Good Evening sf.citi members,
I’m writing to provide you with an update on the letter of inquiry that Supervisor Stefani submitted to San Francisco Controller, Ben Rosenfield, and Chief Economist, Ted Egan in July 2022 requesting a report on the impact of remote work on commercial property and local tax revenue in San Francisco. According to the report, San Francisco is among the lowest in office attendance rates, with approximately office attendance at 40% of pre-pandemic levels. Office-based industries generate nearly 75% of San Francisco’s gross domestic product, and given that remote work is becoming a permanent fixture of San Francisco’s work culture, it’s essential to prepare for the potential impact on San Francisco’s economy and commercial office spaces.
Changes in the Office Market
It’s no surprise that remote work has impacted office vacancy rates. Although office vacancy rates have increased nationally, San Francisco has experienced the largest increase in office vacancy among major office markets, from approximately 5% pre-pandemic, to 24% in the 3rd quarter of 2022.
Typically, reductions in demand for office space result in increases in sublease vacancies, which occur when sub-lessees inhabit the space but existing tenants pay rent under the original lease. In San Francisco, sublease vacancies accounted for 80% to 90% of office vacancies during 2020 and 2021. This dynamic changed in 2022 and today the majority of office vacancies consisted of direct vacancies, which occur when the original lease is broken or expired and not renewed. If direct vacancy rates continue to increase, then the market value of office properties will be reduced.
Additionally, capitalization rates, or a property’s rate of return, can also affect property market values. One projection predicts that San Francisco office capitalization rates could increase from the 5%-6% range to the 7% – 8% range between now and 2028. The market value of office buildings would decline proportionately.
Forecasting the Impact on Property Tax Revenue
While property market values are declining, Prop 13—which limits property tax rate growth—protects the City’s tax base from decreasing market values, likely making the impact less deleterious than expected.
The Controller’s Office is in the process of building a model that will forecast how much market values can decline before property tax revenue is at risk. Although the model is still in development, a few general conclusions can be drawn.
- Rent and office vacancy forecasts in San Francisco should be considered highly speculative because work-from-home routines have not been officially established by employers and employees.
- Few market observers are expecting pre-pandemic levels of office attendance. Across the nation, office attendance levels fall short of pre-pandemic levels.
- Cyclical factors, in the form of rising interest rates, are impacting office property values and creating more downside risk for the City in the short and medium term.
As a next step, Supervisor Stefani will call a hearing to discuss the report. We will be sure to keep you apprised as the item is agendized in committee. Please find the full report attached below and let us know if you have any questions.
Thank you for your continued membership.
Jen
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