California Cities Can Require Developers to Build and Sell Affordable Housing in Their Projects

Local governments may enact laws that require all new residential development projects of 20 or more units to sell at least 15 percent of the for-sale units at a price that is affordable to low or moderate income households, the California Supeme Court has held.

The case marks a defeat for the California Building Industry Association (“CBIA”), who sought to invalidate San Jose’s inclusionary housing ordinance on the basis that the law was an unconstitutional condition in the form of a development exaction under the takings clauses of the United States and California constitutions. An “inclusionary housing ordinance” is a law that requires a developer to construct and offer affordable housing as a part of its proposed development project. The case is California Building Industry Ass’n v. City of San Jose, decided June 15, 2015.

The decision is significant for cities and counties as they grapple with the limited amount of affordable housing in the state. Many cities and counties are now expected to follow San Jose’s example and adopt laws imposing affordable housing requirements on for-sale development in their jurisdictions. The imposition of affordable housing requirements on new for-rent housing is limited by the Costa-Hawkins Rental Housing Act, a 1995 state law.

For developers, the decision is another example of the tough legislative requirements imposed on new developments in California.  Developers of large scale projects have often had to deal with cities and counties demanding that in return for long term vested rights to build their projects, the developer is required to provide a percentage of affordable housing in the overal project. Now, not only can cities and counties bargain for a required percentage of affordable housing in development agreements, they can mandate it as law on projects as small as 20 units (and perhaps fewer!). Developers in cities and counties that adopt such laws will now need to include in their pro formas the cost of building, offering and selling affordable units to low income and moderate income families. Those financial impacts not only include lower returns on construction and development costs, but the added expense of implementing an affordable housing program as part of the project (unless the local government provides those services).  The inclusionary requirements will certainly reduce developer profit, but may also affect the financial viability of the project as a whole.

Chief Justice Cantil-Sakauye wrote for the Court that the conditions that the San Jose ordinance imposed upon future developments did not impose “exactions” upon the developer’s property so as to bring into play the unconstitutional conditions doctrine under the takings clauses of the federal or state constitutions. The conditions do not require the developer to pay money but place a limit on the way a developer may use its property, the court said. The ordinance serves legitimate government purposes of increasing the number of affordable housing units in the city and assuring that new affordable units are distributed throughout the city as part of a mixed-income development. Therefore, the court reasoned, the affordable housing ordinance is a zoning restriction, not a taking. The higher standard of court review applied to takings cases did not apply. Instead, the court could apply the much lower judicial review standard for zoning laws: such laws will be upheld so long as they have a reasonable relationship to a legitimate governmental interest.

CBIA’s lawsuit was a “facial” challenge to the City of San Jose’s ordinance, which argues that the ordinance was unlawful for essentially all reasonably conceivable projects. Another path to challenge the City of San Jose’s ordinance is still available. It is still possible for a developer to make the argument that the law, “as applied” to its particular project, is a taking. Under compelling facts, the California Supreme Court could find that “as applied” the law was confiscatory or an “unconstitutional condition” to the development of the project. However, such a lawsuit would be a risky endeavor given the Court’s prior holding.

In addition, CBIA could appeal the decision to the United States Supreme Court to review the California Supreme Court’s interpretation of federal takings law.  Strategically, it would probably be best for the CBIA to wait for a project with compelling facts in an “as-applied” challenge rather than using the facial attack. It could well be the case that the chances of prevailing would be higher in an “as-applied” challenge.  The risks of losing the case in another “facial” challenge and establishing national legal precedent similar the California Supreme Court’s holding would definitely not be welcomed by the development community.

California Lawmakers Propose Property Tax Reform for Commercial and Industrial Properties

California lawmakers recently introduced SCA 5, a new proposal of an old idea to create a “split-roll” property tax.  The proposed constitutional amendment would remove Proposition 13’s limits on property taxes for commercial and industrial properties. The measure would allow for yearly reassessment of those properties to ensure their property taxes reflect current market value, as opposed to only reassessing a property when it changes ownership.  Protections for residential and agricultural property assessments would remain in place.

Voters approved Proposition 13 in 1978 in reaction to skyrocketing property taxes on homes and commercial properties.  The landmark measure restricted the yearly increase in property taxes and only allowed reassessment when the property changed ownership.

SCA 5 faces numerous tough hurdles before it could be enacted.  As a constitutional amendment, passage of the bill requires a two-thirds vote in both the Senate and Assembly, followed by a vote of the people in the 2016 election.  SCA 5’s first test will be in the Senate Government and Finance Committee, which has not set a hearing date yet, but it could be as early as next month.

WHAT SCA 5 DOES

The proposal includes a complicated multi-step phase-in process for the new yearly reassessments.  Beginning in fiscal year 2018-19, only the half of commercial properties with the oldest assessments would be re-assed.  The new tax rates for these properties would have a three year phase-in period.  They would pay only one-third of the increase in the first year, followed by two-thirds in the second year, and finally paying the full taxes based on the new assessment in the third year.  Beginning in fiscal year 2019-2020, the second half of properties would be reassessed.  They would pay 50% of the tax increase in the first year, and the full increase in the second year.

