California Seeks to Fill Empty Offices

With the growth of remote work and increasing office vacancy rates at the confluence of a deepening housing crisis, it is impossible to miss the potential opportunities of office-to-residential conversions across California, particularly in dense urban areas. In concept, these conversions present hopeful statistics. A recent San Francisco Bay Area Planning and Urban Research Association (SPUR)/ Urban Land Institute (ULI) report estimated that if 40 percent of the currently unleased office space in San Francisco (all of which were deemed to be good candidates using a variety of factors) could be physically converted to housing, 11,235 multifamily residential units could be created.¹ If only the vacant Class B and Class C buildings were converted, approximately 4,200 units could be accommodated downtown.² If even a fraction of these conversions came to fruition locally and if mirrored throughout the state, it would an incredible success.

From a policy perspective, many cities are looking to support conversions to help revitalize their downtown areas, increase property values and boost tax revenues. Moreover, reusing vacant buildings is seen as a smart climate strategy by reducing materials for construction and upgrading buildings to make them more energy-efficient and climate-resilient.

Challenges

At the same time, many professionals are identifying and reporting on the physical challenges of conversions. They have identified the challenges of large floorplates and the need for mechanical, electrical and plumbing system replacements, as well as the necessity of creative solutions to rework interior cores and reenvision exterior improvements. These are just a few of the major (and expensive) improvements needed to make an office building suitable for residential use.³

In the suburban context, another challenge for commercial office "campuses" can be private land use restrictions such as covenants, conditions and restrictions (CC&Rs) that can serve as a further limiting factor by prohibiting residential uses and providing for private rights of enforcement by associations or neighboring landowners.

Local Agency Permitting and CEQA Compliance

To facilitate conversion, some cities already have adaptive reuse ordinances such as the Los Angeles Adaptive Reuse Ordinance that was adopted in 1999.⁴ The Los Angeles ordinance provides streamlining for and incentivizes the conversion of the downtown's historically significant, vacant and underutilized buildings to create housing and hotels, and has been widely credited for the downtown's rapid growth in the last two decades. In part because of the effectiveness of the ordinance, the downtown grew from 18,000 residents in 11,626 residential units in 1999 to an estimated 79,525 residents in more than 46,000 units in 2019.⁵ Recently, there have been calls to expand the applicability outside of the downtown and its immediately neighboring communities,⁶ including by potentially expanding the scope of conversion to include light-industrial zones and further relaxing development standards and streamlining approval to incentivize additional conversions.⁷

Other cities are proposing new legislation that may serve as the prototype for city ordinances elsewhere. In San Francisco, the proposed Commercial Residential Adaptive Reuse Program introduced by Mayor London Breed and Supervisor Aaron Peskin would direct city officials to develop modified building code standards to facilitate conversions.⁸ It would also modify the zoning code to expand permitted uses in relevant downtown zoning districts and would exempt qualifying projects from impact fees (except for any in-lieu fees proposed to satisfy inclusionary affordable housing requirements).⁹ San Francisco's ordinance would also allow the expansion of the existing building envelope by 20 percent or one additional vertical story.¹⁰

It should be noted that even in the absence of state or local legislation specifically tailored to conversions, it can still be possible to seek a change in use pursuant to existing zoning and building codes. The most favorable ordinances permit residential uses, provide credits for existing uses when considering impact fees, allow "grandfathering" of parking based on the existing use and provide flexibility on other requirements such as open space. In terms of environmental review for a conversion under the California Environmental Quality Act (CEQA), buildings that are located within one-half mile of a major transit stop may utilize the less than significant presumption for Vehicle Miles Traveled (VMT) and will have an advantage. Where the traffic trips generated by a residential use are less than the trips generated by the prior use, analysis of other impact areas (e.g., air quality and noise) will be streamlined as well. Where a residential project will have greater impacts than a prior office use, additional environmental analysis may be needed. That is to say, site-specific analysis is needed to evaluate the opportunities and pitfalls for conversion projects to determine permitting and environmental review.

State Legislation

There are also statewide legislative efforts underway to facilitate conversions. First, Assembly Bill (AB) 2097 (introduced by Assemblymember Laura Friedman) was adopted in 2022, not necessarily for the purpose of conversions but which could have a beneficial impact. It limits an agency's ability to impose parking on projects within one-half mile of a major transit stop. Notably, it applies not just to residential projects but to office and mixed-use projects as well. There is some debate about whether this law applies to existing buildings, but there is a strong argument that it does, as there is significant construction work required to undertake conversions, making them development projects to which AB 2097 should apply. This specific law, alongside the general trend of local agencies reducing parking requirements, can help with the economic feasibility of conversion projects, especially in urban and infill areas well-served by transit, where the creation of parking typically represents a significant project expense.

