rent stabilization board date: may 15, 2006 to: honorable ... · conversion ordinance and the...

Rent Stabilization Board RENT STABILIZATION BOARD DATE: May 15, 2006 TO: Honorable Members of the Rent Stabilization Board FROM: Ad Hoc Committee on Condo Conversion Ordinance

SUBJECT: Recommendations to City Council Concerning the Condominium Conversion

Ordinance Recommendation: That the Rent Stabilization Board adopt the following motion to be forwarded to the Mayor and Council for consideration at the May 16th workshop on the Condominium Conversion Ordinance: “That the Rent Stabilization Board supports the overall framework of the Condominium Conversion Ordinance and the background report by the Housing Department. We urge the Council to consider our previous recommendation adopted by the Board on September 8, 2005. However, we believe that the following changes should also be included in the ordinance: 1. Amend B.M.C. Section 21.28.050 to read as follows: Section 21.28.050 Eligibility for one hundred rental units per year to be converted. In order to be considered among the one hundred units permitted to convert each year, the building or buildings proposed for conversion must meet the following conditions: A. At no time within twenty years of the time the application to convert is filed shall an owner of the property have filed with the City of Berkeley a statement of intent to go out of the rental business. B. At the time of application and continuously for ten years prior thereto, no eviction may have occurred pursuant to 13.76.130.A.9 of the Berkeley Municipal Code (relating to eviction for purposes of owner-occupancy or occupancy by relatives of the owner). C. For any units that are vacant at the time the application to convert is filed, the vacancy may not have been created by the termination of a tenancy within the prior five years where the termination occurred: 2125 Milvia Street, Berkeley, California 94704 TEL: 510.644.6128 � TDD: 510.981-6903 � FAX: 510.644.7703 E-MAIL: [email protected] ��INTERNET: www.ci.berkeley.ca.us/rent/

Condo Conversion Ordinance Recommendations May 15, 2006

1. Within one year of the service by the owner of a termination of tenancy notice pursuant to Civil Code Section 1946; or

2. Within one year of a change in the terms of the tenancy noticed pursuant to Civil Code Section 827, including the owner's termination or nonrenewal of a contract or recorded agreement with a governmental agency that provides for a rent limitation to a qualified tenant; or

3. By the tenant household vacating the property when, prior to the termination, the unit had been cited in an inspection report as containing serious health, safety, fire, or building code violations that were not caused by the tenant beyond normal wear and tear and one or more of the violations had not been abated by the date of the termination; or

4. By the tenant household vacating the property and subsequently bringing an action for constructive eviction that is pending at the time the application to convert is filed or that resulted in a judgment for the plaintiffs or in a settlement.

D. The owner must agree that, at the time of sale of each unit, an affordable housing fee, as described in Section 21.28.060, shall be paid to the City. E. The owner must comply with all applicable laws of the City. (Ord. 6882-NS § 1 (part), 2005: Ord. 6852-NS § 5 (part), 2005: Ord. 6352-NS § 1 (part), 1996: Ord. 6158-NS § 3, 1992: Ord. 6144-NS § 2 (part), 1992) 2. Support the following alternatives proposed in the Housing Department staff report:

a. Alternative A2: Reduce the 12.5% cap on condominium conversion mitigation fees for units where the applicants for conversion are owner-occupants by one percent (1%) for every year of owner occupancy.

b. Alternative B3: Increase the cap on the maximum fee to a level higher than the current

12.5% of the sales price.

c. Alternative C1: Set time limit on notices of selection to allow two years from the time of the notice of selection, with a one-year extension at the discretion of the City Manager or his/her designee.

d. Alternative C2: require owners to notify all tenants of their rights and protections prior

to filing a request for selection for condominium conversion.” Background and Need For Rent Stabilization Board Action: Last spring and fall, in response to the Tom v San Francisco case limiting Berkeley’s ability to regulate tenancies in common, Council adopted significant revisions to the Condominium Conversion Ordinance. Council asked staff to return and conduct a workshop (now scheduled for May 16th) so that the public may better understand the purposes of the changes to the

Condo Conversion Ordinance Recommendations May 15, 2006 Ordinance and so that Council may consider refinements and/or enhancements to the Ordinance previously adopted. The Board took an active role in reviewing proposals and advising Council with the changes to the Ordinance that were adopted last spring and fall. In response to the proposed workshop, scheduled for May 16th, the Board established an Ad Hoc Committee to review the staff report (attached) and advise the Board if any additional recommendations to Council should be considered. The Committee met on May 9th and voted 3-0-0-1 (Overman absent) to make the recommendations listed above to the City Council at the May 16th workshop. Name and Telephone Number of Contact Person: Jay Kelekian, Executive Director (510) 644-6128

Housing Department

2180 Milvia Street, Berkeley, CA 94704 ● Tel: (510) 981-5400 ● TDD: (510) 981-6903 ● Fax: (510) 981-5450 E-Mail: [email protected]

May 15, 2006

To: Rent Stabilization Board

From: Stephen Barton, PhD, Director, Housing Department

Subject: Background Information Related to the Condominium Conversion Ordinance

SUMMARY

The following report has been submitted to the Housing Advisory Commission. The summary has been added due to the length of the report, which has five major sections. It begins with an “Overview of the Purposes of the Condominium Conversion Ordinance” (pages 1-2). Next is the “Market Overview” (pages 2 – 15) examines rental and ownership housing in Berkeley. This section reviews the range of rents and tenant incomes and the affordability of rental units to tenants at different income levels, new construction of apartments, vacancy rates, trends in the prices of single-family homes and condominiums, the affordability of homeownership, and trends in the prices of multi-family property. It looks at the relative affordability of renting and homeownership and concludes with the effects of condominium conversion on tenants. The section on “Conversion” (pages 16-20) examines the economics of conversion of rental property to owner-occupancy through tenancy in common and condominium subdivision. The section, “Overview of Recent Policy Changes” (pages 21-23), provides the history of the condominium conversion ordinance and reviews how well it is working so far. The final section is “Condominium Conversion Ordinance Alternatives” (pages 24-27).

OVERVIEW OF THE PURPOSES OF THE CONDOMINUM CONVERSION ORDINANCE

A substantial portion of Berkeley renters face severe problems of housing affordability. These affordability problems are of two types. Renters with lower incomes have difficulty simply paying the rent, while renters with higher incomes have difficulty making the transition to homeownership. The majority of Americans start as renters and eventually become homeowners, but a significant minority remain renters for most or all of their lives.

The housing policies of the City of Berkeley give priority to the needs of those who are most at-risk and to the preservation of the economic diversity of the community. For that reason, the potential effects of condominium conversion on the rental market and lower income tenants are fundamental to consideration of the appropriate balance between rental and ownership units in Berkeley. Limited availability of rental housing creates risks for those least able to protect themselves, and places people at risk of shelter poverty or homelessness. Limited availability of ownership housing makes it harder for people to achieve the most widespread form of property

Website: http://www.ci.berkeley.ca.us/manager

Background Information Related to May 15, 2006 Condominium Conversion Ordinance

ownership and gain full control over their own living space, an aspiration so widely shared that it is commonly referred to as “the American Dream”. These are serious costs in each case, but they are not equivalent when trade-offs must be made between the two.

Many tenants with incomes below 50% of the area median have inadequate resources for other needs after paying the rent. They are in a condition of “shelter poverty”, even if their income places them above the poverty line. These tenants are at risk of displacement and even homelessness and have few alternatives available to them. In contrast, tenants who are struggling to make the step to homeownership have stable incomes at levels high enough to afford to rent.

One of the few things that is predictable about the workings of a market-driven economy is that tenants with lower incomes, and thus lower market power, will be harmed when the housing resources that they depend on become desirable to higher-income people. This harm can be mitigated when there are significant regulatory protections to slow the transfer of those resources and a substantial investment in replacement of the resources as they are lost. The current structure of Berkeley’s condominium conversion regulations does exactly that by limiting the number of multi-family units that can be converted and by requiring payment of mitigation fees based on the reduction in affordability that results from the conversion. MARKET OVERVIEW

Berkeley is home to a unique East Bay housing market in which about 45 percent of its housing stock is offered for rent under regulated conditions, about 12 percent is rented on an unregulated basis, and the remaining 43 percent is owner-occupied housing. This section of the report presents an overview of the rental and ownership housing markets in Berkeley. The analysis examines in a summary fashion both housing demand and supply and identifies in a general way affordability problems facing Berkeley households.1

Rental Housing in Berkeley

Characteristics of Renter Households. As of the 2000 Census:

HouseholdsPercent of

Total

Total: 25,704

Less than $10,000: 6,101 23.7%

$10,000 to $19,999: 4,218 16.4%

$20,000 to $34,999: 4,934 19.2%

$35,000 to $49,999: 3,546 13.8%

$50,000 to $74,999: 3,571 13.9%

$75,000 to $99,999: 1,642 6.4%

$100,000 or more: 1,692 6.6%

Source: U.S. Census, 2000.

