San Francisco's push to turn office buildings into homes hinges on this simple idea

Aug 12, 2023

Converting San Francisco’s old downtown office buildings into housing won’t be an easy task, with high costs, clunky floorplates and existing tenants in buildings only a few of the obstacles developers need to overcome.

Desolate buildings still need to be in places where people want to live.

“Hope is not a strategy,” said Nick Romito, co-founder and CEO of VTS, a leasing and asset-management data company. “The hope that if you convert it, they will come —well, a lot depends on where that building is.”

While New York City’s downtown financial district is home to a number of successful office-to-residential conversions, it also takes a vibrant neighborhood, with bustling cafés, grocery stores and more.

“That is not the same for San Francisco,” Romito said. “The infrastructure and the cost of converting a building — that’s part of it,” he said. “But I’d be more concerned about, even if you can convert it, who wants to live there?”

Romito speaks with the confidence of a New Yorker about the challenges San Francisco faces. He also has skin in the game, with offices at the Embarcadero Center, one of the West Coast’s largest mixed-use properties, which connects the city’s financial district with San Francisco Bay.

A decade ago VTS got off the ground, offering a service Romito characterizes as the Salesforce CRM, -0.45% of the office-leasing industry. It was helped along by his Rolodex of top landlords. Romito previously was a broker in New York City’s notoriously feast-or-famine office sector, while in a previous role he oversaw a portfolio of millions of square feet of office space.

The turmoil in the office properties means many former clients now use his data to help make sense of the coming carnage, while landlords face sharply higher borrowing costs since the Federal Reserve began to rapidly raise target lending rates, a mountain of debt coming due and other tough choices.

See: The $1 trillion ‘wall of worry’ for commercial real estate that spirals through 2027

“What’s cheaper?” Romito said. “Is it cheaper to add amenities in maybe a zombie building, add a floor or two, to create a better experience? Or is it cheaper to knock the entire building down, rebuild something else, and pray to God you lease it?”

San Francisco isn’t a big city by global standards — it ranks just No. 17 in the U.S. by population — but its recent woes are notorious, from a recent population drain to a local fentanyl crisis to oft-voiced concerns about public safety. Breathing new life into old office buildings sounds like an enticing fix for a shelter problem that has been building to a crescendo, after decades of new housing initiatives being voted down.

Like other major California cities, the tide of homelessness in San Francisco increasingly includes people who are elderly. The fentanyl crisis ravaging the U.S. makes matters on the ground in San Francisco still worse.

As Mayor London Breed in June told Bloomberg in a sit-down interview, “The issues around opioids have done something to our city, and to other major cities, like something that I’ve never seen before.”

She now wants action to combat the “doom and gloom everyone is talking about.” As part of that push, Breed called out the tech community to not only “make money from San Francisco,” but to stick around and invest in solutions to its struggles.

Warren Wachsberger, CEO of Aecom Capital, a subsidiary of Aecom ACM, -0.35%, said revamping old office buildings isn’t that simple. “Less than 1% of all apartment units underway, being built nationally, are office-to-residential conversions, despite everybody’s love affair with them,” Wachsberger said, speaking from Los Angeles.

“Many buildings probably won’t work,” Wachsberger said, observing that thick, concrete office floorplates often need to be drilled through and plumbing and heating systems overhauled, with local building codes adding to the headache.

“It’s a lot easier and cheaper to demolish it and start over from scratch,” he said. “That means buying buildings essentially at the cost of land.”

Wachsberger said hopes for an expansion of an office-to-residential conversion effort in Los Angeles in the 2000s likely hinge on incentives for developers and the buildings being in places where people wanted to work, eat, live and shop. “Until that’s able to come back, it’s difficult to create the vibrancy that was there prepandemic,” he said.

San Francisco’s downtown core remains hollowed out, even as the city makes a noticeable push for cleaner and safer streets in the wake of the pandemic. The goal is to draw more office workers back to old commuting patterns, enticing them to buy a morning coffee, a sandwich or after-work drink.

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But its office vacancy rate remains high at 27.1% through the second quarter, according to Cushman & Wakefield CWK, +2.08%. The real-estate firm expects San Francisco vacancies to tick higher through the rest of this year, as some 4 million square feet of leases expire.

As part of its turnaround effort, the city has been getting tougher on open-air drug use in recent months. Over the longer term, it plans to cut homelessness by half in the next five years, revamp downtown zoning and eventually convert unloved office buildings to other uses, including housing.

There also has been a lot of buzz this year around artificial-intelligence technologies, which has been a boon to big companies like Apple AAPL, -4.80%, Amazon AMZN, +8.27%, Alphabet GOOG, -0.18%, Microsoft MSFT, +0.34%, Meta META, -0.79%, Nvidia NVDA, +0.37% and Tesla TSLA, -2.11%, while also sparking a broader stock-market rally.

See: VC spending is in a tailspin, and AI can’t reverse the trend — yet

Gabriella Sierra’s team of researchers at Cushman & Wakefield in San Francisco said in a second-quarter outlook that AI’s anticipated expanding presence might partially revive the tech industry’s footprint in the city.

But AI isn’t likely a cure-all for the city’s financial woes, particularly with San Francisco projecting its budget shortfall to widen to $1.3 billion by fiscal year 2027–28.

Romito said that despite a “bit of a renaissance” in office-leasing demand in the past quarter by businesses with an AI focus and venture-capital funding, it isn’t likely “enough to carry a market.”

Stocks closed higher on Monday, with the S&P 500 SPX, -0.53% and Nasdaq Composite Index COMP, -0.36% scoring the strongest seven months to start a year in decades. The Dow Jones Industrial Average’s DJIA, -0.43% rally has been more modest; it’s up 7.3% on the year so far, according to FactSet.

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Joy Wiltermuth is a news editor and senior markets reporter based in San Francisco.