REQUEST FOR CITY COUNCIL ACTION
SUBMITTED TO: Honorable Mayor and City Council Members
SUBMITTED BY: Al Zelinka, City Manager
VIA: Ursula Luna-Reynosa, Director of Community Development
PREPARED BY: Charles Kovac, Housing Manager
Subject:
title
Middle-Income Housing Program Update
body
Statement of Issue:
On July 20, 2021, the City Council adopted Resolution No. 2021-43 and Resolution No. 2021-44, approving and authorizing the City Manager to enter into Public Benefit Agreements and execute the Middle-Income Housing Program (the “Program”) and associated agreements with California Municipal Finance Authority (CMFA) and project sponsor, Catalyst, for the acquisition and conversion of two market-rate apartments (Elan and Breakwater Apartments) for middle-income housing. Since the City Council approval in July 2021, Catalyst has been actively proceeding with conversion of the Elan and Breakwater properties to middle-income housing.
On May 16, 2023, Councilmember McKeon brought forward an “H” item related to the Middle-Income Housing Program and requested a presentation to update the City Council on the status of the Program. Specifically, Councilmember McKeon requested that the Community Development Department, CMFA, and Catalyst provide a comprehensive report related to fiscal impacts and requested answers to other questions (see Attachment 2).
Financial Impact:
Not applicable. As requested by the City Council, financial impact information of the Middle-Income Housing Program approved on July 20, 2021 is described in this report.
Recommended Action:
recommendation
Receive and file.
end
Alternative Action(s):
None.
Analysis:
A. BACKGROUND
As described in the July 21, 2021 staff report (Attachment 1), middle-income housing is designed for persons earning between 80 percent and 120 percent of area median income (AMI). This segment is considered the “missing middle” between lower income (≤80% AMI) affordable housing and market-rate (>120% AMI) housing since no funding sources exist for this population. CMFA, working with Catalyst as the project sponsor (on behalf of CMFA as the asset manager), acquired the Properties in August 2021 through the issuance of tax-exempt “essential government bonds.” As the bond issuer, CMFA oversaw the underwriting of the bonds prior to issuance and actively manages the performance of the project sponsor Catalyst during the life of the bonds. The operating rent generated at the Properties will pay the debt service on the tax-exempt bonds that were issued in August 2021; therefore, the City does not pay the debt service payments on the tax-exempt bonds. The July 2021 staff report (Attachment 1) referenced a 30 year bond maturity; however, at the time, the underwriting process was underway but not completed until after City Council approval. Upon completion of underwriting and based on the market conditions at the time of sale of the bonds, both projects required a 35 year maturity in the Limited Offering Memorandums; therefore, this staff report will utilize the 35 year bond maturity date for calculations related to foregone property tax as well as for real estate valuation purpose.
As a public agency and a joint powers authority (JPA), CFMA is a tax-exempt entity that is not required to pay property taxes. This property tax abatement, coupled with the tax-exempt financing, provides a significant advantage in terms of cash flow, which allows CFMA to compete with market-rate buyers, and enables CFMA to make the units available to low and moderate income households. The typical split of units is one-third at 80 percent AMI, one-third at 100 percent AMI, and one-third at 120 percent AMI. It is important to note that a non-government entity could acquire a property and restrict units to 80 percent AMI, and those units would qualify for the “welfare exemption” and would not have to pay property taxes on any units at 80 percent AMI or less. As described below, by providing middle-income units, the City will forego current and future property tax revenues with the ability to sell the Properties in 15-35 years with all net proceeds distributed to the City.
The Elan and Breakwater Apartments (“Properties”) consist of 674 total rental units, of which, 647 have been or will be converted from market rate units to middle-income units (ranging from 80% to 120% of area median income). (Note: the July 2021 City Council report indicated 676 total units at Breakwater and Elan Apartments; however, the planned conversion of existing non-residential space into two additional units at Breakwater was later determined not to be a viable option). The balance of 27 units that are located at Elan Apartments are already restricted to moderate income (110% of area median income) per the City’s Inclusionary Zoning Ordinance that was applied at the time of entitlement.
