 cases: Vacant because supply > demand (alright), Vacant because market price < projected value of not filling the space immediately (bad), Occupied on paper only, such as a company owned by the building owners with more floors of the building than employees (bad), and Occupied (good).
> It's probably better for the city to have overbuilt than under, and attempts to discourage vacancy are likely to discourage new construction.
I am in agreement with the general points being made in this discussion, but this jumps out at me as completely backwards.
I know commercial real estate != residential, but we've seen lack of discouraging vacancy has NOT led to increased construction. It just leads to rampant speculation and incredible negative externalities (see San Francisco, the subject of this discussion).
I would need to see some evidence that discouraging office vanacy would lead to under-development. Wouldn't discouraging vacancy lead to lower prices ("market-clearing") possibly even inducing demand, in turn encouraging construction?
I don't claim that you speak for economists, or politicians, or even all of the electorate, but I think your arguments are evident of the prevailing understanding and I'm seriously pessimistic about our future as a result. We are going to continue to do the same things and expect better results.
If the "free market" is so great, but we have to hem and haw about how to make sure billionaire developers can extract tax incentives so they can layoff 10% fewer employees in the next downturn, then we are well and truly [word].
I think I may have been unclear. In that context, I meant non-specific vacancy discouragement, such as simply jacking up commercial property taxes. The ideal market solution would be something approximating a Georgist-style land tax, trying to tax non-improvement appreciation of property at ~100%, killing the land speculation business. But if you implement that at a city scale, there are other cities in every direction more than happy to let the financiers of new construction become obscenely rich off of that speculation. So your options are A) high level reform, at the state or preferably national level, to eliminate that axis of competition or B) trying to solve the specific ill of deliberate vacancy without murdering your city's competitive edge in attracting business and investment.
Understood, thanks for clarifying. I didn't mean to attack your specific wording.
I strongly agree with your mention of "preferably national level" regulation. More and more, across all issues, I see this as our biggest obstacle to progress. A patchwork of state + local policymaking turns everything into a regional feudalist race-to-the-bottom.
Maybe a property tax adjustment based on how much time the property has spent vacant over the past N years?
Something like, every year the property owner pays:
property value * (average vacancy % over N years)
If your property is occupied, you pay nothing extra. If your property sits idle for one year out of five, you pay 20% the property's value to the city every year until your rolling average improves. Maybe throw in some incentives like a partial rebate when the owner signs a new tenant after a stretch of vacancy.
Write it into the law that self-dealing to evade taxes is fraud, if that even needs to be spelled out. Also, vacant properties would count as vacant whenever they are not productively occupied, even if there is an active lease. Have a city inspector perform periodic spot checks, like how health/fire/etc codes are enforced. Fines for violations scale with the property's assessed value, rather than being defined as flat dollar amounts.
Posner and Weyl show in Radical Markets that land cannot be put to optimal use without perpetual auctions where buyers compete to pay the most tax. It’s essentially Georgism. Exploitation of the commercial real estate arises from strong private property rights that are useful in themselves but have clear (and for working class San Franciscans expensive) externalities.
This sounds like a cute academic thought experiment, but in reality is just another way to feed the beast of government. Yet more resources pissed away on armies of inefficient bureaucrats.
There is no shortage of land or desire for development. The problem is and always has been NIMBY regulation. We don’t need any more help from the government to get more housing, we need them to get out of the way.
It's frankly ridiculous to think that the solution is that the "city needs to do something about it". San Francisco utterly and completely mismanaged its homelessness, crime, and the pandemic, and now you want to.. somehow give them more power over commercial real estate and put the same people in charge?
The city caused the problem in the first place, not the "market". What you're seeing isn't a market failure it's a correction.
The root cause of inadequate demand for commercial real estate is a combination of WFH skyrocketing during Covid and rising interest rates and the resulting mass layoffs. How the city government of San Francisco caused Covid or rising interest rates I'll never know.
> What you're seeing isn't a market failure it's a correction.
When a "correction" is big enough to disrupt an entire city's economy, you can go ahead and call it a failure. Either way, it's exactly the job of government to mitigate the impact of these corrections/failures.
Have you seen Louis Rossman’s collection of YouTube videos of block after block of unoccupied Manhattan real estate because of unrealistic asking prices?
