Kevin Truong

Imagine a slow-moving train coming towards you. The lights are shining, the horn is blaring, but it’s just far enough in the distance that the risk doesn’t seem real just yet.&nbsp;

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<p>Imagine a slow-moving train coming towards you. The lights are shining, the horn is blaring, but it’s just far enough in the distance that the risk doesn’t seem real just yet.&nbsp;</p>

That’s a fitting-enough analogy for the state of San Francisco&#8217;s commercial real estate market, which is tilting towards a collapse in property values, leaving the city, its budget and its ability to provide services tied to the tracks.&nbsp;

<p>That’s a fitting-enough analogy for the state of San Francisco's commercial real estate market, which is tilting towards a collapse in property values, leaving the city, its budget and its ability to provide services tied to the tracks.&nbsp;</p>

<p>That’s a fitting-enough analogy for the state of San Francisco&#8217;s commercial real estate market, which is tilting towards a collapse in property values, leaving the city, its budget and its ability to provide services tied to the tracks.&nbsp;</p>

The root of this—of course—is the pandemic and the way that it has completely transformed work patterns in the city, hollowing out a downtown core that once accounted for most of San Francisco’s GDP, 70% of its sales tax revenue and 40% of the city’s jobs. And there’s an uneasy feeling among a coalition of business groups that city leaders are sleepwalking into an economic calamity with far-reaching consequences.

<p>The root of this—of course—is the pandemic and the way that it has completely transformed work patterns in the city, hollowing out a downtown core that once accounted for most of San Francisco’s GDP, 70% of its sales tax revenue and 40% of the city’s jobs. And there’s an uneasy feeling among a coalition of business groups that city leaders are sleepwalking into an economic calamity with far-reaching consequences. </p>

Signal lights of the city’s tenuous fiscal future are starting to flash. Major tech employers like Yelp and Airbnb have <a href="https://sfstandard.com/business/san-francisco-tax-code-encourages-work-from-home/">fled</a> or gone fully remote, leading to mass office vacancies. A swath <a href="https://www.bizjournals.com/sanfrancisco/news/2022/08/26/san-francisco-assessment-appeals-board.html">of commercial landlords</a> are seeking massive reductions in their assessed property values—and associated tax bills. And a recent report from the Urban Displacement Project <a href="https://www.downtownrecovery.com/dashboards/recovery_ranking.html">ranked the city’s downtown recovery</a> as dead last among more than 60 cities across North America.&nbsp;

<p>Signal lights of the city’s tenuous fiscal future are starting to flash. Major tech employers like Yelp and Airbnb have <a href="https://sfstandard.com/business/san-francisco-tax-code-encourages-work-from-home/">fled</a> or gone fully remote, leading to mass office vacancies. A swath <a href="https://www.bizjournals.com/sanfrancisco/news/2022/08/26/san-francisco-assessment-appeals-board.html">of commercial landlords</a> are seeking massive reductions in their assessed property values—and associated tax bills. And a recent report from the Urban Displacement Project <a href="https://www.downtownrecovery.com/dashboards/recovery_ranking.html">ranked the city’s downtown recovery</a> as dead last among more than 60 cities across North America.&nbsp;</p>

<strong>‘Uncharted Territory’</strong>


<h2 class="wp-block-heading"><strong>‘Uncharted Territory’</strong></h2>


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<h2 class="wp-block-heading"><strong>‘Uncharted Territory’</strong></h2>

It’s no secret that office vacancies are high in SF’s downtown. But even as the pandemic wanes, an already-troubling outlook for downtown could only get worse.&nbsp;

<p>It’s no secret that office vacancies are high in SF’s downtown. But even as the pandemic wanes, an already-troubling outlook for downtown could only get worse.&nbsp;</p>

That’s because a slew of office leases signed at the height of the city’s economic boom are poised to expire over the next few years, further inflating vacancies and diminishing what the office towers that draw the city’s skyline are worth. There’s currently more than 25 million square feet of commercial space available for lease or sublease in the city, the equivalent of about 35 Transamerica Pyramids sitting empty.&nbsp;

<p>That’s because a slew of office leases signed at the height of the city’s economic boom are poised to expire over the next few years, further inflating vacancies and diminishing what the office towers that draw the city’s skyline are worth. There’s currently more than 25 million square feet of commercial space available for lease or sublease in the city, the equivalent of about 35 Transamerica Pyramids sitting empty.&nbsp;</p>

Empty desks in the SD Mayer Accounting firm office in San Francisco, Calif., on Friday, July 29, 2022. | Juliana Yamada/The Standard


<figure class="wp-block-image size-full"><img src="https://content.sfstandard.com/wp-content/uploads/2022/09/CommercialPropertyTax-INLINE2.jpg" alt="" class="wp-image-73298"/><figcaption class="wp-element-caption">Empty desks in the SD Mayer Accounting firm office on July 29, 2022. | Juliana Yamada/The Standard</figcaption></figure>


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<figure class="wp-block-image size-full"><img src="https://content.sfstandard.com/wp-content/uploads/2022/09/CommercialPropertyTax-INLINE2.jpg" alt="" class="wp-image-73298"/><figcaption class="wp-element-caption">Empty desks in the SD Mayer Accounting firm office on July 29, 2022. | Juliana Yamada/The Standard</figcaption></figure>

“We’re way above anything that was happening in the Great Recession and dot-com era days,” said Jay Shaffer, a co-founder and principal at Colton Commercial &amp; Partners. “We have this shadow market of sublease availability in seemingly uncharted territories. And sublease inventory is still rising.”&nbsp;

<p>“We’re way above anything that was happening in the Great Recession and dot-com era days,” said Jay Shaffer, a co-founder and principal at Colton Commercial &amp; Partners. “We have this shadow market of sublease availability in seemingly uncharted territories. And sublease inventory is still rising.”&nbsp;</p>

Citing data from real estate firm JLL, SF’s chief economist Ted Egan <a href="https://sfcontroller.org/sites/default/files/Documents/Economic%20Analysis/economic_context_for_development.pdf">tagged future vacancies</a>, in a worst case scenario, as high as 53% in the Jackson Square area and 43% in the mid-Market area in 2024 as the clock runs out on office leases.

