BILL ANALYSIS Ó SENATE TRANSPORTATION & HOUSING COMMITTEE BILL NO: ab 1024 SENATOR MARK DESAULNIER, CHAIRMAN AUTHOR: torres VERSION: 4/10/13 Analysis by: Mark Stivers FISCAL: yes Hearing date: June 18, 2013 SUBJECT: Cooperative housing DESCRIPTION: This bill exempts a stock cooperative or community apartment project from the Subdivided Lands Law under specified conditions and allows a stock cooperative or limited equity housing cooperative to be sold or leased subject to a blanket encumbrance under specified conditions. ANALYSIS: Cooperative housing members own a share in a corporation that owns or controls the building(s) and/or property in which they live. Each shareholder is entitled to occupy a specific unit and has a vote in the corporation. Every month, shareholders pay an amount that covers their proportionate share of the expense of operating the entire cooperative, which typically includes underlying mortgage payments, property taxes, management, maintenance, insurance, utilities, and contributions to reserve funds. Limited-equity cooperatives limit the resale value of shares. Generally targeted at low- and moderate-income people (in the 80-120% of median-income range), the purpose of limited-equity cooperatives is to prevent speculation, encourage long-term residency, and preserve the affordable character of the cooperative for a wide variety of future residents. The Subdivided Lands Law generally requires a person who proposes to subdivide a property into five or more parcels for purpose of sale or lease to obtain a public report from the Bureau of Real Estate (BRE) before the subdivider may market the lots or units. This law is intended to ensure that prospective buyers receive disclosure of pertinent information about the subdivision and that developers complete improvements or arrange AB 1024 (TORRES) Page 2 for their completion. The law contains a number of exemptions, including exemptions for various forms of common ownership. For example, a limited-equity housing cooperative for which a public agency has provided the land or financed or subsidized at least 50 percent of the total construction or development cost or $100,000, whichever is less, is exempt from the public reporting requirement if the regulatory agreements provides assurances for completion of the common areas and facilities and ensures that every prospective purchaser receives prior to sale a membership information report that contains full disclosure of the financial obligations and responsibilities of cooperative membership, rules regarding the resale of shares, the financing of the cooperative, occupancy restrictions, management arrangements, and any other information pertinent to the benefits, risks, and obligations of cooperative ownership. The Subdivided Lands Law also generally prohibits the sale or lease of lots or parcels within a subdivision if the lots or parcels are subject to a "blanket encumbrance," which is a mortgage secured by the entire property or more than one lot or parcel. This prohibition does not apply if the encumbrance contains a release clause that unconditionally allows a purchaser to obtain legal title free and clear of the blanket encumbrance upon compliance with the terms and conditions of the purchase or lease. The prohibition also does not apply if all of the following criteria are met, or if the Commissioner of Real Estate (Commissioner) provides an alternative requirement which he or she deems acceptable to protect the interest of the purchaser: The purchaser deposits the purchase price, or an amount that the Commissioner determines is sufficient to protect a purchaser, into an escrow account. The title to the subdivision is held in a trust that the Commissioner determines is acceptable until a release can be obtained. A bond is issued to the State of California and furnished to the Commissioner that provides for the return of the moneys paid or advanced by any purchaser. The purchaser signs a notice making them aware of the blanket encumbrance and its effect. Cooperative housing developments also fall under the Davis-Stirling Act, which governs all common interest developments (CIDs). The Act requires that a board of directors govern a CID and, when elections are held for the board of AB 1024 (TORRES) Page 3 directors, specifies various election procedures, including use of secret ballots and the appointment of an inspector of elections. This bill : Exempts a stock cooperative or community apartment project from the requirement to obtain a public report from the BRE if all of the following conditions are met: Shares in the stock cooperative or community apartment project are sold to no more than 35 people. All shareholders have a preexisting business or personal relationship, or by the nature of their business or finance experience or by the business or finance experience of their professional advisors who are not affiliated with the issuer of the shares, have a reasonably assumed capacity to protect their own interests in connection with a transaction. Each purchaser is purchasing the share for themselves and not to sell. The offer or sale of shares is not done through an advertisement. The entity issuing the shares files a notice with the Commissioner of Corporations noticing the sale of shares in the stock cooperative or community apartment project. Expands the category of institutions that may provide financing to a limited equity housing cooperative for purposes of qualifying for the exemption from the Subdivided Lands Law to include a state or federally chartered credit union or a certified community development financial institution. Provides that public taxes and assessments levied by public authority are not subject to the prohibition on blanket encumbrances. Allows a stock cooperative or limited equity housing cooperative to be sold or leased subject to a blanket encumbrance if all prospective purchasers are notified that the property is subject to a blanket encumbrance and one of the following conditions is met: The property has or will receive a public report from BRE. The governing documents of the cooperative require the AB 1024 (TORRES) Page 4 board of directors, within one year of 50% of the shares being sold, to create and