FY 18-19 FY 19-20 FY 20-21
Oldest half of assessments 1/3 of increase 2/3 of increase Full increase
Newest half of assessments 1/2 of increase Full increase

In an attempt to make the measure more palatable, the authors of SCA 5 carved out protections for smaller businesses.  Businesses that own their own property worth less than $3 million and operate on that property will have a five year phase-in of the new rates.  Additionally, the proposal exempts business personal property up to $500,000.  The authors say this credit will take 90% of businesses off of the personal property tax roll.

SUPPORT AND OPPOSITION

Proposition 13 reform and the split-roll proposal are old issues that draw predictable support and opposition.  Although most groups have not had time to take formal positions on SCA 5, some business groups, like the Howard Jarvis Taxpayers Association, have already voiced their strong opposition to any changes to the property tax rate.

The authors of SCA 5, Senators Loni Hancock (D-Berkeley) and Holly Mitchell (D-Los Angeles), are supported by the Make it Fair campaign, a coalition of unions and liberal activists who are the primary backers of the bill.  In the likely event that SCA 5 does not pass, the Make it Fair campaign is exploring the option of collecting the necessary signatures to place the measure directly on the November 2016 ballot.

Proposition 13 has long been considered the third rail of California politics. Most Californians strongly support this law that keeps their property taxes low in a state that already has high tax rates.  In light of this, liberal activists have long viewed the split-roll proposal as a half measure that Californians might support.  Polls as recent as 2014 have shown support as high as 62% of voters for a hypothetical split-roll proposal like SCA 5.  However, a new poll published in May by the Public Policy Institute of California found that support for the split-roll had dropped significantly down to 50% of Californians, with 44% opposed the idea.

THE MONEY

Proponents of SCA 5 say the proposal would raise $9 billion a year in revenues for local governments.  The bill would distribute this money based on the current allocation formulas to cities, counties, and special districts.  Local communities could decide how best to reinvest the money in local services like public safety, parks, mental health, and infrastructure.  To comply with complicated funding formulas, the bill funnels the money allocated for schools through a special fund and then to local school districts.  Some of the money would be used to reimburse local assessors for their increased costs, to reimburse the state for lost revenue, and to create new online transparency and accountability for local governments receiving the new funds.

BOTTOM LINE

With numerous hurdles and strong opposition still on the horizon, SCA 5’s fate is far from certain.  Most people consider the bill to be a longshot, but it represents the most concerted effort by liberals to amend Prop 13.  Just last year, a much more modest bill targeted at curbing abuses was defeated in the Senate after passing the Assembly. SCA 5 will likely undergo a number of changes as it works its way through Sacramento.  As it does we will be keeping an eye on it and how it could affect your business.

New Crowdfunding Tool for Real Estate Projects Emerges – But Tread Carefully

Last week, the Securities and Exchange Commission (“SEC”) adopted final rules that will make it easier for real estate firms to pursue capital raises of up to $50 million in a 12 month period.

The rules, commonly referred to as Regulation A+, permit eligible companies to conduct securities offerings without the onerous requirements of full securities registration.  What’s more, companies can solicit funds from individuals who are not accredited investors.  In other words, companies can promote their investment opportunity to any investor with an internet connection, although unaccredited investors will be limited in the amount they can invest.  It’s no surprise why Regulation A+ has been called the private company’s mini-IPO law.

Silicon Valley’s legal community seemed to shrug and yawn when asked about the fundraising opportunities for startup tech companies, according to a recent article in The Recorder.  Time will tell if they are right.  However, in the real estate investment and development community, $50 million can help fund a very attractive real estate opportunity.

Overview of Regulation A+

Of course, the new regulation is not without its process and procedure, so real estate project sponsors need to proceed carefully.  The exemption cannot be used for a “blank check” real estate business model.   In addition, the new rules establish two tiers of offerings that can be made:

Tier 1:  Annual offerings of up to $20 million, including no more than $6 million on behalf of selling security holders that are affiliates of the issuer.  There are no minimum investor qualifications and only reviewed, but not audited, financials are required.  However, Tier 1 offerings are subject to both SEC and state review.

Tier 2:  Annual offerings of up to $50 million, including no more than $15 million on behalf of selling security holders that are affiliates of the issuer.  A company making a Tier 2 offering must provide audited financial statements, annual reports and engage in ongoing reporting.  Tier 2 offerings will be exempt from registration and full Exchange Act reporting and may list their securities on a national securities exchange by filing a short-form registration statement.  Unaccredited investors can purchase no more than (i) 10% of the greater of annual income or net worth (for natural persons) or (b) 10% of the greater of annual revenue or net assets at fiscal year end (for non-natural persons).  Tier 2 offerings are subject to SEC, but not state review.

