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Housing Policy • February 15, 2006

BPOA's Condo Conversion Alternative




To: Mayor and City Council

From: Board of Directors, Berkeley Property Owners Association

Re: Condo Conversion  (February 21, 2006 Agenda Item)

February 12, 2006


Introduction and Summary:


Originally, the amended Condo Conversion Ordinance (“Ordinance”) was supposed to encourage condo conversions in preference to the TIC conversions that have been legalized by California courts.  Instead, the Ordinance (as adopted ion October 25, 2005) will, if made permanent, have precisely the opposite effect:  condo conversions will continue to be rare, and expensive, while TICs will be the only alternative for lower and middle income persons wanting to own their own housing in Berkeley.


Condominiums are the best solution for a variety of Berkeley problems.  There is a surplus of rental units in Berkeley.  Rents have been falling. There is little incentive to renovate older, rent-controlled buildings. As a result they are often in disrepair, and undervalued on the City’s tax rolls. At the same time there is a grave shortage of opportunities for persons who want to own their own homes, and put down roots in the community.  Because of this shortage, the middle class (and particularly young families) has been priced out of town.  Tenants wanting to own their own homes have no choice but to leave.


Some say condo conversions would decrease the stock of affordable housing.  The fact is that they would increase affordable housing where it is most needed. .  Tax revenues to the City would increase. Older, often distinguished housing would be renovated and neighborhood deterioration arrested.


For the above reasons BPOA proposes an alternative.  It would abolish the arbitrary cap in the current draft and substitute one based on current vacancy rates.  It would eliminate the life estate proposed for existing tenants, who are already more than adequately protected by state and local law.   It would retain an “affordable housing fee” but would give owners the option of paying a fixed sum upon conversion, or a percentage of the gain, if any, reported upon sale to the IRS.  There would be no fee where TIC owners convert, or where a tenant buys his/her own unit. There would be no discrimination between new and older rental housing stock.



The Present Ordinance, If Made Permanent, Would Make Condo Conversions Rare and Prohibitively Expensive:


No one denies that TIC’s are a less desirable form of ownership.  They are hard to finance, are legally complicated, and have less value on the market.  They expose buyers to the risks of default by other co-tenants.  Finally, recent court decisions have made them largely exempt from City controls.


For these reasons Berkeley has every reason to encourage existing and prospective TIC owners to switch to a condo form of ownership.  Because of ease of financing, condos are more highly valued and bring in higher taxes.  Because condos require approval of a subdivision, the City has a greater ability to impose minimum standards regarding livable space, code compliance, common area maintenance and the like. 


Despite all this the Ordinance virtually forces desperate buyers and sellers to resort to the TIC framework rather than condos.  Among other things the Ordinance:


            -Imposes a 100 units per year cap on the total number of condo conversions.  With more than 25,000 rental units on the market, with at least 1700 of them vacant, and additional thousands of units coming onto the market as a result of the City’s pro-development policies, there is no justification for such a limit. People faced with the cap, but desperate for alternatives, will go the TIC route (or in the case of tenants wishing to own will simply leave town).


            -Requires an Owner to offer existing tenants a life estate in the unit proposed to be converted:  this provision is most likely pre-empted by the Ellis Act and by existing Berkeley measures which more than adequately protect seniors, the physically challenged, and long term tenants from eviction and which assure a generous payment to others who are forced to find a new apartment.  The real impact of the proposed rule is to give the tenant a means of blackmailing the buyer and seller of the new condo.


            -Imposes a 12.5% tax on the gross proceeds of any condo sale.   The proposed fee, together with the existing 1.5% transfer tax (not to mention income and other taxes) would make conversion economically impossible in all but highly unusual circumstances.  Take for example the buyer of a duplex who pays $600,000 to purchase, adds $200,000 in deferred maintenance and improvements, and sells the duplex as two 2-bedroom condos for $500,000 each.


                        Proceeds of Sale:                                $1,000,000

                        Less original cost:                                                   (600,000)

                        Less maintenance/improvements:           (200,000)

                        Less costs of sale @ 6%                        (60,000)

                        Less 1.5% transfer tax:                                    (15,000)

                        Less 12.5% conversion fee                   (125,000)


                        Net Profit (Loss)                           ($ 0,000)


The above is based on actual sales data as to average sales prices for two bedroom Berkeley condos available from the Multiple Listing Service (“MLS”).[1]  The calculation excludes the City’s fees for subdivision maps and the like, as well as the costs that would be imposed if there were existing tenants on site.


The conclusion is inescapable:  while there are no doubt a very few situations where this large tax on gross proceeds would not break the bank, in nearly all more typical cases, it would make conversion impossible, and would force the parties to convert the units to TICs.[2]


The Ordinance Addresses a Phantom Crisis:


The sponsors of the Ordinance argue that there is a “crisis” in available rental housing, and that condo conversions somehow decrease the stock of “affordable” housing.  They offer no statistics to support their claim and have ignored BPOA’s repeated requests for an impartial survey of vacancy rates, and current rent levels in both regulated and unregulated housing.


