April 27, RE: CAO Proposal to Double the Documentary Transfer Tax (CF No )

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1 April 27, 2012 Honorable Councilmember Paul Krekorian, Chair, City Council Budget & Finance Committee Honorable Councilmember Tony Cárdenas Honorable Councilmember Mitchell Englander Honorable Councilmember Paul Koretz Honorable Councilmember Bill Rosendahl City of Los Angeles 200 Spring St. Los Angeles, CA RE: CAO Proposal to Double the Documentary Transfer Tax (CF No ) Dear Chairman Krekorian and Members of the Budget & Finance Committee: On April 16, 2012, the Budget & Finance Committee ( Committee ) held a public hearing on a series of proposals presented by the City Administrative Officer ( CAO ) on potential expenditure cuts and sources of new revenues in order to help reduce the City s budget deficit. The deficit, projected to be $222 million in FY2013, is significant and deserves collaboration from all parties to bring the City to a fiscally sound position. Remarkably, the CAO s proposal stipulates that nearly half of the funding needed to close this multi-million dollar budget gap comes from a highly volatile and unreliable source real estate sales while unfairly burdening a small fraction of the City s population. Such a proposal is unsustainable and we respectfully urge the City Council not to proceed on this bad policy. With this in mind, we testified at the April 16 Committee hearing on behalf of approximately 20,000 Realtors living or working in the City of Los Angeles that the proposed doubling of the Documentary Transfer Tax an unhealthy choice for the City Council and the City s residents. A doubled transfer tax, combined with the existing Los Angeles County Transfer Tax, would add a full one percent to the price of buying a home. In other words, a Los Angeles home costing $500,000 would face a $5,000 transfer tax bill before the new owners even move in.

2 REALTORS Response to CAO Proposal to Double the Documentary Transfer Tax (CF No ) April 27, 2012 As we describe below, such a charge disqualifies thousands of families and buyers from moving to the City of Los Angeles. Doubling this highly volatile tax sets the stage for unworkable public policy that will not bring the projected new revenues to the City even as it leaves an unmitigatable economic impact on the City s residents and the region s fragile housing market. Pushing Families and Buyers Away from the City of Los Angeles Home prices have historically shown to be volatile and sensitive to many factors that can influence the fair market value of a property. For this reason we argue herein that taxes associated with real estate sales cannot be a reliable source of new revenue, especially for something as critical as closing a multi-million dollar budget deficit. Every quarter, the California Association of REALTORS releases its Housing Affordability Index ( HAI ), which measures the percentage of households that can afford to purchase the median priced home in the state and regions of California based on traditional assumptions. 1 For example, the HAI finds that in the fourth quarter of 2011, 48% of City of Los Angeles households were able to afford the median priced home. In the third quarter of 2011, only 42% could afford the median priced home. 2 A more illustrative way to view price sensitivity based on the HAI is as follows: If the statewide median home price increases by $1,000, then 20,000 households will no longer be able to afford to buy the median priced home. One step further, we review price sensitivity in the City of Los Angeles, based on the current median home price of $300, If the median home price for the City of Los Angeles increases by $1,000, about 1,900 households will no longer be able to afford to buy the median priced home. 1 Please refer to Appendix A attached hereto, the Assumptions and Methodology utilized by the California Association of REALTORS (C.A.R.) to calculate C.A.R. s Housing Affordability Index. C.A.R. is one of the largest state trade organizations in the United States with 160,000 members dedicated to the advancement of professionalism in real estate. C.A.R. is headquartered in Los Angeles. For more information, go to 2 Please refer to Appendix B attached hereto, Housing Affordability Index Traditional, posted on the website of the California Association of REALTORS ( accessed on April 25, Source: Dataquick. Page 2 of 5