Table 1: Tenant Household Incomes in Berkeley, 1999

• 25, 745 (57 percent) of the city’s 44,995 occupied housing units were rentals.

• One-person households accounted for 46 percent and two-person households occupied 31 percent of all rental units in Berkeley.

1 It should be noted that the analysis will not consider housing need in detail, as this is already done in the City of Berkeley’s 2001 General Plan Housing Element and its recently completed Consolidated Plan for Housing and Community Development, 2005-2010.

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• 40 percent of all tenant households had an income under $20,000 and median tenant household income was $27,341 in 1999 (Table 1).

• 750 units were considered vacant and for rent. At the time this was less than 3 percent of Berkeley’s rental housing stock.

The following table (Table 2) sets forth the income ranges of tenant households and the rent levels that are affordable for those households. As the balance of the report demonstrates market rents are unaffordable to a substantial portion of tenant households.

Table 2 - Tenant Household Income and Rent Levels Affordable for Tenant Households

1999 2005

Maximum Affordable

Rent

Range Households Percent of hhds

Cumulative Pct Income Measure

U.S. Census Report

1999 income adjusted by

38% increase in

AMI

30% of income for rent + util ($50 for

util.)

50% of income for rent + util ($50 for

util.) Total: 25,704

Less than $10,000: 6,101 23.7% 23.7% top of range 10000 13800 $295 $525

$10,000 to $19,999: 4,218 16.4% 31.9% midpoint of range 15000 20700 $468 $813 40.1% top of range 20000 27600 $640 $1,100

$20,000 to $34,999: 4,934 19.2% 49.6% midpoint of range 27500 37950 $899 $1,531

median $27,000 city median 27000 37260 $882 $1,503

$35,000 to $49,999: 3,546 13.8% 66.2% midpoint of range 42500 58650 $1,416 $2,394

$50,000 to $74,999: 3,571 13.9% 80.1% midpoint of range 62500 86250 $2,106 $3,544

$75,000 to $99,999: 1,642 6.4% midpoint of range 82500 113850 $2,796 $4,694

$100,000 or more: 1,692 6.6%

Trends in Rents. Berkeley has had a voter-approved rent control system based on a voter initiative in place since 1980. In 1995, the State legislature adopted the Costa-Hawkins Act2, which mandated vacancy decontrol for all rent-controlled units. From 1996 through 1998, 15 percent rent increases were authorized upon vacancies. Full vacancy decontrol went into effect January 1, 1999. Vacancy decontrol of Berkeley’s rental market led to substantial increases in average rents and a division of the rental housing stock into a shrinking low-rent portion not experiencing any vacancy increases, and a growing balance of the rental stock which has rents reset at market levels.

2 California Civil Code Sections 1954.50 to 1954.535

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• As of December 2005, just 4,423, or 25 percent of all rent controlled units in Berkeley, have not had vacancy increases. The average monthly rent of these units is $721. In contrast, 69 percent of all rent controlled units have been permitted full vacancy decontrol increases since January 1999. The median monthly rent of these units is $1,204, which is 67 percent higher than the average for long-term rent controlled units.

• Market rents remained stable in the past few years and even decreased somewhat since the peak of the market in 2001 after an exceptional surge in the late 1990s and in 2000. However, rents in the City have continued to increase because vacancy decontrol increases continue. (Table 3).

Trends in Rents in Berkeley Compared with the Nation. Berkeley rents increased at a rate well in excess of the increase nationwide. For example, from 1990 through 2005, the nationwide rents increased by 57 percent in contrast to the 123 percent increase in Berkeley during the same period.3

1-Bedroom 2-Bedroom

Citywide Median Rents, 1998 $624 $777

1999 $950 $1,3002000 $1,100 $1,5002001 $1,200 $1,6502002 $1,150 $1,6002003 $1,100 $1,5002004 $1,050 $1,4002005 $1,095 $1,450

Percent Change, 1998-2005 75% 87%

Percent Change, 1999-2005 15% 12%

Percent Change, 1998-2001 92% 112%

Percent Change, 2001-2005 -9% -12%

Market Median Rents

Source: City of Berkeley Rent Stabilization Board, 2006. Median rents are cumulative as of December 31 of each reported year.

Table 3: Median Rents in Berkeley, 1998 to 2005

To place these increases in context, the rate of rent increases in Berkeley under rent controls prior to vacancy decontrol also exceeded national averages, although they were lower than in the rest of the Bay Area (Table 4).

TABLE 4 - RENT INCREASES PERMITTED UNDER BERKELEY RENT REGULATIONS COMPARED WITH RENT

INCREASES IN OTHER METROPOLITAN AREAS PRIOR TO THE INTRODUCTION OF VACANCY

DECONTROL

Jan. 1979 - Jan

1995 Jan 1981 - Jan 1995

Berkeley (with annual increases) 130% 136%

(with annual increases + indiv. adj.) 138% 144%

San Francisco-Oakland area 162% 107%

United States 117% 84%

Metropolitan Areas

Atlanta 117% 74%

Baltimore 114% 91%

Boston 137% 102%

Chicago 126% 97%

3 CPI for all urban consumers, rent of primary residence was in 1990 138.4; by 2005 it increased to 217.3.

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Denver 101% 63%

Honolulu 155% 123%

Houston 71% 54%

Kansas City 92% 62%

Los Angeles 139% 92%

Minneapolis 105% 65%

New York 128% 99%

Portland 101% 74%

St. Louis 93% 63%

San Diego 141% 80%

Seattle 114% 70%

Washington, D.C. 136% 99% Source: Baar, "Issues and Options for Rent Increases Standards …", Oct. 1995

Currently, median rent levels in Berkeley are well above national levels and rent levels in other major cities on the West Coast outside of California. See Table 5.

1999 2005

Berkeley $690 $952 38%

1999 2005

United States $519 $635 22%Denver $585 $673 15%Portland, OR $562 $607 8%Seattle $677 $765 13%

Table 5: Comparing Berkeley Rents to Other Cities and the U.S., 1999 to 2005

Sources: City of Berkeley Rent Stabilization Board; 2000 Census; Bureau of Labor Statistics.

City/Metro Area

Percentage Increase in Controlled

Rents

Rent Controlled Units Median Rent, 1999

City/Metro Area

Percentage Increase in Metro Area

Median Rent

Affordability of Rental Units. The burden of rents relative to overall rental household income is measured in the census. However, such analysis is subject to the limitation that the census does not distinguish between student and non-student households. As of the 1990 census, the median rent to household income ratio for all tenant households was 27 percent, and as of the 2000 census the ratio was 30 percent.

A substantial portion of the renter households in Berkeley experience high rent-to-household income ratios. In 1999, before full vacancy decontrol had much impact, 29 percent of all households had rent to income ratios of over 50 percent and another 7 percent had rent to income ratios of over 40 percent. Entrants into the rental housing market now face median rents at initial occupancy of $1,171 compared to the 1998 median rents of $643.

The median rents at initial occupancy are far beyond the affordability level of at least 40 percent of all tenant households. As indicated, as of 1999, 40 percent of all tenant households had an annual income under $20,000. Assuming that incomes of these households rose with the percentage increase in the AMI (38 percent since 1999), as of 2005 this same 40 percent of all tenant households would have an annual income under $27,600, nearly reaching the $29,000 for a 1 person household at the level of 50 percent of Area Median Income (the income threshold for

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eligibility in the Section 8 program).4 The average initial rent for a new occupancy of $1,171 is over 50 percent of the income for these households.

Significant rent burdens predate the onset of vacancy decontrol, as Table 6 shows. Tenant households paying 30 percent or more of their incomes for rent comprise nearly half (47 percent) of Berkeley’s tenant households, and 29 percent of all Berkeley tenant households pay 50 percent or more of their income for rent.