<p>Citing data from real estate firm JLL, SF’s chief economist Ted Egan <a href="https://sfcontroller.org/sites/default/files/Documents/Economic%20Analysis/economic_context_for_development.pdf">tagged future vacancies</a>, in a worst case scenario, as high as 53% in the Jackson Square area and 43% in the mid-Market area in 2024 as the clock runs out on office leases.</p>

The current vacancy epidemic cuts across buildings of all sizes and price ranges in San Francisco’s downtown core, from the struggling mid-Market area to the sparkling office towers of the East Cut.&nbsp;

<p>The current vacancy epidemic cuts across buildings of all sizes and price ranges in San Francisco’s downtown core, from the struggling mid-Market area to the sparkling office towers of the East Cut.&nbsp;</p>

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For example, 415 Natoma, a 653,900 sq foot office tower owned by Brookfield Properties that was the sole ground-up office project to deliver in San Francisco in 2021, currently has just one announced lease: 20,000 square feet taken by “remote-first” startup Thumbtack. Nearby office towers 123 Mission (Juul Labs, Inc.), 50 Fremont (Salesforce.com, Inc.) and 199 Fremont (CalSTRS) were each at least 30% vacant, according to CoStar data, along with a constellation of other big office buildings.&nbsp;&nbsp;

<p>For example, 415 Natoma, a 653,900 sq foot office tower owned by Brookfield Properties that was the sole ground-up office project to deliver in San Francisco in 2021, currently has just one announced lease: 20,000 square feet taken by “remote-first” startup Thumbtack. Nearby office towers 123 Mission (Juul Labs, Inc.), 50 Fremont (Salesforce.com, Inc.) and 199 Fremont (CalSTRS) were each at least 30% vacant, according to CoStar data, along with a constellation of other big office buildings.&nbsp;&nbsp;</p>

A few large buildings, like 550 California St. and 455 Market St, were <a href="https://www.sfchronicle.com/sf/article/real-estate-san-francisco-17414133.php">placed on the market</a> in recent months at deep discounts to what they would have fetched before the pandemic, but were eventually pulled when offers came in that were even lower than those already-discounted prices.

<p>A few large buildings, like 550 California St. and 455 Market St, were <a href="https://www.sfchronicle.com/sf/article/real-estate-san-francisco-17414133.php">placed on the market</a> in recent months at deep discounts to what they would have fetched before the pandemic, but were eventually pulled when offers came in that were even lower than those already-discounted prices.  </p>

In the case of 550 California St., a downtown office tower owned by Wells Fargo, bids came in at 60% to 70% under what the building would have sold for in 2019, real estate brokers said.&nbsp;

<p>In the case of 550 California St., a downtown office tower owned by Wells Fargo, bids came in at 60% to 70% under what the building would have sold for in 2019, real estate brokers said.&nbsp;</p>


<figure class="wp-block-image size-full"><img src="https://content.sfstandard.com/wp-content/uploads/2023/08/image-6.jpeg" alt="" class="wp-image-190264"/><figcaption class="wp-element-caption">Screenshot</figcaption></figure>



<h2 class="wp-block-heading"><strong>Zombie Buildings&nbsp;</strong></h2>


The risk of a San Francisco real estate collapse is palpable enough that it’s caught the attention of at least one Wall Street hedge fund—and not in a good way.&nbsp;

<p>The risk of a San Francisco real estate collapse is palpable enough that it’s caught the attention of at least one Wall Street hedge fund—and not in a good way.&nbsp;</p>

Dan McNamara, founder of New York hedge fund Polpo Capital, became known for the lucrative short bets he made against regional malls run into the ground by e-commerce and Amazon.&nbsp;

<p>Dan McNamara, founder of New York hedge fund Polpo Capital, became known for the lucrative short bets he made against regional malls run into the ground by e-commerce and Amazon.&nbsp;</p>

Now, McNamara is eyeing the commercial office market for another short bet, and San Francisco is near the top of his list. McNamara started his firm last year to take advantage of what he considers to be mispricings in the commercial mortgage-backed securities (CMBS) market.

<p>Now, McNamara is eyeing the commercial office market for another short bet, and San Francisco is near the top of his list. McNamara started his firm last year to take advantage of what he considers to be mispricings in the commercial mortgage-backed securities (CMBS) market.</p>

“We thought there was a unique opportunity to take advantage of the impending distress within the commercial real estate market,” McNamara said. “San Francisco has been an amazing example of this; we’ve had all these tech companies that have been driving office space usage for the past 20 years. But we believe that’s changed forever.”

