CAPITAL MARKETS TODAY PROVIDES CONTEXT AND CLARITY TO KQED SB 1079 CRITICISM

Housing uncertainty is one of the most significant stressors a family can face. Homeownership is one of the few ways for working-class Americans to build generational wealth and leave a financial legacy, but that can be an abstract notion amid a crisis.

Even in ideal circumstances, the average lower-income family is being priced out of the market. Increasing Federal Reserve interest rates means that average mortgage rates climbed as high as 5.78% this year . This is up from a record low 2.65% average amid the pandemic.

On June 30th of this year, the COVID-19 Residential Mortgage Foreclosure Moratorium also expired. Before this, lenders were forbidden from foreclosing as a relief effort for lower-income Americans. Today, thousands of working-class families restarted mortgage payments during an inflationary environment and uncertain economy.

Compared to the stock market, the real estate sector is still in a bull market. This precludes low-income families from new home purchases (or foreclosure negotiation) as rental properties become an increasingly valuable investment for capital gains and consistent rental cash flow.

The average single-family rental property’s monthly rent rose over 13% since 2021 to $2,495. And, since this is a national average, you’ll see average rents nearly 100% higher in demand-heavy areas like San Francisco. ?

Because of this, institutional investors are quick to snatch up foreclosed properties for improvement and rental. Current estimates show that institutional investors own up to 40% of the single-family rental market and that the proportional increase shows no sign of slowing.

So, between rising mortgage rates, foreclosure resumption, and hungry investors, there is little hope for a working-class family to build generational wealth – and no hope in fighting foreclosure.

Luckily California law SB 1079 , passed in 2020, sought to mitigate some of that uncertainty for families in crisis and facing foreclosure. Amongst other provisions, it prioritized foreclosure purchases to owners, government agencies, renters, and nonprofits to level the playing field.

That’s where the trouble began.

A High Hurdle?

SB 1079 gives priority classes a maximum of 45 days to match the bid of institutional investors, individuals, and other unprotected types. The intent is obvious. By allowing equitable access to the foreclosure auction, current residents and proponents of lower-class home ownership compete to retain their hope for generational wealth.

The issue is systemic. Foreclosure auctions in California are conducted only in cash, and few (if any) tenants or foreclosed owners can access hundreds of thousands of dollars in cash to match a bid. Although the 45-day stipulation does give an individual time to seek assistance, the simple fact is that these proprieties are not financeable by traditional lenders as you cannot access the property for an internal appraisal.?Furthermore, its buyer beware, meaning that the buyer at auction has to run their own title to ensure there are not any liens against the property they may impact their acquisition financially and lastly, there is no title insurance. As a result, the realty of a potential owner occupant or tenant occupant showing up at the foreclosure sale with a 100% cash is highly unlikely with the exception of the wealthy.?These realities lead to an inability to match the winning bid or, in the best case, draw a mortgage at a premium, unaffordable interest rate that perpetuates the foreclosure and poverty cycle.

Furthermore, some took advantage of non-profit protection. The rules in the bill were loose and didn’t require a nonprofit to be a 501(c)(3). This designation means that the nonprofit operates for charitable purposes and is subject to strict disclosure laws.

Since “flippers,” individuals or small companies that quickly purchased foreclosed homes to repair and sell for a profit, were now edged out by the protected classes, they devised a strategy. Many of these flippers redesignated themselves as generic nonprofits and were again able to compete in the foreclosure market against the spirit of the law, if not the letter.

Flippers, by their nature, prioritize profit over ownership and evict remaining tenants immediately, so the law was explicitly designed to reduce their competitive edge. Unfortunately, their evasion and concealment under vague nonprofit terms cast a shadow over the whole endeavor.

Nonprofit Nuance

Recently one nonprofit came under fire via an article published by a local NPR office in the bay area, KQED.?Southside Community Development and Housing Corporation (SCDHC), a 501(c)(3) with operates its asset management business out of Encinitas CA to use the tools granted by SB 1079 to promote its mission of homeownership.

Since the prospect of foreclosure is undeniably stressful and because SCDHC is active in the distressed asset market nationally, they took the brunt of some criticism as a result of investors who took advantage of the law to create non 501c3 nonprofit to benefit from the law.

SCDHC has closed hundreds of transactions in multiple states with the express purpose of helping to promote homeownership while funding their local affordable housing operations.???

Three Perspectives

Although it would be preferable to highlight all the national goodwill SCDHC builds, we would be remiss not to address some concerns specifically mentioned in the NPR article. This is not an effort to reject or invalidate the feelings and concerns of some but rather to provide needed context.

Richmond, CA

SCDHC, because of its housing counseling outreach, knows how valuable owning equity in a home or property can be. That’s why, when a Richmond, CA triplex was foreclosed on, SCDHC purchased the property to try to promote its objective of homeownership.?SCDHC’s standard operating procedures is to reach out to the tenant to determine if they can purchase the property and if not offer cash to assist in relocation.

