EAST PALO ALTO
CITY COUNCIL
STAFF REPORT
DATE: March 1, 2022
TO: Honorable Mayor and Members of the City Council
VIA: Jaime M. Fontes, City Manager
BY: Rachel Horst, Housing and Economic Development Manager Karen Camacho, Housing Project Manager
SUBJECT: Introduction of East Palo Alto Opportunity to Purchase Act ("EPA OPA") Ordinance
Recommendation
Waive the first reading and introduce an Ordinance titled “East Palo Alto Opportunity to Purchase Act” (“EPA OPA”), adding Chapter 14.26 to the East Palo Alto Municipal Code.
Alignment with City Council Strategic Plan
This recommendation is primarily aligned with:
Priority No. 6: Create a Healthy and Safe Community
Background
At a public hearing on January 25, 2022,1the City Council considered an ordinance titled East Palo Alto Opportunity to Purchase Act (“EPA OPA” or “Ordinance”). The City Council voted to continue the public hearing to March 1, 2022.
The following updated chart details the major milestones in the EPA OPA process.
EPA OPA Milestones
Date Description
June 4, 2019
Council adopted Resolution No. 5128, authorizing the City Manager to submit an application to the Partnership for the Bay’s Future for a Challenge Grant for Housing Protection and Preservation (“Challenge Grant”).
November 2019 The City was awarded a Challenge Grant. Challenge Grant Fellow began work in February 2020 and continued through 2020 and 1 The full January 25, 2022 public hearing item can be viewed at:
http://eastpaloalto.iqm2.com/Citizens/Detail_Meeting.aspx?ID=1486 2021.
January 2021
City Council adopted as one of its Council Priorities, “Advancing the Concept of TOPA/COPA and Other Homeownership
Opportunities.”
July 20, 2021
Staff provided an update on Challenge Grant progress to City Council and received authorization to apply for a Partnership for the Bay’s Future Breakthrough Grant.
July 2021 –
September 2021
Nine Affinity Group meetings (67 participants) and two Focus Group meetings (19 participants) were conducted to gather community input. Participants consisted of homeowners, tenants, landlords, and real estate agents.
October 5, 2021
Policy & Action City Council item to provide a report on OPA progress and seek direction on development of an ordinance. City staff were directed to bring back a proposed OPA Ordinance for hearing.
November 16,
2021
Public hearing for OPA Ordinance. City Council directed staff to hold a community meeting on OPA and return to the next City Council meeting with an updated Ordinance.
December 1,
2021
Community meeting via Zoom on OPA with 276 participants of which 72 spoke during the public comment portion.
December 3 & 6,
2021
Staff hosted virtual office hours to provide residents and stakeholders with an additional opportunity to ask questions or express concerns.
December 7,
2021
Public hearing for OPA. Staff presented on recommended
changes to the Ordinance based on City Council direction and extensive community feedback. City Council took over two hours of public comment from 128 speakers and continued the item to December 22.
December 22,
2021
Public Hearing and First Reading of OPA Ordinance. Staff proposed several amendments to the draft Ordinance first proposed in November 2021. The Ordinance also included edits recognizing the extensive public feedback received to date. City staff were directed to continue the item at the next regular Council meeting in the new year.2
January 13 & 14,
2022
Staff hosted accessible office hours to receive further community input.
January 18, 2022 The City Council voted to move the item to a special meeting scheduled for January 25, 2022.
January 25, 2022
Public hearing with first reading of the Ordinance. Presentation from David Rosen & Associates on findings from their analysis on potential impacts of EPA OPA. City Council received further clarification on Qualified Nonprofits and foreclosures from staff.
Item continued to March 1, 2022.
In addition to the major milestones, on February 1, 2022, the City of East Palo Alto was 2 The full December 22, 2021 public hearing item can be viewed at:
http://eastpaloalto.iqm2.com/Citizens/Detail_Meeting.aspx?ID=1464 announced as one of 11 Partnership for the Bay’s Future 2022-2024 Breakthrough Grant recipients.3 The City applied for a Breakthrough Grant in July 2021 to assist with, among other activities, implementation of an EPA OPA if adopted. Breakthrough Grant jurisdictions receive a Breakthrough Grant Fellow for a two-year period to implement the grant scope. If the City Council adopts an EPA OPA, the Breakthrough Grant Fellow can provide added staffing capacity to support the City over the next two years in the implementation of the Ordinance.
