You may have noticed the cascade of articles about foreclosure-related evictions that have streamed through mainstream media and the blogosphere. The common theme is that tenants are drowning and need a legislative life vest. But you may not know that the Los Angeles City Council, in an ill-advised and shortsighted move, voted to give them more than that vest; it handed them an ocean liner, sinking everyone around them.
I am talking about the ordinance 180441 or Article 14.1 of
Chapter IV of the Los Angeles Municipal Code, known as the "Eviction of Tenants
from Foreclosed Residential Rental Properties." It essentially bars evictions
from foreclosed properties and places foreclosed single-family residences under
the rent stabilization ordinance (RSO). Listed as an emergency measure, the
ordinance barreled scrutiny-free through city hall in 12 days, leaving the
public and neighborhood councils little time to respond.
This ordinance states a tenant cannot be evicted from a foreclosed
house, condominium or post-1978 apartment building-all which would normally be
exempt from the RSO--unless one of two conditions are met: 1) the tenant fails
to pay the rent or breaches the lease in a significant way (residing in the
country illegally or getting roommates in violation of the contract do not
qualify as eviction-worthy offenses), or 2) the landlord plans to occupy the
property or demolish the premises, which triggers payment of pricey relocation
fees. In other words, a renter must be allowed to live in a foreclosed home
until the new buyer takes possession, gives proper notice for him to move, and pays
The ordinance was established to safeguard tenants from getting a mere 60-day notice, as state law provided, when they had fully complied with their lease. Although some tenant protections are sensible, this ordinance goes radically overboard, proving disastrous for buyers, financially strapped homeowners, property maintenance crews, real estate agents, banks, neighbors and the community as a whole.
The ordinance encourages fraud. According to local Realtors,
it is common these days for a property owner, who is losing his home in foreclosure,
to sign a bogus lease agreement with a friend or relative (pretending to be a "tenant")
at a below-market value. The owner can then continue to live in the property
for pennies on the dollar, and can, upon eviction, collect $7300 - $18,300 in
relocation fees. Real estate agents say they frequently find utility bills listed
in the name of the property owner rather than the "tenant," indicating a scam
rather than a valid lease. Sometimes two property owners facing foreclosure
will switch houses and sign bogus lease agreements for each other. A new cottage
industry has emerged: owners facing foreclosure are contacted and told that for
a fee they can stay in their homes. The above scheme is explained.
When foreclosing on houses, banks do not have rental schedules in their files like they do with large apartment buildings; this makes it easy to pretend a low lease amount is fair market value. High-end properties-which may have a view, a large lot or elaborate upgrades--are ideal for this purpose. A "tenant" can convincingly argue that $2000 per month is all that can be collected for a house that would really bring in $5000 due to amenities.
The new ordinance also hurts buyers, especially those who have
slender bank accounts and lack experience in the real estate market. Let's
assume a first-time buyer wants to purchase a tenant-occupied foreclosure.
First, he must get a loan on the property. The bank may charge him a higher interest
rate and the insurance company may charge him an excessive premium due to the fact
that the property cannot be owner-occupied at the close of escrow.
Even though the buyer plans to reside in the home, he cannot
ask the tenant to leave until 60-days after the close of escrow, at which time the
buyer will be responsible for thousands of dollars in relocation fees. If the renter
refuses to vacate, the buyer will have to hire an attorney and go through costly
and time-consuming eviction process. In the meantime, the tenant could stop paying
rent, destroy the house and steal appliances. Unless the insurance company
chips in, repairs and replacements will come out of the buyer's pocket as will the
unsubsidized mortgage payments.
Why would anyone purchase a tenant-occupied foreclosure? Apart from a naïve buyer who is unaware of the ramifications, these properties sell to savvy investors who require deep price discounts in order to accept the tenant-related risks. Realtors tell me that they must regularly mark down these properties by 20-40% in order to get them sold, thereby devastating neighborhood values. Nearby homeowners may not be able to refinance or sell their homes for their true worth. When property values tumble, tax revenues decrease, and the overall economy suffers.
The ordinance means an increase in foreclosures as tenants learn it is in their interest to undermine short sales. A short sale occurs when a homeowner, who wants to avoid foreclosure and has a property worth less than the mortgage, asks the bank to take a reduction on the note so he can sell. The bank agrees.
However, when a tenant learns about the ordinance, he is usually unwilling to cooperate with a short sale. He knows that if he refuses to leave, he can force the property into foreclosure, and can probably avoid paying rent for a number of months, stay in the home until 60 days after it is sold, and receive thousands in relocation fees. It is a windfall for the tenant, but quite painful for the property owner, who was hoping to maintain a semblance of creditworthiness and sell for the highest price so as not to be damaged by exorbitant taxes. Neighbors prefer short sales because they sell for more than foreclosures and usually mean a smoother transfer of ownership. Short sales are also better for a bank's bottom line, thus making wiser use of taxpayer "bailout" funds.