Written by Apartment Management Magazine on . Posted in Blog

Last month, we discussed the complexities of California’s affordable housing crisis and the role that Federal tax laws and housing policies have played in creating California’s affordable housing shortages. This month, we continue our discussion with the complexities created by California’s legislature and various local jurisdictions and offer several proposed solutions to alleviating California’s present affordability situation.

California State Level

At the inception of the industrial age California was well suited for urbanization due to its mild climate and abundant land for development. Like other regions, California started out by limiting access to housing for people of color, and by class. While California was not a slave state when admitted to the union in 1850, many of its citizens were from the south and brought with them the same ideas about people of color. California Law also sanctioned deed limitations known as “restrictive covenants.” Accordingly, a property could not be sold to those restricted on the deed. For example, Blacks, Latinos, and Native Americans were often restricted, and those restrictions were often extended to Asians and Jews. Ironically, W.E.B. Dubois was quoted as saying “Los Angeles had the most beautifully housed group of colored people in the United States.” It was 1948 when African American attorney, Loren Miller of Los Angeles, won the case Shelly vs. Kraemer before the United States Supreme Court that struck down the enforcement of restrictive covenants, which prevented many evictions and confiscations of property.

In 1950 the California Real Estate Association, the predecessor of the California Association of Realtors, sponsored an initiative that became Article 34 of the California State Constitution. Article 34 reads: “No low rent housing project shall … be developed, constructed, or acquired in any manner by any state public body until, a majority of the qualified electors of the city or county in which it is proposed to develop, construct or acquire the same, voting upon such issue, approve such project by voting in favor thereof at an election.”

The basis of Article 34 was clear, to prevent people of color and those in poverty from moving into affluent white neighborhoods. The voters in Los Angeles have repeatedly rejected housing projects and have turned down Federal dollars that would have come with them. According to Daniel Yukelson, with the Apartment Association of Greater Los Angeles, over 15,000 units were rejected as a result of Article 34 during the 1960’s. There is a bill moving through the legislature today to place the repeal of Article 34 on the 2020 ballot. The repeal of Article 34 has failed in the past. Because it is a California constitutional amendment, the repeal of Article 34 will require a vote of the people. As of today, Article 34 remains an impediment to affordable housing in California.

In 1970 the California Legislature passed the California Environmental Quality Act, known as CEQA. CEQA was modeled after the federal act known as NEPA, the National Environmental Policy Act, which was passed in 1969. Talk about things changing, CEQA was signed by Governor Ronald Reagan and NEPA was signed by President Richard Nixon, just saying! CEQA was originally limited to public projects, however, numerous court rulings have modified CEQA far beyond its legislative intent. For all practical purposes CEQA now covers any building including a single-family home! For a small filing fee, someone can file a CEQA challenge to block anything. Today the majority of CEQA filings have nothing to do with the environment. For example, CEQA is being used to block projects that offer competition to another project. Often the filing could be a weapon in a labor dispute. Getting through a CEQA challenge could take years and make projects cost prohibitive. The “weaponizing” of CEQA has blocked thousands of housing units in California.

In the early 1970’s the Federal government initiated a program called revenue sharing, also known as Community Development Block Grants (CDBG). To be eligible for CDBG’s, cities had to apply through states, and some states like California also required cities to complete housing elements as part of their general plans. The housing element would contain a plan as to how a city would entitle houses based on data from a regional body. In Los Angeles, that regional body is known as SCAG (Southern California Association of Governments). SCAG does an analysis of housing needs then produces a document known as the Regional Housing Needs Assessment (RHNA). The RHNA is a guide for cities to modify their general plans to accommodate housing needs.

The Federal government has long since given up revenue sharing as well as the requirement that cities complete a housing element. The state has not been enforcing the law although it is still on the books. While the law didn’t require a city to build actual housing units, it did require the city to show how its land use planning would accommodate the needed units.

California Governor Gavin Newsom has begun enforcing the housing element requirements on cities. In addition, there are a few proposed bills moving through the legislature that will strengthen the housing element requirements already in law. Several such bills failed last year.

In 2011 California eliminated redevelopment agencies, or RDA’s. By 2000, due to reductions in other funding, RDA’s were providing over 50% of the affordable housing funds in the state. In fact, then Assembly Woman Maxine Waters authored a bill mandating that a percentage of all RDA expenditures had to go toward affordable housing. An RDA works by using tax increment financing. Simply put, tax increment financing allows a local RDA to obtain land for a reduced price, particularly useful for vacant or blighted properties. The RDA could then sell or give the land to a developer with the understanding that it would be redeveloped, and the taxable value would be increased. The increase in valuation due to the improvements represents the increment that would be used to finance the government acquisition of the land. The elimination of RDA’s was a major blow to affordable housing in California.

In 2018 the California Energy Commission passed Title 24, which requires all new buildings in California to have solar panels beginning January 1, 2020. In addition, all new buildings will be required to make extensive use of energy efficiency. Like many programs this could make environmental sense, however, it will add costs. It may reduce greenhouse gases, and help in the fight against climate change, but for the poor and citizens who file their federal taxes on the short form, it will provide little few any benefits. Since most units are individually metered, it’s not clear who would maintain the panels.