The purpose of this staff report is to continue the public hearing and address the following direction from City Council:
1.) Clarification on the applicability of the Ordinance to Limited Liability Companies (“LLCs”) and trusts;
2.) Consideration of potential additions to exemptions language to include transfers of property to nieces and nephews as types of family members; and
3.) Further review of Right of First Refusal and overall economic impact of the Ordinance on local real estate market.
Analysis
Clarification of OPA Applicability and Exemptions
The OPA exempts a number of property and transfer types from the provisions of the Ordinance. The full list of exempt transfers is found in subsections 14.26.040 A and B.
The City Council requested:
1.) further clarification on the exclusion of certain types of LLCs from the exemption provision in subsection A.2;
2.) further clarification on the type of transfer that is exempted from OPA pursuant to subsection B.4; and
3.) potential inclusion of nieces and nephews in subsection B.1, which describes the inter vivos transfers that are exempted from the Ordinance.
Exempt and Non-Exempt LLCs
Subsection 14.26.040.A, among other exemptions, provides an exemption from the Ordinance for owner-occupied single-family dwellings, duplexes, and triplexes, with or without Accessory Dwelling Units (ADUs). Non-owner-occupied, or absentee, properties are exempt from the OPA if the owner of the property or properties is an East Palo Alto resident who has lived in another property in the city as their principal residence for at least one year.
This exemption for properties of East Palo residents provided in subsection 14.26.040.A.2 does not apply to properties with the following types of owner entities:
a. A real estate investment trust, as defined in Section 856 of the Internal Revenue Code;
b. A corporation; or
c. A limited liability company in which at least one member is a corporation. 3 See the July 30, 2021 staff report for further details on the City's Breakthrough Grant application. http://eastpaloalto.iqm2.com/Citizens/Detail_LegiFile.aspx?Frame=&MeetingID=1420&MediaPosition=95.624&ID=1813&CssClass= Staff wish to clarify that LLCs4 as a type of ownership entity do not “disqualify” a property from the exemption pursuant to this subsection if all members of the LLC are natural persons. Staff noted in the January 18, 2022 staff report that this subsection uses the definition of investorowned properties in CA Civil Code Section 1947.12 (AB 1482) to further clarify that this exemption for properties of East Palo Alto residents applies when both (or more) properties are owned by a natural person or persons.
It should be noted that LLCs are included in the Definitions section in 14.26.020: “Owner” means: any natural person, corporation, association, partnership, joint venture, limited liability company, trustee, business entity and its respective agents, or any other entity, who is the owner of record of a residential property.
According to the PropertyRadar database, there are approximately 243 residential parcels owned by LLCs in East Palo Alto (5% of all East Palo Alto residential parcels). A total of approximately 230, or 94.7% of the residential parcels owned by LLCs, include at least one corporate member; a total of approximately 12, or 4.9% of the residential parcels owned by LLCs, have multiple non-corporate members; and only 1, or .4%, of all residential parcels owned by LLCs lists an individual member. EPA OPA would apply to the nearly 95% of LLCowned parcels that include corporations; approximately 5% of LLC-owned properties would be exempt because the LLC is composed of natural persons.
Revocable Trusts
Subsection 14.26.040.B.4. exempts a transfer of bare legal title into a revocable trust, without actual consideration for the transfer, where one or more transferors is a current beneficiary of the trust from the OPA.
This subsection clarifies that the action of transferring a property into a revocable trust5 does not qualify as a property transfer under the OPA, as long as the person or persons are also a beneficiary of the trust. As an example, an owner or owners placing a property into “X Family Trust” would not subject the property to any provisions of the OPA.
Inter Vivos Transfers
As currently written, the Ordinance exempts property transfers to family members from the OPA, as described in subsection 14.26.040.B.1: an inter vivos transfer, whether or not for consideration, between spouses, domestic partners, parents and children, siblings, and/or grandparents and grandchildren.