maintain during the term of the encumbrance a financing reserve equal to at least three months of the amount of debt service payments due on the blanket encumbrance. Every purchaser in the stock cooperative is an accredited investor with a net worth of $1,000,000, not including their home, or at least $200,000 in annual income or $300,000 as a couple or are close family members. Exempts stock cooperatives in which all members and shareholders automatically become members of the board of directors from the election provisions of the Davis-Stirling Act that are applicable to the election of directors, except for the provision allowing a member to bring a cause of action to challenge the election of the board of directors. COMMENTS: 1.Purpose of the bill . According to the author, housing cooperatives lower the barrier to property ownership and therefore create an important vehicle for the creation and preservation of affordable housing. This bill will remove some of the more significant barriers to developing cooperative housing. First, the bill allows for a cooperative to sell shares when the development is subject to a blanket encumbrance. It is almost impossible to develop cooperative housing without a mortgage on the property, which is a form of blanket encumbrance. Under current law, however, a cooperative cannot sell shares if there is a blanket encumbrance. As a result, the current prohibition on blanket encumbrances has the effect of banning housing cooperatives in California. This bill creates safeguards to protect members of cooperatives, while allowing a cooperative to obtain a mortgage. Second, to obtain a BRE public report, a cooperative must prepare numerous documents and forms, often with the help of attorneys, accountants, and engineers. This process can cost a new cooperative $10,000-$20,000 in professional and filing fees and take up to one year. For cooperatives in which the prospective residents have a preexisting business or personal relationship, this bill will remove this onerous and time consuming requirement through an exemption to the Subdivided Lands Law. AB 1024 (TORRES) Page 5 2.Undoing an important consumer protection . A BRE public report is designed to protect consumers in two ways: 1) by ensuring that a developer completes promised infrastructure and establishes financing and governing structures that will ensure the long-term success of the development; and 2) by informing purchasers of financial and structural matters related to the purchase of a unit. This bill would undo these important protections for cooperatives of less than 35 units in which the prospective residents have a preexisting business or personal relationship. The bill seems to assume that residents of an existing apartment building that want to convert the building to a cooperative, because they know each other, have some greater level of real estate experience than other homebuyers and therefore do not need the oversight of the BRE in setting up their cooperative. In reality, most renters have little experience in buying real estate and none in setting up more complicated structures like a cooperative. Moreover, precisely because of the existing relationships in which peer pressure may be exerted, such a conversion among existing tenants may not be an arms-length transaction among independent parties. Such conversions, like all subdivisions of property, benefit from the oversight of the BRE and the notice provided by a public report. The committee may wish to consider removing the Subdivided Lands Law exemption from the bill to ensure adequate consumer protection. 3.Finding the balance on blanket encumbrances . Currently, developers or residents cannot build or convert a cooperative without a mortgage, but with a mortgage they cannot sell shares. The bill solves this classic dilemma by allowing cooperatives to sell shares in a development subject to a blanket encumbrance under certain conditions. Specifically, the development must satisfy one of three conditions: 1) be exempt from a BRE public report; 2) maintain a specified reserve account; or 3) sell shares only to "accredited investors." These conditions may not be the right ones, however. As discussed above, cooperatives should remain subject to the BRE public report process. Second, assuming there is even a market for cooperative shares among accredited investors, it is not clear that persons with $200,000 in annual income are in a position to lose their home and investment in the event of a foreclosure on the blanket encumbrance. Requiring a reserve account, on the other hand, is a prudent measure to ensure that the development can meet its blanket encumbrance obligation and protect shareholders AB 1024 (TORRES) Page 6 from foreclosure. But to the extent that BRE already accounts for the blanket encumbrance when it reviews the development's financing under the public report process (in which case it may establish its own reserve requirements), it may not be necessary to require a reserve for such projects in statute. The committee may wish to consider allowing blanket encumbrances for cooperatives under the following conditions: 1) when the encumbrance is accounted for in a public report, or 2) when the cooperative maintains a specified reserve fund. 4.Technical amendments : On page 6, line 19 strike "11013.3" and insert "11013.6". Strike Section 4 from the bill. On page 7, line 31 strike "11003.2" and insert "4190 of the Civil Code". Replace Section 6 with an amendment adding subdivision (f) to Section 5100 of the Civil Code to read: "Directors are not required to be elected pursuant to this article if the governing documents provide that all members are directors." 1.Double referral . The Senate Rules Committee has referred this bill to both this committee and the Judiciary Committee. Assembly Votes: Floor: 73-0 Appr: 17-0 Judic: 10-0 H&CD: 7-0 POSITIONS: (Communicated to the committee before noon on Wednesday, June 12, 2013.) SUPPORT: California Center for Cooperative Development (sponsor) Bay Area Community Land Trust East Bay Cooperative Housing California Sustainable Economies Law Center San Francisco Community Land Trust Walnut House Cooperative AB 1024 (TORRES) Page 7 OPPOSED: None received.