The whole point of community rules on private property is that an ugly or rundown property will drive down the value of the properties around it. The same happens with domain names. The reason we have startups with ridiculous names like Meebo, Loopt, Reddit and Xobni are because all the reasonable names are taken by squatters who just plaster the domain with ads and make a tidy profit while they wait for a sucker to hand them over thousands of dollars.
I agree that people legitimately doing business on the web shouldn't face a constant, ominous threat of seizure. At the same time though, the web could use some communal standards to make the community better for everyone.
I also don't think your analogy is very applicable, since domain names are just floating in the ether, not sitting in physical proximity of one another. Ads plastered on one will not drive down the values of the others — the complete opposite, in fact. Furthermore, no one would buy prime commercial real estate, do nothing with it, and then be able to cover their costs with some ads on it — whoever bought it would go bankrupt. Ignoring all that, however, I really feel that if someone wanted to do so, the city council should not be able to levy fines on them for letting their property go into disrepair. Would I want to live next to such a property? No, definitely not. But it's their property and I respect their rights to do as they wish with it. I don't feel the ends justify the means in this case.
You're right that no one would buy prime commercial real estate and do nothing with it. That's because prime commercial real estate is expensive. But the prime real estate of the web wasn't expensive. In fact, all of it sold for just a few bucks back in the 1990s.
Imagine that there was a time when the prime commercial real estate of today was cheap and squattable in perpetuity. Imagine that a handful of people back in the 1600s "claimed" the majority of land in the US simply by having seen it (or, even more aptly in this comparison, by having thought of it). Imagine that all this land is their "property", regardless of whether they live on it, work on it, improve it, or even care about it. Under such a system, the descendants of these handful of people would today be collecting rent from everyone in the country, whether on prime commercial real estate or otherwise. Rather than a nation of rugged individuals (think Homestead Act), it'd be a nation of landed gentry (think British aristocracy).
When it comes absentee landlords, the notion of "property" is rather flimsy. What right does an absentee landlord have to an abandoned property? The only thing that maintains an absentee landlord as the "owner" of a property is the government's willingness to use force against anyone who claims otherwise.
I think one of the most important things about private property is not necessarily that you can demand its fair value when you sell it, but rather that you alone can decide whether it is for sale in the first place.
From my way of thinking, domain squatting certainly isn't a dignified way to make a living or something to be proud of, and it's certainly a pain in the ass to everyone else, but I think it certainly is within the rights of those who choose to do it. Who cares if someone has a better use for a domain name? If you bought it, it's yours whether anyone else like it or not.
You might argue that squatting is not within the rights of those who do it — according to ICANN regulations — but then I would say that there's already process in place to resolve those sort of disagreements. Whether there are issues with that process is another question. That process may be imperfect, but I think what you are proposing introduces many more problems than it solves.