New legislation proposed this year by Assemblymember Matt Haney, AB 1532 (known as the Office to Conversion Act) aims to impose mandates on local agencies that would streamline the processing of conversion projects. In particular, AB 1532 (in its current version) would:

• make a qualifying office conversion project a use-by-right in any zoning district
• exempt an office conversion project from environmental review under CEQA
• exempt a project from impact fees not directly related to office conversions and allow fees to be paid over 10 years
• exempt projects from new parking and open space requirements
• require that the California Department of Housing and Community Development (HCD) establish a program to fund conversion projects
• specifically apply to charter cities

In order to be eligible, conversion projects must include 10 percent low-income units and must use a "skilled and trained workforce" to perform the conversion. As with other laws that require the payment of prevailing wages, this obligation will likely limit the application of the law (if adopted) as cost prohibitive in some locations.

Another new bill, AB 529 (proposed by Assemblymember Jesse Gabriel), would require the California Building Standards Commission to work with HCD to revise existing state adaptive reuse codes to better facilitate office to residential conversion projects. It would also add expanding adaptive reuse programs to the list of actions for which a local jurisdiction can be deemed to advance "prohousing local policies," which earns it additional points in applying for grant money to support housing and infrastructure programs.

Financial Feasibility

The SPUR/ULI report estimated a cost of $472,000 to $633,000 per unit for conversions, including labor and materials.¹¹ That estimate did not include seismic upgrades. The report surmised that conversion projects are not currently economically feasible in most locations, although that could change if office building values decrease significantly, as is commonly projected.

State legislators have recognized this reality and are prioritizing funding. Last year, $400 million in adaptive reuse funds went into HCD's Infill Infrastructure Grant Catalytic Qualifying Infill Area Program,¹² and as of earlier this month, roughly 55 applications had been filed that would account for $105 million of that available funding.¹³ California Gov. Gavin Newsom has included an additional $400 million in this year's budget proposal.¹⁴ Another tool is use of the Mills Act to obtain property tax abatement in exchange for restoration and maintenance of historic buildings.

Conclusion

While there are many known and unknown challenges with conversion projects, it certainly feels as if the state is at an inflection point and that those able to unlock the potential of conversion projects could be significant changemakers.

Holland & Knight attorneys have been working on adaptive reuse projects for decades and have broad experience and knowledge to assist in the evaluation and implementation of conversion projects. To highlight a few capabilities:

• Land use attorneys can conduct zoning analysis to determine local permitting and environmental review, as well as help harness available state programming.
• Construction attorneys can help evaluate buildings to determine physical feasibility.
• Transactional attorneys can negotiate and secure approvals under existing CC&Rs and other private restrictions, as well as structure agreements for the disposition of conversion projects.

Please see Holland & Knight's West Coast Real Estate, Land Use, Environment and Energy Group Fast Facts for more information, and contact the authors or another member of the West Coast Land Use and Environment Team to discuss additional opportunities.

Notes

¹ See Office-to-Residential Conversion in San Francisco's Changing Real Estate Market, March 28, 2023.

² Id.

³ See So You Want to Turn an Office Building Into a Home?, March 11, 2023.

⁴ See Adaptive Reuse Ordinance: 20 Years of Preservation in Downtown Los Angeles.

⁵ Id.

⁶ See L.A. City Councilmember Proposes Expansion of Adaptive Reuse Ordinance, Dec. 17, 2020.

⁷ See New Report Makes the Case for Expanding Adaptive Reuse Citywide, April 16, 2021; also see Recommendations to Improve & Advance Adaptive Reuse Citywide, March 7, 2023.

⁸ See Repurposing San Francisco Office Buildings for New Housing, May 2, 2023.

⁹ Id.

¹⁰ Id.

¹¹ See Office-to-Residential Conversion in San Francisco's Changing Real Estate Market, March 28, 2023.  

¹² See California's $400 Million Office-To-Housing Conversion Fund Lures Investor Applicants, March 7, 2023.

¹³ See California's $400 Million Office-To-Housing Conversion Fund Lures Investor Applicants, March 7, 2023.

¹⁴ See New Bill Aims to Convert California's Offices Into Housing, March 6, 2023.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.