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They approach tenants (renters and previous owners) and offered to sell the property to them rather than immediate eviction proceedings. Since many tenants cannot afford the cash cost or financing terms, SCDHC offers complimentary credit counseling as part of good faith interaction. In addition, SCDHC offered all the tenants and previous owners cash assistance to assist in relocation.

Unfortunately, neither the renting tenants nor the previous owner responded to SCDHC’s requests or offers. SCDHC had no choice but to begin eviction procedures but was approached at the last minute by a land trust. With this, SCDHC saw an opportunity to help the residents of the complex still and gave the land trust ample time to generate financing – after which SCDHC sold the property at more than $200,000 under market value to assist in their financing approval.

In the interim, SCDHC incurred tax costs, insurance costs, legal expenses, cost of capital and closing fees – all while not generating rental cash flow.?After all fees and transaction costs, and because SCDHC sold the property well under market value, they profited a net of less than $1000.

Thousand Oaks

After a single-family homeowner took out a second mortgage on his Thousand Oaks, CA property, he could not continue payments, so SCDHC purchased the home at a foreclosure auction. After working with the owner, rather than evicting, SCDHC sold the property back to him, again well under market value.

This gave the homeowner an immediate 20% equity in the property and put him back on track to continue a financial legacy. Again – it is difficult to remain impartial during times of severe stress like housing uncertainty, and no perspectives are invalid; however, the homeowner ultimately came out of the ordeal close to where he was before it began, although no doubt at an enormous emotional cost.

Joshua Tree

The final property highlighted in the NPR article was in Joshua Tree National Park. In this, a family owned a home and ultimately rented the property directly to their daughter. Unfortunately, the parents could not continue paying for the property, and SCDHC bought the house at foreclosure.

After giving the tenant time to seek financing, which she untimely obtained, SCDHC allowed even further time for her to make the necessary repairs the lender required prior to closing.?The property was sold to her for $150,000 under market value.?

Now, not only did the tenant not face eviction as she would have had otherwise, but she now owns the house and recovered her family’s generational wealth dream.

Ironic

The NPR articled highlighted a flipper who communicated that he was upset with the law because nonprofits like SCDHC where bidding properties away that he would normally purchase at foreclosure sale. The question to the NPR reporter who wrote the article is if a flipper or institutional investor had purchased any of the three properties mentioned above, would the flipper/investor sell back to the previous owner or tenant at under market value with timelines far exceeding the normal timeline to move through the process.?The answer to that question is no, they would not have hesitated to begin evictions, let alone give the buyers an inordinate amount time to obtain financing and would have evicted immediately and resold the property at market value.

Lastly, the flipper mentioned in the article contacted SCDHC because they purchased a property at foreclosure sale that the flipper had originally won and his bid was upset by SCDHC.?The flipper wanted SCDHC to sell the property at his costs because he indicated he was going to rehab and sell to an owner occupant. SCDHC sold the property under market value to the flipper with a notarized affidavit that he would rehab and sell to an owner occupant.?The property value at the time was $302,000 and was sold to the flipper for $185,000 with the notarized affidavit.?According to public records, the flipper still owns the property which now has a value of close to $330,000.?

Endless Opportunity

These are only a few success stories that could be misinterpreted without sufficient context. Southside Neighborhood Stabilization, the limited partner to SCDHC, maintains full transparency and has a site full of these success stories. Perusing their SB 1079 results, you can see that most of the transactions end in a sale to the owner occupant. Furthermore, reinforcing SCDHC’s commitment to homeownership, they will only sell SB 1079 homes under certain conditions :

1.?????Sale to an owner occupant. In this, the buyer must sign an affidavit that confirms they will occupy the property. This buyer cannot be a corporation, partnership, or limited partnership.

2.?????Investor. To prevent unscrupulous flipping or rental abuse, investors must sign an affidavit that they will repair and sell the property to an owner-occupant. Investors in the rental sector are not permitted to purchase an SCDHC property.

3.?????Non-profit. To prevent similar instances as flippers abusing SB 1079, SCDHC requires nonprofits to present a 501(c)(3) certification and affirm they will sell the house to an owner-occupant or provide affordable rental housing.

From these examples and Southside Neighborhood Stabilization’s rules that exceed SB 1079’s requirements, there is a clear picture of SCDHC’s commitment to community and to giving lower-income communities an equitable playing field.

Unfortunately, due to some misplaced concern over SCDHC’s intention and commitment, they’ve stopped their SB 1079 operations until California law provides more fidelity and addresses some glaring loopholes.

A Difficult Enterprise

There are many misconceptions about nonprofits. Some of these likely caused a portion of the negative feedback. Affordable housing nonprofits, especially those not dependent upon government grants, must generate funding for their operations and good deeds – they don’t, and ultimately can’t, give away foreclosed homes. All organizations like SCDHC can do is advocate for the occupant and provide every opportunity to remain in the house.

