LEGISLATIVE ANALYST REPORT

TO: Members of the Board of Supervisors

FROM: Shauna Johnson and Andrew Murray, Office of the Legislative Analyst

DATE: January 11, 2005

RE: Approving a Method for Community Land Trusts to Convert Existing Residential Buildings to Limited Equity Condominiums (File No. 032031) (OLA No. 031-04)

Supervisor Daly requested that the Office of the Legislative Analyst analyze the impact of the proposed Limited Equity Conversion ordinance on the City’s rental housing stock, the vacancy rate, and low and high-income renters.

Executive Summary

Very few San Francisco renters can afford to own a home in the City. One method of enabling homeownership, particularly for low- and moderate-income renters, is through limited equity condominium conversion, or the process of converting apartment buildings to affordable condominiums. The proposed Limited Equity Conversion ordinance would expand the existing City condominium conversion process to allow a community land trust (CLT) to convert apartment buildings of 7 units or more to condominiums. A CLT is a nonprofit organization that owns land and makes it available for specific long-term community use. In this case, a CLT would buy apartment buildings and sell them as condominiums to existing tenants at below-market rates, in part made possible by public and private subsidization. Once converted, the condominiums would be sold on a limited equity basis, meaning that the CLT would own the land, the tenants would own their unit, and when a unit is resold, the resale price and equity to the seller would be limited.

Under the proposed ordinance, 2,000 units would be permitted to convert each year and tenants who choose not to purchase their unit would receive a lifetime lease, entitling them to protections provided by the rent stabilization laws. Proponents believe that limited equity condominium conversion could be the answer to creating homeownership opportunities without displacing tenants. However, opponents contend with issues such as displacement of vulnerable tenants and preservation of the rental housing stock (particularly rent-controlled units).

The OLA found that the impact of the proposed ordinance on the rental housing stock, the vacancy rate, and on low- and high-income renters would be the following:

• The rental housing stock could decrease by over 1% per year;
• Non rent-controlled housing units in converted buildings would essentially become rent-controlled units through lifetime leases;
• The rental vacancy rate would increase by up to 0.06% per year;
• Homeownership opportunities for low- and moderate-income renters would increase through affordable purchase prices;
• Displacement among renters that choose not to purchase their units would be minimized; and
• High-income renters would have the option to purchase their unit or continue to rent at their current rate.

Background

Homeownership benefits owners by providing an opportunity to build equity in a secure investment and improves quality of life. In addition, there are external benefits including neighborhood and family stability, increased community investment, reduced crime, as well as fewer behavior problems and improvement in school performance among children.¹ Homeowners have greater financial incentives than renters to improve neighborhood quality, become involved in civic affairs, and maintain their property at a high standard.²

Unfortunately, most San Francisco residents face very limited homeownership opportunities. A 2002 study commissioned by the San Francisco Rent Board found that 44% of San Francisco tenants had recently considered buying a home, and 14% of renters were interested in buying a condo. Of those interested in buying, 74% indicated they continued to rent for financial reasons. As a result of San Francisco’s expensive housing market, in 2004, only 14% of San Francisco households could afford to purchase a median-priced home ($597,493) in the area.³

The City sponsors a number of programs geared toward increasing homeownership for low- and moderate-income residents. Currently, the Mayor’s Office of Housing administers seven housing programs designed to make homeownership affordable. These programs include the 2004 Single Family Mortgage Revenue Bond Program, City Second Loans for Designated Townhouse Units, Condominium Conversion Program, Inclusionary Program, Extra Credit Home Purchase Program, Down Payment Assistance Loan Program (DALP), and the American Dream Downpayment Initiative (ADDI).

