While a single property owner may grapple with high vacancy rates, an entire downtown facing widespread vacancies becomes a challenge for municipal administrations. The shift in retail spaces due to the rise of e-commerce and adjustments in office spaces amid remote work trends accentuates the vulnerabilities within commercial real estate. These fissures impact not just the industry but also reverberate throughout the city and its community, posing a larger concern for local authorities to address.
“There are record high vacancies, both on upper floors in terms of the commercial space and at ground level in terms of the retail space,” said Peter Strazzabosco, deputy commissioner of the Chicago Department of Planning and Development. “A lot of the Class-A office construction was already pulling financial organizations, and companies off of LaSalle Street…. Covid came in and really exacerbated the conditions that were moving along incrementally.”
Across the country, the downtown area of San Francisco struggled during the pandemic, too.
“We’re a visitor destination. When we shut down during Covid, we shut down pretty hard,” said Marisa Rodriguez, CEO of San Francisco Union Square Alliance. “We’re not primarily residential, so we couldn’t pivot. A lot of our businesses closed and could not weather that storm.”
With economic shifts and evolving market demands, city governments are strategically addressing distressed assets, recognizing the potential for repurposing underutilized properties. This concerted effort seeks not only to revamp these spaces but also to align them with contemporary needs, fostering community development and economic rejuvenation.
SF: Flexible Zoning Diversifies Land Use
With a staggering office vacancy rate of 29% and over 26 million square feet of unused office space, predominantly within older buildings, the City by the Bay has been seeking innovative measures to address this surplus of vacant properties.
In February 2023, Mayor London Breed articulated her vision through the launch of Roadmap to San Francisco’s Future in response to the economic shifts triggered by the pandemic. One of the key strategies is to facilitate new uses and flexibility in buildings.
The San Francisco Planning Commission pushed forward a legislative proposal back in March aimed at encouraging and streamlining the transformation of empty office spaces into housing units while offering more flexibility in permissible uses.
“Our downtown is unique in that the zoning is very flexible today,” said Lily Langlois, Principal Planner of San Francisco Citywide Planning, “For one reason or another, our downtown has largely been office uses, and that’s really more of a market forces issue rather than a land use or regulatory issue.”
The city passed various legislation to ensure that almost every land use is permitted downtown, including an adaptive reuse program. “There’s a new program that basically says if you have an existing building and you want to convert it to housing, you can waive most of the planning code requirements that are applicable for new buildings – things like open space exposure and bike parking,” explained Langlois.
In addition to waiving a lot of code requirements, if the applicant meets all of the criteria, they don’t need to have a hearing before the planning commission. “The hope is that these products can be approved pretty quickly,” added Langlois.
“Union Square is actually a very attractive place to have your office,” said Rodriguez. She sees the potential of the neighborhood being not just a destination market. “Let’s think outside the box and create opportunity for the community. Let’s go residential. The one thing that hasn’t happened in Union Square that has happened in our financial district is a study on conversions for our kind of historic neighborhood,” said Rodriguez.
Langlois identifies three things to be called out when it comes to the city’s inclusionary housing: zoning change, transfer tax and property tax. Mayor London Breed announced in October that she will be placing a measure to assemble a tax incentive for office-to-residential conversion onto the March 2024 ballot. If passed, the measure would allow the city’s transfer tax, which can be up to 6% on transactions over $25 million, to be waived.
“The city is talking to both our local and state leaders to see if there are things that we can do to help provide some type of relief of property taxes,” said Langlois. However, at the end of the day, clearing regulation blocks is not enough. “From a financial standpoint, we’re hearing that it’s still really difficult to make these projects pencil. Everything is really constrained financially at this moment,” she said.
CHI: TIF Incents Conversion Projects
In Chicago’s central Loop, LaSalle Street has historically been known as the epicenter of banking and financial markets. With a significant rise in office and retail vacancies along this corridor, officials are aiming to diversify what they’ve deemed an office-centric environment.
Under the banner of the “LaSalle Street Reimagined” initiative, the program mandates that a minimum of 30% of new housing in the area falls under the classification of affordable housing, adhering to city ordinances.
“We made a policy decision a couple of years ago to make TIF available for affordable housing development downtown because we know that some of these properties are already going to naturally look to convert a portion of their office space towards housing,” said Strazzabosco.
