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Up, Up and Away

By Matthew Yglesias  

"Up, Up and Away"

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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?

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