As property values in California have reached levels unseen relative to the income of the average working Californian, the need to do something is becoming more urgent. Another challenge of this crisis is that citizens are having to make longer commutes to work, which ironically negates any benefit to be gained by the solar panels or energy efficiency. I won’t go into all the issues with energy in California but suffice it to say California has some of the highest rates in the nation. But for the mild climate along the coast, the out of pocket costs would be higher. For those who live in the central valley or away from the coast, prices are exorbitant.

In California there have been a series of acts that taken together have inhibited the development of housing. California follows many of the Federal tax rules with respect to tax deductions. Following the Federal rules, the State of California created a tax credit allocation committee in the State Treasurer’s office. This committee dispenses the frontend tax credits for low income housing projects. Getting a project through the committee can take over a year. While Los Angeles has its own committee, the process is cumbersome, nonetheless. Remember, these credits were formerly distributed by the developer, without government intervention.

While the California public is demanding more affordable housing, the legislature has chosen to vilify rental property owners, thus exacerbating the problem. There are bills to make it more difficult to evict renters, bills to increase relocation costs if a rental property owner wants to upgrade or move into their own property. There are bills to provide attorneys for renters being evicted, and a bill to make rent control statewide, following the lead of Oregon. There is a bill to require rental property owners to rent to applicants with criminal felonies. There is even a bill to reverse the defeat of Proposition 10 in the 2018 general election!

Proposition 10 was an attempt to repeal the Costa-Hawkins Rental Housing Act, a piece of legislation from 1995 which provided that all apartments built in California after 1995 are exempt from rent control. Costa-Hawkins also exempted single family homes and condominiums from rent control and decontrolled rent when a renter moved out of a unit by choice. I worked on this legislation in 1995.

If a property owner must evict a renter for cause in Los Angeles getting into court could take 4 to 6 months to do so. Let’s say the rent on a unit was $1,500 per month, that’s $6,000 in lost income. Add likely $10,000 for legal fees and the rental property owner is down $16,000. Now let’s say the public financed attorney gets a continuance that could add another three months or $4,500. So now the cost to the rental property owner is $20,500.

And, then there are costs to “re-hab” the vacated unit, which can range from $5,000 to $10,000. So, evicting a renter in the Greater Los Angeles area could exceed $30,000 or more. Who in their right mind wants to be a rental property owner in California, when you could simply invest in a 401(k) plan and forget about it? However, without small, “mom and pop” rental property owners, the affordable housing challenge would be insurmountable.

Local Government

Cities and counties play a major role in the California housing pipeline. All buildings must have entitlements, (e.g., permits to build). In many cities, zoning restrictions make it difficult to develop housing. The Century Foundation described what they call “exclusionary zoning.” For example, making areas residential 1 or R-1 limits the number of units that can be developed on a site. Since we know density reduces cost, R-1 zoning therefore increases cost and thereby excludes some developments. The history of some zoning laws was to prevent “certain people” from moving into specified neighborhoods by making them more exclusive. The City of Minneapolis, Minnesota recently outlawed R-1 zones. I don’t believe we have that much political courage in our California cities as zoning is an impediment to housing.

A continuing battle at the local level is the development of “granny flats” now known as accessory dwelling units, or ADU’s. In many areas, there is room for conversion of garages or adding a unit to an existing structure. The cities and state have been fighting over this for over 20 years. I authored Assembly Bill 1866 to permit “granny flats” in 2002. Cities fought them then and it remains a fight today. It’s getting better, but issues remain. Several ADU bills have been introduced since 2002, but the matter is still unresolved.

Several California cities have enacted rent control, to stabilize rental costs. What we saw in most of these cities is that rent control had a chilling effect on apartment development and sales. In Los Angeles and San Francisco, these cities each amended their laws to exclude units built after a date certain. In Los Angeles, units built after 1978 are exempt from rent control and in San Francisco, units built after 1979 are exempt. There have been discussions to repeal these provisions. Clearly, any attempt at repealing these exemptions would end up in a court battle as builders had invested with an expectation that they were protected in law and exempt from rent control. In Los Angeles when rent control was passed, apartment construction stopped. So, the next year the city exempted all units built after 1978. As you might have expected, almost half the units included in the initial rent control program in Los Angeles are now off the rental market, making the vacancy rate worse.

The overwhelming majority of economists, including Nobel Prize winner Paul Krugman, agree that rent control is an impediment to housing development. There are those who feel the protection of renters today is more valuable than developing more units. In many cities, renters have purchased houses and at the same time held on to their rent-controlled units as the below market price is considered an asset. In some cases, the unit is sublet to family or friends. In extreme cases, rental property owners pay renters to move.

An important dynamic of the apartment rental business is how properties are valued. Single-family homes are valued at what people will pay. In fact, one of the things a buyer should do is check what homes in an area are selling for. This is called checking for “Comps.” On the other hand, apartments are valued based in part on the income the property generates.

