San Francisco Caught Between a Rock and a Hard Place

San Francisco Mayor London Breed has proposed a reduction of the city’s tax on subleased space through 2029 as a way of spurring office occupancy levels.

However, an analysis released by the Controller’s Office of Economic Analysis has concluded that the loss of revenue from the tax reduction is likely to outweigh any benefits from the action—because the tax on subleasing has become a major revenue stream during the pandemic.

The analysis found than an additional 50K to 100K of subleasing might result from Breed’s proposal to exempt office tenants from the 3.5% commercial rent tax on sublease space they normally would have to pay, the San Francisco Business Times reported.

According to the analysis, the new leasing activity would generate about $3.8M in new rent payments as well as an estimated $1.5M to $2.5M in downtown spending by office workers occupying the sublet space, which translates into about $1M in additional business tax revenue for the city.

The study also projected that San Francisco’s transit system would collect $300K to $700K in additional transit fares.

But in another sign that San Francisco’s beleaguered downtown is caught between a rock and a hard place, the controller’s report noted that the city has been collecting a whopping $17M per year in taxes from subleasing since the pandemic began—money that is now desperately needed to help close municipal budget deficits.

More than 27M SF of office space in San Francisco is empty, a vacancy rate that represents close to 30% of the total. As downtown offices have been hollowed out by tech companies adopting remote work and downsizing office footprints, subleasing has soared in the city.

The amount of office space available for sublease in San Francisco is nearing a record 10M SF, with 900K SF added to this total in the first quarter, according to CBRE’s Q1 2023 report.

In making her proposal, Breed said it would eliminate a “double-dip” tax effect on commercial leases—the tax currently is imposed on direct leases and subleases for the same property. The idea of cutting the tax on subleasing has drawn support from local business groups.

The lion’s share of the sublease tax revenue, about $14.5M, is earmarked for the city’s Babies and Families First Fund, an early childcare fund. According to Breed, the childcare fund currently has a balance of about $400M, so cutting the sublease tax wouldn’t have any short-term effect on the fund.

However, the balance of the sublease revenue goes directly into San Francisco’s general revenue—meaning the city would lose at least $2.5M in existing tax revenue for the budget while generating only about $1M in new revenue to replace it.

Several members of the city’s Board of Supervisors have indicated they are not likely to support the tax cut at a time when the city is facing budget deficits for the next two years.

“When we talk about rezoning to reimagining space in some of these buildings downtown, that’s a positive. When we talk about creating an entertainment district and a 24/7 marketplace downtown, that’s a positive,” Shamann Walton, a board member, told the Business Times.

“But taking away $17 million meant as revenue each year—I think that’s completely ridiculous to be having a conversation about that when we’re facing a deficit over the next two years,” Walton said.