New York's commercial rents are far too high

WHAT'S getting in the way of a recovery for New York City's small businesses? Continued weak demand is surely the main factor. But the fact that commercial rents remain artificially inflated compounds the problem. More businesses could survive, more commercial spaces repurposed for other uses and more new businesses started if commercial rents actually reflected market conditions.

The city and state need to act, imposing a broad set of remedies to lower commercial rents. If they don't, the city faces the prospect of a lingeringly weak economy hamstrung by rents that are, as the saying goes, too damn high.

Commercial rents are a key variable in any city economy. If rents are too high, small businesses can't make enough profit to survive, and repurposing (turning retail space into office space, say, or office space into storage space) is too risky for the landlord. This leads to so-called high-rent blight. But if rents are too low, landlords don't have the incentive to rent or develop properties.

Ideally, rents should go up and down in tandem with supply and demand. But that isn't happening in New York City. Commercial rents are "sticky": They stay high even when demand is low.

There appear to be several reasons for this phenomenon. First, because commercial leases are typically long, some landlords, especially those with other income streams, wager that it's better to wait for demand to return than to commit to a cheap long-term lease. If a landlord has an offer today for US$10,000 per month but thinks a US$20,000-per-month tenant may appear in a year or three, he may decide to wait.

Sometimes landlords, who are also getting squeezed by the pandemic, would be willing to rent for less money but are blocked by their mortgages and lenders from doing so. This is another reason commercial rents are so sticky. Mortgages for commercial properties in New York City typically set a minimum rent, which makes price cutting a form of default. The problem is compounded when mortgages have been securitised and the terms can be modified only by investor consensus.

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A related reason for artificially high rents has to do with how property values are determined. To accept US$10,000 a month in rent from a property that once earned $20,000 a month could entail recognising a multimillion-dollar decrease in the official property value - a situation many properties owners are eager to avoid, even if it means passing up revenue in the short term.

Finally, there is the matter of tax deductions. While a property owner cannot legally deduct losses based on hoped-for rental income, losing money while one waits for a renter can be used to offset certain other forms of income. And it's possible that Donald Trump is not the only player in New York real estate who has creative accountants.

To be sure, many landlords in New York City have been adjusting rents for existing tenants, on an informal basis. Landlords do fear vacancies, and many are suffering themselves. But they are given too many reasons - and sometimes obligations - to keep rents high. As a result, storefronts stay empty and the whole city suffers.

How can the city and state help unlock these assets? First, the state should pass a law voiding minimum-rent terms in existing and future commercial mortgages so that landlords do not risk defaulting if they lower rents. (Yes, such a law would be constitutional.) Second, the city should use property taxes to create a disincentive to leave storefronts empty, as State Senator Brad Hoylman of Manhattan and others have proposed. A storefront unoccupied for, say, more than 90 days could see a property tax increase high enough to cover the revenue lost by the city from not renting the property. That would help get the market moving.

Third, the city should modify zoning rules that interfere with repurposing spaces. Finally, the state should create a specialised task force to audit questionable deductions in the commercial real estate market.

This plan would help push commercial rents down to market rates. And, unlike classic rent control, which puts a limit on price raises, the idea is not to impede the market but to make it work. The city and state would be undoing the restraints that are preventing rents from obeying the law of supply and demand.

As the cliché goes, every crisis presents an opportunity. New York City has been hit hard by the pandemic, and economically its small businesses have been hit the hardest. Yet New York, when it needs to be, can be creative: Its recent rapid transformation into a city of great outdoor dining is just one example. Bringing about a reduction in commercial rents could help power the kind of rebirth that has been this resilient city's proudest tradition. NYTIMES