Using 2005 rents, Table 7 illustrates the increase in income tenants need to move into a newly vacant unit from a rent-controlled while maintaining a housing affordability ratio of 30 percent (that is, assuming the tenant continues paying just 30 percent of household

income in gross rent even in the newly occupied unit). To maintain adequate housing affordability, a tenant would need a percentage increase in annual income ranging from 59 to 103 percent.

Householdsin Ratio

Group

Percent ofTotal

Total: 25,704

Less than 20% 6,677 26.0%

20 to 29 percent 5,026 19.6%

30 to 39 percent 2,769 10.8%

40 to 49 percent 1,819 7.1%

50 percent or more 7,518 29.2%

30 percent or more 12,106 47.1%

Not computed 1,895 7.4%

Table 6: Gross Rent as Percent of Household Income in Berkeley, 1999

Note: Data for this census were collected shortly after full vacancy decontrol increases were introduced in Berkeley.Source: U.S. Census, 2000.

In the past few years, market rents have leveled off and vacancy rates have been higher than their levels in the 1990’s. However, market rents have settled at a plateau that is unaffordable for a substantial portion of tenant households.

Unit SizeMedian

ControlledRent

AnnualIncome

Needed toAfford

CitywideRent

MedianMarket

Rent

AnnualIncome

Needed toAfford

Market Rent

PercentageIncrease in

AnnualIncome

Needed toAfford

Market Rent

Studio $536 $21,440 $850 $34,000 58.6%

Data on rents and incomes of tenant households support this conclusion even when the most generous assumptions are made about current tenant household incomes and it is assumed that tenant households can expend 50% of their income on rent and utilities.

1

2

3

-Bedroom $604 $24,160 $1,095 $43,800 81.3%

-Bedroom $714 $28,560 $1,450 $58,000 103.1%

-Bedroom $1,029 $41,160 $1,990 $79,600 93.4%

Table 7: Income Needed to Afford Citywide versus Market Rents in Berkeley, 2005

Source: City of Berkeley Rent Stabilization Program; City of Berkeley Housing Department.

4 This is calculated as $20,000 x 1.38 (reflecting 38 percent increase in AMI). This is an optimistic assumption, since the incomes of lower-wage workers and people receiving public assistance have not increased as rapidly as the incomes of higher salaried workers. Family incomes at the 25th percentile declined by 3% from 1969 to 2002 in California, while middle-income families gained 22% and high-income families at the 75th percentile gained 46%. Deborah Stone, “Recent Trends in Income and Poverty”, Public Policy Institute of California, February 2004.

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Table 8 sets forth the distribution of initial rents for the 4332 units that were rented to new tenants in 2005. Even the lower initial rents for new tenants in 2005 are above the median rents of units that have not been subject to a vacancy increase since 1999. For example, the median rent for all units which have not had a vacancy increases was $721, while initial rents in the lowest 10th percentile for new tenants were $850 for one bedroom units and $1099 for two bedroom units. Furthermore, while there might be a substantial number of units available for rent at a higher rent levels, competition for available units at the lower rent levels would be particularly stiff and lower income households would not necessarily be able to obtain these units since some higher-income households will prefer lower rent units in order to save money for other things.

Table 8 Rent Levels for New Tenants in 2005

Studio l br 2 br 3 br

Rent levels

5th percentile 575 775 995 1265

10th percentile 650 850 1099 1478

20th percentile 730 900 1200 1670

30th percentile 795 950 1300 1800

40th percentile 845 1000 1350 1900

50th percentile 850 1095 1425 1950

75th percentile 950 1225 1695 2300

90th percentile 1050 1400 1950 2900 Source: Tabulations from data in Berkeley Rent Stabilization Board data base - Vacancy Registrations 2005. No of units: all units - 4332; studio -

1028; 1 bedroom -1824; 2 bedroom - 1305; 3 br - 144; 4 br - 31. (Addresses identified as room rentals excluded.)

The table below (Table 9), shows that even the lowest market rents for new tenants are not affordable to many tenants. 45% of all tenant households could not afford the initial rents for virtually any of the one-bedroom units (e.g. units with rents in the lowest 5th percentile) that became available in 2005 if their housing expenditures (rent + utilities) were limited to 30% of their income (the federal affordability standard.)

Fully 31% of tenant households, cannot afford newly available one bedroom units even if they devoted 50% of their income to housing costs, The table below sets forth percentage of tenant households that can afford the initial rents of vacant one bedroom units based on the assumption that the incomes of tenant households have increased at the same rate as the area median income (AMI) since 1999, and the alternative assumptions that they either devote 30% or 50% of their household income to housing costs. (The assumption that the incomes of low-income tenant households have increased at the same rate as the AMI is unlikely to be true. Recent demographic studies have concluded that the incomes of low-income households have increased at a slower rate than the overall population. See footnote 7.)

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Rent Levels for New Tenants and Income Required to Afford Rents One Bedroom Units Rented to New Tenants in 2005

TABLE 9- ONE BEDROOM UNITS - RENTED TO NEW TENANTS IN 2005

1824 Units

Pct Tenant Households that

Cannot Afford Rent

Required Income to Afford Rent

Contract gross 30% income 50% income 30% income 50% income

Rent Rent Max rent max rent paid for rent paid for rent

($50 util) 5th percentile 775 825 45% 31% 33000 19800 10th percentile 850 900 48% 33%

36000 21600

20th percentile 900 950 50% 34%

38000 22800

30th percentile 950 1000 52% 36%

40000 24000

40th percentile 1000 1050 53% 37%

42000 25200

50th percentile 1095 1145 57% 40%

45800 27480

75th percentile 1225 1275 59% 42%

51000 30600

90th percentile 1400 1450 68% 47%

58000 34800

Source: Rent data compiled from data in Rent Stabilization Board data base of vacancy registrations in 2005. Tenant household income levels estimated by adjusting 1999 (2000 census) income levels by the 38% increase in the AMI since 1999. This data base does not include approximately 6,000 units that are exempt from rent control including approximately since 1980, Section 8 units, and

units in subsidized low income projects.

Since Berkeley is a “university community”, a substantial minority of its low-income tenant population is a student population. The census reports do not contain a breakdown of the income of tenant households cross-tabulated by age or occupation. However, the census reports provide data on the household income by age category, which indicate that in most households with an income under $ 25,000 the householder is 25 years old or more. That data indicates there are 12,482 households with incomes under $25,000 annually, of which 9,424 are households where the head of household is age 25 or older, while there are 5,058 such households where the head of household is age 24 or less. The very low-income category for the Census year of 1999 was set at $23,000 for a one-person household and $26,000 for a two-person household, and the Census reported a total of 12,697 very low-income renter households in that year so these figures are a decent approximation of the number of very low-income households. Not all heads of household under the age of 25 are students, and not all students are under the age of 25, but this gives a general sense of the likely proportions. See Table 10 for a breakdown by age of Household incomes

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Table 10 - By Age of Householder:

Household Income, Percentage of Tenant Households Below Poverty Level, and Percentage of Tenant Households Expending over 35% of Income for Rent

total under 25 over 25 25 to 34 35 to 44 45 to 54 55 to 64 65 to 74 75 or more

Total in Tenure Table 6,569 38,446 8,950 7,927 8,732 5,484 3,413 3,940

Homeowner 19,207 189 19,018 1,147 3,483 5,289 3,815 2,515 2,769

Renter 25,808 6,380 19,428 7,803 4,444 3,443 1,669 898 1,171

Gross Rent over 35% of gross Renter Household Income 10,437 4,280 6,157 2,350 1,368 1,097 568 328 446

Income Below Poverty Level - Renter Hhds 7,292 4,087 3,205 1,209 724 688 359 73 152

Income Below Poverty Level - Homeowner Hhds 907 99 808 82 118 139 134 193 142Tenant Households Total in Income Table 6,731 38,276 8,894 7,941 8,613 5,349 3,401 4,078

Less than $10,000 6,757 3,234 3,523 837 622 673 447 386 558

$10,000 to $14,999 2,786 740 2,046 551 309 320 213 206 447

$15,000 to $19,999 2,463 649 1,814 544 357 249 188 216 260

$20,000 to $24,999 2,476 435 2,041 598 309 392 193 178 371

$25,000 to $29,999 2,160 298 1,862 588 271 351 214 209 229

$30,000 to $34,999 2,159 291 1,868 630 327 329 221 153 208

$35,000 to $39,999 2,052 154 1,898 540 478 307 191 204 178

$40,000 to $44,999 1,788 153 1,635 507 353 320 191 94 170

$45,000 to $49,999 1,570 126 1,444 400 346 278 132 137 151

$50,000 to $59,999 3,225 199 3,026 891 629 627 390 232 257

$60,000 to $74,999 3,898 178 3,720 870 861 907 531 257 294

$75,000 to $99,999 4,320 74 4,246 767 1,049 1,189 608 354 279

$100,000 to $124,999 2,941 99 2,842 482 793 699 399 230 239

$125,000 to $149,999 1,882 56 1,826 342 352 467 389 151 125

$150,000 to $199,999 2,144 24 2,120 193 509 644 459 201 114

$200,000 or more 2,386 21 2,365 154 376 861 583 193 198

New Apartment Construction. Despite the surge in new apartment construction and applications for permits to construct new apartment buildings over the past few years, new construction constitutes only a small part of the housing stock. From 1980 through 1999 building permits were obtained for only 702 multifamily units. This total for the whole twenty years equaled about 2 percent of the preexisting supply, a construction rate of about 0.2 percent per year relative to the preexisting supply. From 2000 through 2005, permits were obtained for 960 multifamily units. The total for this six-year period equaled about 4 percent of the preexisting supply, a construction rate of about 0.7 percent per year relative to the preexisting supply.