As indicated in the July 2021 staff report, the acquisition of the Properties resulted in the loss of 2022 property tax and future property tax revenues to the City’s General Fund. The July 2021 analysis was based on an average 14 percent City share of the 1 percent property tax levied on the assessed value of the properties and did not include the voter approved 1.5 percent supplemental public safety employee retirement levy. When you add the public safety retirement levy the effective rate is 15.5 percent. Further, the July 2021 analysis was based on pre-acquisition assessed valuation (additional discussion on this topic is found later in this staff report under response to Question 5). As described later in this report, 2022 property taxes for the Properties were estimated for year 1 at $378,069. To determine the loss of property taxes over a 35-year period (full term of the outstanding bonds), staff increased the property taxes by two percent annually, which is the maximum increase allotted for without a sales transfer or improvements to the property that trigger a reassessment. For a 35-year period, the City would forego an estimated total of $20,926,549 in property tax revenue. Based upon providing 647 middle-income units, the cost to create these affordable housing units would be approximately $32,344 per unit ($20,926,549 divided by 647 units). Comparatively, a traditional affordable housing project, while usually at the lower income level, includes $70,000-90,000 of subsidy per unit and qualifies for the welfare exemption and are exempt from property taxes. Most of the funding available to subsidize affordable housing is for lower income housing leaving little or no options to preserve workforce (i.e. moderate income) housing. The Program provides an ability to preserve attainable housing costs by preventing a market rate investor from purchasing the property and increasing the rents and instead restricts the rents preserving this “middle income” housing stock.
Beyond the public benefit of creating the restricted middle-income units, the Properties also represent an investment opportunity with potential long term financial benefits for the City in the form of public equity. Under the recorded Public Benefit Agreement, the City, at its sole discretion, may force a sale of the Properties between year 15 and year 35, and the City would receive the net sale proceeds. Since the Properties are financed through the issuance of tax-exempt bonds and there are no equity partners, all excess sale proceeds after payoff of the bonds go the City. Over a 35-year period, the Properties could realize $595,611,279 in valuation at the end of year 35 (assuming a conservative annual appreciation of 1.8%). The City could realize significant value in owning major real estate assets that could be sold to market-rate buyers, thereby maximizing value to the City. Alternatively, the assets could be sold to affordable housing developers to be rehabilitated with new, more deeply restricted affordable housing covenants recorded on the Properties. This decision could be made in the future depending upon the City’s needs and policy priorities.
The residents of these Properties interface with Catalyst, as the project sponsor or Catalyst’s designated property management firm. Annual rent increases are capped at no more than 4 percent, which is less than the rent limits under AB1482, the adopted State tenant protection legislation. It is important to note that existing tenants are not displaced regardless of household income, as the conversion of market rate units to middle-income units occurs over a few years as leases expire and current tenants move on to other housing opportunities.
B. RESPONSES TO SPECIFIC QUESTIONS REGARDING MIDDLE-INCOME HOUSING PROGRAM
On May 16, 2023, Councilmember McKeon brought forward a list of questions that he and the City Council wanted staff to address regarding the status/update of the Middle-Income Housing Program.
1. How many of the 649 housing units are occupied? There are a combined 674 units at Breakwater and Elan. These properties have a blended occupancy rate of 95 percent. At Breakwater, 359 of 380 available units (94%) are occupied, with an additional 20 units under renovation and not available for immediate occupancy. At Elan, 265 of the 274 units (97%) are occupied. A five percent vacancy rate is typical in multi-family housing. Additional information regarding occupancy by unit type can be found in Attachment 3. All of the currently vacant units (30 total; 21 units at Breakwater and nine units at Elan) are currently being marketed to only low and moderate income households per the Program restrictions.