> U.S. office buildings are unlikely to regain their peak pre-pandemic values until at least 2040 as demand for desk space weakens, Bloomberg News reported, citing a forecast by Capital Economics. Values are expected to plunge 35% from the peak by the end of 2025 and take 15 years or more to recover as hybrid and remote work reshape real estate, acccording to London-based Capitol Economics.
> “Demolitions and conversions of the worst assets may partially counteract the impact on valuation-based indices,” economist Kiran Raichura wrote. “But ultimately landlords will have to bear those costs, so the road ahead for office owners is set to be an arduous one.”
> Major institutional investors, including Brookfield and Blackstone, have defaulted on some office buildings, choosing to stop loan payments rather than spend more on money-losing properties, Bloomberg reported. It’s estimated that office buildings account for $43 billion of $64 billion in potentially distressed assets.
Other major downtowns (and tangentially, mass transit systems) are in peril, but just as you don’t have to outrun the bear, just your slowest friend, SF is bearing the brunt of it.
Real estate investors make a bet that the rents they receive will cover the mortgage payments.
Markets are cyclical. The full reason why any particular system oscillates or is chaotic is complicated, however in this case the fact that there is a long lead time measured in years for any new supply to be created and the decision to build is partially based on prevailing interest rates and the supply of money.
Most cities lock the use type of any particular building in by the use of zoning and all kinds of regulation. That means the owners or potential owners aren't free to just change the building use to attempt to provide supply to match demand.
Should people be able to make predictions about future business and economic conditions and then undertake business based on those predictions? They are going to bet wrong a lot. In fact due to the nature of feedback systems, there will always be some investors that bet wrong.
Let's simplify this a little and just take one example of something the city and county of SF has control over, property tax. SF is a little unique by being both a city and county. In California the counties have control over lien tax sales for non payment of property tax. How quickly should the county of SF auction off properties that haven't paid their property tax?
Property becomes tax-defaulted land if the property taxes remain unpaid at 12:01 a.m. on July 1st. Property that has become tax-defaulted after five years (or three years in the case of property that is also subject to a nuisance abatement lien) becomes subject to the county tax collector’s power to sell in order to satisfy the defaulted property taxes. The county tax collector must attempt to sell the property within four years of becoming subject to sale. The county tax collector may offer the property for sale at public auction, a sealed bid sale, or a negotiated sale to a public agency or qualified nonprofit organization.
Should the County of San Fransisco increase the number of property tax delinquent properties that they slap with nuisance abatement (they could pick any kind of reason such as dirt and graffiti, squatters, crime incidents, etc) in order to expedite these properties being put on the market?
Cool. It'll be nice to have the plans all drawn up after the 5-10 years of council committees this will sit through, so that we have something ready to go for the next recession.
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[ 2.1 ms ] story [ 61.7 ms ] threadEveryone just accepts that rents are nowhere near the market clearing price and that buildings are left abandoned. There are many factors at play: covenants, GRM, LTV, properties trading for tax loss value and depreciation rather than usage.
I'm generally a fan of free markets but in this case it absolutely seems to make sense for the city to step in and do something about it. Is there a way to solve this in general, specifically change policy such that commercial real-estate rent more quickly reflects the market-clearing price?
Ultimately, regulation would require a clear distinction between 4 cases: Vacant because supply > demand (alright), Vacant because market price < projected value of not filling the space immediately (bad), Occupied on paper only, such as a company owned by the building owners with more floors of the building than employees (bad), and Occupied (good).
I am in agreement with the general points being made in this discussion, but this jumps out at me as completely backwards.
I know commercial real estate != residential, but we've seen lack of discouraging vacancy has NOT led to increased construction. It just leads to rampant speculation and incredible negative externalities (see San Francisco, the subject of this discussion).
I would need to see some evidence that discouraging office vanacy would lead to under-development. Wouldn't discouraging vacancy lead to lower prices ("market-clearing") possibly even inducing demand, in turn encouraging construction?
I don't claim that you speak for economists, or politicians, or even all of the electorate, but I think your arguments are evident of the prevailing understanding and I'm seriously pessimistic about our future as a result. We are going to continue to do the same things and expect better results.