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Most of the buildings completed since 2000 are now rented. However, given realities of the condominium market and unmet demand for ownership opportunities among prospective middle-income homebuyers, developers are routinely obtaining underlying condominium maps for their newly-opened projects. Developers intend a substantial portion of their new projects now for the condominium market.

Vacancy Rates. A review of official and academic literature on housing markets indicates that historically a 5 percent vacancy in the rental market has been considered to be a reasonable vacancy rate that allows an appropriate level of tenant mobility. Vacancy rates below that level have been considered evidence of a tight housing market, which reduces tenant mobility and often serve as the definition of a rental housing emergency. The limited available evidence indicates that rents do not actually stabilize until vacancy rates reach 6 percent to 9 percent and do not decline until vacancy rates exceed 9 percent.5

There is no reliable data on the current vacancy rate in Berkeley. Vacancy rate data is compiled as a part of the decennial census. As of the time the 2000 census survey (1999), the rental rate was approximately 3 percent. However, vacancy data is not systematically collected between census counts. A survey by the East Bay Property Owners found that the vacancy rate for a sample of 234 units in 20 buildings was 4.2 percent.6 However, a sample of this size is not adequate to provide statistically reliable data.

The vacancy rate can be higher or lower for a wide variety of reasons. In a university town such as Berkeley there are substantial variations in the vacancy rates depending on whether the University of California and Vista College are in session. Also, in a university town there is a high rate of turnover (move-ins and move-outs), so that a higher vacancy rate may reflect the high rate of tenant mobility.

Profit maximization strategies by property owners may shape vacancy rates as well. For example, an apartment owner might prefer a rent level that results in a 10 percent vacancy rate if the average rent per unit received with that vacancy rate is 10 percent higher than the rent level that results in a 5 percent vacancy rate. This is because under this scenario, the overall net operating income of an apartment building with a 10 percent vacancy rate might be higher than the yield with a 5 percent vacancy rate.7

5 See John Gilderbloom and Richard Applebaum, Rethinking Rental Housing, Philadelphia, PA: Temple University Press, 1988, pp.52-54. 6 Corkery, “A Persistent Soft Rental Market”, Rental Housing, March 2005, p. 36, published by Alameda County Rental Housing Association. 7 “Landlords face an optimizing problem in which they seek to maximize net rents through setting the gross rents and accepting the level of vacancies that rent implies.” Rosen and Smith, “The Price Adjustment Process for Rental Housing and the Natural Vacancy Rate”, American Economic Review, Vol. 73, No. 4, p.782 (Sept. 1983). Another expert states: “With given demand and cost curves, each landlord will set his rent so as to maximize the difference between his total costs and total rent receipts. These rents may be such that only a portion of his apartments will be occupied.” Blank and Winnick, “The Structure of the Housing Market”, Quarterly Journal of Economics, Vol. 67, No. 2, 188 (May 1953).

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Housing markets are typically cyclical and can be affected by short-term changes in the rate of new construction or changes in employment. In the Bay Area, where the underlying demand for rental housing is extremely strong, short-term increases in vacancies may easily be offset by modest decreases in rents. Such decreases are usually short-term, lasting only until the next upward cycle.

Ownership Housing in Berkeley

Characteristics of Homeowner Households. As of the 2000 census:

• 19,207 (43 percent) of the city’s 44,995 occupied housing units were owner-occupied units.

YearSales

Volume

Median Home Price Monthly Cost

Monthly Cost as a percent of

Area Median Income (4

person household)

1990 NA $223,909 $2,131 58.0%1995 540 $230,000 $1,857 40.2%1997 726 $265,000 $2,081 41.6%1999 770 $310,000 $2,402 43.9%2000 554 $425,500 $3,464 61.5%2001 532 $491,000 $3,668 61.5%2002 540 $520,500 $3,754 60.5%2003 661 $560,000 $3,804 59.6%2004 663 $631,000 $4,293 62.7%2005 690 $740,000 $5,043 73.6%

Table 11: Home Sales Prices in Berkeley, 1990 to 2005

Sources: City of Berkeley Housing Department; MetroScan; RealQuest.com

• One-person households occupied 27 percent of all owner occupied units and two person households occupied 37 percent of all owner occupied units.

• 74 percent of all homeowner households had incomes over $50,000 while the owner occupied median household income was $80,324 in 1999, well above the area median for a four-person household.

Trends in House and Condominium Prices. From 1990 to 2005, median single-family home prices increased from $223,000 to $740,000 (see Table 11) an increase of 230 percent compared to the 86 percent increase in area median income (AMI)8 and the 53 percent increase in the Consumer Price Index (CPI) over that same period.

However, homeownership costs increased at a rate substantially below that of house prices due to a sharp decline in mortgage interest rates. As a result, the cost of homeownership for a new purchaser increased by approximately 100 percent compared to the 182 percent increase in house prices.9

Most of the increase in house prices in Berkeley occurred since 1999. The trends in condominium prices have paralleled the trends in house prices. In that year average house prices were $310,000; for condominiums the median price was $228,500. In 2005, the median sale price of a condominium reached $480,000, up 110 percent since 1999. See Table 12.

8 The Area Median Income (AMI) in 1990 for a 4-person household was $44,100, and for a 2-person household, it is estimated to be $35,280; in 2005, AMI for a 4-person household was $82,200, and $65,750 for a 2-person household. 9 Assumptions – 10 percent downpayment, average annual mortgage interest rates were 10.18 percent in 1990 and 5.84 percent in 2004. Taxes and insurance equals about 1.8 percent of purchase price.

Page 11


Affordability of Homeownership. From 1990 through 1997, home prices remained relatively stable (and even declined some in the recession of the early 1990s) and ownership costs for new purchasers were within an affordable range. From 1994 through 1997, housing costs (housing cost/AMI ratio) for new purchasers who made 10 percent down payments were in the range of 40 to 45 percent.

YearSales

VolumeMedian

Home PriceMonthly

Cost

Monthly Cost as a

percent of Area

Median Income (2

person household)

1995 51 $165,804 $1,338 36.3%1999 120 $228,500 $1,771 40.4%2000 87 $305,000 $2,483 55.1%2001 105 $301,500 $2,252 47.2%2002 92 $335,000 $2,416 48.6%2003 113 $355,000 $2,411 45.1%2004 122 $443,000 $3,014 54.6%2005 135 $480,000 $3,271 59.3%

Table 12: Condominium Sales Prices in Berkeley, 1995 to 2005

Sources: City of Berkeley Housing Department; MetroScan; RealQuest.com

From 1997 to 2000 median single-family home prices increased from $265,000 to $425,000 and the housing cost/AMI ratio increased to 62 percent. Since 2000 house prices increased an additional 50 percent; however, the housing cost/AMI ratio remained stable due to a substantial decline in interest rates, until 2005 when interest rates began climbing. In 2005 the housing cost to AMI ratio increased to 74 percent, as a consequence of a 17 percent increase in sales prices over the prior year.

The Rental Housing Business

The yields from apartments in the San Francisco Bay Area, in terms of net operating income (income after operating expenses, not including mortgage payments) are far above national, averages. For example, in 2003 the national average net operating income per month of an apartment was $331 compared to averages of about $750 in Oakland and San Jose (See Table 13). Current Berkeley rent levels approximate the rent levels used to derive the averages for Oakland and San Jose. The high Bay Area net operating income (NOI) as a percentage of rent is an accurate measure of the shortage of rental housing in the Bay Area. If the Bay Area had an adequate supply, then rents would fall and NOI would be reduced to approximately the national average.