An owner may therefore sell or transfer their property to the above family members without subjecting the sale of the property to the OPA process. City Council identified nieces and nephews as additional relations that could be added to this exemption. The suggested addition of language to the Ordinance is provided in the Recommended Changes/Corrections to the Ordinance section of this staff report, below.
Impact of Right of First Refusal
4 A Limited Liability Company is a type of legal entity that is sometimes formed by individuals who invest in real estate. Generally speaking, an LLC arrangement separates and protects members’ personal assets from the business of the LLC (the real estate investment).
5 Revocable trusts are a common legal entity that owners of a property may form. Trustees of a revocable trust identify beneficiaries to whom they can pass their assets.
At the January 25, 2022 public hearing,6 City Council asked staff to further look into the potential economic impacts of the “Right of First Refusal” in the OPA. Specifically, staff was requested to further research the question of whether, and to what extent, the Right of First Refusal may affect the East Palo Alto housing market.
As reported by David Rosen & Associates in their analysis of potential OPA impacts, dated January 14, 2022, single-family house prices are driven in large part by the regional housing market, which is characterized by high demand, limited supply, and a strong regional economy, and national trends such as rising interest rates. Such conditions, coupled with the fact that the OPA would affect only a subset of units in East Palo Alto, indicates that the overall impact of OPA on home prices is not expected to be significant.
Staff’s further review of available literature revealed very limited empirical evidence of the economic implications of a right of first refusal or a relationship between a right of first refusal in a local policy such as OPA and home prices, such that the findings could be applied to East Palo Alto in this context.
Right of First Refusal
Under EPA OPA, the Right of First Refusal period is when a Potential Eligible Purchaser has a right to match a third-party buyer’s offer (also referred to as “Third Party Purchaser’s Offer”).
Not every property or transfer subject to OPA will include a Right of First Refusal; for example, it does not apply if the Potential Eligible Purchaser does not take the required steps within the required timeframes, or if there is more than a 15% difference between a valid offer submitted by a Potential Eligible Purchaser and that of a Third-Party Purchaser.
Analyses of Right of First Refusal
A right of first refusal is a common practice in real estate transactions, businesses, statutes, and more, and courts have sanctioned rights of first refusal.7 Some studies8 have applied a theoretical framework to anticipate the potential impacts of a right of first refusal based on the behavior of all sides of a transaction: the buyer with the right of first refusal, the seller, and a third-party buyer.
It is challenging to directly apply the expected outcomes of various studies, with their 6 See: http://eastpaloalto.iqm2.com/Citizens/Detail_Meeting.aspx?ID=1486. 7 E.g., see American Broadcasting Cos. v. Wolf, 430 N.Y.S.2d 275, 281 (N.Y. App. Div.), appeal dismissed, 413 N.E.2d 1173 (N.Y. 1980), aff’d, 420 N.E.2d 363 (N.Y. 1981) (A right of first refusal is a “valuable right which has enjoyed the protection of the courts.”).
As cited previously, a January 2021 report lays out the eight jurisdictions nationwide that assign a right of first refusal to tenants, demonstrating its long-term term protection in the courts. These include Baltimore, MD (enacted in 1979 for 1-unit buildings), Washington, DC (enacted in 1980 for 1, 2-4, and 5+ units), Montgomery County, MD (enacted in 1981 for 4+ unit buildings), Takoma Park, MC (enacted in 1986 for 1, 2-6, and 7+ unit buildings), New Hampshire (enacted in 1968 for manufactured home parks), Minnesota (enacted in 1991 for mobile home parks), Prince George’s County, MD (enacted in 2013 for 20+ units), and San Francisco (enacted in 2019 for 3+ units). See: Scott Bruton and Gretchen Nicholls, “Opportunity to Purchase Policy Options for the City of Minneapolis,” LISC Twin Cities and CNHED, January 2021, pgs. 24-40, https://lims.minneapolismn.gov/Download/File/4846/Opportunity%20to%20Purchase%20Policy%20Options%20for%20the%20City %20of%20Minneapolis%202020-01178%20update.pdf.
