City of East Palo Alto
Evaluation of Selected Housing Trust
Fund Revenue Source
March 9, 2022
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources PREPARED FOR :
City of East Palo Alto
2415 University Avenue
East Palo Alto, CA 94303
PREPARED BY:
David Paul Rosen & Associates
1330 Broadway, Suite 937
Oakland, CA 94612
510-451-2552
510-451-2554 Fax
[email protected]
www.draconsultants.com
3941 Hendrix Street
Irvine, CA 92614
949-559-5650
949-559-5706 Fax
[email protected]
www.draconsultants.com
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources Table of Contents
1.0 Summary and Recommendations .............................................................. 1
1.1 Gross Receipts Business License Tax..................................................... 1
1.2 Transient Occupancy Tax ...................................................................... 2
2.3 Parcel Tax
2.0 Business License Tax.................................................................................. 2
2.1 Existing Gross Receipts Business License Tax in East Palo Alto ........... 2
2.2 Existing East Palo Alto Gross Receipts Tax on Rental Properties of Five or More Units .............................................................................. 4
2.3 Gross Receipts Tax on Rental Properties in Other Bay Area Cities..... 4
2.4 Potential East Palo Alto Gross Receipts Tax on Residential Properties with Less than Five Units................................................... 6
3.0 Transient Occupancy Tax ........................................................................... 7
3.1 Existing Transient Occupancy Tax in East Palo Alto ............................. 8
3.2 Transient Occupancy Tax on Short-Term Rentals................................. 8
3.3 Potential Increase in Transient Occupancy Tax Rate............................ 9
4.0 Parcel Tax.................................................................................................10
4.1 Existing Parcel Tax on Large Commercial Properties.......................... 10
4.3 Potential Parcel Tax on Residential Parcels........................................ 11 City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources List of Tables
1 Gross Receipts Business License Tax Rates, City of East Palo Alto
3 2 Annual General Fund Revenues from Gross Receipts
Business License Tax, City of East Palo Alto
4 3 Business License Tax from Multifamily Properties with Five or More Units and Potential Increase, City of East Palo Alto
5 4 Gross Receipts Tax on Residential Rental Properties, Selected Bay Area Cities
7 5 Potential Revenue from Gross Receipts Business
License Tax on Residential Rental Properties Owned by
Non-Residents
8 6 Budgeted Annual General Fund Revenues from
Transient Occupancy Tax
10 7 Potential Increase in Transient Occupancy Tax Revenue from Increasing the Rate from 12% to 14%
11 8 Potential Annual Revenue from a $100 Flat Rate Parcel Tax on Residential Parcels
13 Evaluation of Selected Housing Trust Fund Revenue Sources March 9, 2022 1 1.0 Summary and Recommendations
In 2019, the City of East Palo Alto requested DRA to evaluate various funding measures that would provide an ongoing, sustainable source of funding for affordable housing in the City. Recently, the City asked DRA to update its report with additional recommendations.
This is a supplemental document to the comprehensive report provided in January, 2020.
Specifically, DRA provided additional evaluation of the following three potential revenue sources for the City’s Affordable Housing Trust Fund (AHTF):
• Potential modifications to the City’s Measure O business license tax (which is a gross receipts tax, or GRT) on rental properties with five or more units, including:
o Increasing the tax rate from 1.5% to 2.0% or 2.5%;
o Eliminating the exemption for rental properties during the first ten years after the issuance of a certificate of occupancy;
o Applying a gross receipts tax to rental properties with less than five units. • Potential increases to the transient occupancy tax (TOT). • A parcel tax on residential properties in the City.
As described more fully in DRA’s 2020 report, new general taxes, or tax increases above prior limits, require approval from a majority of voters. A city or county tax dedicated to a specific purpose qualifies as a special tax, requiring a two-thirds vote of the electorate.
Non-dedicated taxes require a simple majority vote. This report describes DRA’s analysis of the above three revenue options to capitalize the HTF, including projections of potential revenue generation, as data permit.
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 2 DRA’s recommendations are as follows:
1.1 Gross Receipts Tax
a. Increase the GRT rate on rental properties with five or more units to 2.5%. DRA estimates that an increase in the GRT tax on multifamily properties of 5 or more units from 1.5% to 2.5% could generate close to $400,000 in additional revenue per year (see Table 3). Raising the rate to 2.0% would generate an increase of half that much.
b. Eliminate the exemption for rental properties during the first ten years after the issuance of a certificate of occupancy. We are not aware of other local GRT’s that exempt new businesses, rental housing or others. We do not believe that a tax of
1.5% to 2.5% is of sufficient magnitude to discourage new rental housing development. Section 5.08.125 D of the City’s municipal code provides an avenue for entities subject to the tax to seek a hardship exemption due to exceptional circumstance.
c. Broaden the GRT to apply to rental properties with fewer than 5 units. The Cities of Berkeley and Oakland apply their GRT to rental properties of all sizes. DRA estimates that a GRT applied to rental properties of less than 5 units could raise approximately $1.15 million per year (see Table 5).