Tax Increment Financing (TIF), funds redirected from property taxes, stands as the city’s most significant incentive. Within the LaSalle corridor, its TIF district ranks among the city’s wealthiest, boasting an audited balance of $197 million as of the close of 2021.
Within specified TIF districts across the city, tenants and owners of industrial and commercial properties can also apply for the Small Business Improvement Fund (SBIF). Drawing funding from TIF revenues, SBIF is a grant funding dedicated to permanent building enhancements and repairs throughout the city.
Participants in the program have the opportunity to secure grants covering a range between 30% and 90% of remodeling expenses, with maximum grants capped at $150,000 for commercial properties and $250,000 for industrial properties.
“We’re trying to incentivize as part of the idea to make it equitable for any Chicagoans to come and live downtown,” said Strazzabosco.
“We have a lot of office buildings that were built not that long ago that are performing at 96% occupancy,” said Michael Edwards, president of the Chicago Loop Alliance, a business improvement district. “These are largely along the west side of the Loop and the edge along the Chicago River.”
Edwards is seeing a flight-to-quality trend in the area, “There are some open markets in neighborhoods just outside of the Loop that have been performing better as people have been downsizing. Tenants pay twice as much rent for half as much space,” he said.
As the workforce chooses to spend less time in the office, a younger group takes the stage in the Loop. “What we’ve noticed after the pandemic is that while office remains super important, it’s a little less visible in terms of a driver. And what’s taking its place are the 55,000 students,” said Edwards. “Visitor ranking, in terms of physical impact, would be theater visitors, residents, students and office workers. The mix is different than it was before.“
As the story of distressed assets unfolds across the skylines of downtown Chicago and San Francisco, a narrative of transformation emerges. These urban landscapes, once emblematic of bustling commerce and vibrant city life, now navigate the complexities of economic shifts and changing real estate dynamics. Yet, amidst the challenges lie opportunities for reinvention and revitalization. The tale of distressed assets in these iconic cities is not merely one of adversity but also resilience, where strategic vision and adaptive measures pave the way for a new chapter in their storied histories.
Pittsburgh Rolls Out Conversion Program
Similar to the dominance of office spaces along Chicago’s LaSalle Street, the majority of structures in downtown Pittsburgh were designed for office and warehousing purposes. Compared with pre-pandemic levels, downtown pedestrian traffic has dropped by 33%, while downtown employment has decreased by 50%.
The city is poised to aid the transformation of empty office properties into residential units within the Golden Triangle, Pittsburgh’s central business district (CBD). One of the main channels is to introduce the Pittsburgh Downtown Conversion Program (PDCP).
Launched in April 2022, PDCP supports developers through loans for office-to-residential conversion projects that reserve 20 percent of their units for low-income households. The PDCP also initiated various activities to invigorate the downtown area, including weekly markets and installations of public art, attracting visitors, residents, and employees to engage in cultural events. These initiatives contributed to the resurgence of pedestrian activity in the Golden Triangle, reaching pre-pandemic levels, with approximately 60,000 people visiting Market Square every week.
The PDCP emerged from discussions involving multiple stakeholders, including the city, the mayor’s office, Allegheny County, the Commonwealth of Pennsylvania, and the Pittsburgh Downtown Partnership. It aims to initiate the downtown’s economic recovery by offering financial assistance for transforming vacant, older Class B and C office buildings into residential units.
In May 2023, Pittsburgh’s Urban Redevelopment Authority (URA) granted its inaugural PDCP loan of $300,000 for the conversion of the Triangle Building at 926 Liberty Avenue. Built in 1866, the property’s renovation will encompass 15 residential units, including a ground-floor café and a small grocery store. Among these units, three will offer affordability to residents earning 50 percent or below the area median income (AMI), while the rest will be available at market rents.
The second conversion project under PDCP, The Pittsburgher, located at 428 Forbes Avenue, plans to introduce a combination of 130 units, comprising both market-rate and affordable housing. The PDP aims to transform around 4 million square feet of office space in the Golden Triangle into residential units.
Be sure to read the first and second in the series, Distressed Asset Borrowers: To Sell or Not To Sell and Distressed Asset Buyer: To Buy Or Not To Buy, as well as Stages of Asset Distress.