The loans that they got to build the building were underwritten assuming X square feet of retail space would be rented at $Y per square foot.
If they were to rent the spaces at lower rates, the bank would need to reassess the building, taking the lower rental rate into consideration. Then the Loan-to-Value would be higher, making it harder and more expensive to refinance after the 5 to 10 year term of the loan. The bank doesn't want that either, as long as the payments are coming in on time.
Strangely, keeping the space vacant doesn't require the bank to reassess the space as though it's renting for $0.
So, the financial incentive for the borrower and bank is to keep the space vacant at $Y than rent it for less.
* Banks must re-evaluate the loan once a year based on the average real lease rate for that year OR the next year's contractually committed income. (Not the 'we would love to least it at X' fabrication.)
* In addition to Land Value Tax and any applicable income tax, all not-leased units and spaces would be taxed as if any asking price over comparable units within a reasonable distance, like a 12 city block or mile square centered on that unit, were booked income. Example: Studio apartments currently leased within 20% that units size within the 1 mile square average 1000 USD/mo, a vacant apartment which asks for 950/mo has a taxed rate of 0, while an apartment asking for 1200/mo would be taxed as if they had rented that space for 200 that month, even though there was 0 income. The goal is to apply a small downward pressure to rents and also directly reward renting beneath the mean average within the area. Maybe it should even be at a higher rate, like taxed as if 50% or even the full asking rate had been earned. Of course the highest possible rate (E.G. renting for one single smallest unit of time every time) would be utilized, including any one time fees for background checks, etc.
> Banks must re-evaluate the loan once a year based on the average real lease rate for that year OR the next year's contractually committed income. (Not the 'we would love to least it at X' fabrication.
yesfitz’ comment is not correct, and lenders do care about their collateral experiencing insufficient cash flow. They do not care about specific empty spaces, but if revenue is not as expected, then obviously risk of default is higher, and they will notice.
I think "not correct" is unfair.
The comment's audience was people who are unfamiliar with the effect of financing on market rents. To that end, I left out some nuance and caveats.
I appreciate your expansion on my statement though: "The bank doesn't want that either, as long as the payments are coming in on time."
But Debt Service Coverage Ratio (DSCR) looks at Net Operating Income, not just the collateral property's rents.
DSCR is recalculated at intervals based on the lender's policy.
That policy varies from bank to bank.
All banks' policies are examined by regulators, so it's not as though banks can totally ignore DSCR, but there are ways to mitigate policy exceptions that range from business as-usual to "Extend and Pretend"[1] that's been common since the Federal Reserve rapidly raised rates in 2022.
The loans that they got to build the building were underwritten assuming X square feet of retail space would be rented at $Y per square foot.
If they were to rent the spaces at lower rates, the bank would need to reassess the building, taking the lower rental rate into consideration. Then the Loan-to-Value would be higher, making it harder and more expensive to refinance after the 5 to 10 year term of the loan. The bank doesn't want that either, as long as the payments are coming in on time.
Strangely, keeping the space vacant doesn't require the bank to reassess the space as though it's renting for $0.
So, the financial incentive for the borrower and bank is to keep the space vacant at $Y than rent it for less.