Even as retailer Macy’s announces it will close its iconic Union Square store, San Francisco’s downtown is still not close to hitting bottom. Commercial vacancies are running at all-time highs, and office landlords are stubbornly holding on to their properties, waiting for a workplace comeback that seems more improbable by the month.
To bring foot traffic and more back downtown, Mayor London Breed and allies have put Proposition C on next week’s ballot. It’s a tax break, and backers say it’s an incentive to convert vacant offices into housing. Without the carrot, say proponents, residential development is less likely, because turning offices into homes is difficult and expensive.
Right now in SF, sellers of large properties pay a hefty tax, up to 6 percent for buildings valued at $25 million or more. That’s the highest of any California city. SF voters have approved multiple property transfer tax hikes in recent years, eager to fill the city’s coffers during the real estate boom. The most recent was in 2020 with Prop I, intended to generate funds for public housing.
But the boom is over. Moody’s estimated SF’s downtown office vacancy rate at a dismal 32.5 percent at the end of 2023. Around Civic Center it was even higher at 41.2 percent. Moody’s refers to many such buildings as “dinosaurs.”
Prop C aims to tempt developers to salvage some of that primeval space by turning it into housing, despite the economic barriers.
Here’s the carrot: If a developer converts a building up to 5 million square feet into housing before 2030 and then sells it, the developer would pay no transfer tax. In other words, the reward comes only at the end of a long process.
It would also permit the Board of Supervisors to cut the transfer tax in the future; such breaks currently need voter approval. Any future tax hikes would still need to go before the voters.
A skeptical analysis
Prop C is one facet of Mayor London Breed’s multifront plan to activate downtown, according to the measure’s spokesperson, Joe Arellano. More diverse downtowns with a wider range of building uses are now the goal to build resistance to disruptions like the pandemic. This UC Berkeley study notes how mixed-use downtowns in San Diego and Baltimore have had fairly strong recoveries, while SF ranked dead last because of overspecialization in office construction.
A key to that diversity is housing, particularly in class B and C buildings — older, smaller, and less expensive offices that make for better housing prospects — which means giving developers incentives to embark on those costly conversion jobs. “The city has to shift” its assumptions, says Arellano.
In an analysis issued last week, SF chief economist Ted Egan estimates that Prop C could lower the development cost of large rental apartment conversions by 6 percent. (Projects that look to develop condominiums would see a smaller benefit of 2 percent, Egan estimates.)
A 6 percent break on a big building can be a huge boon to developers in post-pandemic SF, but Egan cautions that it’s hard to predict how many new projects this will result in “because there have been so few conversions” to use as a baseline.
Office-to-housing conversion cannot occur, at present, without a substantial public sector subsidy, and the opportunity cost — in the form of lost office space — is likely to lead to a net loss to the city’s economy.
SF chief economist Ted Egan
Nevertheless, such a tax break might not be enough to tempt developers. “Conversion of office space to housing does not appear to be financially feasible at the moment,” Egan writes, “and the proposed incentive is likely too small to close the feasibility gap.” He cites two recent studies that calculate how low office building prices would have to go to make them feasible for residential conversion.
What’s more, Egan cautions that despite “obvious economic benefits to increasing the downtown population,” adding housing at the expense of office space can have negative economic effects: “Office-to-housing conversion cannot occur, at present, without a substantial public sector subsidy, and the opportunity cost — in the form of lost office space — is likely to lead to a net loss to the city’s economy.” Perhaps a better solution, he says, is to ease zoning controls. “Relaxing these [height] restrictions could lead to more housing with a lower opportunity cost.”
‘Cynical ploy’
John Avalos, former SF supervisor and head of the Council of Community Housing Organizations, has penned the opponent’s argument in the city voter guide. He frames Prop C as a giveaway to real estate interests. He also criticizes the measure for potentially taking some power over tax breaks away from voters and notes that 100 percent affordable housing developments are already exempt from the transfer tax, which Prop C spokesperson Arellano confirms.
In an email to The Frisc, Avalos called Prop C a “cynical ploy to use a popular idea — like making downtown San Francisco into a more mixed office-residential neighborhood — to roll back voter-approved increases” in taxes.
“If [developers] want to get out of the tax, they can already build affordable,” Shae Watson, spokesperson for SF’s Small Business Forward, another Prop C opponent, adds via email. Watson also points to Egan’s analysis that Prop C isn’t likely to spur many conversions.
Other C critics include the influential SF Democratic County Central Committee, the Harvey Milk Club, and the SF Tenants Union. Supporters include SF YIMBY, SPUR, and GrowSF. Representatives of mayoral candidates Daniel Lurie and Mark Farrell did not immediately respond to requests for comment.
Prop C spokesperson Arellano acknowledges that the measure and its tax relief alone can’t transform downtown. Other tools would be needed to make a difference. He points to a recent proposal from state Sen. Scott Wiener to exempt downtown projects from state environmental review, known as CEQA, which could make development more feasible.
Arellano also acknowledges Egan’s caveat that the measure, if successful, will reduce SF’s office stock. But he says trading some of that economic potential for more reliable residential demand is part of shoring up downtown’s future: “Everything’s on the table.”