September 11, 2012

Taxation and Government Finance Committee
Land Use and Environmental Committee

The following is for study only and has NOT been approved by the Taxation and Government Finance Committee, Legislative or Executive Committees or the Board of Directors.

Issue:
In the wake of the Federal Housing Finance Agency (FHFA) restricting Fannie Mae and Freddie Mac from investing in mortgages encumbered by certain private transfer fees (PTFs), should PTFs be banned completely?

Action:
Optional

Options:
1. Sponsor legislation to completely ban PTFs
2. Support legislation to completely ban PTFs
3. Other
4. Do Nothing

Status/Summary
In recent years, some developers have required the payment of a PTF as a condition of purchasing a residential property.  The governing covenant requires payment of such a fee - which is usually a percentage of the purchase price - each time the property is resold.  The fees are generally paid to an environmental organization for open space preservation or environmental mitigation; however, the fee can simply be paid to a private party for whatever purpose they see fit.  At the fall, 2008, business meetings, the Board of Directors adopted the final report of a PTF task force which recommended that C.A.R., "take a "wait and see" attitude with regard to sponsoring legislation to prevent or regulate the imposition of [PTFs].  Specifically, the sponsorship of any such legislation should occur if the makeup of the legislature changes significantly enough that it is politically feasible that legislation will win approval."  In March of this year, the FHFA promulgated a rule - for Fannie and Freddie backed mortgages - requiring that there be a "direct benefit" to the real property encumbered by the PTF covenant.  Even though the type of projects that can be funded by FHFA PTFs has been significantly limited, environmentalists and builders are still likely to oppose a ban on PTFs.  The limited PTFs may still help builders curry some favor with the local government with regard to proposed developments.  That said, is this the time to attempt a complete ban on PTFs?

Discussion
In recent years, some developers have required the payment of a PTF as a condition of purchasing a residential property.  The governing covenant requires payment of such a fee - which is usually a percentage of the purchase price - each time the property is resold.  The fees are generally paid to an environmental organization for open space preservation or environmental mitigation; however, the fee can simply be paid to a private party for whatever purpose they see fit.

C.A.R.’s History with PTFs

C.A.R. was concerned about PTFs when they first started to appear in California half a dozen years ago.  These concerns included that PTFs put homeownership farther out of reach for more families and that there was no requirement that the fees be used to benefit the homeowner.  As a result, at the spring, 2006, business meetings, the Taxation Committee recommended that a task force be appointed to address the PTF issue.  At the following fall, 2006, meeting, the Board of Directors adopted the task force's final report which included the recommendation that C.A.R. sponsor legislation to prohibit the imposition of PTFs.

In February, 2007, C.A.R. sponsored the introduction of Senate Bill 670 (Correa) which would have banned the imposition of PTFs.  The legislation was referred to the Senate Transportation and Housing Committee where the chair of the committee stated that he believed that the issues raised by C.A.R. regarding PTFs could be addressed by placing limits on the imposition of PTFs instead of an outright prohibition.  Since it appeared unlikely that an outright prohibition would be approved by the committee, amendments to SB 670 to place significant limits as to the amount and duration of PTFs were discussed, but there was insufficient support in the legislative committee for placing such significant limits on PTFs and the amendments were not approved by the committee.

Given the difficulty of achieving a prohibition on PTFs, C.A.R. staff was directed at the fall, 2007, business meetings to "explore the option of expanding the use of the Mello-Roos Law to allow funding for environmental mitigation and/or affordable housing, while otherwise prohibiting" PTFs.  At the winter, 2008, business meetings, staff reported that expanding the Mello-Roos Law in such a way "would have the advantage of placing the funding derived via Mello-Roos districts for these purposes within the heavily regulated statutory structure that has been developed over the years." At those meetings, the Taxation Committee recommended that the president form a task force to explore alternatives using mechanisms such as Mello-Roos to deal with the problems associated with PTFs.

At the fall, 2008, business meetings, the Board of Directors adopted the final report of this second task force which rejected placing PTFs within the Mello-Roos Law because, among other reasons, it "could open the door to attempts to add other services/facilities that can be funded by Mello-Roos that provide little, if any, benefit to the homeowner."  The final report recommended that C.A.R., "Take a "wait and see" attitude with regard to sponsoring legislation to prevent or regulate the imposition of [PTFs].  Specifically, the sponsorship of any such legislation should occur if the makeup of the legislature changes significantly enough that it is politically feasible that legislation will win approval."

FHFA Timeline

In August, 2010, the Federal Housing Finance Agency (FHFA) proposed a guidance "that would restrict Fannie Mae, Freddie Mac and the Federal Home Loan Banks from investing in mortgages with private transfer fee covenants."  The Notice of Proposed Guidance described concerns that PTFs may:

-  increase the costs of homeownership;
-  limit property transfer or render them legally uncertain;
-  detract from the stability of the secondary mortgage market, particularly if such fee will be securitized;
-  expose lenders, title companies and the secondary market participants to risks from unknown potential liens and title defects; and
-  contribute to reduced transparency for consumers because fees often are not disclosed by sellers and are difficult to discover through customary title searches, particularly by successive purchasers.

(Note: With regard to the last point, C.A.R. sponsored legislation that was signed into law in 2007 requiring the recordation of a PTF disclosure document.)

In January, 2011, the FHFA stated that it had received several thousand comments on the proposed guidance and had decided to instead address the PTF issue by regulation rather than through guidance.  The proposed rule "would except private transfer fees paid to homeowner associations, condominiums, cooperatives, and certain tax-exempt organizations that use private transfer fees to provide a direct benefit to the owners of the encumbered property."

C.A.R. objected to allowing these entities to impose a PTF but, ultimately, the FHFA decided to allow these entities to do so.  However, when the FHFA issued its rule in March of this year, it required there be a "direct benefit" to the real property encumbered by the PTF covenant.  " Direct benefit means the proceeds of a private transfer fee are used exclusively to support maintenance and improvements to encumbered properties, and acquisition, improvement, administration, and maintenance of property owned by the covered association of which the owners of the burdened property are members and used primarily for their benefit."

Moreover, the direct benefit must fund activities that:

-  Are conducted in or protect the burdened community or adjacent or contiguous property, or
-  Are conducted on other property that is used primarily by residents of the burdened community.

In other words, the benefit must be to - or provided to property proximate to - the burdened property, or to property used primarily by the residents of the burdened community.

This last restriction is a major change as previously there was no restriction whatsoever as to where the PTF funds could be spent.  It is a significant departure from the PTFs that environmentalists and builders have used to date.  In fact, in the wake of the promulgation of the FHFA rule, a state senator approached C.A.R. about authoring legislation that would completely ban PTFs.  However, it is not clear that the majority party will want to completely ban PTFs.  Even though the type of projects that can be funded by FHFA PTFs has been significantly limited, environmentalists and builders are still likely to oppose a ban on PTFs.  The limited PTFs may still help builders curry some favor with the local government with regard to proposed developments.  And, legislators may still see PTFs as a means for achieving, for example, needed environmental protection or mitigation. Also, with non-FHFA mortgages, benefits can be provided without restriction as to location; some legislators may welcome that latitude.