Aaron and Bruce Norris are joined again this week by Paul Herrera. Paul is the Government Affairs Director for the Inland Valley Association of Realtors. Paul serves as an advocate for realtors on local issues, helping to preserve and protect property rights and the value of homeownership. His unique experience includes an award-winning journalism career with newspapers in Florida and California. He covered real estate, small business, the aviation business, and the confluence of government policy, politics and business.
It seems like there are a lot of things up for grabs this year. One of the key things is Prop 13, which a lot of people either want to be altered or done away with completely. Bruce asked what the process is for this to occur. Paul said the process goes through voters, so they do not feel that Prop 13 is under direct assault. It was passed by 2/3 of Californians and is a Constitutional amendment. It can only be done if voters agree to make the changes. That said, there are some tweaks that could be damaging. Anything, even the smallest change, has to go through voters. Specifically, it is 51% of voters, or the majority. To get it even in front of voters, it does require a 2/3 vote of the state legislature.
Bruce asked Paul if he sees anything effecting Prop 13 as a likelihood in the next year. However, Paul said he does not expect to see anything negatively effecting it tremendously this year. There was a challenge on split roll, treating commercial property differently than residential property. That was postponed to 2020 at the earliest. Bruce asked who decides whether to postpone it, and Paul said it is the people who have the money and trying to get the signatures to put on the ballot in the first place and overturn it to make it change when the prices change.
The property, or tax basis, would float based on some other triggering mechanism other than the change in ownership. There are two sides to that equation. On one side, a guy owns a commercial building and is very happy where it is. However, the view is that this is costing a lot of revenue. Bruce asked what would happened with prices and inventory should it pass. Paul said any time you raise taxes on something, you reduce its attractiveness, and this in turn reduces the value. There are other factors as well, including the strength of the economy. Who knows what else is happening, but it has some dampening effect.
The question that gets asked a lot is regarding how California has adapted to be a state where property taxes are relatively low. As tax rates go, California is a they are a low tax state when it comes to property taxes. They adapted by making income taxes very high. The question often asks is in regard to wanting more revenue and where to raise taxes. The question is how much and how much you need. The question is what they are trying to get to and what problems they are trying to solve by collecting a certain percentage of the economy and taxation.
California has adapted. This begs the question of whether changing Prop 13 will affect income taxes and capital gains taxes. Or, should we get to some figure that is multiples of our current state budget. As a citizen in California, you do look at how expensive it is living here, especially in California with a new state Federal law or tax. You are not able to write this off against Federal income tax. For anyone making significant money, it is pretty costly. You start having the real issue of people migrating out for tax reasons. You don’t have to make significant money. If you have enough money to afford a home in California, you probably are hitting up against that $10,000 cap right now.
Bruce next mentioned AB 2631, the bill that has to do with seniors selling their property and being able to keep their existing tax base. Paul reiterated by saying this is the legislative version of the property tax portability item on which they are working. The Assembly bill that is currently in the Legislature is not likely to go very far, although there is a version that is now being discussed. We have now officially qualified for the ballot in November. The voter initiative would now allow seniors 55 and older to carry their current Prop 13 protected tax basis to another primary residence.
This is without limitation on geography and can happen anywhere in the state. They can also buy more expensive property with a blended basis where you take the portion that is protected and add in whatever you buy up from. You can it multiple times, although a limited number of times in your lifetime. Once you become a senior, you have a built-in tax basis for as long as you own property. This is on schedule to be on another ballot.
Aaron asked what the though was behind the unlimited piece. Paul said Prop 90 and 60 currently exist, both which give a one-time exemption. With Prop 60 has to do with every county in California, while Prop 90 has to do with somebody coming in from a different county and exists in 9 of the 61 counties. The one-time use can become a barrier, particularly when you turn 55 and have another generation of life to go. At this point, it is not like 55 is old since you can still have kids at home. People are having kids later in life now.
Another current law, if you are married, is in regard to the limitations to one for both sides of the equations. If they divorce later on or there is a several year age difference between the two, they both lose it and it is gone. Paul said they make it unlimited where he is. However, the fact that it is unlimited does not mean it is necessarily going to be useful to use it every five years. You don’t necessarily have that much of a basis to step up depending on what happens to the property values. They did want it to be universal, and Paul initially worked on the group that developed it.
Their initial concept was to make it for everybody, regardless of age. They wanted people to be incentivized to purchase a home early. Now you have purchased a level of affordability, not just on your home, but also on your tax basis. It is a fixed number. If you are fortunate enough to purchase a home at age 25, a decade later you may want to move into a larger home because you care about school districts and have a family. Paul and his company wanted them to not have to face a steeply increased tax bill. This did not pull as well, and there were some concerns about this and the costs it would bring.
