We are witnessing more and more vacant commercial real estate space. How many office buildings or retail buildings with vacant space really have to be vacant? Too many asset managers expect to re-lease expired leases at the same or higher rent. This type of thinking is either the product of a masochistic, naive or foolish (or all three) person. The supply/demand relationship of commercial space has changed. We are in a recession. Increased unemployment has reduced the demand for office space, and unemployed people shop and buy less. Accordingly, rents have changed. They have gone down.

The presumed logic behind attempting to charge a lessee whose lease expired the same or more rent is that if the space is leased for less income, then the real estate will be worth less. Herein lies the illusion. Today’s buyers or lenders base their valuations of commercial property on collected rent, not scheduled rent. Scheduled rent is a wish for rent that doesn’t exist.

There are added financial disadvantages to a property that uses scheduled rent for the purpose of computing value. Scheduled rent doesn’t factor in the costs of re-leasing space. That would include leasing commissions which can convert a 100% economic occupancy to 94% economic occupancy. It doesn’t factor in tenant improvements which could equal one to two years of rent. It also doesn’t include lost rent, which is a 100% perishable commodity. Yet the asset manager sits with vacant space hoping someone is foolish enough to value it based on scheduled rent(s).

Following are the three real estate classes that make policy for income presentation: Owners, asset managers (de facto owners), and property managers. The reader can decide which ones are masochistic, naive or foolish.

1. The owner who keeps space vacant at a perceived higher rent is analogous to the common stock holder who bought stock at $50 per share that now trades at $25 per share. He won’t sell because he doesn’t want to take the loss. News flash! The loss is there, whether you sell or not.
2. Asset mangers represent the largest amount of square feet and numbers of properties. They are hired by institutional owners. Their compensation is customarily a percentage of the value of the real estate. The amounts used for scheduled rents are always more than the amount of collected rents.
3. The property manager’s compensation is a percentage of income collected. The problem there is the motivation could be to rent regardless of the amount, or quality of the lessee.

The manipulation of commercial real estate’s income stream is just one of the many reasons why the following axiom does not change: Due diligence is the indispensable methodology for maximizing return-on-investment while minimizing risk.