If the "free market" is so great, but we have to hem and haw about how to make sure billionaire developers can extract tax incentives so they can layoff 10% fewer employees in the next downturn, then we are well and truly [word].
I strongly agree with your mention of "preferably national level" regulation. More and more, across all issues, I see this as our biggest obstacle to progress. A patchwork of state + local policymaking turns everything into a regional feudalist race-to-the-bottom.
Something like, every year the property owner pays:
If your property is occupied, you pay nothing extra. If your property sits idle for one year out of five, you pay 20% the property's value to the city every year until your rolling average improves. Maybe throw in some incentives like a partial rebate when the owner signs a new tenant after a stretch of vacancy.Seems pretty simple.
There is no shortage of land or desire for development. The problem is and always has been NIMBY regulation. We don’t need any more help from the government to get more housing, we need them to get out of the way.
The city caused the problem in the first place, not the "market". What you're seeing isn't a market failure it's a correction.
> What you're seeing isn't a market failure it's a correction.
When a "correction" is big enough to disrupt an entire city's economy, you can go ahead and call it a failure. Either way, it's exactly the job of government to mitigate the impact of these corrections/failures.
https://youtube.com/watch?v=2Trz65P1gnA
https://youtube.com/watch?v=1Yv1jx5I9TE
Also:
https://www.connectcre.com/stories/u-s-office-pricing-not-ex... (U.S. Office Pricing Not Expected to Recover Until 2040)
> U.S. office buildings are unlikely to regain their peak pre-pandemic values until at least 2040 as demand for desk space weakens, Bloomberg News reported, citing a forecast by Capital Economics. Values are expected to plunge 35% from the peak by the end of 2025 and take 15 years or more to recover as hybrid and remote work reshape real estate, acccording to London-based Capitol Economics.
> “Demolitions and conversions of the worst assets may partially counteract the impact on valuation-based indices,” economist Kiran Raichura wrote. “But ultimately landlords will have to bear those costs, so the road ahead for office owners is set to be an arduous one.”
> Major institutional investors, including Brookfield and Blackstone, have defaulted on some office buildings, choosing to stop loan payments rather than spend more on money-losing properties, Bloomberg reported. It’s estimated that office buildings account for $43 billion of $64 billion in potentially distressed assets.
Other major downtowns (and tangentially, mass transit systems) are in peril, but just as you don’t have to outrun the bear, just your slowest friend, SF is bearing the brunt of it.
Largely, it's been a problem created by the city "doing something about it."
Zoning laws restrict what property can be used for, producing inflexibility and inefficiency.
Overbearing public safety laws contributed to their abandonment.,
Bureaucratic red-tape and building laws prevent other areas from scaling and adjusting.
Markets are cyclical. The full reason why any particular system oscillates or is chaotic is complicated, however in this case the fact that there is a long lead time measured in years for any new supply to be created and the decision to build is partially based on prevailing interest rates and the supply of money.
Most cities lock the use type of any particular building in by the use of zoning and all kinds of regulation. That means the owners or potential owners aren't free to just change the building use to attempt to provide supply to match demand.
Should people be able to make predictions about future business and economic conditions and then undertake business based on those predictions? They are going to bet wrong a lot. In fact due to the nature of feedback systems, there will always be some investors that bet wrong.
Let's simplify this a little and just take one example of something the city and county of SF has control over, property tax. SF is a little unique by being both a city and county. In California the counties have control over lien tax sales for non payment of property tax. How quickly should the county of SF auction off properties that haven't paid their property tax?
https://sco.ca.gov/ardtax_public_auction.html
Tax-Defaulted Land Sales
Property becomes tax-defaulted land if the property taxes remain unpaid at 12:01 a.m. on July 1st. Property that has become tax-defaulted after five years (or three years in the case of property that is also subject to a nuisance abatement lien) becomes subject to the county tax collector’s power to sell in order to satisfy the defaulted property taxes. The county tax collector must attempt to sell the property within four years of becoming subject to sale. The county tax collector may offer the property for sale at public auction, a sealed bid sale, or a negotiated sale to a public agency or qualified nonprofit organization.
Should the County of San Fransisco increase the number of property tax delinquent properties that they slap with nuisance abatement (they could pick any kind of reason such as dirt and graffiti, squatters, crime incidents, etc) in order to expedite these properties being put on the market?