San Francisco’s Proposition C Passes, Paving Way for Increased Property Rents

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From top left: Jamie Mahoney, Michael Federle, Blake Peterson, Peter Conte

Proposition C was designed to levy a tax on San Francisco commercial property leases that City officials hope will bring approximately $146 million a year, with 85 percent of funds designated for childcare and education among children from birth to five years old and 15 percent of funds available for general city purposes.

It was part of the June 5th, 2018 election, and the measure narrowly passed after weeks of careful vote counting, by 4,114 votes, according to Ballotpedia. The tax exempts commercial landlords with less than $1 million in gross receipts, along with rents for nonprofit, government, arts, industrial and non-formula retail uses, among other state exemptions.

The tax will almost certainly be passed on to the commercial tenants, increasing the average rents in the city, which could have the unintended consequence of pushing some tenants away from San Francisco.

We sat down with a team of commercial real estate experts from Transwestern to help us navigate the new law and determine its impact on the industry. Jamie Mahoney, Blake Peterson, Peter Conte and Michael Federle provided the feedback.

Tell us briefly what is Proposition C, and what is it intending to accomplish?

Jamie Mahoney: Universal Childcare for San Francisco Families Initiative, or better known as Proposition C, is a tax intended to raise funding for early childhood education and childcare for low and middle-income families in San Francisco. The initiative is funded from an increase to taxes on gross revenues from commercial landlords.

What/who is included in the law, and what/who is excluded?

Jamie Mahoney: The measure raises a 1 percent tax on revenues received from the leasing of warehouse space, and 3.5 percent tax on revenues received from leasing of commercial space. Exclusions to the taxes include use such as residential, non-profit organizations, arts activities, most retail, as well as industrial.

How much money is the law projected to collect annually?

Jamie Mahoney: The City estimates the measure will raise $150 million dollars annually from commercial landlords.

How did the Proposition come to be? Who sponsored it?

Jamie Mahoney: Proposition made it to the ballot due to a successful citizen initiative led by San Francisco Supervisors Norman Yee and Jane Kim. Supporters were able to achieve signature requirements to get the initiative onto the June 5th ballot. The signatures proved to be important since the requirement to pass a vote only came down to a simple majority. The competing measure, Proposition D, did not meet the signature requirement, and therefore would have had to achieve a two-thirds majority in order to pass.

Now that Proposition C passed, who will be most affected by the new law, directly and/or indirectly?

Blake Peterson: The law is written as a tax on commercial landlords, however, most commercial leases are structured in a way to allow taxes such as this one to be passed directly on to tenants. Occupancy costs in San Francisco are already high, and this is another way for the city to take advantage of the healthy economy in San Francisco.

What are the consequences (intended and unintended), in your eyes, of this Proposition passing?

Peter Conte: The intended purpose of the measure is funding a need and an important initiative in the city. However, the increase in occupancy costs will put the burden on businesses that did not have a say in the vote.

Is there a way for the law to be challenged? Do you anticipate it being challenged?

Peter/Blake: The measure can be amended or repealed by the San Francisco Board of Supervisors per Section 2113 of the ordinance. However, the likelihood of the measure getting amended or repealed would not be a favorable position politically.

Does the law have a sunset clause? If not, when may it be challenged?

Peter/Blake: There is no sunset clause in the law. As we just mentioned, the San Francisco Board of Supervisors could amend or repeal the law, but it would be unlikely that would happen. Voter support for a future ballot measure is likely the only way the tax would be repealed

There has been a resurgent tax movement recently, head tax in Seattle, similar tax proposals in Silicon Valley. Do you see this form of taxation spreading across other sectors, and how could it possibly manifest itself?

Michael Federle: [What is considered] low income in San Francisco is almost twice the national household income, so the cost of living here sets it apart from other markets. As you mention, it is similar to the Seattle head tax of $275 per employee that was earmarked for homeless relief, but that law was immediately rejected by large employers such as Microsoft and Amazon and was quickly repealed. Assuming an average of $75 per-square-foot in rent, and 200 square-feet per employee, Prop C would equate to a $570 per head tax as a comparison. The difference I see here is that childcare is valuable to nearly all parents (or future parents) in such an expensive city, and to the employers that benefit from their talent taking less family leave. This could explain the narrow victory, presumably split by age group. However, if you look at the percentage of yay versus nay, it’s too close to say it could be a sweeping future trend anywhere.

How will this affect investor decisions moving forward? Will this compress values?

Michael Federle: It doesn’t seem that Proposition C will affect values much since employers that make up most office tenants are here due to the huge talent pool. But base year leases will definitely see an expense increase until the total rent paid becomes too high, and then more move outs will occur. Once that happens, all-in rents will subside. My feeling is that the traffic gridlock has a more negative impact than a 3.5 percent tax increase. Long, uncomfortable commutes could result in talent moving elsewhere. Still, this will be good news for Sacramento and other outlying venues that are a more affordable option for businesses considering a move.

Peter Conte, Senior Vice President, Leasing Services
Peter specializes in technology real estate, representing high-growth and dynamic entrepreneurial companies such as Adyen, WeWork and Eatsa. Having started his career in integrative biology and genetics, he is now in his 13th year of San Francisco real estate, using this hands-on laboratory background to better understand the needs of biotech clients.

Michael Federle, Senior Vice President, Investment Services Group
Michael represents institutions, developers and high net worth individuals in the sale, acquisition and financing of quality real estate assets. His total sales and financing volume is approaching $3 billion of completed retail, mixed-use and office building transactions in addition to the sale of over 4,400 apartments. Michael and his team have an emphasis on exclusively representing property owners.

Blake Peterson, Senior Vice President, Asset Services
Blake oversees property management and engineering of Transwestern’s Northern California assets. Current clients include Workday, Swift, TH Real Estate, Shea, Lift, Barings and Griffin Capital. She brings over 15 years of experience in property management, specifically in operations, construction and finance. Previously, Blake was a Director of Asset Services for Cushman & Wakefield, overseeing 34 Class-A commercial office buildings in downtown San Francisco totaling more than 7 million square feet.

Jamie Mahoney, Research Analyst
Jamie tracks local, national, and global market trends to deliver acute analysis and creative insight needed to serve clients across all service lines. He is part of Transwestern’s Thought Leadership Advisory Group, and 2017 company-wide research award winner for his work on studying the impact of autonomous vehicles on commercial real estate.