1.2 Transient Occupancy Tax
a. Increase the TOT rate from 12% to 14%. East Palo Alto’s TOT is below the upper limit on typical TOT rates. Increasing the TOT rate from 12% to 14% would raise approximately $479,000 annually based on the TOT raised in 2019, or $115,000 annually based on the more constrained TOT revenue the City budgeted for 2021 (see Table 7). Hotel occupancies plunged at the start of the COVID-19 pandemic and recovery of hotel occupancy rates in the region has been slow, resulting in the lower TOT revenues in the last several years.
b. Consider the feasibility and cost/benefit of applying the TOT to short-term rentals in East Palo Alto. Other Bay Area communities have instituted such a tax. DRA has insufficient information on short term rentals in East Palo Alto to estimate the potential revenue generation in a TOT on short-term rentals.
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 3
1.3 Parcel Tax on Residential Properties
a. Consider a parcel tax on residential parcels. A tax of $100 per parcel per year would generate an estimated $458,000 in annual revenue.
2.0Gross Receipts Business License Tax
2.1 Existing Gross Receipts Business License Tax in East Palo Alto The City of East Palo Alto levies a gross receipts business license tax on a range of businesses in East Palo Alto. Table 1 summarizes the gross receipts business license tax applied to all businesses in East Palo Alto except owners of five or more rental units, which is discussed separately below.
Table 1
Business License Tax Rates
City of East Palo Alto
Annual Gross Receipts Range Tax
-- $1,000 $50
$1,001 $100,000 $125
$100,001 $250,000 $250
$250,001 $500,000 $500
$500,001 $10,000,000 $1 for each $1,000 of gross receipts $10,000,001 And up $10,000 + $0.50 for each $1,000 of gross receipts above $10,000,001
Source: City of East Palo Alto 2022 Business License Renewal, Instructions for Completing Declaration; DRA.
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 4 Table 2 summarizes budgeted annual revenues from the gross receipts business license tax in East Palo Alto for FY 2019/20 through FY 2021/22.
Table 2
Annual General Fund Revenues from Business License Tax
City of East Palo Alto
FY 2019/2020 to FY 2021/22
FY 2019/2020
Actual
FY 2020/21
Budget
FY 2021/22
Budget
$1,585,840 $975,000 $1,280,000
Source: City of East Palo Alto FY 2021/22 Adopted Budget; City of East Palo Alto; DRA.
2.2 Existing East Palo Alto Gross Receipts Business License Tax on Rental Properties of Five or More Units
In 2016 East Palo Alto voters passed Measure O, with 77.5% approval, authorizing a tax equal to 1.5% of gross rental receipts on the owners of five or more rental units. The tax is a general tax, but text of the measure emphasized the City’s proposed use of funds for housing-related purposes. The Measure O business license tax may not be passed on to tenants. It does not apply to any units during the first 10 years after a certificate of occupancy is issued. Anyone leasing less than five units, nonprofit operators of affordable housing, Section 8 units, or below market rate units with deed restrictions are exempt.
Table 3 summarizes the annual business license tax collected under Measure O from FY 2018/19 through February, 2022 at the existing 1.5% tax rate. The table also shows DRA’s estimates of total annual revenues from the Measure O business license tax at increased tax rates of 2.0% and 2.5%, respectively, as well as the annual increase in revenues achieved by going to these higher rates.
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 5 Table 3
Annual General Fund Revenues from Measure O Business License Tax And Potential Revenues from Increase in Tax Rate
City of East Palo Alto
FY 2019/2020 to FY 2021/22
FY 2018/2019 FY 2019/2020 FY 2020/21
FY 2021/22
(as of
2/18/22)
1.5%1
(Actual) $599,000 $600,300 $546,700 $552,200
2.0%
(Estimate) $798,667 $800,400 $728,933 $736,267
2.5%
(Estimate) $998,333 $1,000,500 $911,167 $920,333
Increase from
1.5% to 2.0% $199,667 $200,100 $182,233 $184,067
Increase from
1.5% to 2.5% $399,333 $400,200 $364,467 $368,133
1 Actual figures at current 1.5% tax rate are rounded. For the past three years, the City has been collecting from about 32 owners/property management companies.
