2004 V32 1: pp. 55–84 REAL ESTATE ECONOMICS The Economics of Maintenance for Real Estate Investments George W. Blazenko ∗ and Andrey D. Pavlov ∗∗ We propose a theory of urban decay. Following a negative real estate demand shock, property managers optimally suspend maintenance and the probability that they ever restart can be modest. Because maintenance expenditures are proportionately less risky than are the incremental building profits they gener- ate, managers impose a more demanding profit standard on maintenance than on the initial investment. This differential in profit standards means that rather than maintain existing investments, property managers favor new investments, which, if marginally acceptable, they also leave unmaintained. Contractually required maintenance (e.g., for publicly subsidized real estate investments), increases the minimum profit for the initial investment acceptance and discour- ages subsidized real estate investments in favor of unsubsidized investments. However, the required profit for acceptance of a permanently maintained in- vestment is below the profit boundary for maintenance if maintenance is not contractually required. Consequently, the subsidy that induces the investment is least expensive if maintenance is not required, more expensive if mainte- nance is permanently required and most expensive if maintenance is induced immediately after initial construction but thereafter is at the discretion of the manager. All of our findings are strongest for poorer quality properties. In its 1999 study “Places Left Behind in the New Economy,” the U.S. Depart- ment of Housing and Urban Development (HUD) notes that even at the peak of the last economic expansion, many urban areas saw no substantial revitalization or economic growth. 1 In this paper, we propose a theory of maintenance for real estate investments that explains this disturbing finding. For a significant fall in operating profit that leads to maintenance suspension, there is a large proba- bility that maintenance is never resumed even as new construction takes place elsewhere. If normal maintenance expenditures are largely determined by the physical attributes of a building and are unrelated to its profitability, then they are less risky than the incremental building profits they generate. Maintenance adds proportionately more to the value of investment expenditures than to the value of operating profits, and, therefore, maintenance adds to a property’s value ∗ Simon Fraser University, Burnaby, British Columbia or blazenko@sfu.ca. ∗∗ Simon Fraser University, Burnaby, British Columbia or apavlov@sfu.ca. 1 The complete report is available at: http://www.hud.gov/library/bookshelf18/pressrel/ execsumm.html.