<p>“We thought there was a unique opportunity to take advantage of the impending distress within the commercial real estate market,” McNamara said. “San Francisco has been an amazing example of this; we’ve had all these tech companies that have been driving office space usage for the past 20 years. But we believe that’s changed forever.”</p>

A<a href="https://itep.sfo2.digitaloceanspaces.com/20211101_PropertyTaxReport.pdf"> report published in November</a> by the Institute of Taxation and Economic Policy (ITEP) calculated that San Francisco could see a short-term decline in commercial property values of up to 43%, the highest projected in the study.

<p>A<a href="https://itep.sfo2.digitaloceanspaces.com/20211101_PropertyTaxReport.pdf"> report published in November</a> by the Institute of Taxation and Economic Policy (ITEP) calculated that San Francisco could see a short-term decline in commercial property values of up to 43%, the highest projected in the study.</p>

The logic is obvious: San Francisco’s software-dominant economy pivoted easily away from offices during the pandemic, and has <a href="https://sfstandard.com/business/san-francisco-tax-code-encourages-work-from-home/">little incentive to return.&nbsp;</a>

<p>The logic is obvious: San Francisco’s software-dominant economy pivoted easily away from offices during the pandemic, and has <a href="https://sfstandard.com/business/san-francisco-tax-code-encourages-work-from-home/">little incentive to return.&nbsp;</a></p>

In some ways, the city is a victim of its own success by creating an economic model so heavily dependent on tech in the aftermath of the Great Recession, said Wade Rose, president of the business advocacy group Advance SF.

<p>In some ways, the city is a victim of its own success by creating an economic model so heavily dependent on tech in the aftermath of the Great Recession, said Wade Rose, president of the business advocacy group Advance SF.</p>

“We initiated the growth of an economic sector that could pivot on a dime,” Rose said. “So they closed down fast and exposed this vulnerability.”

<p>“We initiated the growth of an economic sector that could pivot on a dime,” Rose said. “So they closed down fast and exposed this vulnerability.”</p>

Lenders have taken a dim view of the office market and that’s doubly true for slow-to-recover San Francisco, leaving fewer options for refinancing.&nbsp;

<p>Lenders have taken a dim view of the office market and that’s doubly true for slow-to-recover San Francisco, leaving fewer options for refinancing.&nbsp;</p>

“It&#8217;s frozen,” McNamara said of current market conditions. “I do believe San Francisco is the most challenging office market today partly due to the fact they became oversupplied very quickly when the model changed to hybrid.”

<p>“It's frozen,” McNamara said of current market conditions. “I do believe San Francisco is the most challenging office market today partly due to the fact they became oversupplied very quickly when the model changed to hybrid.”</p>

<p>“It&#8217;s frozen,” McNamara said of current market conditions. “I do believe San Francisco is the most challenging office market today partly due to the fact they became oversupplied very quickly when the model changed to hybrid.”</p>

The properties most at risk are mid- to lower-tier buildings purchased near the peak of the market. Commercial real estate insiders say that those property owners are negotiating with lenders to avoid foreclosure, but that it may be sooner rather than later before the dam starts to break.

<p>The properties most at risk are mid- to lower-tier buildings purchased near the peak of the market. Commercial real estate insiders say that those property owners are negotiating with lenders to avoid foreclosure, but that it may be sooner rather than later before the dam starts to break.</p>

McNamara sees refinancing issues leading to defaults, delinquencies and a class of unoccupied “zombie-type buildings.” That may be already starting to happen.

<p>McNamara sees refinancing issues leading to defaults, delinquencies and a class of unoccupied “zombie-type buildings.” That may be already starting to happen. </p>

Of the some 200 large properties identified by CoStar as “high vacancy,” at least three have defaulted on their 2021 property tax bills, according to a city tax database. Those include a property at 25 Taylor St. formerly occupied by the coworking firm WeWork, and a 1182 Market St. property formerly owned by the local real estate giant Shorenstein Properties.

<p>Of the some 200 large properties identified by CoStar as “high vacancy,” at least three have defaulted on their 2021 property tax bills, according to a city tax database. Those include a property at 25 Taylor St. formerly occupied by the coworking firm WeWork, and a 1182 Market St. property formerly owned by the local real estate giant Shorenstein Properties. </p>

Other building owners are asking the city to cut their tax bills on the grounds that their buildings have lost much of their value—as much as half, in some cases.&nbsp;&nbsp;

<p>Other building owners are asking the city to cut their tax bills on the grounds that their buildings have lost much of their value—as much as half, in some cases.&nbsp;&nbsp;</p>

It’s not unusual for landlords to ask for revisions to their tax bills in an economic downturn. But the pandemic’s impact on real estate was dramatic enough that the city’s assessor-recorder, Joaquin Torres, took the step of surveying property owners and calculating a temporary property value reduction of $2.89 billion, out of $328.5 billion in total assessed value, in the last fiscal year. He said it’s too soon to know what the longer-term impact will be.

<p>It’s not unusual for landlords to ask for revisions to their tax bills in an economic downturn. But the pandemic’s impact on real estate was dramatic enough that the city’s assessor-recorder, Joaquin Torres, took the step of surveying property owners and calculating a temporary property value reduction of $2.89 billion, out of $328.5 billion in total assessed value, in the last fiscal year. He said it’s too soon to know what the longer-term impact will be.</p>

“We just don’t know yet,” Torres said. “It&#8217;s a wait-and-see approach right now as we continue to defend the values that we have.”

