Converting Retail Into Housing: Bill Could Make California First State To Enable This Reuse

A bill passed by the California Senate would compensate cities for lost retail tax revenue if they allow vacant property to be converted for housing.

A proposal in the California Legislature could make the state the first to provide incentives to cities to turn vacated retail space into housing as the nation’s most populous state looks at different approaches to address a shortage of housing affordable to working families.

The state Senate passed a measure that would encourage cities to convert abandoned retail sites into affordable workforce housing, in part by compensating cities for lost sales tax revenue that otherwise would have been generated by retail occupiers.

Senate Bill 15, put forward by Democratic Sen. Anthony Portantino of Los Angeles, now heads to the state Assembly for consideration. It would make California the first state to enact such a policy on a statewide level if it becomes law.

“With SB 15, we can construct affordable housing on land formerly used by commercial retailers and give local governments fiscal incentives to reward them for rezoning, approving, completing and allowing occupancy of affordable housing projects,” Portantino said in a statement following his bill’s passage in the Senate by a 38-0 vote Tuesday.

The concept of converting vacant retail space into housing has been floated previously in California, and at the national level, as major retail chain closings mounted well before the pandemic amid rising use of e-commerce services. The latest proposal could set the stage for other states to follow suit as an unprecedented number of retail closings and bankruptcies last year during the health crisis brought the issue of vacant space to the forefront in cities nationwide.

The national mall vacancy rate, for instance, has grown to roughly 7.4% as mall retailers including department stores have given back more space — over 3.5 million square feet — than they’ve leased this quarter alone, according to the most recent data from CoStar.

Last summer, leaders of the U.S. Department of Housing and Urban Development advocated for more use of vacated retail and other commercial property to provide new housing. Los Angeles County supervisors passed a zoning ordinance allowing multifamily development in certain commercial zones, and L.A. regional officials are gathering lists of commercial properties where developers could be attracted to create new housing.

There are challenges. Concerns about such commercial reuse policies have been raised by officials in some cities, who say decision-making authority over local zoning could be usurped. “City leaders have the requisite local knowledge to discern when and which sites are appropriate for repurposing and which are not,” said Mike Griffiths, founder of California Cities for Local Control, which represents more than 400 mayors and council members, in a statement.

Even so, proponents argue that under the state bill, cities across California could see long-empty spaces put to use to address housing issues facing those same communities. According to a 2015 projection by the California Department of Housing and Community Development, the state needs 1.8 million new housing units, or 180,000 new homes annually, just to meet demand from expected population and household growth through 2025. Gov. Gavin Newsom campaigned for office seeking to add 3.5 million housing units to the state by 2025 based on other projections of potential need.

California’s housing costs are among the highest in the nation, putting housing out of reach for many occupations including teachers, nurses and public safety officers. That issue, along with high taxes and other costs of doing business, has led several companies to leave California to set up operations in lower-cost states.

“Lack of affordable housing is a major issue for current and potential employers in California counties and negatively impacts our economy,” Portantino said.

If passed by the Assembly and signed by the governor, the measure would allow local cities to receive from the state the average of the annual amount of sales tax revenue generated by a given site for the past seven years, provided the site gets converted and occupied with new housing. The city would receive that average amount for a total of seven years.

If the city approves a mixed-use development on the site, the city would be eligible for the sales tax rebate only on the amount of square footage dedicated to housing.

‘Better Use’

Mike Moser, principal in brokerage firm Retail Insite, said changes proposed in legislation to encourage cities and lessen zoning restrictions could help ease transitions that may need to be made at locations throughout the state as housing becomes more in demand than retail.

While some regions like San Diego and Orange County remain tight for retail supply and demand, there are other locations throughout California where vacant properties have become no longer feasible for retail or have become dilapidated while awaiting new tenants.

Demand trends suggest more of these properties may need to be converted to mixed uses with housing as one of the elements, but local regulations prevent that from happening in a timely manner.

“The developer knows there’s a better use for that property, but that developer right now will very often need to go through a very complex process to either rezone or get a community plan amendment approved,” Moser told CoStar News. “That could take two or more years before you could even get started on a project with housing in it.”

The measures are among a slew of initiatives put forward in the California Legislature over the past two years, with mixed results, seeking to boost the supply of affordable housing while tackling problems arising from the affordability crisis, such as rampant homelessness.

The Legislature is also considering a bill by Sen. Anna Caballero, a Salinas Democrat, giving local governments authority to approve residential development infill projects on existing land zoned for retail or office uses without needing to rezone the property. Senate Bill 6 passed the Senate last month and is awaiting review by the Assembly.

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