Small Sites Insights

written by
 The Jones Team

With new money funding Small Sites acquisitions,
Qualified Non-Profits are looking to buy.

Since we last wrote about the Community Opportunity to Purchase Act (COPA) in the August 2020 issue, much has changed. At the top of the list is the possibility that funding has come through for implementing the program through the Preservation section of the Small Sites Program. In November 2020, San Francisco voters passed three propositions to authorize and fund a variety of housing issues. Prop A, the “Health & Homelessness, Parks and Streets Bond” generated a $487.5 million bond; Prop I increased the Sale Transfer Tax on San Francisco real estate sold for over $10 million; and Prop K authorized the city to develop or buy 10,000 units of affordable housing. In addition, back in November 2018, Prop C, “Gross Receipts Tax for Homelessness” was passed, but it was held up in the courts. After a September 2020 ruling, it now appears to be in the clear with close to $500 million that has been held in escrow and is now available to spend. The exact amount available in the Small Sites Program (SSP) is not clear, but the Preservation section is a key funding bucket for the program, and it has money ready to use.

What IsCOPA?
In April 2019, the San Francisco Board of Supervisors passed—and the mayor signed into law—the Community Opportunity to Purchase Act (COPA). The legislation became effective on September 3, 2019, and it requires sellers of residential buildings with three or more units (including vacant land that may be developed to include 3+ units) to offer their properties first to a Qualified Non-Profit (QNP) before putting the property on the market to sell to any private party. It was designed to prevent the loss of low-income housing via the Ellis Act, an increasing issue in San Francisco, particularly in the Mission District.

COPA in 2020
There were a few Small Site acquisitions completed last year, but according to many of the sales agents we spoke to for this article, most of the COPA activity was a pass on the building, resulting in delays in the normal sales process without benefits for low-income tenants. The speculation was that this was mainly due to lack of funding available to QNPs for purchases.

COPA in 2021 and the Future
With the potential of a significant influx of taxpayer funds through the Small Sites Program, it appears there is now money in the QNPs acquisition wallets. If this is the case, then the new question owners in San Francisco should be asking themselves is, “How do I know if my property is a candidate to be sold to a QNP for the Small Sites Program?” We were fortunate to interview Juan Diego Castro, a Project Manager at Mission Economic Development Agency (MEDA), who helped us answer this question. Castro was very gracious with his time, and he untangled the rules and regulations and gave us tips to help us better understand the system. As it turns out, tenant “buy-in” to the SSP is the biggest factor to help make a deal work.

For a building to be considered, 80% of the tenants need to be willing to participate in the Small Sites Program. If this is not in place, the QNP will move on to another deal. Because QNPs now see all offerings in San Francisco over three units through COPA, there are lots of properties to review. So, if the tenants are not willing to participate, and/or the deal is not financially feasible, the QNP has a lot of choices, and they simply move on to the next deal. As Castro put it, “As a QNP, we have many potential acquisitions and in the long run, tenant participation makes the acquisition and future ownership smoother.”

What Is Tenant Buy-In?
Castro guided us through the process: “It is important for the tenants to understand the two main benefits of the program in order to ‘buy-in.’ First, tenants are guaranteed permanent affordable housing. Second, the City will fund any essential repairs and replacements that might have been deferred by the previous owner.” You would think these two benefits would make it easy to get buy-in from tenants, especially in San Francisco’s heated rental market, but Castro explained that it can be hard when tenants ask, “What will my rent look like?" and "If I am getting rid of rent control and operating under this new program, what does that really mean?” And one aspect of the SSP is a means test, which will determine the tenant's minimum rent. Tenants are sometimes less receptive to this because it could mean a rent increase. (Note that every existing tenant is eligible to stay, regardless of their income). Tenants are expected to pay the minimum rent at the onset of the program, which is 20% of their current income; then each year the rent will increase by 2% to 3.5% depending on operational expenses.

As many owners in San Francisco know, means testing has always been, as MC Hammer put it, a “Can’t touch this” issue. The tenants who are the most likely to object to the program are the ones who would have their rent increased compared to rent control. (It is a bit ironic, because if means testing were added to rent control, then this would never be an objection for this program.) We recently heard through the brokerage community that one sale that was pretty far along in Chinatown fell apart when a tenant realized that by participating in the program his rent would increase. This tells us that the best SSP candidates are buildings where 80% of the tenants are not making significant income.