Table 13: Rents and Net Operating Incomes for Garden Apartments US and Western Cities - 2003

Geographic Area Monthly Monthly Monthly Net Operating

or City Rent Operating Net Operating Income as Pct

Expenses Income* of Rent

U.S. 696 299 331 48%

Houston 659 303 289 44%

Phoenix 707 272 319 45%

Oakland 1137 398 742 65%

Sacramento 768 324 419 55%

San Jose 1282 447 757 59% Source: Institute of Real Estate Management (IREM), Income/Expense Analysis Conventional Apartments (National Ass'n of Realtors, Chicago,2004) *Net operating income does not equal monthly rent minus operating expenses due to vacancies. Rents are for rented units while expenses and net operating income reflect averages for the whole building including rthe vacant units.

Page 12


Apartment values increased substantially from 1994 to 2005 as shown in Table 14. The average sale price of an apartment building per apartment unit increased from $44,300 to $111,400, although prices leveled over the past two years.

This increase may be attributed to several factors. The exceptional rent increases have led to a substantial growth in net operating income10 because rent increases have far outstripped cost increases. “Capitalization” rates for apartment buildings have declined sharply (from about 9 percent to about 6 percent) due to declines in interest rates and rates of returns in other types of investment.11

Rental property values have certainly experienced robust increases since 1994, on the order of about 150 percent. But these values, from the standpoint of investors deciding among competing vehicles for profitability, are in competition with values seen in the single family home and condominium market, particularly the latter.

YearSales

Volume (Units)

Average Price per

Apartment Unit

Percentage increase since

19941976 NA $13,392 NA1977 NA $17,312 NA1978 NA $20,000 NA1994 522 $44,322 NA1999 501 $79,546 79.5%2000 284 $80,732 82.1%2001 280 $96,250 117.2%2002 259 $86,253 94.6%2003 493 $120,114 171.0%2004 718 $111,026 150.5%2005 2,356 $111,393 151.3%

Table 14: Historical and Recent Sales Prices of Apartment Buildings in Berkeley

Source: City of Berkeley Housing Department; MetroScan; RealQuest.com; 1976 through 1978 data from Ken Baar, "Issues and Options for Rent Increase Standards...," October 1995.

While it may not be feasible to convert some existing rental properties to home ownership, with a per unit average market value of $111,000 for rental property compared with $480,000 per unit median value for condominiums there is clearly a tremendous economic incentive to convert. New construction and conversion of existing buildings are the two major strategies for addressing this unmet demand in today’s ownership housing market in Berkeley.

10 Net Operating Income = Gross Rent <less> Operating Expenses. Net Operating Income is the return used to cover financing costs and provide cash flow. 11 In other words, investors are willing to pay more than they were a few years for the same net operating income. A net operating income of $100,000 which may have been worth $1.11 million ($100,000/.09) in 2000 now may be worth $1.67 million ($100,000/.06).

Page 13


Table 15 analyzes and compares the profitability of a hypothetical conversion project in TIC versus condominium ownership. The table makes a further comparison of the two types of conversions on a per-unit as well as a property-wide basis. It relies for comparison on the value of the property as an apartment building as well.

TIC Unit Condominium Unit TIC Property Condominium

PropertyPer Unit Average Value Sold as a Rental Apartment in 2005* $180,000 $180,000 $900,000 $900,0

Per Unit Conversion Costs $2,702 $10,901 $13,510 $54,507Per Unit Transfer Tax $3,000 $3,750 $15,000 $18,750Per Unit Transaction Costs $24,000 $30,000 $120,000 $150,000Per Unit Affordable Housing Mitigation Fee - 12.5% of Sale Price NA $62,500 NA $312,500

Anticipated Per Unit Sale Price $400,000 $500,000 $2,000,000 $2,500,000Net Per Unit Proceeds of Conversion $370,298 $392,849 $1,851,490 $1,964,243

Net Per Unit Proceeds of Conversion in Excess of Value of Apartment in 2005 $190,298 $212,849 $951,490 $1,064,2

Difference with respect TIC Unit/Property NA $22,551 NA $112,7

Sources: City of Berkeley Planning and Development Department; interviews with local attorneys.

Conversion to:

Table 15: Comparison of Returns from TIC and Condominium Conversions on a 5-unit property

* Per unit apartment value for this analysis assumes approximately 150 percent of recent average rental unit value in a high-end Berkeley property.

00

43

53

This conceptual model of a conversion project indicates strongly that TIC conversions in a 5-unit property realize over $190,000 in per-unit net proceeds in excess of the unit or property’s value as a rental apartment building (or over $950,000 in net proceeds for the entire property over its value as an apartment building). The profitability of condominiums (assuming a 25 percent condominium premium over TIC value) is even more robust, despite the 12.5 percent affordable housing mitigation fee: per unit net proceeds reach nearly $213,000 in excess of the unit’s value as a rental apartment (and over $1 million for the entire property in excess of its value as a rental).

The Affordability of Renting versus Homeownership

The costs of condominium ownership (which are substantially below the costs of owning a single family home) are nearly double the costs of renting . The monthly cost of owning a median priced condominimum $450,000 are more than double market rents of one and two bedroom apartments, typically in the range of $1,200 to $1,500, and are affordable for only about 13% of tenant households with an income of $75,000 or more. (See Table 16). The table also shows the mitigation fee approximately as it would apply to these sample conversions. In those cases where the conversion did not lead to such major decreases in affordability, the formula would reduce or eliminate to fee.

Page 14


TABLE 16 - RENTAL V OWNERSHIP COSTS

Renting Monthly

Cost Condo Price

Range

PCT Condo Sales withing Price Range (135 sales in Berkeley '05)

Condo Price

Condo Ownership

Monthly Cost

Increase in Monthly Cost over Renting

Affordability Loss

Capitalized (cost diff./.06 cap rate *12)

Conversion Mitigation Fee

Conversion Mitigation Fee Ceiling 12.5% Condo Price

1095

1 br median

rent $325k or less 4% 300,000 1990 895 179065 247744 37500

1200 $326-375k 10% 350,000 2289 1089 217742 297868 43750

1200 $376-425k 14% 400,000 2587 1387 277420 368992 50000

1200

1 br med condo price 420,000 2706 1506 301291 397441 52500

1450

2 br median

rent $426-475k 18% 450,000 2885 1435 287097 390116 56250

1500

2 br med condo price 490,000 3124 1624 324839 437015 61250

1500 $476-525k 14% 500,000 3184 1684 336775 451240 62500

1500 $526-575k 12% 550,000 3482 1982 396452 522364 68750

1700 $580k or more 27% 600,000 3781 2081 416130 553488 75000

Assumptions: Mortgage - 95% of purchase price, mortgage interest rate - 6%, property taxes = 1.4% of purchase price, insurance = .03 of purchase price, monthly homeowners association fees (including water& refuse collection = $200, tax benefit = 20% of mortgage interest + property taxes

Effects of Condominium Conversion of Multi-family Property on Tenants

It is sometimes argued that conversion of rental housing to ownership has no effect on the rental market because each conversion allows a tenant to become a homeowner, thus providing an equivalent reduction in the demand for rental housing. This argument is incorrect for several reasons. There is a continuing flow of new tenants into the housing market, particularly in Berkeley where thousands of new students arrive every year, while many graduating students attempt to remain in the community. Condominium conversion can thus shift the balance of renters and homeowners in the community to the detriment of tenants. Conversion also reduces the demand for construction of new homeownership units and thus can create a corresponding reduction in the overall supply of new ownership housing within the region. The reduction in the supply of rental housing due to conversion is less likely to have the corresponding effect of supporting additional construction of rental housing, because the majority of tenants are a lower-income group than those who are able to become homeowners and while their needs are just a

Page 15


great, their market power or “effective demand” is much less due to their lower incomes, and because it is much harder for developers to obtain permission to build rental housing in most of the Bay Area than it is to develop ownership housing. In addition, new rental housing is typically built at the high end of the rental market, as we have seen in Berkeley, so new construction may not replace units at the rent levels of those undergoing conversion.

