Office conversions pitched for California housing woes

Office market turmoil since the COVID-19 pandemic amid a housing shortage has driven calls for office-to-residential conversions in San Francisco and Los Angeles.

While the concept sounds simple, so far such conversions have been easier said than done, at least in San Francisco.

Both cities have been throwing everything they can at solving the decades-old statewide housing crisis and have been dealing with office vacancies as employers contemplate the value of bringing workers back into offices full time.

So far, office-to-residential hasn’t penciled out in San Francisco.

“It is absolutely true that office is more profitable than housing in San Francisco,” said Anne Taupier, director of development in San Francisco’s Office of Economic and Workforce Development.

“Our rental rates in housing have not really come back from the pandemic. I have office developers who are talking to me about constructing new office because Class A and premier space really remains at a premium,” she said. “That is why we are focusing on office conversion in older Class B and C office.”

Conversely, Los Angeles is on its third wave of office-to-residential conversions since the early 2000s, says Garrett Lee, president of Jamison Properties, whose company issued $60 million in taxable variable rate demand multifamily housing revenue bonds in October to fund the conversion of a 1950s era, 13-story office building at 3325 Wilshire Boulevard into 236 apartments and 15,000 square feet of ground-floor retail.

Lee oversees the multifamily development and construction division of the commercial office company founded by his parents in the mid-1990s.

Jamison operates 18 million square feet of commercial office, retail, medical, and multifamily properties throughout Southern California and has recently grown into one of the most active multifamily developers in Los Angeles, bringing to market more than 7,000 units, Lee said.

The company is on its 10^th office to residential conversion with the 3325 Wilshire project, said Lee, whose company joined the office to-residential trend during the second wave in Los Angeles in 2011-2013.

The Wilshire project resulted in Jamison working with Western Alliance Bank on a bond solution to fund construction costs.

“This was our first transaction with Jamison,” said Monica Suarez, managing director of municipal finance at Western Alliance Bank. “This financing structure resulted in a lower cost of funds for Jamison, by taking advantage of a taxable variable rate demand obligation structure.”

Traditionally, construction projects of this sort would have been financed through conventional commercial bank construction loans, Suarez said, but there has been limited capacity for commercial bank construction lending post regional banking crisis of 2023, Suarez said.

“This structure offers an alternative to a conventional structure loan,” Suarez said. “With the seven-day floater, they can draw down, as needed, for the project. It mimics a construction draw-down loan, with issuance once a month until the total has been fully issued.”

The company is only paying interest on what has been issued, reducing the capitalized interest versus a traditional municipal bond structure where the bonds are issued up front, she said.

To the north, San Francisco’s Class A high rise office space has largely recovered from the pandemic to an 8% vacancy rate, but the lower-quality Class B and C category, largely built in the 1970s and 1980s sits at 33%, Taupier said.

According to fourth quarter office vacancy reports from JLL, a global commercial real estate brokerage, Los Angeles’ office vacancy rate year-to-date in the fourth quarter was 28.4%. “Firmer return-to-the-office mandates have begun to stem the tide of space giveback and will help stabilize Los Angeles’s office demand,” the brokerage said.

With the aim of adding 30,000 market-rate housing units to San Francisco, city leaders have taken steps to make it easier to convert older stock Class B and C office buildings to housing for middle class residents.

“We would love to have 30,000 new residents in downtown to support the bakeries and bars, so we aren’t so susceptible to a pandemic event or global economic swings,” Taupier said. “Historically, we haven’t had to worry about it, but recovering from the pandemic was different for us.”

All of the major cities in California have been doing a full-court press over the past decade to try to deal with the twin issues of a lack of affordable middle class housing and homelessness.

As of January 2024, there were at least 187,084 people experiencing homelessness in California, according to the U.S. Department of Housing and Urban Development, a 3% increase from the previous year. 

California cities and counties have issued billions of dollars in bonds to support affordable housing over the past several years.
 Issuance of housing bonds for the first half of 2024 nationally was at $22.2 billion in 357 issues, up 31.7% from first half 2023’s figure of $16.9 billion in 381 issues, according to LSEG. 