Bruce asked how both sides fund their efforts to either get something passed or prevent something from getting passed. The realtors have an association of realtors, and that is part of what they contribute every year. Paul said this is exactly how it works; and with realtors the members provide voluntary funds and dues. With both, a portion of each, whether it is voluntary and they pay above and beyond their dues, or a portion of what they pay as membership, is what funds the political action. By political action, people think of candidates. However, the vast majority of the money actually goes elsewhere.
Aaron asked if the California Association of Realtors accepts donations outside of membership. Paul said they do to an extent, but there are certain limitation on exactly how it works. What is more likely is that the Association will join coalition efforts where multiple groups are putting in funds into the same issue. This has more to do with state ballot initiatives or a candidate issue. If you are talking about lobbying efforts in Sacramento where they talk to lawmakers and try to sway votes in one direction or another, then that is mostly paying staff and representatives to be up there to explain how it works and what impact it may have. This can be coalition effort as well where there could be all kinds of groups working together.
This week and next on the radio show, they will be discussing issues that specifically impact real estate investors. We do not necessarily have a lobbying wing in the state or nationally. Aaron asked where you would plug in if you want to get involved but not a member of CAR. Paul said this is a real issue, and there is not a particularly cohesive organization that represents investors, some extent landlords, and they have noticed that. A real challenge is happening right now to these industries, and they are seeing some of the strongest obstacles being proposed legislatively and through the ballot. Finding the right partners from among the investor community is hard since a lot of investors are lone rangers. They are out there trying to make a living and not thinking about how they will join forces with all their competition.
Bruce asked how the other side is funded. He does not know if the other side wears different hats many times. However, if you are going to fight rent control, the question is who you are fighting and how they are funded. Paul said there is always an interesting coalition of funding options. If you look at the current challenge to the long-standing California law that limits rent control, that is largely being funded by the AIDS Foundation of Los Angeles. That group gets involved in issues that are beyond what the name suggests.
There is also organization since there are tenants groups formed across the state in various cities where you can imagine the amount of rental increases. The cost of housing has gone up so much over the last decade, and there is a lot of angst over that. They have organized, and they are trying to find some solution to what they deem as an unaffordable situation. This was known as Costa-Hawkins, and Bruce wondered when this was first implemented. Paul said it was the mid-late 90s. We had a big price run at that time too from 1996-2000. We went up in price quite a bit. Bruce wondered if this was starting to make homes unaffordable and this kicked it off, or if Costa Hawkins is contained rent control.
Paul said the primary benefit of Costa Hawkins is that it is said that cities and counties cannot enact rent control on new construction. Bruce asked if this was the case and they were doing just this, which Paul said they were. They want to do so again, and this is why they want to repeal Costa Hawkins. The argument has been that what they need to control price increases and rental increases is supply. We need to build more housing as long. As long as there is a mismatch between the population, growing economy, and the amount of housing available, we are not going to see affordable housing unless you force it through government controls.
Bruce asked about if he had a rental and could get $2,500 for it. It seemed like the market would tell him that he could not. He may even have a hard time getting it lowered to $1,900, and this is the market. Bruce wondered how this gets out of balance, and if we are concerned about people saying they cannot afford to live here and living if it gets too high. Paul said they are certainly seeing this. They are really seeing a problem with the California middle class being very much squeezed, especially from coastal communities and the Inland Empire. The latter has especially been a release valve for affordability for so long.
Things have gotten pretty expensive, and the way it gets out of balance is you constrict supply. You don’t build enough homes, so you have incomes that are chasing what is available out there. At some point, they will bid it up until they find a place in which they can live. This is the way the market is supposed to work, and the secondary reaction is supposed to be investors seeing income supporting more construction, and therefore they build more. This is where government gets in the way in the first place. They start by getting in the way of new supply; and in order to try to solve that problem, they are thinking they should constrain the price as well. You just leave one problem to be solved by a second problem, which leads to all kinds of issues later on and simultaneously increasing prices for building. It is the weirdest mix, and nobody is talking.
Rent control is really a strange concept. Paul knows why they are trying to do it, and you have sympathy for people who are worried about being able to afford or rent. However, rent control is essentially the government telling the landlords and tenants they are not allowed to come together and agree on a price. They tell them when they can agree. If you have a willing individual who wants to pay and a willing supplier who wants to give them a lease, they will say no.
