Matt Yglesias

The Trouble With High Rent

Thinking more about the decline in the commercial real estate market issue left me with a new line of thought. The past several years in which a lot of people were either making money through real estate speculation or else tapping their (notionally) rising home equity to compensate for a lack of rising wages has created a habit of thought in which rising real estate prices is a good thing. And of course the fact that the housing bubble crash led to a huge snarl throughout the financial system further encourages that. But the snarl isn’t caused by falling prices per se, and as a general matter things like rising commercial real estate prices are a bad thing. You might have a store that’s selling people products they want to buy at a price they can afford. And the store could be making money. But then up goes its rent and suddenly it’s not making money. So it tries to raise prices, but that just reduces the number of people who want to buy the products and it’s still losing money. Next thing you know, the store is out of business and it gets replaced by a new bank branch or something and the whole neighborhood’s worse off, to say nothing of the people who used to work at the store.

Rising real estate prices in one town or neighborhood relative to the rest of metro area is a sign of increased desirability. Similarly, when real estate prices go up in one metro area relative to the country as a whole, that’s also a sign of increased desirability. And increased desirability is a good thing. But you shouldn’t mistake the price increase for the increased desirability — it’s a negative consequence of other good things. It’s a form of resource depletion that, like rising commodity prices, that, though correlated with growth, is actually a constraint on growth rather than a cause of it.

Up, Up and Away

With residential real estate crashing and the economy in recession, naturally commercial real estate is going down the tubes as well. But this raised an eyebrow:

Effective rents, after free rent and other landlord concessions, have already started to fall and are expected to decline 30 percent or more across the country from the euphoric days of the real estate boom, according to real estate brokers and analysts.

That is making it all the more difficult for owners, who projected ever-rising rents when they financed their office buildings, hotels, shopping centers and other commercial property.

What on earth could have led people to project “ever-rising rents” on these properties? I could see taking a look at a very specific place — midtown Manhattan, say — and deciding that rents were bound to only go up. After all, Manhattan’s not getting any bigger, and it’s already totally built-out. So as long as the total volume of economic activity in Greater New York rises, so should rents in midtown. Of course a giant Wall Street crash would throw a wrench into that calculation, but the basic thinking is easy enough to follow. But most of the country’s not like that. When rents rise in shopping malls in the suburbs of Las Vegas, people build more shopping malls. There’s nothing wrong with that — the rising rents indicate that there’s demand for more shopping malls. But it would be crazy for a mall builder in that situation to assume that the rents would keep rising forever. The reason the rents were going up was excess demand for shopping malls — demand that the new malls are supposed to be meeting.

Joe Nocera has an interesting story in the New York Times Magazine about why Wall Street’s complicated risk management formulae went bad. But a lot of this stuff, like the “ever-rising rents” on commercial real estate, really doesn’t seem like a very complicated issue to me. Why on earth would commercial rents in general just keep going up forever and ever all across the country?