The proposed ordinance will combine three separate mechanisms to create affordable homeownership opportunities for residents – community land trusts, limited equity ownership, and condominium conversion. Community land trusts (CLTs) are nonprofit organizations established to provide affordable homeownership opportunities. CLTs purchase property, which they resell at reduced rates, subsidized by federal, state, and local grants, government loans, and charitable contributions. CLTs make housing available for purchase through a land lease, which enables the lessee to use the land for restricted housing purposes over time.⁴  By owning the land lease, a CLT is able to make the units affordable in perpetuity by restricting the resale prices. Additionally, initial purchase prices are limited by the ordinance to the extent that the tenant’s total housing costs (including mortgage, homeowners’ association fees, property taxes, insurance, and utilities) would not exceed 35% of their gross income.

CLTs often hold property through a method called limited-equity. In a typical condominium, each owner, in addition to owning their unit, also owns a share of the common space and land upon which the building lies. In a limited-equity arrangement, the CLT retains the land and sells the residential units, making housing more affordable. Additionally, as a condition of owning a unit in a CLT-controlled building, the buyer agrees to certain resale and limited equity restrictions. These restrictions keep the unit affordable to subsequent generations of homeowners in perpetuity.

Opponents of condominium conversions assert that the process negatively impacts affordable housing because it involves removing rental housing (often rent controlled) from the market, in the process sometimes displacing vulnerable tenants. However, the proposed ordinance would offer all tenants of a converted building who choose not to purchase their unit the option of a lifetime, rent-controlled lease. Therefore, limited equity condominium conversions would not displace vulnerable tenants in the same fashion that other condominium conversions can.

Current Law

Because converting apartments to condominiums can reduce the number of affordable apartments, as discussed above, the City restricts the number of rental units that can be converted. Under current law, an unlimited number of two-unit apartment buildings can be converted to condominiums if both units are occupied for one year by separate individuals who each own at least a 25% interest in the property during the entire occupancy period. Buildings with 3-6 units can be converted at a limited rate, through a lottery administered by the Department of Public Works. Among 3-6 unit buildings, a maximum of 200 units can be converted annually. Presently, no apartment building containing 7 or more units can be converted.

The Proposed Ordinance

In December 2003, Supervisor Daly introduced an ordinance (File No. 032031) that seeks to increase homeownership in San Francisco by allowing only a CLT to convert apartment buildings of 7 or more units. To initially convert, tenants of at least 51% of the units would have to agree to purchase their units. Any tenants that do not want to purchase their units at the time of conversion would be entitled to lifetime rent-controlled leases and the option to purchase their units in the future. Under the proposed ordinance, a maximum of 2,000 units per year would be permitted to convert and unused allocations could be carried over to the following year. However, no more than 3,000 units could convert in any 12-month period.

When a CLT converts an apartment building, all units in the building become condominiums; some units will be owned by the CLT and rented to existing tenants, while others will be purchased by tenants who opt-in to buy. Long-term affordability of the unit would be maintained through an agreement between the buyer and the CLT that gives the CLT the first right to purchase and resell the condominium at a price based on the seller’s purchase price and appreciation of the unit.

The proposed ordinance has the following conditions, which distinguish it from the City’s current condominium conversion process:

• Buildings containing 7 or more units could be converted, up to a maximum of 2,000 units per year;
• Only nonprofit CLTs could convert buildings;
• Buildings would have to meet eligibility standards based on the incomes of the existing tenants;
• Existing tenants would have the first right to purchase units – those that choose not to purchase units would be entitled to lifetime, rent-controlled leases and the option to purchase in future; and
• The purchase price of converted units would be kept low, not exceeding 35% of tenant’s gross income, and resale prices would be limited to maintain affordability of the units.

Importantly, because CLTs would be the only organizations permitted to convert units in large buildings, CLTs would only have to compete to purchase these buildings with other CLTs and landlords that intend to continue operating them as apartments (which in most cases are subject to rent control). This keeps the price of these buildings far below what it would be if they could freely be converted to condominiums by any owners.