3 REALTORS Response to CAO Proposal to Double the Documentary Transfer Tax (CF No ) April 27, 2012 A change in the Los Angeles median price of just three-tenths of one percent disqualifies a substantial number of families from coming to the City. Meanwhile, a doubled Documentary Transfer Tax, together with the Los Angeles County transfer tax, represents a housing cost increase more than three times greater than the increase analyzed by the HAI. Where will those disqualified families go? Families and buyers not qualified in the City of Los Angeles may instead buy in a neighboring city in Los Angeles County depending on such personal factors as proximity to jobs and other land uses to the extent possible. When families are unable to locate close to desired jobs and other uses, they may be forced to commute longer distances and thereby contribute to economic losses from time spent on the road while further burdening the City s and the region s transportation infrastructure. Ultimately, as buyers vote with their feet they bring property tax dollars, community involvement and in some cases their sales tax dollars away from the City of Los Angeles. The Four-Year Budget Outlook and Update to the Three-Year Plan to Fiscal Sustainability published on April 6, 2012 by the CAO ( CAO Report ; CF No ), compares a theoretically doubled Documentary Transfer Tax to even higher tax rates in other cities (Table 2; page 14), as well as to those of other large U.S. cities. The highest tax cities appear to be in the San Francisco Bay Area. It is inadvisable to double this tax based on policies in Bay Area cities or other U.S. cities while overlooking the fact the City of Los Angeles would potentially have the highest such tax in its own region. This competitive disadvantage for the City becomes apparent as buyers choose simply to buy somewhere else, maybe next door in a neighboring city. Doubled Tax Doubled Revenues The effect of high taxes relative to those of nearby cities illustrates how the revenue projections in the CAO Report are not reliable for the City Council or the voters to proceed on doubling the Documentary Transfer Tax. In other words, the impact of buyers purchasing elsewhere implies that revenue expected by the City will not fully materialize because a certain number of real estate sales will not occur. We understand that in FY , Documentary Transfer Tax revenues were about $99.5 million. The logic of the CAO Report s projections suggests that doubling the tax brings in double the revenue, or an additional $100 million: Preliminary estimates show that doubling the current documentary transfer tax rate would generate an additional $100 million in ongoing revenues (page 14). Page 3 of 5

4 REALTORS Response to CAO Proposal to Double the Documentary Transfer Tax (CF No ) April 27, 2012 This assumption is incorrect and is not supported by the facts. As the tax goes higher, taxpayers will choose to go elsewhere where the tax and therefore home prices are lower. The CAO Report furthermore projects $100 million in on-going revenues. Can the City reasonably expect $100 million each year in new revenues? It cannot. We understand that the below schedule shows the Documentary Transfer Tax revenues over the last several years: 4 FY = $217,000,000 FY06-07 = $188,056,000 FY07-08 = $132,921,000 FY08-09 = $80,966,000 FY09-10 = $89,645,000 FY10-11 = $99,548,000 The data suggest that the span of just six years saw a wild swing of revenues; the tax revenues in FY were almost 120% higher than in FY The City is already aware of the risks inherent in depending on the Documentary Transfer Tax for critical policy measures. The CAO Report notes that the Documentary Transfer Tax is subject to large fluctuations (page 15). Meanwhile, the Supplemental to the Proposed Budget: Revenue Outlook released on April 20, 2012 by the Office of Mayor Antonio R. Villaraigosa appears to recognize this risk as well: These revenues [Documentary Transfer and Residential Development Taxes] are volatile and have realized negative growth in recent years. Steady growth is assumed for both with the projected improvement in the real estate market (page 11). Nonetheless, while we would also hope for improvement in the real estate market, it is premature and overly risky to base such an important choice on the real estate market. The critical public policy associated with doubling the Documentary Transfer Tax is clear: reducing the budget deficit and thereby upholding core City services and preserving jobs. And yet, the CAO Report s proposal implies that almost half of the funding to close the $222 million budget gap comes from one of the most volatile and unpredictable sources of revenue available. A Matter of Fairness The pressure to come up with millions in funding to close the City s budget gap falls unfairly on a very small group of City residents. Real estate sales data indicate that approximately 2-4% of properties are sold each year in a local jurisdiction. It is patently unfair to burden so few individuals with the responsibility of closing the budget gap to the benefit of the entire City. The 4 Source: Council District 11. Page 4 of 5

5 REALTORs Response to CAO Proposal to Double the Documentary Transfer Tax (CF No ) April 27, 2012 cost of living in a region - including the costs represented by critical City services and public safety- should be borne equally by all those who benefit from those services and not just a tiny portion of individuals. Nonetheless, the CAO Report appears to endorse this very concept: "Increasing the rates of the documentary transfer tax... would burden a smaller subset of individuals and be based solely on voluntary transactions." 5 Doubling the Documentary Transfer Tax is an unworkable solution. It is unsound public policy for the City and it pushes families and homebuyers out of the community. An increased tax cannot bring reliable funding to the City in order to uphold services and preserve jobs, and as such we respectfully urge the Committee and the City Council not to proceed on this proposal, especially at such a fragile moment of tentative recovery in the housing market. Sincerely, President Beverly Hills/ Greater Los Angeles Association of REALTORS Shannon Cistulli, President Glendale Association of REALTORS Ruth S. McNevin, President Pasadena-Foothills Association of REALTORs Becky Park, President South Bay Association of REALTORS Attachments s CAO Report, page 14. Page 5 of 5