<p>“We just don’t know yet,” Torres said. “It's a wait-and-see approach right now as we continue to defend the values that we have.”</p>

<p>“We just don’t know yet,” Torres said. “It&#8217;s a wait-and-see approach right now as we continue to defend the values that we have.”</p>

<strong>The Prop. 13 Effect&nbsp;</strong>


<h2 class="wp-block-heading"><strong>The Prop. 13 Effect&nbsp;</strong></h2>


The pandemic has already eroded the city’s business and sales taxes, both of which are reliant on downtown commuters. A hit to the city’s biggest source of tax revenue—property taxes—could be even more devastating.&nbsp;

<p>The pandemic has already eroded the city’s business and sales taxes, both of which are reliant on downtown commuters. A hit to the city’s biggest source of tax revenue—property taxes—could be even more devastating.&nbsp;</p>

Because of Prop. 13, San Francisco has some protection from a sudden collapse in property tax revenue. That 1978 law, which limited when properties can be reassessed for tax purposes to the point of sale and restricted annual appreciation to 2%, has the effect of stabilizing property tax rolls in a downturn.&nbsp;

<p>Because of Prop. 13, San Francisco has some protection from a sudden collapse in property tax revenue. That 1978 law, which limited when properties can be reassessed for tax purposes to the point of sale and restricted annual appreciation to 2%, has the effect of stabilizing property tax rolls in a downturn.&nbsp;</p>

Older buildings—even ones worth tens of millions at market prices—can pay taxes based on decades-old valuations. By contrast, newer towers spun up or sold during the last decade’s development frenzy contribute staggering sums to the city’s rolls, helping to drive property tax revenue in the city’s general fund north of $2.3 billion in the 2020-2021 fiscal year.&nbsp;

<p>Older buildings—even ones worth tens of millions at market prices—can pay taxes based on decades-old valuations. By contrast, newer towers spun up or sold during the last decade’s development frenzy contribute staggering sums to the city’s rolls, helping to drive property tax revenue in the city’s general fund north of $2.3 billion in the 2020-2021 fiscal year.&nbsp;</p>

But no one seems to have clear answers on what the pandemic will do to that cash cow. And the city’s own forecasts are looking increasingly out of step with reality as tech’s remote-dominant office culture metastasizes into a state of permanence.&nbsp;&nbsp;

<p>But no one seems to have clear answers on what the pandemic will do to that cash cow. And the city’s own forecasts are looking increasingly out of step with reality as tech’s remote-dominant office culture metastasizes into a state of permanence.&nbsp;&nbsp;</p>

The city’s most recent budget forecasts estimate that office workers will <a href="https://sfstandard.com/business/remote-work-san-francisco-downtown/">telecommute 33% of the time</a> when an in-person return to the office stabilizes.​​​​ That number seems strikingly optimistic compared to data from key card company Kastle Systems indicating that SF’s downtown offices are only about 30% full.&nbsp;

<p>The city’s most recent budget forecasts estimate that office workers will <a href="https://sfstandard.com/business/remote-work-san-francisco-downtown/">telecommute 33% of the time</a> when an in-person return to the office stabilizes.​​​​ That number seems strikingly optimistic compared to data from key card company Kastle Systems indicating that SF’s downtown offices are only about 30% full.&nbsp;</p>

Rose suggested that the infusion of federal stimulus funds during the pandemic may have lulled city leaders into a false sense of financial security.

<p>Rose suggested that the infusion of federal stimulus funds during the pandemic may have lulled city leaders into a false sense of financial security.</p>

“The city didn’t have to fire anybody and there wasn’t so much immediate pain felt,” Rose said. “There’s a propensity to say, don’t make it worse than it is.”

<p>“The city didn’t have to fire anybody and there wasn’t so much immediate pain felt,” Rose said. “There’s a propensity to say, don’t make it worse than it is.”</p>


<h2 class="wp-block-heading" id="h-heads-in-the-sand"><strong>Heads in the Sand</strong></h2>


Rose<strong> </strong>sees an inflection point when leases expire, buildings are revalued, budgets are slashed and the problem can no longer be ignored.&nbsp;

<p>Rose<strong> </strong>sees an inflection point when leases expire, buildings are revalued, budgets are slashed and the problem can no longer be ignored.&nbsp;</p>

The city’s budget office expects property tax revenues to continue to grow. But Howard Chernick, an economics professor at Hunter College and co-author of the report that forecast an up to 43% decline in SF’s property values, paints a much worse picture: His team sees a decline of up to 15% in property tax collections amounting to a&nbsp;roughly 4% drop in total revenues.

<p>The city’s budget office expects property tax revenues to continue to grow. But Howard Chernick, an economics professor at Hunter College and co-author of the report that forecast an up to 43% decline in SF’s property values, paints a much worse picture: His team sees a decline of up to 15% in property tax collections amounting to a&nbsp;roughly 4% drop in total revenues.</p>

Based on the most recent numbers, that would mean a decline of roughly $240 million annually. And because tax revenues on average increased steadily each year since the Great Recession, any drop could be painful for a city that banks on growth to pay for an array of services and a workforce of roughly 35,000.&nbsp;

<p>Based on the most recent numbers, that would mean a decline of roughly $240 million annually. And because tax revenues on average increased steadily each year since the Great Recession, any drop could be painful for a city that banks on growth to pay for an array of services and a workforce of roughly 35,000.&nbsp;</p>

