Will San Francisco's Conversion Incentive Work?

It took nearly a week to certify the results, but San Francisco voters have narrowly approved a ballot measure creating a new incentive aiming to spur conversions of empty office buildings to housing.

The measure, known as Proposition C, exempts property from real estate transfer taxes, ranging from 0.5% to 6%, the first time a commercial property is sold for conversion to residential use. The exemption applies to projects that receive final approval before Jan. 1, 2030.

Proposition C limits the aggregate amount of space that can be exempted from the transfer tax to a total of 5M SF. It also increases the city’s annual limit on new office development in proportion to the amount of office space lost to conversions.

The measure was approved by a 52.9% to 47.1% margin of city voters in the March 5 election, according to results posted by the San Francisco Chronicle.

San Francisco’s fiscal chief already has warned not to expect a slew of conversions to result from the transfer tax exemption.

An economic impact analysis conducted by City Controller Ben Rosenfield and the city’s Office of Economic Analysis said Proposition C is not likely to save developers enough money to pencil in conversion projects that produce profits.

“Conversion of office space to housing does not appear to be financially feasible at the moment, and the incentive is likely too small to close the feasibility gap,” the city’s analysis said.

San Francisco’s property transfer tax gradually increases from 0.5% on transactions of $250K or less to 6% on trades worth more than $25M. Transactions of $1M to $5M pay 0.75%; this increases to 2,25% on trades of $5M to $10M and 5.5% for transactions ranging from $10M to $25M.

“In San Francisco, the economics of conversion of office space to housing are made particularly challenging by the weakness in the city’s housing market,” the analysis said, citing data from Zillow indicating that San Francisco has seen the third-steepest drop in housing prices of any large county in the U.S. from 2019 through 2023.

The analysis threw cold water on a December 2023 report from Moody’s Analytics which indicated that 13% of office buildings in the city were “viable candidates” for conversions—particularly in the North Financial District, South Financial District and Union Square office submarkets—saying Moody’s report did not study the financial feasibility of conversions.

The controller’s analysis cited a report released by San Francisco think tank SPUR at the end of last year which determined that office conversions are not currently financially feasible in San Francisco. The SPUR report was based on an average acquisition cost for office buildings of $183 per SF and it found an “average feasibility gap” of $267,000 per residential unit.

Because condos are sold individually, the transfer tax exemption would only generate savings of $9K per unit on an office-to-condo conversion, the city’s report said; this would increase to about $33K per unit for rental apartment conversion projects. The transfer tax exemption will represent a 2% reduction in development costs for condos and a 6% reduction in costs for conversions to apartments, excluding the cost of acquiring the office building, the report found.

“Given the size of the incentive relative to the feasibility gap indicated in the SPUR report, and the fact that office buildings are currently trading for more than that report assumes, it is unlikely that the (Proposition C) incentive will stimulate conversions unless and until market conditions improve,” the controller’s analysis said.

“If market conditions change in the future, and conversions do become feasible, the incentive is likely to lead to a negative economic impact, and an extended period before foregone transfer tax revenue is recouped by higher property tax revenue for the city,” the analysis said.

“Broader goals of revitalizing downtown and increasing housing opportunities are certainly important but might better be pursued through zoning changes that could be economically and financially beneficial to the city,” the controller’s report concluded.

Multifamily Spring:

Multifamily Spring is coming to New York City this April 18. This year’s program will bring together the industry’s most influential and knowledgeable real estate executives from the multifamily sector for 5 hours of face-to-face networking and over 5.5 hours of can’t miss sessions. Learn more or register here.