Downtown Investors Are Betting on Office Comebacks, Not Residential Conversions

June 29th marked another contentious SF Planning Commission meeting, with residents queued up to rail against more housing in their neighborhoods. They expressed common complaints, including how rich developers would get richer and that there were tens of thousands of vacant homes the city needed to spring free (which is nonsense).

At this meeting, though, a new argument emerged: There’s no need to build more because vacant office towers will provide plenty of housing once converted to residential units. “Plans are afoot to repurpose office buildings in downtown San Francisco,” said Jean Barrish of the neighborhood group Planning Association for the Richmond, asserting that SF actually had “not enough demand, too much supply.”

As The Frisc reported in late 2020, the numbers don’t add up. In June, the real-estate firm CBRE estimated San Francisco was sitting on about 25 million square feet of disused office space, but little of it makes sense as residences. Earlier this year, architecture firm Gensler singled out 12 buildings that “rated well” for conversion but warned that even with those, “the cost could be too high.”

You can’t just carve up office floor plans like Tetris blocks. Converting a large downtown high-rise into apartments or condos requires an elaborate and expensive overhaul of the entire building. There’s another reason Salesforce Tower and its shorter cousins aren’t likely to be converted into a looming stack of bargain condos: The companies buying and holding these assets are still betting that SF’s office market will flout the work-from-home gospel.

“There is demand for offices, and it’s going to go up,” says Santino DeRose, a broker at Maven Commercial. “It’s going to be a mixture of small companies expanding and big companies downsizing. The majority of these investors are long-term, they’re going to wait for the return, just like the last two downturns going back to the ’80s.”

Hans Hannson, a broker at Starboard Commercial Real Estate, agrees. “I’ve been through four downcycles. This is just like the ’89 quake all over again. That quake, like the pandemic, created an age of uncertainty: ‘Is the next one gonna hit, will it destroy us all?’ People pulled out of the city and you had buildings red-tagged and yellow-tagged. It was a mess, but we came back from that. We have a boom and bust market, always have.”

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Hannson acknowledges the differences — ”tech is gone, remote work is hurting us, that’s all true” — but predicts that buyers priced out of the market at its peak, like nonprofits and legal and financial services, will want to move in at cheaper prices.

It’s easy to be skeptical. The city’s office vacancy rate was 4 percent before the pandemic, hit 15 percent at the end of 2020, and has kept climbing to 30 percent.

The Budget & Legislative Analyst’s office estimated in February that SF lost some 147,000 daily office workers compared with March of 2020. What’s more, the analytics company Placer ranked San Francisco as having the worst pandemic comeback in the nation among major cities, as measured by office commutes.

In response, Mayor London Breed is courting the University of California to come in, among other moves. A few recent sales, however, give at least a glimmer of credence to the optimism of DeRose and Hannson.

In May, news broke that 350 California would sell for $67.5 million, then 180 Howard fetched some $62 million, and 550 California went for around $46 million. These prices were a fraction of previous valuations, true. But why would anyone spend $60 million on a building that everyone thinks is going to sit empty?

Clearly these buyers believe the demand to occupy will return, and it won’t come from people looking for a sign that says “If you lived here, you’d be home by now.”

This is no place like home

To turn office towers into homes, a laundry list of factors need to line up just right. The structure must lend itself to apartment layouts; developer Charmaine Curtis notes “the challenges of getting light and air into buildings.”

In addition, the building has to be completely empty, and construction costs must come down, especially if affordable housing is to be part of the mix. It is no cheaper to build subsidized housing than market-rate housing. The city is looking to lower fees and other requirements that raise the price tag, but it can’t do much to make construction materials and labor cheaper.

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Developer Eric Tao told the SF Chronicle that in most cases, conversion only makes financial sense when a building sells for less than $100 per square foot. (Tao did not return requests to confirm the figure.) That math is sobering. 350 California’s $67.5 million sale price translated into $250 per square foot, and it was quite the fire sale.

For developers thinking of conversions on the cheap, a recent viral Zillow listing in San Rafael serves as a warning. You not only end up with a condo that looks like a depressing office, you also get roasted on social media.

Derek Daniels, a researcher with Colliers, couldn’t name a single office-to-housing project, despite a lot of exploration of the idea.

Liz Ranieri of Kuth Ranieri Architects says the lack of interest is disappointing. “San Francisco should step in and buy some of these buildings” for housing, she adds, predicting that private interests just won’t take the plunge.

SF’s chief economist Ted Egan expects office leasing to pick up as rents continue to drop, although he did not comment on the effect this could have on housing prospects.

At least one person in the real-estate industry says the current WFH demand is a problem that will be solved by employers playing hardball. “If you’re working from home, why wouldn’t I hire a guy in Ireland or India to do your job?” says Markus Shayeb, vice president of TRI Commercial. “Every CEO owes it to investors to get work done as cheaply as possible.”

It might have taken longer than some hoped for, but city leaders are now scrambling for revival ideas. “We don’t think anyone has a clear sense yet over how many underutilized office buildings will ultimately pursue conversion to other uses,” says Kia Kolderup-Lane, a spokesperson for the mayor’s economic recovery team.

Developers will become amenable “under the right conditions,” according to Kolderup-Lane, who touted recent legislation from Breed and Sup. Aaron Peskin that streamlines conversions downtown and around Union Square.

In years to come we may well see office conversions here and there, like the old AAA building on Van Ness Avenue. But based on current attitudes of the people who hold the purse strings, it’ll take a shake-up much bigger than even the pandemic to turn the staid world of business real estate into true believers.

That leaves us back where we started. If we want housing, we’ll have to build housing, not count on the discarded hermit crab shells of corporate America.