Why are commercial real estate markets so often gridlocked?

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I live in a very prosperous neighborhood of New York City, the Upper West Side, where the main thoroughfare, Broadway, is full of vacant storefronts. Except for a few recent restaurant closings, this isn’t a product of the recession—it was just as true a couple of years ago. I mainly blame the banks, which at the height of their expansionist frenzy were adding branches on every corner, driving out more useful neighborhood businesses and overpaying on rent, thus driving up the expectations of every commercial property owner in the neighborhood. That led to lots of shop and restaurant leases not being renewed, and lots of ground floor commercial space going unused because for all their expansionism the banks were never going to need all the commercial space on Broadway.

Now the banks are retrenching. I imagine rents will eventually sink far enough to reflect this new economic reality, and the storefronts of Broadway will fill up again. But it’s taking absurdly long, and millions (hundreds of millions? billions?) of dollars in economic value is going lost in the process. The Upper West Side commercial real estate market would seem to be spectacularly inefficient.

It’s not just the Upper West Side. Sometime Curious Capitalist commenter Marcus reports (in a lecture he gave last week) of trying to rent some commercial space in the depressed and vacancy-plagued central business district of Newcastle, an Australian coastal city north of Sydney:

I contacted 13 separate Commercial Real Estate Agents in Newcastle via email seeking information about potential properties to lease. I gave them a price range – at the medium to high end of the asking price for most Newcastle commercial property), preferred but flexible locations, specific indications of what i was looking for and multiple contact details.

I offered to pay for some capital improvements and said i was able to fly to Newcastle from Melbourne to inspect any properties that might be likely candidates. Given the incredibly dire state of the commercial property market in Newcastle i was actually worried that i might be a little run off my feet with phone calls.

The total number of properties i have been encouraged to look at was nil. The total number of phone calls received was nil. The total number of “thanks but we don’t have anything for you at the moment” emails was nil.

Marcus’s explanation:

[M]any of these buildings are worth more as losses, write offs and deductions that as going concerns. The potential rents are so low that few can actually be bothered renting them. The commission for real estate agents are negligible. Commercial leases are by default prohibitively long and often require property owners to meet expensive obligations.

That, and the cost of complying with regulation can make small businesses and small real estate transactions uneconomic. Marcus came up with a clever partial solution in Newcastle—starting an nonprofit called Renew Newcastle that persuades property owners to let it take over their vacant commercial space on a rolling 30-day basis and then cleans it up and rents it out for use as shops, galleries, studios and a tea house. I don’t know how you make that work in a neighborhood like mine that isn’t in obvious need of rejuvenating but does have a temporarily dysfunctional commercial real estate market (that is, I can’t imagine landlords along Broadway agreeing to participate in Renew Upper West Side). But the common theme—that commercial real estate is prone to market failure—is pretty striking.

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