2. How many have been remodeled as planned and at what cost? At Breakwater, 35 units have been fully renovated, with five (5) additional units scheduled to be delivered in July. Each unit renovation includes new flooring, appliances, cabinets, countertops, paint, and additional improvements. The average renovation cost per unit is $43,875. At Elan, while the unit interiors were not in need of significant renovation, all interior hallways have received fresh paint and new flooring. Over the next several weeks, the exterior of the property will be painted, the pool will be resurfaced, and the clubhouse will be renovated.
3. How many of the units are leased to persons earning 80%-120% of the Area Median Income, as required? Breakwater and Elan have achieved a blended program qualification rate of 57 percent since acquisition. At Breakwater, 232 of 400 units (58%) have been leased to program-qualifying households. At Elan, 153 of 274 units (56%) have been leased to program-qualifying households. On average, 16 units per month have converted. As noted by CFMA and Catalyst, a full transition to program-qualifying households is limited by two primary factors:
• The Regulatory Agreements recorded against the properties carry explicit non-displacement clauses.
• COVID-related conditions and tenant protections lowered turnover compared to industry norms, including protections that allowed all existing residents to transition to month-to-month leases without the additional fees that multifamily owners typically charge to incentivize residents to execute new 12-month leases.
As such, while every effort is made to program-qualify households, the collective balance of units (43%) is rented to residents who are non-program qualifying, which may be due to: being over-income, affirmatively choosing to not provide information needed to qualify, or continuing on a month-to-month basis. Additional information on program qualification progress, including breakouts by AMI level and unit type, can be found in Attachment 3.
4. What are the average monthly rents? Breakwater has an average monthly rent of $2,324 for program-qualified households, representing a 24 percent discount to current market rents. Elan has an average monthly rent of $2,307 for program-qualified households, representing a 23 percent discount to current market rents (see Attachment 3 for market rents). Total rental discounts amount to nearly $3.3 million annually. Average in-place rental discounts are anticipated to further increase as additional units are leased to program-qualifying households. Additional information on average monthly rent by property, including breakdown by AMI level, can be found in Attachment 3.
5. To fund the Middle Income Housing Program, the City has to forgo future property tax revenues for up to a 30-year period. How much in property tax did the City forego in 2022 and what is the estimated amount for 2023 and over the next 30 years?
This question will be answered based on a 35 year bond maturity instead of a 30 year bond maturity, as previously noted in this staff report. Further, the 2021 staff report analyzed the foregone property tax based on the assessed value pre-acquisition and the property taxes that the City was collecting at the time. It is uncertain whether these assets would have transferred without the Program; therefore, the analysis was based on the pre-acquisition assessed value. With that being said, following the change in ownership, Breakwater’s assessed value increased by nearly $46 million from $139 million to $185 million (33%). Elan’s assessed value increased nearly $9 million from $125 million to $134 million (7%). As mentioned earlier in this staff report, the 2021 analysis was based on an average 14 percent of the 1% property tax levied on the assessed value of the properties, and did not include the voter approved 1.5 percent supplemental public safety employee retirement levy. When you add the retirement levy it’s an effective rate of 15.5 percent.
Due to these dynamic variables, providing a static response to this question is difficult. The following narrative assumes the same methodology used in 2021 (pre-acquisition value with a 2% annual property tax inflation, an average 14% of the property tax levy, and 1.5% public safety employee retirement levy) except that it includes a 35 year bond maturity date instead of a 30 year bond maturity date. Below the narrative response is a chart that shows and compares the foregone property tax utilizing the average 14 percent share of the levy, a scenario utilizing the average 14 percent levy plus the supplemental retirement levy 1.5 percent (15.5% total), and a scenario utilizing the average 14 percent levy plus the supplemental retirement levy and the post-acquisition assessed valuation.
Breakwater - It is estimated that the City would have collected $220,413 in property taxes from this asset in 2022, based on the 2021 pre-acquisition tax valuation and including the public safety employee retirement levy. Assuming 2 percent annual property tax inflation, it is estimated that the City will forgo $224,822 in property taxes from this asset in 2023. Over a 35-year period, which reflects the full term of the outstanding bonds, the City’s foregone property taxes related to this asset are estimated to be $11,019,517, should the property remain JPA owned. This amount represents approximately 3 percent of the anticipated value of the property after the bonds are matured in 35 years ($345,417,199), as outlined in Breakwater’s Public Benefit Agreement. If the City sells the property, this is the anticipated amount the City would receive.