Nonprofits like SCDHC have many obstacles. When a nonprofit is not dependent upon government grants, it must enter public-private partnerships. This means a nonprofit must raise capital from external (public) entities like private capital and investors.

This is difficult because the investors in this partnership have no control over the assets (in this case, foreclosed homes) and face an undue risk. Since they assume that risk compared to other investments, they often expect a premium return.

The public-private relationship, therefore, generates a “double bottom line,” where the nonprofit is beholden to returning investor capital and generating returns to fund their operations.

In practice, a third bottom line is supporting the investment operation itself. In SCDHC’s case, closing costs, legal fees, and time costs ate most of the remaining revenue after they repaid investors.

In a perfect world? Enough average Americans would donate to affordable housing nonprofits to negate the need for these partnerships. Still, 501(c)(3) nonprofits like SCDHC have few other choices to do the most public good possible.

Nonprofits like SCDHC are also prime examples of low-hanging fruit for public ire. Many larger legitimate nonprofits working under a similar construct do not attract scrutiny due to their size and capital for legal and public relations assistance.

The smaller “nonprofits” that take advantage of the SB 1079 loophole are likewise too small to be a viable target for legal or public action. In SCDHC’s case, as a medium-sized firm, a series of missed contexts and misunderstood intent made it an easy target for media outrage.

A Proposed Alternative - AB 1837

Soon, AB 1837 will go to the California Senate to close some of SB 1097’s loopholes. Unfortunately, its means result in the wrong ends. The bill requires nonprofit foreclosure buyers to affirm that purchases house lower-income residents for 30 years. Astute readers will notice that there is no provision or advocacy for ownership, as the spirit of SB 1097 implied and nonprofits like SCDHC sought to enable.

Since purchasers will need to repair the units to enable lower-income families to buy properties outright with financing, the nonprofits will incur significant expenses in addition to standard transaction costs. They will then be required to sell the property for less than they paid for it after purchase and repair, making the entire affair impractical.

Instead, the nonprofits’ likely course of action will be to keep lower-income families in poverty and prevent generational wealth – keeping the property as a perpetual rental and further driving these working-class families out of the housing market.

An alternative exists that makes the transaction practical for the nonprofit. Instead of renting the entire property, the nonprofit could sell the house but maintain ownership of the land. This does, of course, end in the same rental trap as before and is an absurd proposition for most Americans (although standard in some South American countries).

Others agree with the assessment of AB 1837. The National Diversity Coalition, a 501(c)(3) representing three million minority residents of California, recently went on record against the measure : "this is likely an unintended consequence that the bill authors didn't see […] instead of elevating people out of poverty, the new bill traps them in it."

Alternatives

To be sure, SB 1079 needs revision. Dishonest flippers posing as nonprofits is the primary loophole in the existing bill, and it can be closed quickly without implementing measures as drastic and misguided as AB 1837.

Some amendment proposals are easy to implement and would effectively cut the problem off at the source. To be eligible for SB 1079 priority provisions, nonprofits should:

1.?????Require 501(c)(3) status. Allowing generic nonprofit designation is the biggest drawback to the current legislation. 501(c)(3) nonprofits have many hurdles to incorporation, all designed to ensure legitimacy. And, after inception, these designated nonprofits require strict accounting and transparency that undesignated counterparts do not.

a.?????Be designated 501(c)(3) for two years. The time requirement would prevent larger firms with greater resources from expediting or obfuscating the process of immediately redesignating and continuing operations.

2.?????Require past housing experience. This is a no-brainer, as equitably navigating this process is complex. Requiring housing experience ensures all parties are treated well with home ownership and community care in mind while preventing the purchase of “shell nonprofits” by bad actors as cover.

3.?????Report outcomes. Beyond minimum 501(c)(3) requirements, which are extensive on their own, California should mandate public disclosure of each transaction and outcome. SCHDC’s website provides a perfect example of this expectation. Each property and transaction are listed with the result, with all legal documentation available for the public. This prevents legal abuse and gives the public accessible means to conduct audits.

Rushing to Failure

SB 1079 needs to be revised, but AB 1837 is not the solution. Instead of demonizing and marginalizing nonprofits like SCDHC, who have a demonstrable history of community outreach and neighborhood stabilization, the leagues of flippers working under pretenses to evict tenants and gentrify neighborhoods should be held to account.

As AB 1837 does with its sweeping mandate, oversimplifying the issue will only keep underrepresented minority and low-income families in a cycle of poverty and despair. As the nation’s wealth gap increases, demonstrated during the pandemic when capital moved from the poorest to the top 1%, home ownership is the last bastion and hope for these communities to build wealth to last.

By creating a nation of renters, we destroy the vibrant and diverse communities that make America what it is. If all neighborhood residents are transient, temporary occupants, then there is no true feeling of belonging or stake in the neighborhood's vitality. Owner’s care about their property and community, putting in and taking out far more than just the market value of a home.?