Source: City of East Palo Alto FY 2021/22 Adopted Budget; City of East Palo Alto; DRA.
2.3 Gross Receipts Taxes on Rental Properties in Other Bay Area Cities DRA reviewed the business license tax requirements on rental properties in other Bay Area cities. The City of San Jose does not charge a gross receipts tax but charges a business license tax on all rental units on a sliding scale based on the number of housing units.1 The cities of Berkeley, Oakland and San Francisco levy gross receipts business license taxes (GRTs) on rental properties, as summarized in Table 4.
1 The base tax for 1 to 2 units is $207, with an incremental tax of up to $28 per unit for projects with 500 or more units and an overall project cap of approximately 166,300.
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 6 • Oakland charges the same GRT rate (1.395%) for all residential rental properties. • In November, 2016, Berkeley voters passed Measure U1 establishing an enhanced business license tax on owners of properties with 5 or more rental units. Starting in 2018, Berkeley charges two rates, with a higher rate (2.880%) for properties with five or more housing units and a lower rate (1.081%) for smaller properties. The City estimates the revenue generated from the measure has the potential to create roughly 400 affordable homes in Berkeley over the next 10 years and also fund emergency rental assistance.
• Starting in 2014, San Francisco transitioned to a gross receipts tax for all business activities, which was to be phased in over five years with incremental increases in the GRT. Proposition F, approved by voters in November 2020, became effective January 1, 2021 and completes the City’s transition away from payroll taxes. San Francisco’s tax rate is on a sliding scale by gross receipts and is phased in over the 2021 to 2024 tax years.
o Small businesses with less than $2,000,000 in San Francisco gross receipts (this threshold is adjusted annually for inflation) are exempted from the GRT. o A residential landlord is considered a “small business enterprise” in San Francisco in terms of the exclusion from the GRT if and only if the landlord leases fewer than four units in any individual building. o Lessors of residential real estate may exclude from gross receipts 50% of the total amount received from the rental of real property to tenants in occupancy at any location in San Francisco that is subject to limits on rent increases.
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 7 Table 4
Gross Receipts Tax on Residential Rental Properties
Selected Bay Area Cities
Tax Rate as % of Gross
Receipts
Berkeley Rental Properties with 5+ Units
Rental Properties with <5 Units
2.880%
1.081%
Oakland All Rental Properties 1.395%
San Francisco1 Rental Properties with 4+ Units
With Gross Receipts up to $5M
With Gross Receipts greater than $5M
0.442%
0.465% 1
For tax year 2024, if certain thresholds are met. Rates for 2021 tax year are approximately 90% of the 2024 rate and are gradually increased during tax years 2022 and 2023 if certain thresholds are met.
Source: Cities of Berkeley, Oakland and San Francisco; DRA.
2.3 Potential East Palo Alto Gross Receipts Business License Tax on Residential Properties with Less than Five Units
The City of East Palo Alto is considering levying a gross receipts business license tax on rental residential properties with fewer than five rental units in East Palo Alto. According to analysis of PropertyRadar data by City staff, the City has approximately 1,434 residential parcels owned by non-residents of the City, broken down as follows:
Single-Family Residential (SFR) Parcels 1,118
Multi-Family Residential (MFR) Parcels1 175
Other Residential Parcels 141
Total Parcels Owned by Non-Residents 1,434
DRA’s analysis of the same data set estimates that there are as many as 30 multi-family parcels with 5 or more units, leaving roughly 145 multifamily residential (MFR) parcels with fewer than 5 units that are owned by non-residents. DRA’s analysis of the PropertyRadar data estimates an average of 2.60 units per parcel for MFR parcels with two to four units.
According to RentCafe.com, the average apartment rent in East Palo Alto is $2,700 as of January, 2022. This rent may underestimate the average rent for single-family (SFR) rental 1 Includes parcels with more than two units, excluding condos or townhomes.
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 8 homes, which tend to be larger than multi-family units. DRA did not estimate GRT revenue from the 141 “other residential parcels” owned by non-residents.
Based on DRA’s estimates, summarized in Table 5, a GRT of 1.5% on residential parcels owned by non- residents, could raise approximately $690,000 in annual revenue, while a GRT of 2.5% could generate approximately $1.15 M in annual revenue.
