The ABCs
of Prop D

written by
Terrence Jones

The pros and cons of the Retail Vacancy Tax.

I found some compelling arguments on both sides of the Retail Vacancy Tax, the proposed measure that will tax retail landlords if their spaces are empty for more than 182 days. My initial feelings were strongly anti-tax, but as I researched the topic, the pros and cons got foggier and I was surprised by the polarization on this issue. 

For example, a November 22, 2019 SFist.com post seemed to be a slap in the face of our esteemed city leaders with allegations of onerous permitting requirements and red tape, but at the same time it also accused landlords of hoarding space.

“Retail storefront vacancies are a new common blight across formerly thriving commercial corridors like the Castro and North Beach, with the empty-shop phenomenon spreading into Hayes Valley. City Hall red tape and onerous permitting requirements are not exactly helping matters, as a lengthy Eater SF report this week showed how the western neighborhood businesses face hurdles in opening new storefronts, too. But the allegation that landlords are hoarding space has been a suspicion of, say, anyone familiar with the astonishing 16-year vacancy of the Castro Hamburger Mary’s location (which did eventually open in spring 2018). We may never see such a long-term vacancy again, as the Examiner reports that Sup. Aaron Peskin’s proposed Storefront Vacancy Tax will be on the March 2020 ballot after unanimous Board of Supervisors approval Thursday. This was an 8-0 vote with three supervisors, including Peskin, already off for their Thanksgiving holiday. But the retail vacancy tax now goes before you, the voters.”

And according to a November 14, 2019 article in the San Francisco Business Times, a well-known commercial agent Hans Hansson noted that vacancy indifference in the ownership community is not the problem.

“. . . the actual number of vacancy-indifferent landlords is very small, and a majority of landowners with vacant spaces run into a multitude of other factors in trying to fill them up. Hansson said there were 340 vacant storefronts in the city at that time…Shifts in consumer shopping habits, the Bay Area's high cost of living and San Francisco's lengthy permitting process have all served the pool of available tenants has shrunk considerably in recent years…The majority of building owners, and certainly retail brokers like myself, are all aggressively trying to fill these vacant spaces," Hansson wrote. "In almost all cases, the rent is not the stumbling block; it's the high cost of starting the business, strict government regulations and the risk of ultimate success."

In talking with Maryo Mogannam, president of the San Francisco Council of District Merchants Associations, he felt that the tax could be good for existing small retailers who are punished by neighboring vacant spaces, although he was not initially in support of the tax. He has four stores in San Francisco called The Postal Chase, which do packing, shipping, and allow people to receive packages, and he did not see how the initial proposed vacancy tax would benefit him. He gives Supervisor Aaron Peskin credit for re-crafting the proposed law to make it better before submitting it to the board to move it forward to the ballot. The new law will only impact thirty Neighborhood Commercial Districts (NCD) versus the entire city. He said, “Boarded-up, vacant retail spaces in a district creates urban blight and decreases the foot traffic for our members. If your store is next to a vacant space, potential customers could just stop at the boarded up-store because their perception is that the offerings end there. And consumers are fickle. If it is not easy for them and they are not getting a vibrant shopping experience, they will hop into a car and drive to Serramonte to spend their money.”

In fact, Maryo’s association is supporting the tax. Although it was a close vote of 9-5, the small business merchants felt it was a good thing. Maryo was able to give me some real color to the vacancy issue. For example, the West Portal district has had significant trouble with the departure of Walgreens, Radio Shack, and Waldenbooks. Those spaces have seen long vacancies that have hurt the neighboring merchants. Another good example is in Noe Valley where Real Food closed 10 or 15 years ago and remained vacant for at least 10 years before Sephora finally occupied the space. These vacant storefronts, also called “dark spaces” in the commercial real estate business, create places where tent encampments can build. Even worse, dark spaces are often host to graffiti and fire danger from squatters cooking with open fires.

According to Maryo, the commercial retail environment is stacked against the small merchant in San Francisco. Rents are high, wages are high, there are too many small business taxes and fees, and (of course) the “Amazonization” of commerce has been crushing. Another issue, and one of the biggest, is the city’s efforts to reduce cars by getting more people to ride MUNI, but MUNI is unreliable. If a passenger wants to get off on the way home to shop at an NCD, they don’t know if they will be able to get back on without a long wait. Maryo should know, he worked for MUNI before his retail career. It amazes him how we live in a first world city and first world country, but the public transit is more like third world.

