Assessing a Commercial Property Showdown in San Francisco

Relations between major property owners and local government officials in a place with left-leaning politics such as San Francisco are never going to be wholly cordial, but it takes a major economic downturn for the knives really to come out.

“Some of these corporations have gotten away with murder in the past,” County Assessor Mabel Teng was saying the other day.

“The Board of Supervisors and their liberal politics have alienated a lot of corporate America with the anti-business attitudes at City Hall,” Ken Cleaveland, director of government affairs at the San Francisco Building Owners and Managers Assn., told me the same afternoon.

If it sounds as though a showdown is looming at City Hall, that’s right.

In the last two years, the number of assessment appeals filed by major property owners in San Francisco has tripled. The owners of some of San Francisco’s most prominent commercial landmarks, including the Transamerica pyramid and 555 California (the Bank of America building), are claiming the value of their properties have been cut in half during the recent economic slump. They’re insisting on commensurate reductions in their property taxes, which the law accommodates.

Teng, who took office at the beginning of this year, is willing to agree that the economy might have pared some value from major buildings, but she doesn’t want to be a patsy, either. The assessor’s office has been woefully outgunned by skyscraper owners in the past, she says.

“They know how to use every opportunity,” Teng says. “They have facilitators, like personal injury attorneys, who get a cut” of whatever assessment reduction they can achieve.

Mark Ong, tax division director at PricewaterhouseCoopers, who would qualify as one of Teng’s “facilitators,” paints a far less sinister picture. “My clients are all trying to make sure they pay their fair share, but nobody wants to pay more” than they should, he says. “They are just trying to stay alive” -- at least until an expected recovery in 2005 or 2006.

For property owners of major buildings seeking significant reductions, it pays to assemble the big guns; at a tax rate of 1.1% of assessed valuation, a $30-million valuation reduction is worth $330,000 in tax savings, which is enough to pay a squadron of experts and still have plenty left over.

Therefore it’s not surprising to hear Teng’s deputy, Richard Hillis, describe the experience of walking into an assessment appeals board hearing for Transamerica Corp. a few months ago: “They had 12 to 15 people there -- corporate staff, local appraisers, expert witnesses. We had two.” (The board ultimately reduced the assessment for the Transamerica pyramid from $236 million to $187.5 million for 2001; the owners are pressing for a further reduction to $97 million for 2002.)

Teng has asked the city for $250,000 to hire her own corps of outside experts, but no one in her office talks as though there’s any prospect of creating a truly level playing field.

Teng and Hillis say they’re worried this unequal deployment of professional firepower will end up increasing the relative financial pressure on residential ratepayers. Between 1975 and 2001, Hillis notes, the percentage of San Francisco property taxes paid by homeowners rose from 41.5% to 51%, and large-scale commercial reappraisals are likely to raise that share even more.

The assessor’s office also is wary of giving big owners a break that may look justified as a snapshot of today’s market but doesn’t reflect the longer-term value of San Francisco office property.

Teng cites as an object lesson the reassessment awarded to the Fairmont Hotel, one of Nob Hill’s toniest, in 1995 in the wake of the last property slump. “They started at $82 million and got that reduced to $58 million,” she recalls. “Two years later, the hotel was sold for $100 million.”

The context of this crossfire, as anyone might guess, is the collapse of the Bay Area’s dot-com economy. The crash has emptied huge swaths of San Francisco’s more marginal business districts. Multimedia Gulch, the bay-front neighborhood that once housed hundreds of hot-ticket Internet start-ups in lavishly upgraded ex-warehouses, “is just a gulch now,” Cleaveland says. Even in some of the most desirable blocks of the central financial district, occupancy levels and rents have gone down sharply.

A generally soft economy has only added to the pain from the high-tech meltdown. “We are way past the dot-com bubble bursting,” Frank Fudem, a tenants representative at BT Commercial Real Estate, told me. “This is now a significantly smaller economy than we had” during the downturn of the early 1990s.

The situation has opened a suppurating wound in the $5-billion municipal budget, which already is facing a $347-million deficit. If the owners of all buildings worth $50 million or more win their pending appeals, according to a printout Hillis prepared for me, the city’s assessment roll will be slashed by $8 billion, or more than a third. That would cost the city roughly $90 million in property taxes.

By most accounts, the scale of this collapse is unique among California cities. Los Angeles hasn’t experienced anywhere near the same plunge in occupancy rates or office tower values, L.A. County Assessor Rick Auerbach says. That’s true even on the Westside, where values have been most volatile.

But for all of San Francisco’s very real troubles, Teng maintains, some building owners are using the economic malaise to try to extract reassessments they don’t deserve.

Although property brokers cite a citywide office vacancy rate of more than 20%, the real rate varies widely -- from more than 40% in the dot-com district to less than 10% among the so-called Class A buildings of the downtown financial district.

“The best buildings downtown are very stable and well-positioned,” says Wes Powell, senior vice president and regional leasing director for building management firm Jones Lang LaSalle. “The central business district wasn’t overpopulated by Internet companies, and most landlords have been able to maintain a diversified corporate tenant base.”

He ticks off a list of signature downtown buildings with direct vacancy rates below 10% (that is, outside of vacant space the primary tenants may be trying to sublet). It comes to 14 of the top 23 Class A buildings in town -- several of which are nevertheless applying for assessment reductions of 10% to 50%.

Another aspect of the problem, some say, is that average rents have fallen while expenses have risen. “Rents grew through the ‘90s, spiked in 2000, and have now fallen off a cliff,” Fudem says.

A tenant now pays annual rent of $25 a square foot for what Fudem calls “pretty good space” in the financial district that might have brought in $80 or $90 three years ago. That’s the same level as 1993, Fudem says, but the difference is that landlords’ operating expenses and taxes are eating up more than half of that sum, compared with only 40% a decade ago. Some landlords desperate to keep their buildings filled are accepting rents that actually yield them zero after taxes and expenses are covered, he says.

Perhaps the most unnerving aspect of the slump in landlords’ eyes is the uncertainty about how long it will last. Some market observers say there won’t be a real recovery until the Bay Area finds some new industry to match the explosive growth of the dot-coms. It’s not unusual to hear real estate people musing speculatively about what new lode may be out there. (“Biotech? They rent lab space, not office space.”)

Some predict gloomily that so much space is vacant in the city that even a vigorous recovery won’t burn off the overhang for another 10 or 20 years.

Others say San Francisco has confounded such dismal expectations before. Powell argues that low rents eventually will attract tenants back downtown from the outlying reaches of the Bay Area, where they were driven by the outlandish office prices of the go-go years.

“It’s the simple law of supply and demand,” he says. “San Francisco is still one of the top five places where people want to put their money, and may be among the top three.” He pauses. “But don’t kid yourself. This was a big downturn.”

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Golden State appears every Monday and Thursday. Michael Hiltzik can be reached at golden.state@latimes.com.