On March 11, 2024, it was announced that San Francisco voters approved Proposition C, amending the Business and Tax Regulations Code to waive the real property transfer tax for the first five million square feet of nonresidential space converted to residential use. Mayor London Breed placed Proposition C on the ballot to address both the City’s housing shortage and high office vacancy rates (approximately 32%) by improving the financial viability of office-to-residential conversions.

Proposition C also (i) allows the Board of Supervisors to amend or repeal the real property transfer tax without sending the proposed changes to the voters, as was previously required, and (ii) amends the Planning Code to add to the annual “Prop. M” cap on permitted new office space any office square footage that was converted to residential use.

PROPERTY TRANSFER TAX WAIVER

San Francisco (the “City”) imposes the real property transfer tax (the “Transfer Tax”) on the sale of all real estate. The Transfer Tax is progressive, meaning that the City taxes more valuable transfers at higher rates, up to 6% for transfers valued at $25 million or more. Proposition C waives the Transfer Tax for the first five million square feet of nonresidential space converted, in aggregate, across the City.

Conversion projects seeking to qualify for the Transfer Tax waiver must meet the following requirements:

• The project must convert non-residential space to residential use. For mixed-use projects, “residential use” includes mechanical space and common areas in the proportion that such areas serve the residential use.
• The converted square footage must be within the first five million square feet of nonresidential square footage converted to residential use under Proposition C.
• The resulting Floor Area Ratio (FAR) must be at least 1:1.
• Demolition, new construction, and additions are permitted. However, any net new square footage must not exceed 10% of the original square footage. If any existing residential square footage is replaced, only the net new residential square footage is eligible for the Transfer Tax waiver.

Conversion projects will still be subject to other applicable City approvals. After “Final Approval” of the project, a Transfer Tax waiver must be requested and a “Qualifying Certificate” must be issued by the Planning Department. If the Final Approval is not a building permit, a building permit must be issued within three years of that approval. Before transfer, an “Exemption Certificate” must be issued by the Planning Department, which will be recorded against the property. The Transfer Tax waiver will sunset on January 1, 2030, meaning that a Qualifying Certificate must be issued before that date.

IMPLICATIONS AND THE ROAD AHEAD

As San Francisco continues to wrestle with high office vacancy rates and the challenge of meeting its housing goals, office-to-residential conversions present an intriguing solution to both problems. Historically, such projects have generally been deemed financially infeasible in San Francisco due in part to high construction costs, taxes, development impact fees, and inclusionary affordable housing requirements.

San Francisco recently adopted a suite of Planning Code amendments to streamline the entitlements process for residential conversion projects and temporarily reduce applicable development impact fees and inclusionary affordable housing requirements. Proposition C further addresses the high cost of conversion projects by waiving the Transfer Tax, which can otherwise represent a significant burden for higher value properties. This waiver may be enough to push certain projects into financial feasibility, while others may require even further reform that addresses other barriers such as building code requirements, high construction costs, and falling rents.

As we previously reported, Senate Bill (SB) 1227, introduced by Senator Scott Wiener on February 15, 2024, would also help facilitate residential conversion projects by creating a new CEQA exemption for student housing and qualifying residential mixed-use projects in the Downtown Revitalization Zone, which includes the Financial District, Union Square, Eastern SOMA, Mid-Market, and Civic Center neighborhoods. SB 1227 would also create a new state property tax exemption for moderate-income housing in the Downtown Revitalization Zone, as specified. SB 1227 could be utilized in combination with Proposition C if commercial uses are also provided or retained (the project would need to be less than two-thirds residential to qualify for the new CEQA exemption under SB 1227) and/or where moderate-income housing would be provided. However, robust labor requirements would need to be met to qualify for the new CEQA exemption, including prevailing wage, skilled and trained workforce, and health care expenditure and apprenticeship requirements for construction craft employees, depending on the size of the project. Those labor requirements are expected to cut against the financial feasibility of residential conversion projects.

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