As nonprofit 501(c)3 organizations, all CLTs would be subject to federal low-income housing tax-exemption guidelines because they are providing low-income housing. Section 42(g) of the Internal Revenue Code (IRC), requires "qualified low-income housing projects" to set aside a certain number of units for low-income tenants.⁵ The Internal Revenue Service (IRS) establishes "safe harbor" rules that nonprofit organizations must abide by when administering low-income housing programs. According to the IRS rules, nonprofit organizations devoted to low-income housing must either allocate 75% of the units to low-income residents or 20% of the units to very low-income residents and 40% to moderate income residents. Additionally, up to 25% of units could be provided at market rates to tenants with incomes above the low-income limit, allowing a limited number of high-income renters the opportunity to become homeowners.⁶

The proposed ordinance relies on income requirements for the San Francisco area as a percentage of the area median income (AMI) determined by the Department of Housing and Urban Development (HUD). According to the HUD income levels, San Francisco households would be considered low-income if they earn 80% or less of the area median income; moderate-income if they earn up to 120%; and high-income if they earn 200% or more.⁷  Making some reasonable assumptions about mortgage terms, low- and moderate-income families could afford mortgages of about $160,000 and $245,000 respectively.⁸ Given the average sales price of an apartment building with 7 or more units ($177,000 per unit),⁹ many condominiums converted under the ordinance could be made affordable to tenants with only modest subsidization.

A CLT hoping to convert a building to a condominium would have to apply to the Conversion Board, which the ordinance would establish to oversee the conversion registration process of eligible CLTs. The Conversion Board would be responsible for establishing application requirements, promulgating additional rules governing CLTs, and assessing fines for failure to meet requirements. By observing the conditions set forth by the Conversion Board, the ordinance would ensure that condominiums are sold and resold in perpetuity at affordable rates. Appendix A describes the 10 conditions that a CLT must meet in order to be eligible to convert apartments to condominiums.

Additionally, a conversion fund would be established to assist with the financing of housing projects (including conversions) where at least 75% of the units will be affordable to those at or below 80% of the area median income (under $54,247 annually). Funding would come from resale of converted units, in which the seller would pay 5% of their net gain on the unit sale to the conversion fund. Not all CLT conversion would require subsidies; however, the conversion fund subsidy would be an important part of financing the conversion of buildings with a high proportion of low-income renters.

Upon introduction, the ordinance was assigned to the Land Use Committee under the 30-day rule and in January 2004 was referred to the City’s Planning Department, where it was determined to be exempt from environmental review. No other action has yet been taken on the ordinance.

Community Land Trusts

There are two types of land trusts that exist to control land use for the benefit of people in the future as well as the present, however they focus on different types of land use. Conservation land trusts work to preserve agricultural land and open space and community land trusts (CLTs) concentrate on acquiring land for affordable housing and community development. The CLT concept was developed in the 1960s and the establishment of CLTs began in the 1980s.¹⁰ Currently, there are over 160 CLTs ¹¹ that exist across the U.S. in 31 states and in Washington D.C and collectively they hold nearly 6,000 units of affordable housing.¹² As nonprofit organizations, a board of directors oversees CLTs and an elected board of trustees operates each building. There is no personal ownership of the assets that the CLT owns or controls.¹³ In addition to providing affordable housing development and/or preservation, CLTs often offer the following services to their respective communities: homeownership center or education program, open-space preservation, non-profit facilities, economic development, construction job training, community planning, and anti-crime organization.

Effects of the Ordinance

The proposed ordinance would impact a number of stakeholders. These include the current owners of buildings eligible for conversion; owners of other apartment buildings and condominiums; low-, moderate-, and high-income tenants; and the City itself. The analysis of the effects of the proposed ordinance are done assuming that all other things remain unchanged, such as rental housing demand, the number of rental units, the economy, rental prices, and related policies. The expected impacts of the ordinance are:

• Owners of buildings of 7 or more units would have an additional market for their buildings (CLTs in addition to other landlords), which would marginally increase the demand for their buildings;
• Owners of apartment buildings of all sizes would not experience substantially reduced demand for rental housing because the reduced number of renters (new homeowners) in the market is exactly offset by the reduced number of apartments available (converted condominiums);
• Owners of condominiums hoping to sell would not experience a substantial reduction in demand for condominiums because most of the new owners of the converted condominiums would be low- and moderate-income households, which are generally priced out of the existing condominium market;
• Owners of condominiums hoping to sell would not experience an increase in supply of condominiums because the resale restrictions on the newly converted condominiums essentially put them in a separate resale market;
• High income tenants that currently live in buildings eligible for conversion would have the opportunity to purchase converted units at market rate or continue to rent at their current rate;
• Low- and moderate-income tenants in converted buildings would have an affordable homeownership opportunity, with a guarantee of a lifetime lease with rent control should they choose not to purchase; and
• The City would experience a new burden of having to administer the program, but the additional cost would be offset by new fees.

Number of CLT Conversions

Although the concept of a CLT has been around since the 1960s, a small number of housing units are currently controlled by these organizations. Therefore, it is difficult to predict whether this ordinance would result in substantial CLT condominium conversions and whether the maximum allocation of 2,000 units per year would ever be met. Two particular constraints are CLTs’ ability to raise sufficient private and public funding to subsidize the purchase of buildings they would like to convert and the ability of low- and moderate-income households to assemble resources sufficient to purchase the converted condominiums, even at the relatively low cost offered.

Rental Housing Market

In 2003, there were 353,506 total housing units and 322,335 occupied housing units. Of the occupied housing units, 197,638 (61%) were renter occupied.¹⁴ The proposed ordinance would allow as many as 2,000 rental units to be converted to condominiums annually, reducing the rental stock by over 1% per year. However, because the reduction in rental stock would be offset by an almost equal number of renter households converting to homeownership, there would be no net loss of rental housing relative to rental housing demand.

Tenant Displacement

Although this ordinance will likely lead to the conversion of rent-controlled buildings (low- and moderate-income tenants are more likely to dwell in older buildings) and lead to the loss of rent-controlled units, no tenant currently living in rent-controlled units converted would be displaced. All tenants of converted buildings will have the option to purchase their unit or accept a lifetime lease. Under the lifetime lease option, rent cannot exceed the rent charged on the date the application packet is submitted, plus any increases permitted under the Rent Ordinance after that date.

Tenants that do not initially purchase their unit will be granted an "option to purchase" that remains valid as long as the tenant resides in the unit. This provision of the proposed ordinance could be useful for low-income renters that want to become homeowners in the future, but face financial challenges such as saving money for a down payment or repairing their credit.

Rental Vacancy Rate

Currently, the rental vacancy rate in San Francisco is 6.7%.¹⁵ If the maximum conversions were achieved, 2,000 per year, the rental vacancy rate would increase to 6.8%, due to the decrease in the total number of rental units without a corresponding increase in unoccupied rental units. Table 1 shows how the vacancy rate would be impacted by the proposed ordinance.

Table 1: Effect of the Proposed Ordinance on the Rental Vacancy Rate

According to the proposed ordinance, if a rental unit were vacant before the application filing, then the unit would be sold to prospective buyers that earn no more than the area median income ($67,809). Or if a unit were vacated after the conversion filing, then the unit would be sold to buyers that earn no more than 40 times the last monthly rent adjusted by the percentage change in area median income. Subsequent to conversion, vacant units are to be sold at the same level of affordability provided to the previous tenants as a rental.

Financial Risks

While homeownership is beneficial in many respects, it poses some risks. To begin with, although real estate has generally been a very stable and financially rewarding investment in San Francisco, there is no guarantee that property values will continue to appreciate at historical rates. Homes can require substantial and expensive upkeep and repairs. For renters unaccustomed to the outlays associated with infrastructure improvements, it can be difficult to remain sufficiently solvent to meet unexpected expenses. To make prospective owners aware of some of the risks, many CLTs offer homeownership education and advice for tenants considering a purchase.