Table 5
Potential Revenue from Gross Receipts Tax on Residential Rental Properties Owned by Non-Residents
City of East Palo Alto
Single-Family
Residential
Multi-Family
Residential
<5 Units Total
Estimated Number of Parcels
Owned by Non-Residents1
1,118 145 1,263
Estimated Units Per Parcel2 1 2.6
Estimated Units Owned by NonResidents1,118 377 1,495
Average Monthly Rent3 $2,700 $2,700
Gross Annual Rental Income4 $34,412,000 $11,604,000 $46,016,000 Gross Receipts Tax Revenue @
1.5%
$516,000 $174,000 $690,000
Gross Receipts Tax Revenue @
2.5%
$860,000 $290,000 $1,150,000
1 For MFR parcels, equals a total of 175 MFR parcels less an estimated 30 parcels with 5 or more housing units.
2 Average of 2.6 units/parcel for parcels with 2 to 4 units owned by non-residents. 3 Average apartment rent per unit from RentCafe.com for January 2022. This may underestimate the average rent, especially for single-family units, which tend to be larger than apartment units. 4 Assumes 95% average occupancy rate.
1 Sources: City of East Palo Alto analysis of PropertyRadar data; DRA analysis of PropertyRadar data; RentCafe.com; DRA.
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 9
3.0Transient Occupancy Tax
California Revenue and Taxation Code section 7880 authorizes the legislative body of any city, county or city and county to levy a tax on the privilege of occupying a room or other living space in a hotel or other lodging unless the occupancy is for a period of more than 30 days. Such transient occupancy taxes are often referred to as “hotel” taxes.
Most cities set the rate of their TOT as a percentage of the hotel room rate. According to the League of California Cities, TOT rates generally range from 8% to 14%. Some cities set a cap, providing the city council the option to set the TOT at the cap rate or any lesser rate that the city council shall determine by resolution.
3.1 Existing Transient Occupancy Tax in East Palo Alto
The City of East Palo Alto currently charges a TOT of 12%, which is the maximum approved by the City Council. Additional increases in the TOT in East Palo Alto must be approved by a majority of voters. Of the TOT collected annually in East Palo Alto, the City’s current policy is for 80% to remain in the General Fund, 10% to be allocated to the TOT-Affordable Housing Fund (for affordable housing development), and 10% to be allocated to Children Youth Family Fund (for local grants).
Table 6 summarizes the budgeted annual revenues for FY 2019/20 through FY 2021/22 from the City’s Transient Occupancy Tax.
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 10 Table 6
Budgeted Annual General Fund Revenues from Transient Occupancy Tax City of East Palo Alto
FY 2019/2020 to FY 2021/22
Fund Category FY 2019/2020 FY 2020/21 FY 2021/22
General Fund $2,300,000 $950,000 $550,000
CYSFF1 $287,500 $118,750 $68,750
Housing Programs2 $287,500 $118,750 $68,750
Total $2,875,000 $1,187,500 $687,500 1
The CYSFF Fund accounts for 10% of the Transient Occupancy Tax (TOT) collected as approved by voters to fund various nonprofit organizations providing services to children, youth, and families. 2 The Housing TOT Fund accounts for 10% of the Transient Occupancy Tax (TOT) collected as approved by voters and committed by Council to fund affordable housing development activity.
Sources: City of East Palo Alto Adopted Budgets for FY 2019/20, FY 2020/21 and FY 2021/22; City of East Palo Alto; DRA.
3.2 Transient Occupancy Tax on Short-Term Rentals
Short-term rentals have become a topic of interest in many communities, and an increasing number of cities, counties and states have passed laws to regulate these types of rentals. For example, the City of Pacific Grove requires owners of short-term rentals (STRs) to obtain a STR or Home Sharing License. These ordinances apply to all properties (including rooms and guest houses whether or not detached) rented for less than 30 days.
In 2017, the City Council approved an ordinance allowing a maximum of 250 STR licenses in the City at a time, and implementing a lottery to determine who receives those licenses.
Vacation rental hosts are required to collect the city’s transient occupancy tax (TOT) from guests and file monthly TOT returns with the city. While Airbnb collects this tax from guests on behalf of its hosts, other short-term rental platforms (such as HomeAway and VRBO) do not. Short-term rental operators using those platforms are responsible for collecting it themselves. The TOT rate in Pacific Grove is 12%. The City estimates that STRs generate more than $1 million a year in TOT revenue.
As other examples, Redwood City passed a similar STR law in 2018, and estimates that the 12% TOT tax could generate $400,000 a year for the City.
DRA was unable to estimate the number of STR listings on AirBNB, or other STR sites, in East Palo Alto.
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 11 The City could also evaluate whether a GRT tax on short-term rentals in East Palo Alto could be levied as a gross receipts business license tax, rather than a transient occupancy tax (TOT).