8 See: David I Walker, "Rethinking Rights of First Refusal," Stan. JL Bus. & Fin. 5 (1999); Marcel Kahan, “An Economic Analysis of Rights of First Refusal,” NYU Center for Law and Business, Working Paper #CLB-99-009 (June 1999); Marcel Kahan, Shmuel Leshem, and Rangarajan K. Sundaram, "Rights of First Refusal," NYU Law and Economics Research Paper 07-42 (2009); Yao-Min Chiang and Jarjisu Sa-Aadu, "Right of First Refusal (ROFR) Effects in Auctions with Reserve Price: Empirical Evidence from Taiwanese Government Land Auctions,” available at SSRN 2409599 (2014); Brit Grosskopf and Alvin E. Roth, "If you are offered the Right of First Refusal, should you accept? An investigation of contract design" (2005); Sushil Bikhchandani, Steven A. Lippman, and Reade Ryan, "On the Right-of-first-refusal," Available at SSRN 621181 (2002); Leandro Arozamena and Federico Weinschelbaum, "A note on the suboptimality of right-of-first-refusal clauses,” Economics Bulletin 4, no. 24 (2006): 1-5. respective assumptions about information level, relative negotiating power, and values, to the proposed EPA OPA. It should be noted that the EPA OPA places limits on the Potential Eligible Purchaser to exercise the Right of First Refusal and is intended to create a level of certainty for the Third-Party Purchaser to know if their offer will require a match.9 As a reminder, EPA OPA contains the following provisions:
1. A Potential Eligible Purchaser (“PEP”) must submit a timely Statement of Interest.
No provision in the ordinance allows for a PEP that did not submit a timely Statement of Interest to exercise a Right of First Refusal.
2. In addition, a PEP must submit a timely Offer. No provision in the Ordinance allows for a PEP that did not submit a timely Offer to exercise a Right of First Refusal.
3. When a Third-Party Purchaser makes an offer within 15% of the PEP’s offer, and the owner is willing to accept that offer, the PEP may exercise the Right of First Refusal.
Otherwise, the PEP may not exercise the Right of First Refusal.10
4. If the above-mentioned conditions are met and the PEP is therefore able to exercise the Right of First Refusal, and the PEP is willing to accept all the terms and conditions of the Third-Party Purchaser’s Offer within the time specified by the Ordinance, the owner must proceed to sell the residential property to the Potential Eligible Purchaser.
Some more recent studies on the right of first refusal may provide insights into the real-world impact of a right of first refusal.11 However, it remains difficult to extrapolate the findings of any of these studies to make a substantial claim about the impact of this provision in the Ordinance on house prices in East Palo Alto.
Evidence from Washington, D.C.
Staff was requested to report on available data or studies published on the four-decade old Tenant Opportunity to Purchase Act (“TOPA”) policy in Washington, D.C. In 2013, a Fiscal Policy Institute Report on the Washington, D.C. policy found that the per-unit costs to acquire properties under D.C.’s First Right Purchase Program continued to rise and differed by ward due to factors such as the location, year of sale, and how much rehabilitation the building needed.12 In FY 2012 alone, 5,000 District housing units went up for sale across 99 buildings that could have potentially been supported by the local TOPA ordinance, but District resources were not adequate to meet the high demand, leading to a loss of a significant amount of lowand moderate-cost housing. Despite this increasing per unit cost, the report found that the first right to purchase remained a cost-effective preservation tool, as the cost was lower than other types of affordable housing development.
It is important to note some distinctions between the policies and housing conditions in Washington, D.C. and East Palo Alto. As just one example, Washington’s right of first refusal 9 Note: Definitions of right of first refusal vary substantively between studies and between EPA OPA and the analyses staff reviewed.
10 The proposed Ordinance states: An Owner interested in accepting a Bona Fide Offer to Purchase from a Third-Party Purchaser shall disclose that offer to any Potential Eligible Purchaser that submitted a Statement of Interest and an Offer within fifteen percent (15%) of the offer received by the Owner from the Third-Party Purchaser. 11 For example, Chiang and Sa-Aadu's (2014) paper provides empirical evidence on the effects of a Right of First Refusal for the sale of government owned land in Taiwan from 2007 to 2010. 12 Jenny Reed, "DC’s First Right Purchase Program Helps to Preserve Affordable Housing and Is One of DC’s Key AntiDisplacement Tools," Washington, DC: DC Fiscal Policy Institute (2013), https://www.dcfpi.org/wp-content/uploads/2013/09/9-24-13- First_Right_Purchase_Paper-Final.pdf.