Real estate companies can “test the waters” with, or solicit interest in a potential offering from, the general public either before or after the filing of a Regulation A+ eligible offering statement so long as certain conditions are satisfied.  This can be an important tool for real estate developers who want to gage interest in their particular project before launch.

Some Issues Unique to Real Estate Related Offerings

Unlike a typical startup company offering, structuring a real estate offering properly is crucial to take advantage of the new regulation.

For example, asset backed securities are excluded from the list of eligible securities that can use Regulation A+.  The definition of  an “asset backed security” used by Regulation A+ is the definition found in Regulation AB, which reads in part:  “a security that is primarily serviced by the cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite term period, plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to the security holders[.]” The important take away from this definition for real estate companies?  Regulation A+ cannot be used if a company’s offering is selling participation interests in a pool of real estate secured debt, in pools of long term ground leases, or other similar pooled real estate secured receivables.

Nevertheless, the definition of an “asset backed security” in the Securities Exchange Act does not prohibit single “asset-backed” transactions.  It would be possible to structure a real estate investment transaction so that investors can participate in a single loan or single lease (in the latter case, one for a significant rental value for a long term).  But again, one should proceed with caution in structuring the opportunity.

Finally, another alternative that should be considered is structuring a Regulation A+ offering with preferred equity in a limited liability company.  That being said, it is important think through the structure from a legal and economic perspective before moving forward.  One important consideration would be review of SEC rules at the time of the offering.

Other structuring options may be available.  The good news is that one more tool will soon be available to help real estate project sponsors raise funds in the capital stack. Regulation A+ will take effect 60 days after its posting. We will see how the real estate community reacts to this new financing tool.

Los Angeles County Moves Toward New “General Plan” Governing Development for Next 20 Years

The Los Angeles County Board of Supervisors yesterday took the first important step toward adopting a new General Plan, the constitution for land use policy and development for the unincorporated areas of the county.  The County’s current general plan was adopted in 1980.  This update is intended to apply to all the County’s unincorporated areas through 2035.

With little fanfare, the Board took action on the Final Environmental Impact Report for the General Plan update.  The Board also indicated its intent to approve the general plan, related zoning changes, a climate action plan, and a new Hillside Management Ordinance.  County Counsel will now prepare the necessary final documents for the General Plan update and related approvals and bring them back to the Board for final consideration.  Once finally approved, all future development in the unincorporated areas of the County must be consistent with the new General Plan.

The General Plan divides the county into 11 planning areas to accommodate a more refined level of planning.  Those areas are:

  • Antelope Valley Planning Area
  • Coastal Islands Planning Area
  • East San Gabriel Valley Planning Area
  • Gateway Planning Area
  • Metro Planning Area
  • San Fernando Planning Area
  • Santa Clarita Valley Planning Area
  • Santa Monica Mountains Planning Area
  • South Bay Planning Area
  • West San Gabriel Valley Planning Area
  • Westside Planning Area

The General Plan also establishes mechanisms to implement capital improvement plans for each of these 11 planning areas.  Once funding has been secured and priorities have been set, each capital improvement plan will include studies of necessary infrastructure improvements.

The General Plan also establishes Transit Oriented Districts within one-half mile of a transit station to promote transit-oriented development, or pedestrian-friendly and community-serving uses that encourage walking, bicycling, and transit use.

A sub-element of the plan — the Community Climate Action Plan — includes a greenhouse gas emissions inventory and specific measures to reach the County’s greenhouse gas emission reduction goals in the unincorporated areas. The plan includes a 2020 GHG emissions target for the unincorporated areas — a reduction of 11% below 2010 levels to achieve consistency with the State’s AB 32 goals and the California Air Resource’s Board’s Scoping Plan.  This reduction is the equivalent to removing 506,000 passenger vehicles from the road each year, reducing gasoline consumption by more than 272 million gallons, and providing renewable energy to power over 121,000 homes.  The majority of emissions reductions will come from state-level mandates, and the balance will come from new County policies in five areas:  green building and energy; land use and transportation; water conservation and wastewater; waste reduction, reuse and recycling; and land conservation and tree planting.

The plan sets aside additional land in the County with a “Significant Ecological Area” designation.  The designation is given to land that contains significant biological resources.  Some SEAs include undisturbed or lightly disturbed habitats that support valuable or threatened species, linkages and corridors to promote species movement, and are sized to support sustainable populations of species.  Hillside Management Areas, or lands with a natural slope of 25% or greater, are also governed by new policies to incorporate sensitive hillside design measures to preserve the physical integrity and scenic value of the hillsides.

The action taken by the Board included an amendment offered by Supervisor Hilda Solis, requesting that the Regional Planning Commission report back to the Board in 90 days on the viability of including “value capture” policies in future land use planning.  Value capture mechanisms, as commonly understood, allow local governments to require land owners to “share” the economic value created by “upzoning” changes to land use entitlements, over and above revenue that may be generated by simple increases property taxes when a new structure is finished.  It will be interesting to see how the staff reports back on this issue.