3.3 Potential Increase in Transient Occupancy Tax Rate
In November, 2020, East Palo Alto voters narrowly failed to pass Measure V, which proposed to increase the City’s existing TOT tax rate of 12% to a rate of 14%, to be phased in over two years. Since Measure V proposed to dedicate the increase in revenues to affordable housing development, acquisition and rehabilitation activities in the City, the tax was posed as a special tax, requiring a two-thirds majority to pass.
Table 7 estimates the potential increase in TOT revenues to the City from raising the existing TOT rate of 12% to a new rate of 14%. DRA used the historical data on budgeted TOT revenues from Table 6 to illustrate the potential increase in revenues. DRA’s estimates indicate an increase of 2% in the TOT rate could generate an additional $115,000 to $479,000 in revenues annually..
Table 7
Potential Increase in Transient Occupancy Tax Revenue from Increasing the Rate from 12% to 14%
City of East Palo Alto
FY 2019/2020 to FY 2021/22
Increase in TOT Based on the Budgeted Amount of TOT Revenue in:
FY 2019/2020 FY 2020/21 FY 2021/22
$479,000 $198,000 $115,000
Sources: City of East Palo Alto; DRA.
4.0 Parcel Tax
Article 11 of the California Constitution permits cities to enact an “excise” tax, often called a “parcel” tax, on the privilege of occupying residential property in general, similar to but broader than a transient occupancy tax. In general, such taxes have been submitted to the voters as special taxes for an identified purpose, subject to a two-thirds approval requirement. Between 2002 and 2012, California cities, school districts and special districts City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 12 placed almost 700 parcel tax proposals on the ballot, of which more than half passed1. A parcel or occupancy tax is not a special tax subject to Proposition 13 if its proceeds are not earmarked for a particular purpose.
Most parcel taxes assess a flat fee on each parcel of property, regardless of its size or value. Parcel taxes are regressive, since they represent a larger burden on less expensive properties. A parcel tax rate may differ based on the type of property, for instance improved and unimproved properties may have different rates, and residential and commercial properties may have different rates.
Most parcel taxes in California are used to support local school districts. Relatively few school districts have attempted to pass a parcel tax. More than half of the parcel tax elections held since 1983 have passed, but the districts that passed them represent less than 10% of student population in California.2
4.1 Existing Parcel Tax on Large Commercial Properties in East Palo Alto
In November, 2018, voters in the City of East Palo Alto approved Measure HH, with 79.6% approval, authorizing a parcel tax on large corporations holding real estate in the city. The measure imposes a tax of $2.50 per square foot on commercial office property over 25,000 square feet. Property that is 25,000 square feet or less and property that is not used for commercial office purposes (for example, where the primary business is retail trade, not including retail trade from non-store retailers), agriculture, accommodation and food serves are not subject to the parcel tax. The revenue generated from the tax can be used for affordable and supportive housing programs, with an emphasis on the creation of net new housing; as well as programs that facilitate access to job opportunities for East Palo Alto residents in the science, technology, engineering, and mathematics sectors, the building trades, and strengthen the City’s First Source Hiring Program.
A minimum of 35% of the revenue must be used exclusively for the construction of new, affordable housing stock. A maximum of 15% of the proceeds from the parcel tax can be used for reasonably incurred costs to the City for staff and overhead to administer the ordinance and provide annual reports on the amount of funds collected and expended, and the status of any project.
1 Source: Public Policy Institute of California, “Parcel Taxes as a Local Revenue Source in California,” April 2015.
2 Source: ed100.org.
City of East Palo Alto March 9, 2022
Evaluation of Selected Housing Trust Fund Revenue Sources 13
4.2 Potential New Parcel Tax on Residential Parcels
The City of East Palo Alto is considering the imposition of a parcel tax on residential parcels in the City. The amount of revenue raised will, of course, depend on the parcel tax rate.
Most parcel taxes have been imposed by school districts. Of the 389 parcel taxes proposed by school districts in California between 2003 and 2012, 86% were flat rate. The average rate was $134 per parcel, and the median was $96.1
Table 8 estimates the revenue generation potential of a parcel tax of $100 per parcel on residential parcels in East Palo Alto. As noted above, designating the revenue raised from a parcel tax for housing programs would require two-thirds voter approval of the parcel tax.
Table 8
Potential Annual Revenues from a $100 Flat Rate Parcel Tax on Residential Parcels
Total
Number of Parcels 4,581
Estimated Annual Revenue $458,100
Source: City of East Palo Alto analysis of PropertyRadar data; DRA. 1 Source: Public Policy Institute of California, “Parcel Taxes as a Local Revenue Source in California,” April 2015.