period is 15 days, compared to East Palo Alto’s 5 days for single family dwellings and condominiums. In addition, according to David Rosen & Associates’ January 2022 report, East Palo Alto saw a 3.6-fold increase in home values between 2012 to 2021, outperforming the
2.9-fold, 2.2-fold, and 2.1-fold increase in home values in San Mateo County, Santa Clara County, and California, respectively. Home values are expected to continue to rise due to a variety of reasons: buyers will clearly identify those home sales that are covered by the Ordinance and those that are not; new development projects and improvements, as well as other factors beyond the City’s control such as interest rates, employment, and wages, will drive demand up; and high market demand makes the market very efficient in adjusting to regulatory changes.
A 2018 D.C. Policy Center Housing Report on housing conditions in Washington found that housing prices rapidly increased between 1995-2018; those who purchased a house before 1995 saw a 4.5-fold increase in their investments, which outperformed the 2.6-fold increase in the greater Washington Metro area.13
Recommended Changes/Corrections to EPA OPA Ordinance
The Ordinance has been revised to make it clearer and address points previously raised by the City Council. Staff recommend the Ordinance attached to this report (as Attachment 1) be introduced.
Inter Vivos Transfers
As noted above, the City Council may wish to insert “nieces and nephews” into the types of family members included in an inter vivos transfer as described in Section 18.26.040B.1, as follows:
B. Exempt Transfers. The following transfers of Residential Property are not subject to the requirements of this chapter:
1. An inter vivos transfer, whether or not for consideration, between spouses, domestic partners, parents and children,14 siblings, and/or grandparents and grandchildren, and/or nieces and nephews.
Please note that the Ordinance in Attachment 1 does not contain this language. If directed by City Council via motion at this March 1, 2022 meeting, this language may be added to the Ordinance, and a revised Ordinance reflecting the changes will be presented for adoption at a later meeting.
Next Steps
If the City Council is satisfied with the revisions by the conclusion of this meeting and introduces the Ordinance, staff will return for the adoption of the Ordinance at the next regular City Council meeting.
The Ordinance takes effect on July 1, 2022. Staff anticipate that the process of developing 13 Yesmin Sayin Taylor, “Taking Stock of the District’s Housing Stock,” D.C. Policy Center (March 2018), page 6, https://www.dcpolicycenter.org/wp-content/uploads/2018/03/DC-Policy-Center-Housing-Report.final_.March25.pdf. 14 Note that stepchildren are recognized as children.
Administrative Guidelines will take several months and therefore must commence immediately after adoption of the Ordinance.
As a reminder, the Administrative Guidelines will contain an outline of how EPA OPA works in practice, address “gray areas” for scenarios not explicitly referenced in the ordinance, set threshold criteria to fulfill the ordinance’s intent, and promote program uptake. Key topics of the Administrative Guidelines include qualification of nonprofits, transfer exemption procedures, assignment of rights procedures, noticing and disclosure requirements, prohibited conduct, and more.
Fiscal Impact
There is no fiscal impact associated with this staff report. If adopted, there will be costs related to the implementation of an EPA OPA ordinance. As discussed above, the City’s award of a Partnership for the Bay’s Future Breakthrough Grant could partially mitigate that cost by adding dedicated staff capacity from the Breakthrough Grant Fellow.
In particular, the Fellow can support the development and implementation of the Administrative Guidelines, starting with preparing the draft document for City Council consideration. This would be the first assignment for the new Fellow. Breakthrough Grant Fellows are anticipated to be onboarded with their respective jurisdictions in June 2022.
Public Notice
The public was provided notice via publication in the Palo Alto Daily News on January 7, 2022, and by making the agenda and report available on the City’s website and at the San Mateo Co.
Library located at 2415 University Avenue, East Palo Alto. A postcard was also mailed to all East Palo Alto residents announcing this City Council hearing and listing key points in the Ordinance.
Environmental
The action being considered does not constitute a “Project” within the meaning of the California Environmental Quality Act (CEQA), pursuant to CEQA Guideline section 15378 (b)(5), in that it is a government administrative activity that will not result in direct or indirect changes in the environment.
Attachments
1. Ordinance