Local legislators are only beginning to get their arms around the problem. Supervisor Catherine Stefani <a href="https://content.sfstandard.com/wp-content/uploads/2022/07/Letter-of-Inquiry-on-commercial-real-estate-1.pdf">sent a letter of inquiry</a> asking budget officials to quantify declining demand for commercial space, while Supervisor Ahsha Safai plans to hold a hearing to brainstorm ways to bring workers back downtown.&nbsp;

<p>Local legislators are only beginning to get their arms around the problem. Supervisor Catherine Stefani <a href="https://content.sfstandard.com/wp-content/uploads/2022/07/Letter-of-Inquiry-on-commercial-real-estate-1.pdf">sent a letter of inquiry</a> asking budget officials to quantify declining demand for commercial space, while Supervisor Ahsha Safai plans to hold a hearing to brainstorm ways to bring workers back downtown.&nbsp;</p>

“Do we need to have an honest conversation about the current tax structure?” said Safai. “We need to be putting everything on the table.”&nbsp;

<p>“Do we need to have an honest conversation about the current tax structure?” said Safai. “We need to be putting everything on the table.”&nbsp;</p>

Business and community groups are urging the city to take more action, arguing that policymakers must <a href="https://sfstandard.com/business/4-takeaways-from-the-new-plan-to-rescue-san-franciscos-downtown/">drastically remake downtown</a> into a hub for arts, music and culture with outdoor spaces for visitors and commuters to gather outside of offices.&nbsp;

<p>Business and community groups are urging the city to take more action, arguing that policymakers must <a href="https://sfstandard.com/business/4-takeaways-from-the-new-plan-to-rescue-san-franciscos-downtown/">drastically remake downtown</a> into a hub for arts, music and culture with outdoor spaces for visitors and commuters to gather outside of offices.&nbsp;</p>

But most of those ideas are firmly in the realm of the hypothetical, and it’s unclear what may happen when they collide with the city’s bureaucracy: For example, a $6 million budget allocation for the downtown-focused Economic Core Recovery Program was <a href="https://sfstandard.com/business/restaurants-bars-downtown-economic-recovery-budget-funding-events/">subject to intense scrutiny</a> by the Board of Supervisors before its approval.&nbsp;&nbsp;

<p>But most of those ideas are firmly in the realm of the hypothetical, and it’s unclear what may happen when they collide with the city’s bureaucracy: For example, a $6 million budget allocation for the downtown-focused Economic Core Recovery Program was <a href="https://sfstandard.com/business/restaurants-bars-downtown-economic-recovery-budget-funding-events/">subject to intense scrutiny</a> by the Board of Supervisors before its approval.&nbsp;&nbsp;</p>

When compared to the investment that cities like <a href="https://www.governor.ny.gov/news/governor-hochul-announces-200-million-funding-revitalize-downtown-areas-communities-across-new">New York</a> or <a href="https://www.chicagobusiness.com/government/chicagos-12-billion-recovery-plan-still-contains-some-unknowns">Chicago</a> are making to revitalize their downtowns, San Francisco’s effort barely registers.

<p>When compared to the investment that cities like <a href="https://www.governor.ny.gov/news/governor-hochul-announces-200-million-funding-revitalize-downtown-areas-communities-across-new">New York</a> or <a href="https://www.chicagobusiness.com/government/chicagos-12-billion-recovery-plan-still-contains-some-unknowns">Chicago</a> are making to revitalize their downtowns, San Francisco’s effort barely registers.</p>

The city has much to lose as federal funds that fortified its budget through the pandemic dry up. Some with a stake in downtown’s future are worried that time is running out.&nbsp;

<p>The city has much to lose as federal funds that fortified its budget through the pandemic dry up. Some with a stake in downtown’s future are worried that time is running out.&nbsp;</p>

“It&#8217;s within our power to stop or divert the train and meet it ahead of its collision point,” said SF Chamber of Commerce CEO Rodney Fong. “But that work has to start now, because the sooner you start it, the fewer days of discomfort you&#8217;re going to have.”

<p>“It's within our power to stop or divert the train and meet it ahead of its collision point,” said SF Chamber of Commerce CEO Rodney Fong. “But that work has to start now, because the sooner you start it, the fewer days of discomfort you're going to have.”</p>

<p>“It&#8217;s within our power to stop or divert the train and meet it ahead of its collision point,” said SF Chamber of Commerce CEO Rodney Fong. “But that work has to start now, because the sooner you start it, the fewer days of discomfort you&#8217;re going to have.”</p>

<em>Editor&#8217;s Note: This story has been updated to reflect&nbsp;ownership changes in the properties at 25 Taylor St. and 1182 Market St.&nbsp;</em>

<p><em>Editor's Note: This story has been updated to reflect&nbsp;ownership changes in the properties at 25 Taylor St. and 1182 Market St.&nbsp;</em></p>

<p><em>Editor&#8217;s Note: This story has been updated to reflect&nbsp;ownership changes in the properties at 25 Taylor St. and 1182 Market St.&nbsp;</em></p>

San Francisco braces for epic commercial real estate crash

Sarah Wright

Based on social media rumblings, it seems like there’s a big appetite for converting now-empty San Francisco office buildings into housing. Using the Covid-induced vacancies to help solve the city’s housing affordability crisis and meet state mandates to plan for more than 80,000 new units appears to be a no-brainer.