In many listings, the price is given as a multiple of gross annual rents. So, you might see a sale price as “8 Gross” and this means the sale price is 8 times the annual income of the property. The higher the gross multiplier, the more that will be required for the down payment. Moreover, more outside income will be required of the buyer as a negative cash flow means she will have to come out of pocket to cover costs. This also means a seller will have to decide between accepting a lower sale price, or financing a portion of the sale, known as “taking back paper.”

Another problem in rent control cities is that older buildings have begun falling into disrepair. What happens when the cost of repairs exceeds the allowed income and financial ability of the property owner? The property comes off the rental market. Cities have begun inspections requiring repairs which many owners have no resources to complete. In some cities owners simply take units off the market, known as the Ellis Act. In Los Angeles the city recently passed a requirement that all units have a seismic upgrade to make them safer in earthquakes. The cost of the upgrade is not covered by an increase in rent allowed.

Many areas receive special designations such as HPOZ, or historic preservation overlay zone. On the surface an HOPZ sounds like a good thing, keeping the character of an area from say the 1920’s. Here’s the problem, what if the house had a type of roof that was common in 1924, that is expensive in 2019? What if you want to install energy efficient windows and they don’t fit the HPOZ guidelines? People are losing homes because they can’t afford the repairs. This is an insidious element of gentrification, as most of the victims are seniors. The scam works like this, a homeowner applies for a permit to do a repair. The HPOZ committee denies the permit, requiring repairs and materials that may cost 3 times as much. The homeowner can’t afford the additional costs, the HPOZ committee tells speculators about the homeowner’s dilemma. The house is sold as distressed.

Private Sector

The housing business is just that, it’s a business. Like any other business, the housing business depends on investors. We have seen many government policies that have all but forced the small investor out of the housing business. Looking at television advertising today you see numerous ads for financial services firms. These companies are attracting capital that formerly went into housing. Because sales taxes are no longer deductible, many homeowners are taking cash out of homes to purchase cars or even take vacations! Often the amounts taken exceed the ability of the homeowner to pay and the homes are lost. As we have discussed, many of these homeowners get sub-prime loans, with exorbitant fees as they often don’t qualify for a conforming loan. This also drives up prices, and leads to speculation, known as “flipping.”

For many years the idea of purchasing a home or rental unit was a goal of most Americans. More wealth has been created by real estate than any other source. Today, many younger Americans are electing to rent rather than buy homes. Student loan debt is a factor in this change of strategy. The obvious concern here is that they are losing out on the economic benefits of ownership. Because of high foreclosure rates many single-family homes are now being rented. In fact, some of the financial services firms have formed rental divisions to handle these homes.

Given the vilification of rental property owners and apartment investors, many of those who would formerly have invested don’t. Taken together with the loss of federal and state benefits, fewer investors are going into the housing business. We must ask the question, does a policy encourage or discourage private investment? Without the capital investment of small, private investors, we will not be able to resolve housing crisis. I understand that not everyone can manage rental property, and there are clearly benefits to investment in a 401(k) plan. Given that if you are a renter or an owner, we all must pay for the place we stay. As a renter, your equity position in the property will be the same: ZERO! On the other hand, managing an apartment building is a business that is not for everyone.

Proposed Solutions

Here are my suggested solutions to the affordable housing issues in California:

  • Restore the Federal tax deductions that were eliminated, including deductions for more than two properties. accelerated depreciation, and deduction of front-end costs (e.g., restore the investment tax credit). (Federal Congress)
  • Modify Davis-Bacon to apply only to development projects in excess of $10 million.
  • Restore the property tax deduction for property tax to actual amounts paid, therefore, voiding the$10,000 limitation. (Federal Congress)
  • Have the Government Service Enterprises create a special secondary market for apartment development and purchase of apartments. (Federal Congress)
  • Create a homeowner savings account like 401(k) plans, which would allow tax exempt savings for down payment savings. (Federal Congress)
  • Limit CEQA (California Environmental Quality Act) to public projects as it was originally drafted. Or at a minimum, exempt residential developments. (State Legislature)
  • Maintain Costa-Hawkins in statute and oppose bills to institute state rent control or repeal Costa-Hawkins. (State Legislature)
  • Restore enforcement of the RHNA (Regional Housing Needs Assessment) to cities. (State Legislature)
  • Reinstate RDA’s (Redevelopment Agencies) with a portion dedicated affordable housing.(State Legislature)
  • Fast track residential developments in transit zones.(State Legislature)
  • Establish sunset dates for local rent control ordinances or allow those in place to expire.(State Legislature)
  • Eliminate exclusionary zoning practices, particularly
  • R- 1 zones. (Local Governments)
  • Expedite building permit process and place a time limit on applications for building permits.(Local Governments)
  • Allow development of ADU’s (so-called “granny flats”). (Local Governments)
  • Expedite court process for unlawful detainer hearings. (Local Governments)
  • Create a higher capital gains tax for house flipping, where the flip period is less than 6 months and less than $10,000 was invested in the property.(State Government)

Roderick D. Wright is a former member of the California State Assembly, and the State Senate.  He has been an apartment owner for over 40 years.  He is a member of the Apartment Association of Greater Los Angeles.  He was a founding member of the Minority Apartment Owners Association.  He is also a former real estate developer. roderickdwright@aol.com