An analysis of COPA’s impact on the market and what it could look like in coming years.
Author’s Note: We are not attorneys, nor are we liable for any advice or errors in this article. We have consulted with well-known San Francisco attorney M. Brett Gladstone and liberally quoted from his published FAQs (g3mb.com). We find it amusing that the business of providing housing and selling and investing in real estate in San Francisco requires us to start with a legal disclaimer, but as they say in the brokerage community (much too often), “It is what it is.”
What is COPA?
In April 2019, the San Francisco Board of Supervisors passed, and the mayor signed into law, the Community Opportunity to Purchase Act—COPA for short. The legislation became effective on September 3, 2019 and it requires sellers of residential buildings with three or more units (and includes vacant land that may be developed to include three or more 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.
If a QNP indicates an interest to pursue a property before a five-day notice period expires, they have an additional 25 days to investigate and write an offer. If there is no indication of interest, the property can be marketed freely and the QNP has no further right to purchase.
If a QNP writes an offer within the 25-day “first offer” period, the seller can accept, reject, or make a counter-offer. If no deal is struck, the seller can market the property, but the QNP has a right of first refusal to purchase the property on whatever other terms the seller may accept from another buyer. In other words, the QNP will get a chance to come back for a second bite of the apple. For example, if a QNP offers 20% below the list price for the property and the seller rejects that offer, the QNP still has the right to match the best offer found in the open market. It all sounds very confusing, but in practice, since the implementation of this law ten months ago, no QNP has exercised their right to match the best offer in the market.
Why was COPA enacted?
Prior to COPA, there were small properties that would have been perfect for a QNP to purchase to preserve low-income housing in San Francisco, but too often these buildings were sold before any QNP even knew it was on the market. These buildings often had tenants who were paying far below market rent. They would be sold to developers who used what some refer to as “predatory equity” to buy buildings. Predatory equity is a term used by tenant advocates to describe the investment of money or equity to take advantage of an opportunity where tenants are intended to be displaced. After closing escrow, a developer would initiate Ellis Act evictions to clear out the building of these low-paying tenants and redevelop them as tenancy-in-common offerings to higher-income buyers. The evicted tenants were displaced. The political fallout of this kind of scenario was particularly strong in the Mission district. COPA was developed to eliminate these quiet, quick tenant displacement deals and give QNPs a shot at retaining low-income housing for those who needed it.
What do QNPs really want to acquire for the Small Sites program?
The Small Sites program is a program for purchasing and/or rehabilitating small multifamily properties. The program 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 housing low-income tenants that are in danger of being evicted through the Ellis Act. One of the big gains that COPA offers for the QNPs is the 25-day right of first offer after they indicate interest in a building. This pause when a QNP shows interest in acquiring a project gives the QNP time to talk with the tenants and find out if two-thirds of the tenants are on board for the program and are low-income qualified. The QNPs also need to know that there are no illegal sublet situations, which would complicate the sale. If less than 66% of the tenants are on board, the QNP will pass on the purchase. Prior to COPA, this investigation period was much shorter and more difficult in the free market and most brokers would prohibit the QNP from talking to the tenants.
How has COPA impacted the market?
We recently talked with Jonah Lee, director of portfolio management and preservation at the Mayor's Office of Housing and Community Development. He was incredibly patient with our questions and very helpful in explaining the program. One of the first things we learned is that the COPA program is not actually a program. It is a framework to give the eight QNPs a chance to look at all potential sales that come to market for the Small Sites acquisition program. Although COPA QNPs can use other sources of funding, COPA was designed to facilitate the SF Small Sites Acquisition and Rehabilitation Program. Since 2014, there have been 51 successful small sites, with approximately $160 million dollars loaned to acquire and rehabilitate 536 residential units.
Since COPA has been implemented, there have been only six buildings successfully purchased for a cost of $18.5 million dollars and a total of 42 residential units. Five of those six buildings were purchased by one QNP—the Mission Economic Development Agency or MEDA. Lee noted that one of the difficult issues when the COPA law was enacted was that it created rights to purchase, but it did not create funding to make those purchases happen. As it stands now, with the impending $2 billion projected city budget deficit brought on from the COVID-19 crisis, there is a very real “pause” in all programs throughout the city government and QNPs are working to diversify their funding sources.
When we first learned the details about the program, we thought it was flush with cash for purchases from the November 2019 bond that passed and that there was a large pool of funds from affordable housing linkage fees.
In reality, the bond fund is empty. Voting it in does not actually get the bonds issued, sold, and the cash collected in the city’s bank account. When the bonds are finally issued, the funds earmarked for preservation of existing housing and small sites acquisition are to be approximately $30 million. However, because of COVID-19, it's not clear when this will happen. The expectation is sometime before the end of the year.