<p>Based on social media rumblings, it seems like there’s a big appetite for converting now-empty San Francisco office buildings into housing. Using the Covid-induced vacancies to help solve the city’s housing affordability crisis and meet state mandates to plan for more than 80,000 new units appears to be a no-brainer.</p>

But while San Francisco’s downtown core appears rife with opportunity, with <a href="https://content.sfstandard.com/wp-content/uploads/2022/05/San-Francisco-Office-Figures-Q1-2022-FINAL_O4v7.pdf">a record 24%</a> of office space currently vacant—particularly within San Francisco’s bread-and-butter industry, tech—the city’s planning department currently has no pending applications for downtown office-to-housing conversions.

<p>But while San Francisco’s downtown core appears rife with opportunity, with <a href="https://content.sfstandard.com/wp-content/uploads/2022/05/San-Francisco-Office-Figures-Q1-2022-FINAL_O4v7.pdf">a record 24%</a> of office space currently vacant—particularly within San Francisco’s bread-and-butter industry, tech—the city’s planning department currently has no pending applications for downtown office-to-housing conversions.</p>

Turning offices into homes may seem like an obvious solution to the city’s housing crisis—<a href="https://sfstandard.com/business/elon-musk-twitter-san-francisco-hq-takeover/">Elon Musk even jumped into the fray</a> with a (presumably tongue-in-cheek) pitch to turn Twitter’s headquarters into a homeless shelter—but longtime housing developer Oz Erickson cautions that it’s not so simple.&nbsp;

<p>Turning offices into homes may seem like an obvious solution to the city’s housing crisis—<a href="https://sfstandard.com/business/elon-musk-twitter-san-francisco-hq-takeover/">Elon Musk even jumped into the fray</a> with a (presumably tongue-in-cheek) pitch to turn Twitter’s headquarters into a homeless shelter—but longtime housing developer Oz Erickson cautions that it’s not so simple.&nbsp;</p>

<strong>Behind the Scenes of a Successful Conversion&nbsp;</strong>


<h2 class="wp-block-heading" id="h-behind-the-scenes-of-a-successful-conversion"><strong>Behind the Scenes of a Successful Conversion&nbsp;</strong></h2>


<h2 id="h-behind-the-scenes-of-a-successful-conversion"><strong>Behind the Scenes of a Successful Conversion&nbsp;</strong></h2>

Erickson is chair of the San Francisco-based development firm Emerald Fund. His company’s 400-foot, 418-unit tower at 100 Van Ness is the most significant project in the last decade to successfully convert downtown office space into housing.&nbsp;

<p>Erickson is chair of the San Francisco-based development firm Emerald Fund. His company’s 400-foot, 418-unit tower at 100 Van Ness is the most significant project in the last decade to successfully convert downtown office space into housing.&nbsp;</p>

“It takes a really special building and you have to be willing to give up the current rent of the office space,” said Erickson. “We had an excellent skeleton and it was still quite costly, but way cheaper then than it would be now. It’s hard for me to believe anything pencils nowadays.”

<p>“It takes a really special building and you have to be willing to give up the current rent of the office space,” said Erickson. “We had an excellent skeleton and it was still quite costly, but way cheaper then than it would be now. It’s hard for me to believe anything pencils nowadays.”</p>

Erickson has built thousands of units across the city over his career, but the conversion posed its fair share of unique challenges. For one, the development team had to remove the massive stone facades that encased the former headquarters of the California State Automobile Association.&nbsp;

<p>Erickson has built thousands of units across the city over his career, but the conversion posed its fair share of unique challenges. For one, the development team had to remove the massive stone facades that encased the former headquarters of the California State Automobile Association.&nbsp;</p>

On the plus side for Erickson, the building’s relatively high standard of construction made it an attractive candidate for conversion. And, by reusing an existing structure, the Emerald Fund was able to skirt height limits for residential buildings and fit more units into the project, which raised their profit margin.

<p>On the plus side for Erickson, the building’s relatively high standard of construction made it an attractive candidate for conversion. And, by reusing an existing structure, the Emerald Fund was able to skirt height limits for residential buildings and fit more units into the project, which raised their profit margin.</p>

<strong>Where’s the City in All This?</strong>


<h2 class="wp-block-heading"><strong>Where’s the City in All This?</strong></h2>


<h2><strong>Where’s the City in All This?</strong></h2>

When it comes to conversion projects, it’s not the city’s planning process that’s getting in the way. Dan Sider, chief of staff at the San Francisco Planning Department, said a conversion with no complicated exemptions—an optimistic but not unrealistic scenario—wouldn’t even require a planning hearing and could take as little as three to six months to secure approvals. And even those requiring exemptions don’t face many added hurdles.

<p>When it comes to conversion projects, it’s not the city’s planning process that’s getting in the way. Dan Sider, chief of staff at the San Francisco Planning Department, said a conversion with no complicated exemptions—an optimistic but not unrealistic scenario—wouldn’t even require a planning hearing and could take as little as three to six months to secure approvals. And even those requiring exemptions don’t face many added hurdles.</p>

“The process through our office is fairly straightforward,” Sider said. “The controls are actually set up very well to accommodate housing in the downtown core.”

<p>“The process through our office is fairly straightforward,” Sider said. “The controls are actually set up very well to accommodate housing in the downtown core.”</p>

Jason Ward, a RAND Corporation economist who has studied the feasibility of commercial-to-residential conversions also pointed to an added advantage, particularly in a market like San Francisco: less community opposition.&nbsp;

<p>Jason Ward, a RAND Corporation economist who has studied the feasibility of commercial-to-residential conversions also pointed to an added advantage, particularly in a market like San Francisco: less community opposition.&nbsp;</p>

“It’s a lesser issue than we’re going to knock down these single-family homes and build a 60-unit building,” Ward said. “It’s already there, it usually has parking and it looks more or less the same as it did before.”