I spoke to an owner who has a building close to City Hall with retail space on the street level and rent controlled apartments above. Her first reaction to the Retail Vacancy Tax was “why should there be a tax? Owners like to rent out their retail spaces if they can.” Further, she said she views her apartments as “partnering” with the city. Her modestly priced rent-controlled apartments are providing low-income housing to the city. She typically rents to people who are not making $100,000 per year in income, which she feels is a social good that allows diversification in the city. Since the city highly regulates residential housing through rent control, she considers the city to be her partner in providing low income housing in San Francisco. “However, for commercial spaces, you would think that the city would want to partner with me as well, but a vacancy tax is not a partnership. What the city should be doing to get retail rented is make the streets nice and safe.”

The streets around her building are littered with filth, homelessness, and drug use. She has been managing her building for 15 years and has never seen so many people shooting up on the sidewalk. To her, it feels like the rights of the homeless are being considered on a higher level than those of the taxpayers. She has a space that was a restaurant, and could be once again, but the cost would be about $300,000 with the code upgrades that are triggered by re-building an eating establishment in her old historical building. She cannot afford to cover that cost and any potential restaurant tenants who have approached her cannot afford it either. She has a real fear that if she invests this amount, it could bankrupt her if the restaurant fails. It’s a big risk. If the city offered a program for owners to help finance these types of build outs and expedite the permits like they did in the earthquake retrofit programs, it might help. Plus, it would seem more like the partnership she has with the city with the housing she offers, but unfortunately, this is not part of the Retail Vacancy Tax proposal.

I spoke to a representative of one owner who has had a 40,000 square foot building in the downtown market that has been in redevelopment construction for at least 10 years. To the outside world it simply appears vacant, but the city has made it hard for the owner to fill the space. In fact, the agent called the proposed tax “anti-landlord” and a “Trojan horse.” The owner will be imposed a punishing tax without any assistance in filling the space. And the Trojan horse has two heads. The first allows the city to accumulate more data on an owner’s personal finances, which will allow politicians to tax them even further. The second makes this a “gateway” tax, one that will ease the way for efforts to create a residential vacancy tax for owners who do not rent their vacant apartments fast enough.

He did say there was some logic to the tax in that merchants are having a tough time operating with the homeless crisis. That Safeway pooper was quite eye opening for the real estate market and if more storefronts were filled, it’s likely the homeless issue will be smaller in those areas. But instead of the tax, here are his top three alternatives:

  • Temporarily lift the formula retail ban to allow chain stores. 
  • Ease the ADA and code requirements on older historical buildings that are trying to lease their retail space.
  • Start a city task force to help merchants manage the homeless people.

I spoke to the agent who represents the space at 222 Sutter between Union Square and the Financial District, once home to Loehmann’s. This store occupied a very large ground floor space with a large mezzanine on an upper floor. The space has been on the market for quite a while and they are looking for an upscale retailer to lease the space, which would help hold the value of the building. The owner has considered converting the mezzanine to office use, which could help, but the city wants it to remain retail. If the owner goes down market to bring in a deep discounter like Ross or TJ Maxx, who sign low-cost 20-year leases, when the retail market rebounds, the owner would be stuck with a long-term lease at the lower rent that discounters usually pay. If the owner wanted to sell the building, the value would be based on the rents at the time of the sale. So, in this case, the economics of holding the property back and keeping it empty to maintain the higher market value makes sense, up to a certain point. But, if there is a vacancy tax on top of that, the length of time an owner can afford to hold off meeting the market will be reduced.

After weighing all these examples, I think I am leaning toward voting against the tax, but the thing to remember is that this vote needs a two-thirds super majority to pass. What will matter is what both sides will do to sway the voters leading up to the March vote and who votes. Please get out and vote. Even if the result is not what you want, you will have legitimacy to complain.

Terrence Jones is a Senior Broker Associate at Zephyr Commercial and specializes in the marketing and sale of investment properties. His business specialty is San Francisco rent-controlled apartments. He has extensive experience with sale of properties and   1031 exchanges purchases. He can be contacted at 415-786-2216 or by email at terence@TerrenceJonesSF.com.