Conclusion

The proposed ordinance seeks to provide affordable homeownership opportunities to households currently priced out of an expensive market by enabling tenants to purchase their unit at a price substantially below the condominium market rate. It does so while protecting tenants who choose not to purchase their converted unit.

The OLA found that if the ordinance were operating at full capacity, the rental housing stock could potentially decrease by a little over 1% and the rental vacancy rate would increase by up to 0.06% annually. However, it is difficult to determine whether or not the annual maximum amount of units (2,000) would be converted. Additionally, low- and moderate-income tenants would not be displaced and would secure the option to purchase their unit as long as they reside in the building, while high-income tenants could purchase their unit or continue renting.

Appendix A: Conversion Board Requirements

According to the proposed ordinance a community land trust would be able to covert apartment buildings to condominiums if it met all of the following conditions:

1. Is a non-profit with 501(c)3 status;
2. Has an open membership policy restricted by geography, if at all;
3. Is a zero-equity membership organization; where no one owns shares in it;
4. Provides that its Board of Directors be comprised of three equal, democratically-elected classes representing (1) Lessee Members, (2) General Public, and (3) Public Members;
5. Requires that the lessee and general board members be nominated from among the lessee and general members, respectively;
6. Provides that the dues payable to the CLT from its members shall not exceed 25% of the member’s household income;
7. Provides that every lessee of CLT property, including non-purchasing tenants, automatically become members of the CLT with full voting rights in the CLT;
8. Requires the CLT to retain ownership of the land in perpetuity, and control resale pricing through a land lease agreement with each buyer of a unit;
9. Has adequate financial resources and/or technical capacity to fulfill its role as steward, landlord, and property manager of real estate assets; and

Provides that at least two-thirds majority of each class of membership and each class of board member be required to approve the sale of CLT land, dissolution of the corporation, and revision to any resale formula.

  ¹Rossi, P., Weber, E. (1996) The Social Benefits of Homeownership: Empirical Evidence from National Surveys, Fannie Mae Foundation, Housing Policy Debate, Vol. 7, Issue 1, http://www.fanniemaefoundation.org/programs/hpd/pdf/hpd_0701_rossi.pdf.
²Robe, W., Stewart, L. (1996) Homeownership and Neighborhood Stability. Fannie Mae Foundation, Housing Policy Debate, Vol. 7, Issue 1,   http://www.fanniemaefoundation.org/programs/hpd/pdf/hpd_0701_rohe.pdf.
³California Association of Realtors, www.car.org.
⁴Community Land Trusts and Rural Housing, Housing Assistance Council (1993). http://www.ruralhome.org/pubs/CLT/contents.htm.
⁵IRC 42(g), http://www.irs.gov/pub/irs-tege/rev_proc_1996-32_low-income_housing_guidelines.pdf.
⁶Internal Revenue Service, http://www.irs.gov/pub/irs-tege/rev_proc_1996-32_low-income_housing_guidelines.pdf.
⁷These figures are based on the 2003 U.S. Census Bureau’s American Community Survey, where the median family income was $67,809.
⁸Mortgage and tax no greater than 28% of gross income. Assumes property tax rate of 1.14%, 30-year loan, 6.5% interest rate, no down payment, and property insurance of $1,000 per year. www.mortgage-calc.com.
⁹City and County of San Francisco, Assessor-Recorder's Office
¹⁰Peterson, Tom. "Community Land Trusts: An Introduction" Planning Commissioners Journal (1996), Issue 23, http://www.plannersweb.com/articles/pet112.html.
¹¹This number includes established CLTs and those under development.The Institute for Community Economics (ICE),http://www.iceclt.org/.
¹²Peterson, Tom. "Community Land Trusts: An Introduction" Planning Commissioners Journal (1996), Issue 23, http://www.plannersweb.com/articles/pet112.html.
¹³Community Land Trust Activity in the United States (2001). The Institute for Community Economics (ICE).U.S.
¹⁴Census Bureau 2003 American Community Survey, http://www.census.gov/acs/www/.
¹⁵Ibid