The linkage fees are sometimes referred to as the “fee out” or “fee in lieu” monies. The fees are paid by a developer who will pay into a fund to build affordable housing off site instead of building it on the site they just purchased. For example, in April of this year the developer of a 101-unit project located at Geary and Masonic was allowed to pay a $4.5 million fee instead of building affordable housing at the site. The use of these fees are 90% for building new housing and 10% of these fees can be used for the Small Sites program. At this point in time, all the monies in the account have already been allocated. In other words, there is no funding in this pool to acquire new small sites today. The future inflow of fees is uncertain as fees only come in when the projects move forward to the stage of issuing building permits for the project. The development pipeline in San Francisco is substantial at the moment, but it is extremely hazy during the COVID-19 crisis as to when these developments may actually move forward and the funds will be paid into this pool.
How much money is actually in the fund at this time?
There is currently about $198 million left in Preservation and Seismic Safety (PASS) funds, which is money left over from the seismic brick retrofit bond issue from 1992. The SS part of the name is a misnomer today since there are not many, if any, brick buildings left to retrofit. The Preservation part of the fund is what has been adopted for the Small Sites Program. One of the limitations of this source of funds is that it's considered senior lending and it must be serviced by the income from the tenants in the building. It is what is called “hard pay” or a priority lien on the collateral, which consists of the collected rents in the buildings. Since these funds need to be paired with other funds to make a complete stabilized city-backed project, they can't really be executed until the 2019 bond is funded.
There are also some limited “geographic” funding sources available, but the only one of note is the South of Market (SOMA) Stabilization Fund, which has $2.5 million for projects within that area of the city. This could be a down payment for five smaller projects paired with conventional bank loans.
Downtown Neighborhoods Preservation Fund is another funding source, but those funds are currently on hold. They are dependent on the Oceanwide Center at 50 1st Street, but that project is uncertain at this time, so this source is not presently available.
What does this uncertain funding situation mean for now?
We spoke with Jeremy Williams, a broker at Corcoran GL Commercial who has successfully completed two sales with MEDA pre-COPA. He has heard there is no money for deals at this time for any QNP acquisitions.
When we discussed the program with another broker who has a building that went into contract with a QNP before the shelter-in-place order, he told us his seller decided to stick with extending the sale due to COVID-19, accept the uncertainty of funding, and hope for the best. One of the first rules of being a broker is to make sure the buyer has proof of funds. With the COPA law and current COVID-19 environment, making sure the buyer has the money has become very difficult.
We had a 39-unit SRO at 1515 California, a QNP expressed interest in May, and they wrote an offer 20% below the $10.6 million list price with a six-month close of escrow. The seller elected to pass and take the building to the open market. The QNP now has the right to match the best offer we generate in the market, but the QNP may or may not be able to show they can fund a deal of this size when we get to that stage of the sale.
Richard Hurlburt is a broker at IMPACT, which has closed 40 acquisitions under the Small Sites Program. Hurlburt represents tenant buyers and multiple COPA QNPs. He told us, “So far, no QNP has invoked the right of first refusal under COPA, but we’ve gotten into contract on seven properties at the ‘first offer’ stage. Four of those have closed and three are still in progress.”
What do other brokers think about COPA?
When the program started, the brokerage community was a bit irritated about the government intervention in the sales process. One of my respected broker colleagues, Clinton Textor, feels the process is not fair to sellers. He said, “Our job as a listing agent is to create a large market for our clients in order to generate the highest price. COPA requirements can harm sellers if they don’t endeavor to ensure a competitive sales process. We don’t offer a buy-side commission to agents representing a QNP in most cases. Instead, we offer that fee to any agent who has an accepted offer that is subsequently taken through a right of first refusal by a QNP. A seller should not pay a buy-side broker’s fee in a right of first offer scenario either, since a seller has no choice but to take the property to the QNPs before they can take it to anyone else. COPA can create an anti-competitive marketplace for a property if the agent isn’t mindful about protecting their client’s interests.”
What will the future hold for Small Site acquisitions?
That is the $150 million dollar question. We expect to see the bond that was passed eventually get funded with $30 million for the Small Sites program. Those funds should be able to be leveraged with financing to about $150 million. Once the funds become available, the QNPs will be able to show legitimate proof of funds and make more deals. In the meantime, they will continue to look at all the offerings through COPA and do their best to preserve low-income housing and prevent displacement. In looking at this with our new knowledge and the post COVID-19 armchair quarterbacking, we see the importance of enacting laws that are actually executable. It seems that too often the legislators in San Francisco make a big splash in the news to get reelection votes, but make laws that do not stand alone as functional. COPA is a typical example of this.
The Jones Team consists of Terrence Jones, Senior Broker Associate with Corcoran Global Commercial and his partner Isabelle Salvadori. They can be contacted at (415) 786-2216 or terrence@terrencejonesSF.com.