<p>“It’s a lesser issue than we’re going to knock down these single-family homes and build a 60-unit building,” Ward said. “It’s already there, it usually has parking and it looks more or less the same as it did before.”</p>

Case in point, developers of The Pacific in Pacific Heights were able to build a 76-unit condo building in a neighborhood with a history of anti-development activism by adapting a former medical office building.&nbsp;

<p>Case in point, developers of The Pacific in Pacific Heights were able to build a 76-unit condo building in a neighborhood with a history of anti-development activism by adapting a former medical office building.&nbsp;</p>

<strong>Why Aren’t Conversions Happening?</strong>


<h2 class="wp-block-heading"><strong>Why Aren’t Conversions Happening?</strong></h2>


<h2><strong>Why Aren’t Conversions Happening?</strong></h2>

Here’s the big “why not” when it comes to office-to-housing conversions: Gutting a building and rebuilding the inside as housing is expensive, especially in San Francisco and especially while construction costs are high.&nbsp;

<p>Here’s the big “why not” when it comes to office-to-housing conversions: Gutting a building and rebuilding the inside as housing is expensive, especially in San Francisco and especially while construction costs are high.&nbsp;</p>

Asking rents for downtown commercial leases have dropped around 15% from pre-pandemic peaks, but haven’t dipped further because of the relatively long lease terms signed by commercial tenants, as well as market optimism that the return to office will continue at a gradual pace.&nbsp;

<p>Asking rents for downtown commercial leases have dropped around 15% from pre-pandemic peaks, but haven’t dipped further because of the relatively long lease terms signed by commercial tenants, as well as market optimism that the return to office will continue at a gradual pace.&nbsp;</p>

Essentially, the city and the market aren&#8217;t convinced that empty offices downtown are here to stay.

<p>Essentially, the city and the market aren't convinced that empty offices downtown are here to stay.</p>

<p>Essentially, the city and the market aren&#8217;t convinced that empty offices downtown are here to stay.</p>

“People would need to believe that office uses are going away,” said Louis Cornejo, president and CEO of Urban Group Real Estate. “You talk to 10 people you get 10 different comments. Are we really going to take a chance on our economy based on: ‘Well, it worked for a year or two?’”&nbsp;

<p>“People would need to believe that office uses are going away,” said Louis Cornejo, president and CEO of Urban Group Real Estate. “You talk to 10 people you get 10 different comments. Are we really going to take a chance on our economy based on: ‘Well, it worked for a year or two?’”&nbsp;</p>

What gets built and what doesn’t comes down to a calculation of dollars and cents. The first issue that’s nearly always raised in discussions about office conversions is seismic retrofitting, which can quickly multiply construction costs.&nbsp;

<p>What gets built and what doesn’t comes down to a calculation of dollars and cents. The first issue that’s nearly always raised in discussions about office conversions is seismic retrofitting, which can quickly multiply construction costs.&nbsp;</p>

Older buildings would have to be gutted entirely. As compared to office space, housing requires more kitchens and bathrooms—and the plumbing and power that comes with them. And then there’s city code that requires that every apartment look out onto an open area and include access to open space like a deck or a rooftop. In the case of 100 Van Ness, the designers added a common rooftop for residents to use. These modifications, Sider said, can be difficult to achieve.

<p>Older buildings would have to be gutted entirely. As compared to office space, housing requires more kitchens and bathrooms—and the plumbing and power that comes with them. And then there’s city code that requires that every apartment look out onto an open area and include access to open space like a deck or a rooftop. In the case of 100 Van Ness, the designers added a common rooftop for residents to use. These modifications, Sider said, can be difficult to achieve.</p>

“Most modern office buildings would require a tremendous amount of work,” Sider said.

<p>“Most modern office buildings would require a tremendous amount of work,” Sider said.</p>

In some cases, adaptive reuse projects turn into money pits as developers open up the building and find structural issues, environmental damage and other challenges in bringing older buildings up to code. The <a href="http://www.ladowntownnews.com/news/as-rents-soar-brockman-aims-for-luxury-market/article_9fc8af34-8b40-11e1-ad29-0019bb2963f4.html">Brockman Lofts conversion</a> in downtown Los Angeles, for example, saw its budget balloon from $16 million to $40 million and took seven years to complete.&nbsp;

<p>In some cases, adaptive reuse projects turn into money pits as developers open up the building and find structural issues, environmental damage and other challenges in bringing older buildings up to code. The <a href="http://www.ladowntownnews.com/news/as-rents-soar-brockman-aims-for-luxury-market/article_9fc8af34-8b40-11e1-ad29-0019bb2963f4.html">Brockman Lofts conversion</a> in downtown Los Angeles, for example, saw its budget balloon from $16 million to $40 million and took seven years to complete.&nbsp;</p>

Trey Clark, the head of U.S. investments for Chinese developer Vanke, said the conversion process to residences also leads to less usable square footage because of the addition of corridors and other living spaces.&nbsp;

<p>Trey Clark, the head of U.S. investments for Chinese developer Vanke, said the conversion process to residences also leads to less usable square footage because of the addition of corridors and other living spaces.&nbsp;</p>