Elan - It is estimated that the City would have collected $198,163 in property taxes from this asset in 2022, based on the 2021 pre-acquisition tax valuation and including the public safety employee retirement levy. Assuming 2 percent annual property tax inflation, it is estimated the City will forgo $202,127 in property taxes from this asset in 2023. Over a 35-year period, which reflects the full term of the outstanding bonds, the City’s foregone property taxes related to this asset are estimated to be $9,907,032, should the property remain JPA owned. This amount represents approximately 4 percent of the anticipated value of the property after the bonds are matured in 35 years ($250,194,074), as outlined in its Elan’s Public Benefit Agreement. If the City sells the property, this is the anticipated amount the City would receive.
Combined, Elan and Breakwater would have generated $20,926,549 in property tax revenue over a 35-year period. It is important that the above figures are evaluated with the following context:
• These properties will only be exempted from property taxes so long as they are JPA or government owned. There is no certainty that this will be the case for the next 35 years. The City may elect to trigger its Public Benefit Agreement as soon as 2036, at which time it may elect for the assets to be sold to for-profit owners that pay full property taxes.
• In addition to the long-term economics generated for the City, the rental subsidies alone range from 6 to 8.5 times what the City would have collected in property tax revenues depending on pre or post acquisition assessment values.
• Existing non-profit affordable housing providers within Huntington Beach (including for-profit owners with minority (1%) non-profit “partners”) are also receiving full property tax exemptions, without providing any long-term economic benefits to the City.
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Comparison of Foregone Property Tax Estimates |
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|
2021 RCA |
July 2023 Analysis: 2020-21 Pre-Acquisition Tax Valuation with Employee Retirement Levy |
July 2023 Analysis: 2022-23 Post-Acquisition Tax Valuation with Employee Retirement Levy |
|
Breakwater |
195,179 |
195,179 |
259,000 |
|
Elan |
175,476 |
175,476 |
187,600 |
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Retirement Levy |
0 |
39,713 |
47,850 |
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TOTAL |
370,655 |
410,368 |
494,450 |
6. What are the property management fees paid every year and to whom are they paid?
Breakwater - Over the past twelve months, Greystar was paid $219,000 in property management fees, amounting to 2 percent of collected revenues.
Elan - Over the past twelve months, Greystar was paid $187,000 in property management fees, amounting to 2 percent of collected revenues.
7. What are the annual maintenance and repair fees?
Breakwater - Over the past twelve months, the property incurred $289,600 in maintenance and repair fees, amounting to $724/unit.
Elan - Over the past twelve months, the property incurred $156,000 in maintenance and repair fees, amounting to $569/unit.
8. How many of the retail shops on the first level of Elan are leased? At present none of the retail shops at Elan are leased, as disclosed publicly in the Limited Offering Memorandum (LOM). This trend predates acquisition, with the remaining tenants terminating their leases within months of property closing. Retail vacancy challenges spurred by COVID-19 continue to impact Huntington Beach, where at least 74 retail spaces remain vacant in the sub-market. In addition to these market challenges, Elan faces site-specific challenges such as parking and frontage attributes, which also impact leasing.
CFMA and Catalyst are addressing these concerns, including installing attractive window wraps to improve the street-side look and feel. In addition, they recently hired a new third-party retail leasing broker with a strong track record of success in Orange County.
Environmental Status:
Not applicable.
Strategic Plan Goal:
Economic Development & Housing
Attachment(s):
1. July 20, 2021 Request for City Council Action Narrative regarding Middle-Income Housing
2. May 16, 2023 H Item Report (McKeon) requesting update on Middle-Income Housing Program
3. Elan and Breakwater Apartments: Program Qualifications Reports
4. PowerPoint Presentation to City Council for July 18, 2023 meeting