Why do commercial spaces sit vacant?

Summary

This post was inspired by a question that another Substack blogger received earlier this month. I felt that his answer started off on the right track, then veered off course. So I decided to write my own response.To start, here’s the question that inspired this post:Can you explain why it makes economic sense for landlords in high-priced metros to keep commercial real estate empty for years at a time? … I understand there's a lot of social pressure on landlords to keep rents high or face the wrath of their neighbors, but how can that pressure still work after ten years of losses?The short answer is both simple and surprising: In many cases, lowering the rent on a building will force the bank to foreclose on it.Foreclosure is very bad for both the bank and the operator, so both parties would rather “extend and pretend,” leaving the building vacant while they wait and hope for the market to change.This seems absurd. Surely everyone would be better off if they just lowered the rent and got some use out of the building — getting some rent must be better than getting no rent, right?Intuition fails because normal people think of a building as a building, when in the majority of cases, a building is not a building but a financial product. Behavior that makes no sense for a building can make perfect sense for a financial product.To understand this, I’ll offer a simplified explanation of commercial real estate, and the “extend and pretend” dilemma.Commercial Loans Aren’t Like Residential MortgagesThe first reason our intuition fails us is that very few normal people buy and sell building-sized financial products — or financial product-sized buildings. But most of us will buy or sell a home, or know people who have. This gives us some intuitions about how “property” works:The value is mostly determined by the market — roughly, whatever someone else would be willing to pay for it.Home mortgages are mostly based on the purchaser’s ability to pay.Thanks to extensive federal gove...