'Another Irritant': Challenges Mount For San Francisco Retail As New Tax Looms

Halfway through the first year of a new retail vacancy tax in San Francisco, reasons for the city’s empty storefronts have piled up, expanding well beyond the purview of the tax while the exact method for its implementation remains unclear ahead of the first collections in 2023.

The voter-approved tax, passed by a wide margin just days before the pandemic began in March 2020, was meant to deter retail landlords from keeping property vacant in hopes of finding higher-paying tenants.

Six months in, opponents say it doesn’t address the underlying issues.

“It’s just yet another irritant of operating in San Francisco,” Colliers Executive Vice President Julie Taylor said in an interview. Taylor handles retail tenant and landlord representation.

The overall retail vacancy rate in San Francisco is well within the range that is considered healthy, at 4.9% in the first quarter of 2022, and was even lower in 2019 when the tax was placed on the ballot at 3.5%, according to a Cushman & Wakefield report.

But in individual neighborhoods where the tax applies, like North Beach, Japantown and Inner Clement, vacancies are a bigger problem, leading to creation of the tax.

The Commercial Vacancy Tax was initially slated to go into effect in 2020, but implementation was delayed into 2022 as a result of widespread pandemic-induced business shutdowns. 

Proposed by Supervisor Aaron Peskin, the tax is intended to fill vacant storefronts in some of the city’s busier neighborhoods, prevent "bad actor” landlords from gouging rents and give small businesses more leverage when negotiating leases.

To be subject to the tax, which is levied based on the length of a store’s frontage, retail spaces must be vacant for 182 days or more in a calendar year. The clock on the calendar for the first year of collections began on Jan. 1, 2022.

In 2023, the first year of collections, the tax amounts to $250 per foot of frontage, before escalating to $500 for the second year, and $1K for the third year and beyond. Among those who could be on the hook are landlords, property managers and tenants if the space is subleased.

According to the San Francisco Planning and Urban Research Association, the average commercial property frontage is 25 feet, resulting in a $25K tax for a vacant property by year three. 

Revenue generated by the tax will flow into a specially created Small Business Assistance Fund.

The tax could generate anywhere between $300K and $5M annually in revenue, according to a 2019 economic impact report from the city’s chief economist, Ted Egan.

The impact of the tax is speculative, Egan said in an email to Bisnow, since the city has not done research on the issue since the 2019 report. But, despite a pandemic in the intervening years, Egan believes that the economic analysis wouldn’t be much different today.

“It’s likely more properties would be swept up into it because of the state of the market. Then, as now, the biggest driver of retail vacancies in the city is a lack of demand, due to competition from online shopping and the challenges of starting and operating a small business in the city,” Egan said.

Egan's report acknowledges it would be difficult to differentiate between small, local landlords and large institutional ones, each of which would feel the impacts of the tax differently.

Colliers’ Taylor said some of the affected landlords could be senior citizens who depend upon income from the building to fund their retirement. She noted that these small landlords are already coping with high construction and permitting costs.

“A lot of the buildings I have encountered that are not leased, are not leased because the landlord does not have the capital to bring the building up to code, because whatever was OK 10 years ago or 20 years ago, isn’t OK anymore,” she said.

Those costs are more likely to keep buildings vacant than a “bad actor,” Taylor said.

“There are a ton of reasons why spaces sit vacant, and rent is not one of them,” she said. “The idea of a ‘bad actor’ is lunatic.”

Another complaint is that the permit process for chain stores in San Francisco is more restrictive than in other cities, per the city’s Formula Retail policy, which regulates the placement of chains with 11 or more locations in the U.S.

Taylor says another reason for retail vacancies is the perceived rise in crimes such as property damage.

But, crime data from the city of San Francisco shows that property crimes dropped by 25% from 2019 to 2021. And while larceny theft, the category which includes retail theft, does significantly outrank other types of crime, according to the San Francisco Police Department, it dropped off considerably compared to pre-pandemic levels.

Reported larcenies in the city dropped 31% to less than 32,000 in 2021. But year-to-date in 2022, 14,752 such crimes have been reported, an increase from 12,392 in the same period in 2021.

Taylor points to the recent closures of Walgreens locations as a prime example of businesses not wanting to occupy storefronts in the city. 

Walgreens attributed the closures to what it described as excessive shoplifting — which has been heavily contested, particularly given the pharmacy chain’s saturation of stores in the city, and their proximity to one another. 

The San Francisco Chronicle reported last year that the company had notified shareholders in 2017 of its plans to close stores, eventually shuttering 769 nationwide. The company plans to close an additional 200 stores as a way to save $1.5B in annual expenses amid broader economic turmoil, according to a Securities and Exchange Commission filing.

San Francisco’s retail occupancy situation is complex, in part because of fluctuations between neighborhoods, according to CBRE Senior Vice President Laura Sagues Barr, who specializes in retail leasing.

“There are neighborhoods in which vacancy is up, and there are multiple neighborhoods in which the market has tightened and there’s immense competition for remaining space, and retail sales are stronger now than they were pre-Covid,” she said. “Residential-heavy areas with strong pedestrian traffic are and have been quite strong."

Barr says she has heard from tenants with concerns about theft in the city, but she is optimistic about the city’s overall state, despite the national perception.

“We are seeing improvement. I can tell if someone has been in San Francisco by the way they ask me the question, ‘How are things in San Francisco?’ Once someone gets here and sees what it’s like, those from out of market realize it is much better here than the general press is making it seem,” she said.

And while retail performance is struggling in some parts of the city, restaurants in areas like the Financial District are seeing sales stronger than pre-pandemic. Plus foot traffic is increasing as people trickle back to the office, she said.

Barr cites occupancy data from Kastle Systems, which has shown slight upticks in keycard card swipes as 2022 has progressed, as one noticeable encouraging metric, though the city still lags behind other metros.

The complexity of San Francisco’s retail market means that there is more than one issue to contend with, Barr said. But she is encouraged by growing improvements to some of the common roadblocks, such as rising construction costs and the lengthy permitting process. 

“I know that the city is working to address those, they have made some changes on fronts there that we are hoping tenants and brokers will continue to learn about to make permitting easier in certain cases,” she said.

The larger unknowns of the tax will come down to the implementation, according to Amanda Fried, chief of policy and communications with the city’s Treasurer & Tax Collector Office. 

“We need to make sure we get all of the actors involved, so we can understand: At the end of the day, was this building vacant, and subject to the tax, and who is left holding the bag?” she said.

Implementation has yet to be finalized, with six months to go before tax collections kick in, but it will rely largely on self-reporting and community input, Fried said.

“It’s different. We are really going to lean on the public to help. We want people to report, ‘Oh, this property looks vacant,’” she said. “We do have a pretty robust investigations team and audit team, so we rely on self-reporting, but we do rigorous checks on the other side as well.”