Even without a survey, data is available.  Thus:


                        -In 1979, when Berkeley’s current rent control law went into effect, it was said that less than 3% of the rental stock was vacant, that rents were skyrocketing, and that there was therefore a “crisis”.  The law itself suggests that the ordinance would no longer be needed if the vacancy rate were to rise to 5%.[3]  BPOA believes that vacancy rates over the past few years have approached 8% and at all times have been at or above 5%, which under the very terms of the current law would indicate there is no “crisis”.


                        -We also have data as to rent levels, both in the form of registrations with the Rent Board and public listings of both regulated and unregulated units with the real estate community.  Listing data since the end of 2003 show a steady decline in rental rates charged for vacant units.  For example, one-bedroom units were listed in late 2003 at average rents of $1136-1219/month (the difference is that between North Berkeley and the rest of town).  Today, current listings are at $1110-1205.  In the meantime the cost of living index has increased by 4%.  When adjusted for the COL change, rents have actually declined by 6% over the past two years.


The Real Crisis Is the Lack of Affordable Ownership Opportunities For Low and Middle Income Families.


The average selling price in 2005 for a two-bedroom “starter” home in Berkeley was $676,000, a record high.  Assuming 90% financing at 6% and property taxes and surcharges at 2%, the monthly costs of ownership are more than $54,000 per year, excluding other costs such as maintenance and insurance.   With mean annual Bay Area incomes at $52,100[4], ownership is not a realistic possibility for the average family.  We see the results in the flight of the middle class, falling school enrollments, and the increasing divide between the poorest and richest parts of the population.


The San Francisco Chronicle, citing numerous studies reported on January 29 that “if you own your own home, you are [likely to be] happier and more satisfied with your life, your children are better educated and less likely to get into trouble, your daughters are less likely to become pregnant as teenagers, you vote more often and are more active in your community....” These things are true “even after controlling for such variables as level of income, education, race etc.” [5]   Despite numerous public statements by the Mayor and others that we need to attract more residents “with a stake in the City”, the City has done nothing to alleviate this situation and has instead told HUD that owner occupied housing is “not a priority” in our City.[6]


The BPOA Alternative Addresses the Real Issues


The above are only a few of the defects in the proposal by HAC.  Others include severe discrimination against owners who have exercise their state-guaranteed right to get out of the rental housing business[7]; the attempt to impose heavy fees on tenants in common wishing to convert[8], and unrealistic assumptions about increased revenues to the City.[9]  If adopted, the Ordinance will almost certainly be challenged in the courts.


The BPOA alternative addresses not only the real crisis described above, but issues of fundamental fairness.   Thus:


1.The “Cap” On Conversions Should Be Determined By the Vacancy Rate in the Market. The City’s limit on conversions is justified by a decades-old finding that there is a “housing crisis”can be But when all available evidence shows that the rental housing stock has increased, that vacancies are high, and that rents are falling. the Council cannot in good faith make the required finding.  BPOA proposes an annual impartial survey of rental vacancies.  If the vacancy rate falls below 3%, condo conversions should be limited to 100/year.  If the vacancy rate is more than 3% but less than 5%, conversions should be capped at 500/year.  If the vacancy rate is five per cent or more, there should be no cap.


2.The “Affordable Housing” Fee Should Be Either a Fixed Amount Payable On Conversion Or Should Be Keyed to the Actual Profit Made By the Seller, As Reported to the IRS.   As shown above, it is fundamentally unfair, and makes no economic sense to impose a tax on a money losing transaction, especially where the tax itself is so great that it causes the loss.  Such taxes discourage the renovation of old-stock housing, and the creation of new, desperately needed ownership opportunities.  It is also obvious that as worded, the current ordinance may lead to conversions that produce no immediate revenues to the City.   BPOA proposes that the owner be given an option, i.e. either to pay a fixed fee immediately on conversion, say $15,000 per unit, or to pay a fee upon sale equal to   5% of the profit reported to the IRS.  This would of course be over and above the transfer tax of 1.5% on the gross, and over and above the estimated 30% (or more) in capital gains payable to the state and federal governments.


3. Fees and Caps Should Be Applied In a Non-Discriminatory Way:  The proposal is filled with dense, hard-to-understand language, which gives special preferences to some and penalizes others.  The most flagrant examples are (1) the attempt to impose the affordable housing fees on owner-occupied TICs, (2) the exemption of newly constructed rental housing, even where such housing has been built with City subsidies, and (3) the attempt to give protections to existing tenants beyond those already given by state law and by Berkeley’s own ordinance.  The net impact of all of this, surely intended by the authors, would be to prevent conversions of nearly all existing rental housing, except for a privileged few.   BPOA proposes:


            -There should be no affordable housing fee for conversions of owner-occupied housing that is no longer on the rental market.  This would allow TIC owners to obtain the same financing available to everyone else, and would allow the City to regain some modest control over a segment of the market, which has been deregulated by the courts.


            -There should be no affordable housing fee where the buyer of a condo is an existing tenant.  The City should applaud and encourage tenants who wish to put down permanent roots.


            -The above two cases should be the only exceptions to the fee, which should be charged for all conversions of existing and newly constructed rental housing stock, whether vacant or occupied.


            -Where an existing tenant must seek alternative housing as the result of a conversion, his/her remedies should be those already assured by state and local law.  These include special protections against eviction of the physically challenged, the elderly, and tenants of long standing. For these and other tenants, the Council has already approved of increased, mandatory payments without any proof of actual damages.


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