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Comment by happymellon | Hacker News Reader

I didn't think they could, because of the loans on the properties.

I'll have to dig up the explanation, but basically they take a loan for a $100 property, and if they dropped the rent then basically the loan becomes invalid and they have to repay 100%. So they will never lower rent, even if it's only kicking the can down the road because otherwise it's immediately an issue.

I could be wrong, so I'm going to try and find the source.

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What happens is they do a wil-e-coyote (never look down!) until/if they are forced to. Usually because of insolvency. Then the whole system collapses. The receivers/banks, if it happens, then end up lower rent or selling wholesale to the next company who rents it lower.

The sheer size of such a collapse would tend to get regulators involved though. Think what’s going on in China, etc.

Yep, but they don't ever want to admit failure so keep rents high until they are bankrupt.

Vacancies do not correlate with pricing for commercial real estate largely because of outside forces.

It’s one of the factors causing real estate illiquidity - same happens in residential.

People really don’t want to materialize losses, and will do anything they can to avoid it. It’s why property prices aren’t falling much in residential yet either, except in markets with marginal owners.

And it often works - if it’s just a temporary bump in the road, things recover and blam - they’re rich again.

If it keeps up, at least they’ll have a lot of company and they’ll be less likely to be singled out/more likely to get a bailout.

Atleast in residential rents can and do drop because a large number of rental properties are small time homeowners whose mortgages are not contingent on maintaining a high rent

It depends on the market segment. Most areas, high end/luxury type units are owned by the larger commercial investors and have the same issues. Prop mgmt companies have been doing ‘free month of rent’ type deals for a long time to avoid impacting the headline rent rates for that reason.

Commercial equivalents are usually the Class A stuff. Class B/C is often owned by individuals or small syndicates.

Yes this is true. The banks will insist on repayment of the difference since you're proving that the value of what you borrowed against is suddenly much lower.

That is when Bankruptcy kicks in. Many commercial properties are owned by holding companies, nearly all by some kind of liability shield.

In the US maybe but here in Europe bankruptcy is not really the "get out of jail card" as it is in the US.

In what situation would a bankruptcy of a company not limit the losses to the company? (And prevent individual bankruptcy of officers or shareholders, assuming no fraud or the like)

That’s what both companies and bankruptcy are about no?

Commercial loans are harder to get and costs/interest are much harder because of these risks. Terms are very different too.

You're right about the incentives, but in that case the property gets foreclosed and sold at a loss. So the new owners can charge a lower rent profitably.

We're already seeing Office buildings selling at 60%+ losses off peak valuation in SF, for example.

These real estate holders aren’t on 30 year fixed mortgages though, eventually they’ll have to roll over their debt, and they’ll be upside down and have to sell.

Once that happens they’ll have to reprice to the market.

That's not quite right. But if rents dropped below the loan payments then the property owners really have no choice other than to go into foreclosure proceedings.

And the banks that have to undercut these loans (and maybe society in general) would really, really like to avoid having trillions of dollars of real estate come up for foreclosure again.

There are also tax benefits to keeping rent high. Essentially you can write off the profit of one property with the "loss" of the other. The amount of "loss" is usually the last rent price. There are caviats of course.

I think you have a misunderstanding of income tax law. In the US at least, failure to receive rental revenue isn't considered a loss for tax purposes. The last rent price has zero relevance for income tax accounting.

Commercial property owners can generally deduct expenses like security, maintenance, utilities, etc but that's separate from rent or lack thereof.

Thanks for correction.

This is what they also call on Wall St a "margin call". Essentially, the loans are secured against the property. If the property value gets close/below the margin, the bank will liquidate the assets to secure its funding.

Not really. The vast majority of commercial real estate loans have fixed terms and are not callable.

What if they can't find a tenant. I do not imagine all commercial property is financed with leverage. There will be properties that have paid off their debts. Loan will be recalled if they cannot find a tenant.

Outside of small properties owned by individual investors or syndicates, pretty much all commercial property is financed with leverage. Often there is a separate holding corporation established for each property. Depending on the covenants, the lender may not be able to immediately call the loan in but refinancing is going to be a problem when the term is up.

This may be a trivial question but do they continuously refinance with leverage? Let's say that the property was built 20 years ago, has been operating since then, will there be any mortgage left on it?

Yes, the usual practice is to refinance periodically. It's common for those loans to be for 10 years, but terms vary.

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