Aaron said just from being a tenant in New York City and other places that were rent-controlled, he could verify this was the case. The landlords were not investing a lot of money because they knew they could not get it back out. They could not hide that in the rents that Aaron was paying, at least not where he was living. However, it was the kind of place where you plugged more than one thing into a wall, and the entire building would go out. This happened often, and he was more than happy to do this when he was in his early twenties.
However, it does concern him that they are not thinking that far in advance. Tenants, especially in the Inland Empire, are spending way too much of their income to live and may not get ahead. Aaron said he would rather see them have a conversation about how to build more affordable housing. When he spoke to affordable housing experts, they said the problem was all the money had gone away and nobody had the money to help. Aaron asked what funds went away a few years ago, to which Paul said were the redevelopment dollars. Aaron wondered where the money is coming from since the redevelopment dollars are no longer there.
The challenge is that we cannot subsidize our way out of a housing deficit with the size we have right now. What we are looking to solve for is not how we get people who make $20,000 a year into a home. The challenge is getting people into a home who make $80,000 a year. We cannot even solve for $100,000 a year in San Diego and Orange County. It is difficult to afford a place to live in the Bay Area. This is a challenge they cannot solve.
If a builder could profitably build what he is suggesting, then they would build it like crazy since they can sell it all. John Burns just did a report on the cost of building a home in Florida versus California. It costs $800 grand. For an $800 grand new construction in California, it is $350 in Florida. This is staggering. Lumber is not more expensive in California and whatever else you are going to do, but it is all the path to maybe getting to the permit stage with SEQUA. A builder would be more than happy to construct something he can sell immediately. However, the numbers do not work.
Paul said there is a great number, although he did not have it in front of him. However, it was in regard to a graphic CAL Matters put together about land cost and building costs. California land costs are the most expensive in the country if you count all the entitlements into the process. If you have a piece of untilled dirt that has been sitting there for rural purposes, it is not that valuable in California. If you have it fully approved, ready to go, and permitted to build, then it is incredibly valuable since the cost of getting to that point is out of sight.
Bruce said new homes are built all the time; and what you pay for the land is almost a residual number. You go backwards: what it costs to build, what it costs to get the permit, school fees. Finally, at the end of the day you have a profit and see that this is what you can pay for the dirt. In the downturn, it was a negative number and you had land that was completely worthless or negative value. Now, it has certainly increased. However, in Florida the cost to permit and the speed of the process is lightyears different. You almost have to get both sides together to solve it, or people are going to leave.
There is an entire industry in California of people like Paul who do nothing but get paperwork through government offices. They don’t build anything and don’t know how to repair a light socket. However, they know how to push paper in agencies in order to get the right paperwork and sell the land afterwards. The fact that the industry exists with people like Paul who know which individuals to call is a little hard to stomach.
Bruce said on the other side of that, there was a woman watching the dogs who had her Master’s degree. Her first job was to drive out to the middle of nowhere where there was a potential building project being considered. She was given binoculars, and all day she was there to look for endangered species and they could stop the building. This was her full-time job. This is pretty extreme when the other side is going to that extent. Bruce asked if he owned a building in LA under rent control and Paul was his renter, he wondered if it would be the same rent year-after-year. Paul said there is a step-up basis you can do, although there is a limit to what that basis is. With a rent control, as a landlord you have to raise it to the maximum amount that is allowed each year. Otherwise, you are making a mistake for yourself.
Bruce asked about if he sold the building and the tenant stayed and whether the rules would still apply for wherever that rent is. Even if it is way below market, the new owner still has to adopt that low rental basis as long as they remain in the business. If they intend to convert them to condominiums and make them ownership, that is different. This is essentially the right to go out of business. This is also being challenged right now, and they have had to defend it four or five times in the last five years. In the Bay Area, it was popular to tear down old buildings and construct something new.
Bruce asked about a building under rent control and another that is vacated and if he gets to raise that to market rent or stay at the basis. Paul said it depends on local laws. What is interesting is you have Costa Hawkins, but then you have overlays. Every city has different policies. Costa Hawkins essentially created guard rails around control. The opponents want to remove those guardrails so that localities can do what they want when it comes to rent control. Those are the only concerns they have.
Bruce asked about if this freedom was enacted and if you would have cities all enacting some kind of rent control that would be more aggressive. Paul said not everywhere. In the Inland Empire, we are fortunate in that we do not have this kind of mindset. Paul does not see rent control being enacted, even if Costa Hawkins went away tomorrow. He is not sure about ten years from now. However, for the Bay Area, Los Angeles, Santa Monica, and San Diego, maybe even parts of Orange County, it is a different story. Now you will have a lot more housing refugees looking for a place to live when no is building things in the community and they still have to live someplace.