<strong>The Other Case for Conversion</strong>


<h2 class="wp-block-heading"><strong>The Other Case for Conversion</strong></h2>


<h2><strong>The Other Case for Conversion</strong></h2>

But the considerations of how and whether to rebuild downtown should not be strictly financial, and there are clear benefits to such projects beyond housing, said RAND’s Ward. There is also an environmental and social case for adaptive reuse projects that should be weighed by policymakers thinking through how—or if–they should incentivize these projects, he said.&nbsp;

<p>But the considerations of how and whether to rebuild downtown should not be strictly financial, and there are clear benefits to such projects beyond housing, said RAND’s Ward. There is also an environmental and social case for adaptive reuse projects that should be weighed by policymakers thinking through how—or if–they should incentivize these projects, he said.&nbsp;</p>

These include the environmental benefits of constructing more housing closer to job centers and the desire to activate the city’s downtown core into a more vibrant neighborhood with a greater mix of uses.&nbsp;

<p>These include the environmental benefits of constructing more housing closer to job centers and the desire to activate the city’s downtown core into a more vibrant neighborhood with a greater mix of uses.&nbsp;</p>

In order to tip the scales toward conversions, experts say developers would need to buy into a new vision of the future of downtown in the post-Covid world. It doesn’t appear the city is pivoting in that direction. Over the past few months, Mayor London Breed has made <a href="https://sfstandard.com/business/return-to-office-sf-london-breed-google/">bringing workers back downtown</a> a key part of her economic recovery strategy.&nbsp;

<p>In order to tip the scales toward conversions, experts say developers would need to buy into a new vision of the future of downtown in the post-Covid world. It doesn’t appear the city is pivoting in that direction. Over the past few months, Mayor London Breed has made <a href="https://sfstandard.com/business/return-to-office-sf-london-breed-google/">bringing workers back downtown</a> a key part of her economic recovery strategy.&nbsp;</p>

“In a way the effect of Covid on real estate prices has yet to fully play out. It’s going to be a while until we see what happens when people start trying to sell these buildings off or if they can’t bring in long-term leases,” Ward said. “In the long term these things will make a more favorable environment for (conversions) but it hasn’t happened as quickly as I might have expected initially.”

<p>“In a way the effect of Covid on real estate prices has yet to fully play out. It’s going to be a while until we see what happens when people start trying to sell these buildings off or if they can’t bring in long-term leases,” Ward said. “In the long term these things will make a more favorable environment for (conversions) but it hasn’t happened as quickly as I might have expected initially.”</p>

<strong>Some Spaces are Better Than Others</strong>


<h2 class="wp-block-heading"><strong>Some Spaces are Better Than Others</strong></h2>


<h2><strong>Some Spaces are Better Than Others</strong></h2>

So what structures would be the best candidates for conversion? Class A office spaces like Salesforce Tower and the Transamerica Pyramid are generally considered to be out of the question because of market demand and the high existing revenue they bring in.&nbsp;

<p>So what structures would be the best candidates for conversion? Class A office spaces like Salesforce Tower and the Transamerica Pyramid are generally considered to be out of the question because of market demand and the high existing revenue they bring in.&nbsp;</p>

That leaves lower-rise, older and less valuable offices with ideal characteristics like modern seismic safety engineering, repetitive floorplates and a narrow and rectangular form that makes it easier to meet light and air requirements for housing.&nbsp;&nbsp;

<p>That leaves lower-rise, older and less valuable offices with ideal characteristics like modern seismic safety engineering, repetitive floorplates and a narrow and rectangular form that makes it easier to meet light and air requirements for housing.&nbsp;&nbsp;</p>

While it hasn’t been tried yet in San Francisco, Sider said perhaps the best projects for office-to-housing conversions in terms of design may be group housing—dorm-like buildings where residents share kitchens and common space—because their layouts mirror many current office plans and expensive elements, like plumbing and electricity, may not have to be reconfigured entirely.&nbsp;

<p>While it hasn’t been tried yet in San Francisco, Sider said perhaps the best projects for office-to-housing conversions in terms of design may be group housing—dorm-like buildings where residents share kitchens and common space—because their layouts mirror many current office plans and expensive elements, like plumbing and electricity, may not have to be reconfigured entirely.&nbsp;</p>

“That works more from an infrastructure perspective—whether it pencils is another question,” Sider said.

<p>“That works more from an infrastructure perspective—whether it pencils is another question,” Sider said.</p>

Those projects tend to be affordable housing. That’s specifically where San Francisco is <a href="https://sfstandard.com/politics/city-hall/housing-shell-game-supes-latest-actions-set-to-slow-new-housing-as-state-mandate-looms/">falling behind in its state housing target</a>. But Sider said it’s even less likely developers would pursue affordable housing projects for costly conversions because they tend to be less profitable.

<p>Those projects tend to be affordable housing. That’s specifically where San Francisco is <a href="https://sfstandard.com/politics/city-hall/housing-shell-game-supes-latest-actions-set-to-slow-new-housing-as-state-mandate-looms/">falling behind in its state housing target</a>. But Sider said it’s even less likely developers would pursue affordable housing projects for costly conversions because they tend to be less profitable.</p>

<strong>Setting an Example in SoCal</strong>


<h2 class="wp-block-heading"><strong>Setting an Example in SoCal</strong></h2>


<h2><strong>Setting an Example in SoCal</strong></h2>

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