It is also worth noting that Berkeley’s multifamily housing is almost entirely located within easy walking distance of mass transit and is centrally located to major employment centers, something that is particularly important for low-income people who are less able to afford the costs of maintaining an automobile. Even if additional rental housing at relatively affordable rents is created in outlying suburban locations, this move to auto-dependent areas creates a significantly greater hardship for low-income people than it does for people who can afford homeownership. It has also been argued that conversion of rental units to condominiums will have little effect on low-income tenants because most of the units that convert are among the most desirable, with the highest market rents, and because there are many vacant units in the local housing market. However, an adequate supply of vacant units is essential to a well-functioning rental market, since otherwise tenant mobility is restricted and market rents are driven up. Similarly, an adequate supply of the higher rent units most desired by higher income renters is essential because otherwise these renters will move into direct competition with low-income renters, making it more difficult for them to find housing and driving up rents at the middle and lower end of the market. The full effects of any change in an interdependent regional housing market are complex and difficult to predict. However, it is clear that during the past few decades in the Bay Area, gentrification processes have pushed low-income households out of more and more central locations in urban areas and created tremendous hardship as rents have increased at rates far faster than tenant incomes.

It is also sometimes argued that the problems faced by low-income tenants are problems of income rather than of rent levels. They are both. Obviously higher incomes would permit tenants to afford higher rents, and it is certainly true that there are many tenants whose incomes are so low that without subsidy they cannot afford to pay rent at a level that is necessary to properly maintain the building they live in. At the same time, their problems are exacerbated by the particularly high rents of the Bay Area. If Bay Area rental property owners received the average percentage of net operating income that is typical in most of the United States rents would go down substantially. Reduction in the supply of rental housing through conversion of multifamily properties to condominiums worsens the shortage of rental housing and raises already high rents.

Page 16


II. CONVERSIONS: TYPES, COSTS, AND IMPLEMENTATION ISSUES

Tenancy in common (TIC) is a form of ownership allowed under California real estate law that allows an entire property to be owned by a group of owners in percentage shares. A detailed agreement is written and executed by owners, designating each TIC members’ rights and duties, and this may include exclusive rights to use and occupy particular dwelling units, along with assigned parking, storage, and deck areas.

Figure 1. Source: San Francisco Chronicle, 17 January 2006.

While TIC properties are a group form of ownership of real estate that can be used as a form of home-ownership, in a condominium property, the portions of the property within dwelling unit walls are owned by individuals, while common structures and areas are owned in common by the homeowners’ association at that condominium property.

Lenders have taken an interest in financing TIC conversions. Figure 1 indicates one lender’s effort to tap into the TIC market in the Bay Area. One approach this lender takes to making financing arrangements less onerous (because all TIC members used to co-sign one mortgage note) is to enable each TIC member to have their own note without cross liability to other members of the TIC partnership.

Costs of Converting Rental Property

There are sharply divergent cost structures associated with converting rental property to TICs versus condominiums. Table 17 presents a summary of predictable cost items involved in converting rental properties either to TICs or condominiums. To illustrate these costs and incentives, staff interviewed local real estate lawyers and reviewed web sites of law firms engaged in assisting conversions of rental properties to TIC or condominium ownerships.

TIC Condo TIC Condo TIC Condo

TIC Share Agreement (Formation) $2,000 NA $3,500 NA $5,000 NARecorded Memorandum of Agreement $10 NA $10 NA $10 NAEstimated Cost of TIC Conversions $2,010 NA $3,510 NA $5,010 NA

Subdivision MapParcel Map $5,000 NA NATentative Map (discretionary) NA NA NA

Civil Engineering Consultant Fee NA $8,000 $10,000Planning Department Fees $8,708 $8,708 $8,708

Final Map (ministerial w/in 2 years) NA NA NAStructural Engineering Report NA $5,000 $8,000Up-front Property Tax (1 year at 2.1% of value) $8,400 NA NACalif DRE Regulatory Compliance NA $10,000 $10,000 $20,000 $20,000Funding of HOA Assessment 6 months-equivalent (per unit) NA $1,800 $1,800Funding of Reserve Deficiency on Condition of Property (per unit per year) NA $2,400 $2,400Notice of Local Law Compliance NA NA NA

Planning Department Fees $1,799 $1,799 $1,799Inspection and Resulting Code Compliance Improvements unknown unknown unknown

2 units $2,010 $32,307per unit $1,005 $16,154

5 units $13,510 $54,507per unit $2,702 $10,901

10 units $25,010 $69,507per unit $2,501 $6,951

Table 17: Cost Comparison of TIC Conversions with Condominium Conversions in Berkeley

Estimated Predictable Costs of Sample Conversions

Source: City of Berkeley Housing Department, and Planning and Development Department; interviews with local attorneys.

Condominium Conversion

TIC Conversion

2 to 4 units 5 to 9 units 10 or more unitsCost Element

One cost element that is potentially significant and uncertain, given the aging of many existing rental properties in Berkeley, is the City’s inspection of the unit to determine what code

Page 17


compliance actions must be taken by the property owner before the City can issue a Notice of Local Law Compliance regarding potential conversion of the property to condominiums.

TIC Conversion Costs. The cost of converting rental property to a TIC property is relatively small. It is largely a private matter of investors in the property forming a group, obtaining a share agreement from an attorney expert in drafting such agreements, and recording a two-page memorandum on the grant deed of the property that such an agreement exists.

Condominium Conversion Costs. Condominium conversions are considerably more complex than TIC conversions because creation of separate and saleable units within a unitary, but multi-unit structure requires attention to a variety of structural, ownership, financing, and operational issues that must be addressed by state and local government at the creation of condominium properties. Because of the complexity and array of these issues, the costs associated with condominium conversions are considerably higher than for TICs in Berkeley.

Standard costs associated with converting a property to condominiums include:

• Obtaining a report from the California Department of Real Estate,

• Retention of a structural engineer to assist with developing the common interest association’s operating and capital reserve budgets, and

• Inspection by the City of Berkeley Building Official to determine the property’s compliance with local laws and codes.

Average Sale Price Per Unit in San Francisco

$0$100,000$200,000$300,000$400,000$500,000$600,000$700,000$800,000

Condo Duplex Triplex 4-plex 5&6-plexReal Property Type

Ave

rage

Sal

e Pr

ice

Per U

nit

($)

Pacific Heights/Marina Haight, Noe Valley

Source: Sirkin & Gellman, www.g3mh.com, accessed 1/24/2005.

Figure 2: Comparison of condominium and TIC prices in San Francisco, 2004.

The City of Berkeley is also concerned with mitigating the loss of affordable and long-term rental housing in Berkeley by applying an affordable housing mitigation fee to the sale prices of newly converted condominium units here. The fee is currently applied at 12.5 percent of the sale price of the new condominium unit.

Page 18


City staff is unaware of systematic research into the differences between market prices of TIC units versus condominium units. The San Francisco law firm of Goldstein, Gellman, Melbostad, Gibson & Harris, LLP, however, produced a chart on their web site comparing condominium prices with TIC prices for units in properties of various sizes (see Figure 2).

Data from this chart were used to estimate the discount TIC buyers receive relative to prices paid by buyers of condominiums in San Francisco. Figure 3 presents a chart showing these discounts as obtained from Figure 2 data. Since condominium prices are likely averaged, while TIC prices are broken down by building size, the data likely underestimate the differences for duplexes and overestimate for properties with 5 and 6 units. However, the table suggests that TIC discounts range widely from at least 3 to 5 pe(presumably because they most closely appromuch as 44 to 50 percent for TIC units withinthere is no empirical research available to coFor the purposes of this report, a range of disthe sensitivity of TIC discounts (or their inveeffect on incentives to convert properties to T

The steeper the discount of TICs relative to coptions for home buyers willing to enter a TIprices. More to the point for this analysis, hoproperty owner’s decision to convert. Tables15 percent, and 20 percent condominium premium (the increment of value added by virtue of a unit held as a condominium in preference to it being part of a TIC).