Nine San Francisco Bay counties floated — and then pulled — a $20 billion bond measure last year to support affordable housing construction. 

“That would have been a game changer for the region,” Taupier said. 

Assemblymember Buffy Wicks, D-Oakland, and state Sen. Christopher Cabaldon, a Yolo County Democrat, on Tuesday brought the housing bond concept back to life with a proposal for a $10 billion state bond measure for affordable housing, targeting the June 2026 ballot. 

“These bonds are a necessary step to address the staggering need for safe, stable and affordable housing,” said Wicks in a statement. “Even in a tight fiscal climate, we must act with urgency.”

City leaders have been trying to approach the issue from every angle and office conversion is one tool in the toolbox for California cities, Taupier said.

The high vacancy rate in San Francisco’s Class B and C space has city leaders working furiously to ease red-tape for office space conversions, Taupier said.

“We have 13 million class B-C office space that is probably functionally obsolete,” Taupier said. “We have 8,000 units of new housing construction entitled downtown. and we would love to have 30,000 new residents downtown in a 20- to-30-year period, and a recovered office market.”

She said the city wants to make it as easy as possible for maverick building owners and developers to get in front of the market and start converting soon. “The city’s focus has been on getting costs and other obstacles out of the way,” Taupier said.

Since the city can’t control interest rates or construction costs, Taupier said, it set about changing what it could control.

“We reduced impact fees and inclusionary fees in 2023, on roughly 33% of impact fees and 40% of inclusionary fees,” Taupier said. 

The San Francisco County Board of Supervisors land use committee on Feb. 10 took it a step further and sent a recommendation to the full board that 100% of impact fees be removed for office-to-housing conversions, she said. 

The biggest obstacle for conversions “was property tax costs, transfer tax costs and our inclusionary housing requirements. Those were just prohibitive in San Francisco,” Taupier said.

San Francisco voters in March 2024 approved Proposition C, which waives the transfer tax on office buildings being converted into residential. The transfer tax is a one-time fee imposed on real estate sales. Prior to the change, sales valued at $25 million or more were subject to a 6% transfer tax.

To obtain the transfer tax waiver, project sponsors have to receive planning approval by the end of 2029 and begin construction within three years of receiving approval. The transfer tax exemption would be limited to a citywide cap of 5 million square feet of converted space.

No one has utilized the tax incentive since it passed, said Ted Egan, chief economist for the San Francisco controller’s office.

“People in the development community and workforce development supported this, but the market hasn’t quite made it financially feasible yet,” he said.

“It has to get to the point where people realize the space won’t work for office, and they need to do something else with it,” he said. “We don’t know how much will be reabsorbed by growth in demand for office, and how much will be left to convert for housing.”

When Los Angeles first starting doing conversions in the 1990s, Egan said, that city had lost jobs that never came back. San Francisco, on the other hand, has just reverted to the number of tech jobs it had in 2019, and venture capital for tech and artificial intelligence are both hopping in the region.

Basically, Egan said, the commercial real estate industry is still trying to assess whether work-from-home continues to play a huge role or if office space needs will increase for growing sectors like AI.

“The replacement of 100% remote with office doesn’t seem to be happening,” he said. “Even with employees who like to be remote, being fully remote is seen as being too limiting for their career. You don’t move some place to be part of a scene and then work out of your office.”

According to a November 2023 study from the Public Policy Institute of California, 14% of Californians say they work remotely all the time; 21% have a hybrid work-from-home and in-office schedule and about six in 10, 61% say they are working exclusively in the office. Those percentages have not changed much since November 2021 – about 18 months into the pandemic.

The reason the tech industry has primarily operated out of San Francisco, Austin, Texas, or Boston is because the industries benefit from a cluster of entrepreneurs, venture capital and universities with conducive studies, Egan said.

“If you weren’t part of that scene, you weren’t keeping up,” Egan said.

“And, that still seems to be the case,” he said. “It means folks are still tied to the region — and working in an office, in person, is still part of the equation.”