How Does the Tenant Buy-In Typically Occur?
After a QNP has expressed interest in a property, COPA allows a 25-day discovery period to talk to tenants and try to get buy-in. We learned from Castro that MEDA is very strong in the Mission district and in that neighborhood, they do the outreach to tenants to secure buy-in. However, MEDA, as one of the more successful QNPs, can and does work on projects outside the Mission District with the help of outside tenant organizing groups. My business partner Isabelle Salvadori and I had this experience with one of our listings South of Market. In that case, MEDA expressed interest and had 25 days to investigate the property before making an offer, and the South of Market Community Action Network (SOMCAN) did the outreach to the tenants who lived in the building.

The SOMCAN website notes it is a multi-racial, community-based organization, serving low-income immigrant youth and families in SOMA, Excelsior, and greater San Francisco since 2000. SOMCAN was formed by community leaders from youth, senior, veteran, Filipino, and housing organizations to address gentrification and displacement issues. In 2018, MEDA purchased the building at 4830 Mission Street, an act which protected the tenants, transformed the building to a permanent affordable housing complex, and marked the Excelsior District’s first Small Sites acquisition. SOMCAN provided culturally competent outreach and counseling to multiple Filipino tenant families in the building to educate them about their rights and options, and that led to the successful purchase.

Unfortunately, when SOMCAN reached out to the tenants in the building we had listed, they received no responses, so MEDA decided not to write an offer and we were free to take the building to the market for sale. In this case, the owner was very surprised to hear this because he thought the building would be a great fit for the program. He then asked us to contact his tenants directly to investigate. As he put it, “You know the old Russian proverb: 'Trust but verify.'"

So we called the five tenants and asked them what happened. They claimed that no one had contacted them in any way. We asked Castro for his perspective on what might have happened, and he said, “If you think of this from the tenant's perspective, when an owner lets the tenants know the building is being sold, it can be a nerve-racking experience for the renters. They don't typically understand how fast or how slow a real estate sale can happen.” This could make them more fearful of committing to an agreement they don't fully understand. Castro also said that owners often perceive that they have a happy relationship with their tenants, but it may not always be that way from the tenants’ perspective. In any case, without agreement from the tenants, there was no match, the building was a pass, and we took the property to the open market.

Speaking to Tenants about Tenant Buy-Ins
Castro gave us tips that owners can use to help pre-qualify a building for COPA and get a tenant buy-in consensus or at least start the conversation. “What has been historically helpful in my projects is where the seller reaches out to the tenants and says, ‘I am trying to sell this building and there is this city program that is designed to protect you. You do not have to commit to anything, but why don’t we schedule a time for everybody to talk and listen?’ If the owner makes the space for the tenants to be educated on the facts, then the buy-in is much easier.” During the recent COVID times, these conversations have often been done online via Zoom.

What other factors are important to the Small Sites Program?
Ellis Act Danger—The SSP was created in 2014 to protect and establish long-term affordable housing throughout San Francisco. Typically, a Small Sites sponsor is looking for a property currently housing low-income tenants that are in danger of being evicted through the Ellis Act. Often, these properties are characterized by having several older tenants paying low to very low rent in buildings that range in size from three to six units.

Construction or Rehabilitation Needed—It is common for a family to own a building for many years under rent control and collect low rents from many long-term tenants. Many studies on rent control point to this as an issue common in cities, where a building eventually generates too little income to cover any needed expenses for maintenance and capital improvements. Since the SSP often has funds that can be used for rehabilitation projects with deferred maintenance and/or mandated upgrades like those required by the Soft Story Program, these types of buildings can be a good fit.

SRO—Single Room Occupancy buildings are typically difficult to fit into the Small Sites Preservation umbrella because they operate at very low margins. Historically, the only QNPs with in-house SRO management are Tenderloin Neighborhood Development Corporation (TNDC) and Chinatown Community Development Center (CCDC), and their strength is with 50-unit or more buildings.     

High Vacancy—High vacancy is not appealing to the SSP. It is contrary to the “Preservation” mandate of protecting lower-income tenants and is not as interesting to the QNPs.

With the Small Sites Housing Preservation fund now funded, it's a great time for owners of 3- to 25-unit properties to start the buy-in process with tenants.

The Jones Team consists of Terrence Jones, Senior Broker Associate with Corcoran GL Commercial and his partner Isabelle Salvadori. Terrence can be contacted at (415) 786-2216 or [email protected].