In Table 20, the higher condominium premium assumption suggests that conversion of smaller properties is a distinctly paying proposition t

Per Unit Sale PriceConversion CostsTransfer TaxTransaction CostsAffordable Housing Mitigation Fee - 12.5% of Sale PriceNet Per Unit ProceedsDifference with respect TIC Unit

Table 20: Comparison of

Sources: City of Berkeley P

Discount of Average TIC Per Unit Sale PricesRelative to Condominium Sale Prices

3%

27%35%

50%

5%

32%40%

44%

0%

10%

20%

30%

40%

50%

60%

Duplex Triplex 4-plex 5&6-plex

Real Property TypePe

rcen

tage

Dis

coun

t

Discount in Pacific Heights/Marina Discount in Haight, Noe Valley

Source: Sirkin and Gellman, http://www.willhall.com/TIC1PB1.html

Figure 3: Discount of average TIC per unit sale prices relative to condominium sale prices in San Francisco neighborhoods, 2004.

rcent for duplex units relative to condominiums ximate a single-family type of real property) to as larger properties (5 or more units). Unfortunately,

mpare TICs and condominium prices in Berkeley. counts will be examined to give Council an idea of rse, the condominium price premium) and their ICs versus condominiums here.

ondominiums the more attractive they become as C given higher single family and condominium wever, is the effect of the TIC discount on a rental 20 through 22 illustrate the effects of a 25 percent,

o organize the rental property as condominiums. Net

TIC Unit Condominium Unit TIC Unit Condominium

Unit TIC Unit Condominium Unit

$400,000 $500,000 $400,000 $500,000 $400,000 $500,000 $1,005 $16,154 $2,702 $10,901 $2,501 $6,951 $3,000 $3,750 $3,000 $3,750 $3,000 $3,750

$24,000 $30,000 $24,000 $30,000 $24,000 $30,000

NA $62,500 NA $62,500 NA $62,500

$371,995 $387,597 $370,298 $392,849 $370,499 $396,799

NA $15,602 NA $22,551 NA $26,300

Returns from TIC and Condominium Conversions at a 25% Condominium Premium

lanning and Development Department; interviews with local attorneys.

5 to 9 Units 10 Units or More2 to 4 Units

Page 19


positive proceeds over TIC units range from $15,000 to $26,000, exclusive of costs associated with local law compliance.

One local attorney informed staff that he believes the relative increment of value of a condominium unit in Berkeley over that of a TIC currently to be about 15 percent. This scenario is considered in Table 21. This table indicates (given the assumed 15 percent condominium premium) that the net proceeds of converting a rental property of various sizes in Berkeley to TICs provide a $6,000 to $17,000 advantage (on a per-unit basis) over converting a rental property to condominiums in Berkeley given existing known conversion, tax, fee, and transaction costs.



Per Unit Sale Price $400,000 $460,000 $400,000 $460,000 $400,000 $460,000 Conversion Costs $1,005 $16,154 $2,702 $10,901 $2,501 $6,951 Transfer Tax $3,000 $3,450 $3,000 $3,450 $3,000 $3,450 Transaction Costs $24,000 $27,600 $24,000 $27,600 $24,000 $27,600 Affordable Housing Mitigation Fee - 12.5% of Sale Price

NA $57,500 NA $57,500 NA $57,500

Net Per Unit Proceeds $371,995 $355,297 $370,298 $360,549 $370,499 $364,499 Difference with respect TIC Unit NA ($16,699) NA ($9,749) NA ($6,000)


Table 21: Comparison of Returns from TIC and Condominium Conversions at a 15% Condominium Premium

2 to 4 Units 5 to 9 Units 10 Units or More

The spreadsheet model was adjusted incrementally to test for the condominium premium that would yield a break-even condition for larger condominium properties as compared with larger TICs, staff found that it would take a condominium premium of about 20 percent in Berkeley for condominiumization of larger properties to break even as compared with larger TIC conversions. Results of this sensitivity test are presented in Table 22. At this premium level, condominiums in larger projects would realize a $6,000 to $10,000 per unit advantage in net proceeds from sales in smaller properties over TIC units.

A property owner’s expectations of a particular premium will be influenced not just by cost factors such as those identified here, but also by a number of other factors: the property’s locational advantages in the residential market (including neighborhood characteristics), and availability and relative difficulty of financing.



Per Unit Sale Price $400,000 $480,000 $400,000 $480,000 $400,000 $480,000 Conversion Costs $1,005 $16,154 $2,702 $10,901 $2,501 $6,951Transfer Tax $3,000 $3,600 $3,000 $3,600 $3,000 $3,600Transaction Costs $24,000 $28,800 $24,000 $28,800 $24,000 $28,800Affordable Housing Mitigation Fee - 12.5% of Sale Price

NA $60,000 NA $60,000 NA $60,000

Net Per Unit Proceeds $371,995 $371,447 $370,298 $376,699 $370,499 $380,649 Difference with respect TIC Unit NA ($549) NA $6,401 NA $10,150


Table 22: Comparison of Returns from TIC and Condominium Conversions at a 20% Condominium Premium

2 to 4 Units 5 to 9 Units 10 Units or More

Page 20


OVERVIEW OF RECENT POLICY CHANGES ON CONDOMINIUM AND TIC CONVERSIONS

The Tom v. San Francisco decision invalidated the City of Berkeley’s ban on conversion of rental properties with four units or more to owner-occupancy through creation of Tenancy-In-Common projects (TICs). This created the potential for extensive conversion of rental housing to TIC owner-occupancy, and unregulated conversions could be combined with wholesale eviction of tenants through use of the Ellis Act to go out of the rental business.

Since the City cannot currently regulate TIC conversions, the alternative chosen by the Council was to open up greater possibility for condominium conversion. Condominiums will sell for more than TICs and as part of the City’s condominium conversion process rental property owners must protect current tenants, offer them a chance to purchase their units, and pay mitigation fees of a maximum of 12.5% of sales price to the City that go into the Housing Trust Fund. Expansion of the condominium market in Berkeley could undercut the potential market for TICs by offering owners higher profits from conversion, offering buyers a more attractive form of ownership, and at the same time enabling the City to protect tenants and obtain mitigation fees to create permanently affordable housing.

On May 17, 2005 Council voted an ordinance amendment that lowered the maximum affordable housing mitigation fee for conversion of multi-family properties with rental history to condominiums to 12.5% of the sales price of the condominium unit (BMC 21.28.065.B.1). Under the ordinance no more than 100 units may convert from rental to condominium annually at a rate of 50 every six months (BMC 21.28.040 B). The first round of 10 rental properties with a total of 55 units was selected among those that applied for conversion by October 31, 2005.

In addition, on October 25, 2005 Council voted a set of amendments that included reduced fees of a maximum of 5% of sales price for units with long-term owner occupants (seven years or more), primarily TIC owners, in properties with two to four units (BMC 21.28.065.B.2 and 3). The reduced fee also applies to duplex units occupied by owners who have not lived in the unit for seven years but who were previously Berkeley tenants for long enough to total seven years (BMC 21.28.065.B.2). The reduced fee also applies to owner-occupied duplexes that are exempt from both rent control and good cause for eviction (BMC 21.28.065.B.4). The properties with units receiving reduced mitigation fees of 5% are also exempt from the limit on the number of rental units that may convert to condominiums (BMC 21.28.040 B.2). So far six properties with 14 units that fall into these categories have received their notices of selection to proceed with the conversion process.

Page 21


As shown in Table 23, so far there are a total of 69 units selected for condominium conversion, with 55 rental properties and 14 units in properties with long-term owner-occupants eligible for reduced fees. In addition, there are another 70 units in 15 properties whose owners have submitted a request for selection.

In addition, and not counted in these totals, all owner-occupied TIC units that were exempt from fees under the previous ordinance, those dating back to 1992, continue to be exempt as long as they submit a completed subdivision application by July 1, 2007 (BMC 21.28.065.A.2). Also, up to 15 units in which TIC owner-occupants have lived in their units since 1995 are also exempt (BMC 21.28.065.A.3). So far only one unit has applied under this exemption, and it is included in the totals above.

Setting the affordable housing mitigation fee is a two-part process. First the base fee is calculated, as set forth in BMC 21.28.060 Affordable Housing Fee Requirements. Then any applicable fee reductions are determined as set forth in BMC 21.28.065 Affordable Housing Fee Exemptions and Further Reductions in Fee.

Units on property

Number of properties

Total units

2 73 24 25 26 1

12 1 1213 1 13

Total 16 69

Units on

1468

106

propertyNumber of properties

Total units

2 34 65 16 27 18 2

Total 15 70

Table 23: Characteristics of properties selected for conversion, first round:

Characteristics of properties requesting selection in the next round:

Source: City of Berkeley Planning and Development Department.

