Freedom from the commercial vacancy straitjacket
For over a decade we have reported on concerns over commercial vacancies in our Speculative Vacancies report. This is the first time we have been interviewed on this aspect of vacancy. Our latest such report found a 9.1% commercial vacancy rate throughout greater Melbourne during a period when yet again the media were gasping about record low vacancies.
Journalist Dan Ziffer was particularly concerned about the prevalence of vacancy on the ground floor of so many recently developed mid-ring apartment towers. In an era of online retail is this the best use of location?
Compounding this poor market outcome is the behaviour of banks.
From the accompanying article Ghost shops haunting new developments:
More valuable left vacant
But value is part of the problem.
Karl Fitzgerald, project director at thinktank Prosper Australia, said empty shops are not going to fill up soon, because banks put developers in a “straightjacket” that prevents them lowering rents to attract a tenant.
Retail valuations are often based on the last rent received, so a shop sitting empty is more ‘valuable’ than one that cuts its rent to attract a tenant.
Any rent reduction — even if it lures a tenant — could trigger increased loan repayments, because it changes the loan-to-value ratio (known as LVR) of the property.
PHOTO: Prosper Australia director, Karl Fitzgerald, says alternative uses need to be found for empty shops. (ABC News: David Ross)
“In order to keep the banks happy they cannot reduce those rents,” he explained.
“So they keep them at a higher price and, from there, they wait for the market to catch up to them.
“They’ve got to keep the rates at that level — if they try and reduce them they’ll be asked to make up that shortfall.”
Middle-ring suburbs like Box Hill in Melbourne have been drenched in low-rise apartments in recent years.
Prosper Australia’s research — which tallies water meters where not a single litre of water has been used in a year — suggests as much as 36 per cent of commercial space in that suburb is empty.
Behind this sits the land price.
Developers employ optimistic valuers to justify the exuberant prices paid during bidding wars for the development site. When the dust settles, they find themselves in a bind. Developers only attain finance if the estimated rents are at the top end. Then they (and the community) get stuck with vacancy until the market catches up with these high rents. If the developer tries to drop rents they have to make up the difference resulting from the lower value of that commercial space. That could be a $50,000 hit.
Banks in effect lock developers into a straightjacket, where they are unable to reduce rents. Banks win both in the good and bad times. They leverage rising land values to create money in a buoyant market, but when conditions change, there is no wriggle room for the market to adapt. The market is impeded again.
The West needs a banking ethos similar to the Saint-Simonian model Prof Michael Hudson so often talks about. The French / European model of the 1500’s saw banks enjoy the good times but when there was a market downturn, the banks reduced interest rates to help their clients survive. Instead of sending businesses to the wall to maintain short term profitability, the overall economy recovered more rapidly and the nation benefitted.
In the end it all comes back to speculative pressure on land. This flows through to the point where small businesses are working more for landlords and banks than they are for the wider economy.
The short term solutions are referenced in the Speculative Vacancies report, including:
Victoria’s Vacant Residential Property Tax should be reformed to include:
a. All vacant land within the UGB
b. Charges on Site Value for non-strata titled sites
c. An escalating, sliding tax scale over time: the longer vacant, the higher the charge
d. Significant fines introduced for investors who fail to self-declare their vacancy.
Such a vacancy tax could be applied in the commercial setting. If so, banks would have to take this into account. The cost burden of vacancy would be deducted from the valuation, reducing debts. This would filter through to the bidding process, resulting in lower overall land prices.
In the long run we need to increase the holding charges on land. With the rise of major private equity and superannuation investors in real estate, their deep pockets can withstand a few years of residential or commercial vacancy.
The tax shift away from the productive sector and onto monopolies of all kinds including location is vital. Speculative land prices could not gather such steam under these conditions. Investors would thereby face a higher risk profile. Over-bidding based on ‘expected future capital gains’ would be curtailed.
This is the vital pathway required for Australian small businesses to garner an export advantage. High wages can only be maintained if we adopt a lower overall cost base. This can be achieved via the efficiency gains of land value taxes. A three for one spin off includes:
- lower taxes on cost of goods
- lower land prices
- lower mortgage cost.
Both developers and small business can then bust out of the straightjacket they currently find themselves in.