Judi B.
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Is there a benefit to commercial property owners to keep spaces vacant?
We just learned of a second small business owner along our street (next block) having to close her store. She had asked her landlord for a rent reduction - her current rent is slightly higher than spaces owned by someone else directly across the street. The landlord turned down the request so she's forced to move out. A month ago, the same thing happened to another small business just a few doors further down the street.
We can understand that landlords can't give away space, but it seems odd that commercial property owners seem more content with vacant storefronts than working with their existing tenants to keep spaces occupied.
Good Answers (4)
Ralph B.
Vice President, Tenant Representative, LEED AP, SIOR
Best Answers in: Commercial Real Estate (2), Green Business (1)
There are times when a vacancy is better than a tenant who is paying well below-market. When an owner tries to refinance a property, the lender usually looks to the last lease signed as an indication of what the market is for the building and therefore an evaluation of the property. If a below market lease is signed, it then values the entire building at that reduced rate, which makes it difficult to refinance. Refinancing is a commercial landlord reason to live. Without the equity of refinancing, it is difficult to acquire additional properties (based on cash flow alone).
Having said that, if the landlord is not seeking refinancing, and from a cash flow perspective, it is usually preferable to have a tenant in the space even at a reduced rent. The cost of finding another tenant is very high. The Landlord needs to absorb loss of income for the vacant period, brokerage commissions, tenant improvements to the space, free rent offered to the new tenant as an inducement to rent, etc. It can take years to recover from even a short vacancy. Additionally, in a retail center, vacancies hurt the entire center, which depends on traffic from neighboring stores. One vacancy often can turn into a string of vacancies very quickly in a retail center.
Tony M.
Owner at Self Employed
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I have owned some commercial RE. In general, unless the landlord has a more attractive tenant lined up, or one who may rent a space contingent upon the availability of adjacent or nearby space, the answer is NO. It is possible that a landlord may have had problems collecting rent from the tenant and feels that they are better off with a rentable vacant space than offering rent concessions and a new lease to an economically stressed tenant who has a poor prospect for recovery. Unlike residential property that is valued in accordance with comparable properties in the area where it is located, commercial property values are generally predicated upon the rental income of the property. A rule of thumb I've used is that the value of a commercial property should be between 90 to 120 times the monthly rents. You might pay less if the property is distressed or if tenants are abandoning the property, or more is you have a more beneficial use for the property as an owner/tenant, or if you believe that the rents are lower than market or the rents could be raised if the property is improved. Unfortunately, I believe that business conditions for "main street" businesses, particularly consumer products retail, restaurants (including deli, pizza & coffee shops) and service businesses that rely on discretionary income (beauty parlors & nail salons for example) will continue to deteriorate for some time and you'll see more failures before the situation begins to recover for those businesses.
In general an existing tenant would be viewed as better than a vacant space. As Tony indicated, commercial and multi-tenant residential properties are valued based on their net operating incomes (basically but not exactly income before debt service). A smart owner will however plan for the occasional period of vacancy and will understand that a short vacancy will be less costly to value than a long below market lease.
Some examples of things could make a vacancy more attractive are; the payment history of the tenant, another is the relationship between the property owner and their bank - the owner may be required to maintain a minimum contract rent by their bank. Also a potential factor is the rent that the tenant is asking to pay, it could be so low that the owner feels that they can get a new tenant for more rent at a low enough cost to take the risk. It is possible the owner tried to make a deal and the tenant wouldn't agree, or the owner could be foolishly greedy. There is no sure way to tell without having been in the middle of the deal.
Fred H.
Sr, VP - Director Commercial Lending at Global Fundings, Inc.
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Judi:
Probably not. Here in Alameda (CA) we've seen a couple of commercial real estate cycles. In the 1990's Park Street had vacancies in every block - yet landlords still tried to increase rents when leases came up for renewal!
I agree with the other Answers that there may have been some payment issues between the tenant and the landlord. Frankly, it doesn't make sense that the business owner closed her business because she could not get a "slight" rent reduction. Was that really the reason?
It's important to keep in mind that retail leases are often for five- and ten-year terms. We used to hear all the time about long-term tenants being forced to move (and sometimes close their businesses) because the landlords demands large payment increases when their leases came up for renewal.
What people didn't take into consideration were the years that tenant was paying well below-market rents. Did the business owner put aside some of that money each money for the day when a new lease would be signed? Probably not.
It's useful to remember that while real estate is remarkably efficient overall, in individual cases people don't always act in a rational manner. Sellers ask too much for their properties - buyers offer too little. Landlords ask too much rent - prospective tenants low-ball proposals.
In your example, I wonder if the tenant failed to present a detailed long-term plan. A landlord (one would think!) would entertain a short-term rent reduction as long as there was a plan on the desk to return rents to the previous (market) level.
Did the tenant have a solid business plan to return to a profit level that would support the previous lease payments? Or did she ask for a rent reduction simply because she learned other tenants on the street are paying less?
It will be interesting for you to see how long it takes to re-lease that space. A landlord who raises rents 10% (or refuses a 10% reduction) will lose money for months unless the space gets a new tenant right away.
Finally - there are times when landlords give away space. During the Great Depression building owners let tenants occupy office space for free. Sometimes for utility and cleaning expenses - sometimes not.
The owners calculated the building looked better - and would be more attractive to paying tenants - if it wasn't completely empty. Today some companies with too much space are letting short-term tenants occupy un-used space for free. It helps their remaining employees feel less like survivors in a bunker.
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Mary L.
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Perhaps the landlord has their eyes shut and doesn't realize commercial vacancies are rising. Rents are barely maintaining and certainly are not going up at this point in time.
I would love if you'd keep us posted on this one. At least me..
Christine H.
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Only the owners know what their reasoning is.
Obviously, they didn't feel they needed to lower their rent.
It is beneficial to keep space vacant as long as it does not get encroached by unwanted persons
Michael L.
Commercial Real Estate Broker, LEED AP
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A more relevant question may be about the viability of the tenant that asked for a rent reduction. If they were trying to negotiate a reduced rent to take advantage of a high vacancy market then they were playing negotiating games and lost. If they were no longer able to pay the existing rent the landlord may have evaluated their finances and determined that even with a rent reduction they were not likely to be successful, so he was better off trying to find a stronger tenant.
It is also better to lose a tenant and have the vacant space to give to a new tenant than to have an existing tenant go bankrupt and be unable to get the premises back or to have the court "cram down" the rent/terms.
Ian B.
Consultant at Capita Symonds (formerly Inventures)
Best Answers in: Commercial Real Estate (1), Project Management (1)
In the UK, it could be a couple of reasons. As pointed out by some others, here, Landlords estates are sometimes re-valued on a regular basis and if a letting is made at a lower rent than the accounts suggest, it affects your lending - although the shop is empty, in theory it could be let tomorrow at full rent, this not being the case if you've just discounted it.
The second reason could be redevelopment ... does the Landlord want to redevelop or carry out substantial refurbishment and is therefore using the opportunity for a phased removal of tenants. If this is the case, you might want to be aware if your lease is due to expire and you should take proper property advice.
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Only if they are paid to keep them vacant.
