San Diego gives initial thumbs up to lease 101 Ash for low-income housing

San Diego leaders are embracing a development team’s $250 million proposal to convert the asbestos-ridden, city-owned office tower at 101 Ash St. into hundreds of residential units reserved for low-income families.

On Wednesday, San Diego’s Land Use and Housing Committee voted unanimously in favor of recommending approval of a 60-year ground lease with housing developers MRK Partners and Create Dev LLC. The action tees up consideration of the transaction by the full City Council, potentially at the end of the month.

Under the deal, as currently structured, the city would loan the value of the building, or $45.6 million, to the developer and issue a seller’s note to recoup the leasehold payment, plus 4% simple interest, over a 55-year period. The city is not contributing cash to the project. It also does not anticipate receiving any payments on the loan until year 15.

“This proposal does just what the city needs in a time of crisis — big, bold ideas and a tenacity to re-envision a vacant, underperforming skyscraper into an exciting adaptive reuse conversion from hundreds of offices to lively apartments,” Christina Bibler, director of San Diego’s Economic Development Department and the city’s lead negotiator on the deal, told committee members. “City staff has worked diligently, at the council’s direction, to present an opportunity for you all to consider a different future for this plagued, city-owned vacant asset to be a contributing asset in our portfolio and touch the lives of future generations.”

The MRK-Create team is proposing to remake the office building with 247 residential units deed restricted for families earning 30% to 80% of the area median income, or what’s considered affordable housing. The project also includes three unrestricted manager units, 25,000 square feet of retail space and a 4,000-square-foot child care center.

Councilmembers Kent Lee, Sean Elo-Rivera and Raul Campillo spoke favorably of deal terms and expressed a desire to turn the page from past mistakes associated with the building. But they also acknowledged the significance of reviewing the specific language in the disposition and development agreement and ground lease, which were not ready in time for the committee hearing. Councilmember Vivian Moreno was absent.

“I think this project is certainly an opportunity to turn the site into much-needed affordable housing … and, of course, (an) opportunity to turn what has been part of a dark chapter in our past into something that does serve the public in a meaningful way,” Lee said. “What has helped me in terms of some of this discussion is recognizing that the structure of the terms that you’re presenting are pretty much in line with several other projects that this council has considered.”

Built in 1967, the 21-story office tower at 101 Ash St. takes up a full city block in downtown San Diego and was the longtime home of Sempra Energy until 2015. In early 2017, the city entered into a 20-year lease-to-own deal to acquire the building and use it for a portion of its downtown workforce. The transaction turned into a civic disaster after a bungled remodel effort resulted in asbestos contamination and other issues.

In 2022, San Diego bought out the lease for $86 million in a controversial settlement agreement. The city continues to spend millions annually on building upkeep and security, although the office tower is empty and uninhabitable in its current state.

In January, San Diego City Council members selected the MRK-Create team to convert the office building into a residential tower with first-floor shops.

Los Angeles-based MRK is a privately held real estate investment company singularly focused on affordable housing development, including hotel- and motel-to-residential conversion projects. The company was started by President Sydne Garchik in 2015. Create is a one-person company run by Kelly Modén, a San Diego planning commissioner, specializing in multifamily housing. Last week, Modén set up a distinct limited liability company, MKAFF Housing LLC, for the 101 Ash St. transaction. Modén and Garchik have previously worked together on affordable housing projects.

The partners have put forward a costly conversion plan that requires $40.1 million for asbestos abatement and interior demolition work, and $67 million for the residential remodel. The team is also estimating $20 million in loan and interest charges. In addition, MRK-Create has agreed to enter into a project labor agreement and will pay prevailing wage rates for construction work, adding $18.5 million to the total cost. The partners will eventually pocket $24.5 million as a developer fee that is also baked into the project cost.

The high cost to convert the building into affordable housing — estimated at more than $1 million per unit — is a worthwhile endeavor because it is unusable in any other capacity, Modén told the Union-Tribune.

“This is the best reuse program for that building — to convert it to affordable housing and leverage federal financing through tax credits,” Modén said. “We’re going to be able to house up to 800 people in this building and provide a lot of family units. And we are desperate for affordable housing.”

Affordable housing projects are subsidized by a combination of local, state and federal subsidies to offset construction costs. The subsides, which allow for units to be rented at below market rates to income-qualified tenants, come with government oversight. Rental rates are set by the U.S. Department of Housing and Urban Development each year and are specific to each renter’s family size and annual income.

The MRK-Create team’s financing plan calls for two federal subsidies — low-income housing tax credits and historic tax credits —.that will contribute $114.7 million to the $250.3 million conversion project.

The team will seek $82.5 million in low-income housing tax credits, which are highly competitive and doled out on a rolling basis by the California Tax Credit Allocation Committee. If the developer is awarded the tax credits, it would sell them to private investors to secure project funding. The group is also banking on receiving $32.2 million in tax credits associated with historic properties even though 101 Ash St. is not a historic property.

The ground lease gives the developer a two-year window to secure financing, according to a staff report prepared for the committee meeting.

San Diego is not providing a cash subsidy, but it will underwrite the project through the aforementioned seller’s note, which closes the project’s financing gap. As proposed, the developer will start to repay the $46.5 million loan around year 15, when the project is refinanced. The city will then receive annual payments equal to 50% of the project’s rental proceeds, minus expenses, with money deposited in the city’s general fund.

“Our office believes that the proposal before you today is sound on its fiscal, economic and policy merits,” Noah Fleishman, a fiscal and policy analyst in the Office of the Independent Budget Analyst, told committee members.

Fleishman also noted that the city spent $7.2 million between fiscal years 2023 and 2025 on the maintenance of the unusable building. The city recently budgeted an additional $2.5 million for property management costs in the fiscal year that started Tuesday.

As such, committee members are anxious to get the building off the city’s books. Campillo was disappointed to learn that the deal, as proposed, would require the city to continue paying for building expenses until the close of escrow, which could take up to two years.

Despite a favorable assessment, Fleishman flagged one concern.

“Our office would like to note that the pro forma relies on the project being awarded a federal historic tax credit. Historic tax credits are not guaranteed because the building is not currently registered as a historic building or contributing to a historic district,” he said.

Lawyer Michael Aguirre, the former San Diego city attorney who is trying to unwind the city’s lease-to-own deal for the property, cautioned council members against moving the deal forward, in part because transaction documents were not ready for review.

“If you approve this, we will be in court, and I will tell the judge, ‘Your honor, they never even saw the agreement before they approved it,’” Aguirre said during public comment. “You don’t know what’s in there. … What happens if the income isn’t sufficient to pay the bonds? Who pays the bonds? Do you know? Does anybody here know that? I don’t think so.”

Aguirre also questioned the logic of entering into a 60-year lease agreement for a building that was determined in a 2016 appraisal to have only a 50-year economic life.

The 101 Ash ground lease and development deal documents should be ready next week with the aim of returning to the full City Council at the end of the month for final approval, Bibler said. The timing is meant to ensure that the development team can compete for low-income housing tax credits in September, she said.