6 2001 California Existing Single-Family Housing Market Annual Historical Data Summary 27 CALIFORNIA ASSOCIATION OF REALTORS Updated March 2002 APPENDIX A THE ASSUMPTIONS AND METHODOLOGY USED TO CALCULATE C.A.R.'S HOUSING AFFORDABILITY INDEX Step 1. Step 2. Step 3. C.A.R.'s housing affordability index is based on the median price of existing single-family homes sold from C.A.R.'s monthly existing home sales survey. Starting in 1987, this survey is based on reports of closed escrow sales from 80 Boards or more of REALTORS and multiple listing services around the state. Prior to 1987, the survey was based on reports from 45 Boards. It is assumed that a household can make a 20 percent downpayment on the median-priced home. Therefore, the loan amount needed to purchase a home would be 80 percent of the median home sales price. Using the national average effective mortgage interest rate on al l fixed and adj ustable rate mortgages closed for the purchase of pr eviously occupied homes as r eported monthly by the Federal Housing Finance Board, the monthly payment on a 30-year loan is calculated. Step 4. Monthly property taxes are assumed to be 1 percent of the median home sales price divided by 12. This amount is added to the monthly payment figure calculated in the previous step and is part of the PITI payment. Step 5. Step 6. Step 7. Step 8. Insurance payments on the house are assumed to be 0.38 percent of the median home sales price divided by 12 in order to come up with the monthly amount which is added to the figure for principal, interest, and taxes as above. It is then assumed that this monthly payment for principal, interest, taxes and insurance can be no more than 30 percent of a household's income. Thus, the monthly housing payment is divided by.3 to come up with the minimum monthly income needed to qualify for a loan on the median-priced home. Starting in 1988, data for the distribution of households by various income ranges was obtained from Claritas/NPDC. Monthly figures were developed based on t he projected percent change in the annual median household income compounded on a mont hly basis. Prior to 1988, household income utilized in the housing afordability index was based on projections by C.A.R. using the 1980 census data as a base. The minimum income amount calculated in Step 6 is multiplied by (12) to determine the minimum annual income needed to qualify. This amount is compared to the distribution of households by various income ranges to determine what percent of the households have at least that much income or more; this percent becomes the Housing Affordability Index.

7 1 of 3 4/25/ :22 PM Housing Affordability Index - Traditional APPENDIX B Home Page > Market Data > Data & Statistics > Housing Affordability Index - Traditional Housing Affordability Index - Traditional find the article at: " C.A.R.'s Traditional Housing Affordability Index (HAI) measures the percentage of households that can afford to purchase the median priced home in the state and regions of California based on traditional assumptions. C.A.R. also reports its traditional and first-time buyer indexes for regions and select counties within the state. The HAI is the most fundamental measure of housing well-being for buyers in the state. Download the complete CA Historical Quarterly Series: CA 2006 to present Download the Historical Monthly Series: 1988 to Traditional Housing Affordability Index Methodology Q4 C.A.R. Tradi onal Housing Affordability Index STATE/REGION/COUNTY Q Q Q CA SFH CA Condo/Townhomes Los Angeles Metropolitan Area Inland Empire S.F. Bay Area US r 67

8 2 of 3 4/25/ :22 PM Housing Affordability Index - Traditional APPENDIX B S.F. Bay Area Alameda Contra-Costa (Central County) Marin Napa San Francisco San Mateo Santa Clara Solano Sonoma Southern California Los Angeles Orange County Riverside County San Bernardino San Diego Ventura Central Coast Monterey

9 3 of 3 4/25/ :22 PM Housing Affordability Index - Traditional APPENDIX B San Luis Obispo Santa Barbara Santa Cruz Central Valley Fresno Kings County Madera Merced Placer County Sacramento Tulare Source: CALIFORNIA ASSOCIATION OF REALTORS Terms and Conditions Privacy Policy Permission to Reprint Site Map Copyright 2012 CALIFORNIA ASSOCIATION OF REALTORS