6245

127

16

The process for calculating the base fee is designed to meet the legal requirements for a mitigation fee. The ordinance establishes the loss of affordability involved in conversion of a rental unit to a condominium for each unit. This is based on a comparison of the annualized market-rate rental cost to the annualized cost to the homeowner of mortgage payments, taxes and homeowners association fees. Note that even if the unit is rent-controlled, the base rent for purposes of this calculation is the estimated market rent that would be paid when the tenant vacated and a new tenant moved in. Then the ordinance determines the capital cost of mitigating this loss of affordability if the City were to have to subsidize purchase of the unit at a level that returned the cost to the market rental level. This is determined by using the average fixed-rate mortgage interest rate to establish the capitalized value of the difference. If the purchase of the unit were subsidized by the capitalized value, that would reduce the amount of the mortgage sufficiently to bring the monthly cost of ownership down to the monthly cost of renting the same unit.

If there is a situation in which a property has very little or no difference between the rental costs and the ownership costs, then the fee will be little or nothing. In today’s market, the typical base mitigation fee resulting from this analysis will be quite high. For example, if the cost of ownership is $1,000 a month more than the market rent, at an interest rate of 6% the capitalized value of the $12,000 a year difference is $200,000.

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Since most base fees are at a level that very substantially reduces the profit from conversion, very few rental conversions took place until the recent amendments that set a cap on the conversion fees at 12.5% of sales price.

At present the ordinance seems to be working reasonably well. Staff has issued notices of selection for 55 rental units and there are an additional 70 rental units waiting for the next selection round. This is enough to use of the allowable 100 units, and there is no reason to lower the fee as long as the demand for conversion is sufficient to use up the allotted 100 units. At the same time, the number of applicants is not so many that a higher fee would be likely to be sustainable at this time, and the economic analysis of condominium and TIC conversions suggests that the current fee level is about as high as it can be without starting to tip the balance toward TICs. Staff will continue to monitor ordinance implementation and the housing market generally to see if applications diminish or TIC conversions increase substantially, and will be prepared to recommend changes if either of these occurs.

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CONDOMINIUM CONVERSION ORDINANCE ALTERNATIVES

A. Alternatives for Affordable Housing Mitigation Fees for Conversion to Condominiums by Long-term Occupants

The mitigation fee for conversion of multifamily property to condominiums is currently capped at 5% of sales price for units where one of the applicants for conversion has lived in the unit for seven years or more. This is reduced from the normally applicable cap of 12.5% of sales price that applies to conversion of units in multifamily property to condominiums in order to encourage and support long-term residency and discourage speculation.

Alternative A1: Make no change in the current ordinance provisions.

The Housing Advisory Commission has discussed the current ordinance and declined to recommend any changes in the fee levels for long-term residents. There are substantive reasons for this. Fees for conversion of owner-occupied units discourage a situation in which rental property owners encourage first-time buyers to enter into risky forms of ownership with the idea that they will eventually be able to convert the property to condominiums without any payment of mitigation fees. In order to do this, it is important to prevent use of tenancy in common as an intermediate step to evade condominium conversion mitigation fees. The current fee reductions are beneficial to long-term residents while still maintaining such an incentive structure.

Alternative A2: Reduce the 12.5% cap on condominium conversion mitigation fees for units where the applicants for conversion are owner-occupants by one percent (1%) for every year of owner-occupancy.

This alternative helps discourage plans to use intermediate forms such as tenancy in common in place of direct conversion to condominiums, while providing a graduated scale that reduces the fee over time and completely eliminates the fee for long-term owner-occupants who have lived in their units for twelve and one half years.

The fee reductions start with the date of owner-occupancy rather than based on tenancy in the unit to avoid creating a situation that could encourage rental property owners with long-term tenants to sell the property as TICs with the ability to immediately convert to condominiums without payment of mitigation fees. This would open the door to manipulation of the process and creation of individual windfalls in place of mitigation fees used according to a program.

Alternative A3: Apply the reduced 5% cap to long-term occupants who moved in on or after July 1, 2005 but eliminate condominium conversion mitigation fees for units where the applicants for conversion have been owner-occupants prior to July 1, 2005 and qualify as long-term occupants.

This alternative helps discourage future efforts to use intermediate forms such as tenancy in common in place of direct conversion to condominiums, while eliminating the fee for those long-term residents who moved in prior to revisions to the ordinance which made conversion feasible.

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Alternative A4: Completely eliminate condominium conversion mitigation fees for units with long-term owner-occupants.

Some owners have argued that even though condominium conversion increases the value of the property and makes it less affordable in the future, it is not fair for the City to charge a mitigation fee for conversion to condominiums when higher income people who were able to purchase single-family homes do not contribute to the City’s affordable housing programs when their property values go up.

B. Alternatives for Affordable Housing Mitigation Fees for Conversion of Rental Property

Alternative B1: Eliminate expiration date on provision limiting the fee for conversion of rental properties to 12.5% of the sales price.

This provision was time limited to January 31, 2006 in order to allow the first set of 50 units to be selected and to determine how well the ordinance is working before continuing to move ahead. This part of the ordinance does seem to be working well, with somewhat over 100 units in the queue for selection.

Alternative B2: Allow a discount for fees that are paid at the time the map is filed rather than waiting until sale of the units.

An argument for this is that otherwise the City may have to wait years until the conversion fees are paid, and there is a great current need to create permanently affordable housing for very low-income people in Berkeley. With an average tenancy of five years, a discount from 12.5% to 9% would reflect a reasonable discount rate of just over 6% annually.

An argument against this proposal is that it may simply result in reduced fees on units that would have been sold quickly in any case. Application of the discount to whole buildings could reduce such selectivity but might limit its use to buildings where most of the units were vacant or the tenants agreed to buy-outs, in which case the City would be helping to finance the tenant buy-outs with the fee reduction.

Alternative B3: Increase the cap on the maximum fee to a level higher than the current 12.5% of sales price.

The argument for this is that additional funds for mitigation of the loss of rental housing are both appropriate and needed in light of the increase in property value that results from conversion from rental to condominium and the accompanying loss of affordability. However, the current level of demand for conversion at the 12.5% of sales price level does not appear to be sufficient to support an increase, especially in light of the need to avoid creating a competitive advantage for TIC conversion over condominium conversion. If interest in conversion leads to a substantial waiting list, then Council could reconsider increases in the cap on fees.

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Alternative B4: Reduce or eliminate fees for conversion of rental property that is rented at market rate or at rents above a certain level.

The argument for this is that the purpose of the condominium conversion ordinance was to protect rent controlled units, and that rental units at current market rates or in luxury units are not affordable to low-income tenants, so there is no significant economic impact from allowing their conversion. However, a larger rental market helps low-income tenants by reducing the need for them to compete with higher-income tenants over a limited pool of rental units, and while rent controlled units that turn over are initially rented at market the tenant who remains for a longer period of time will benefit from good cause for eviction requirements and controls on future increases.

Alternative B5: Allow the Planning Commission to approve proposals of equivalent financial value to the mitigation fees if they include permanent affordability restrictions on some units or repayable purchase assistance to current tenants.

The argument for this proposal is that on a case-by-case basis it would allow alternative uses of the mitigation funding to assist tenants in purchasing the units they live in. Tenants could be offered a choice of repaying the assistance on sale of the unit or accepting resale restrictions that created an “inclusionary” unit. Without such a provision, the City will be unable to help individual tenants who request such assistance.

The arguments against this proposal include that it would divert program funding from the broader purpose of mitigating the effects of conversion by creating more affordable housing to a narrower purpose of individual assistance. It could greatly delay receipt of funds for creation of permanently affordable housing, and that while the fees could help as down payment assistance, they would not reduce the cost of condominiums to a level that is affordable to low-income tenants. In addition it would create a great deal of administrative cost and complexity to administer agreements that are different in different projects.

C. Recommended Procedural Changes

1. Set time limit on notices of selection to allow two years from the time of the notice of selection, with a one-year extension at the discretion of the City Manager or his designee.

People who obtain permission to convert should not be able to simply hold the permission and wait on market conditions while others whose applications were lower priority are denied the opportunity to convert. At the same time, there can be delays that are not the responsibility of the owner and that should be taken into account.

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2. Require owners to notify all tenants of their rights and protections prior to filing a request for selection for condominium conversion.

Tenants should be informed at the earliest practical point in the process in order to avoid unnecessary fear and anxiety about their right to continue their tenancy. The City should provide owners with a standard informational statement that owners could use to ensure that they have met their obligation to inform tenants. The current ordinance simply requires the owner to notify all tenants of a request for selection once it has been filed.

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rent stabilization board date: may 15, 2006 to: honorable ... · conversion ordinance and the...

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