By Alan Hirsch
After years of complaining by neighbors about conversion of single family homes into Mini-dorms, the first baby steps will finally be before City Council Tuesday Night.
This is the first push back on something that is destroying Davis as a family town.
A push back on the city laisse fare attitude to date has facilitated investors…as the cost of middle class families who want to move into town.
The “Rental Industry” is the largest industry in town by far. This fact largely flies under the radar. Most of the rental units in town are in larger complexes, which are typically well run and managed; they do environmental upgrades and give back to the community. Case and point: Tandem Properties. But not to ascribe evil to them, these investors represent the 0.1%.
However, over the years a mini-dorm industry has grown up on the margins. Encouraged by tax laws, and protected by the political clout and good reputation of the larger complexes in town, it has converted thousands of single family homes to mini-dorms. Shockingly, one third of Davis single family homes are now owned by investors. Investors own not one or two, but snap up multiple homes in competition with family wanting to live here. Some investors now own over 20 single family homes….So these investors also are clearly in top 1%…and even the top 0.1%. (the 45+ single families in Davis owned by Andrew Dowling and family probably represent between $5 and $15 million in equity.
Davis Sustainability at Risk
Until now, the long term sustainability middle class in Davis being squeezed out by mini-dorm industry has flown under the radar. Only in the last few years have the alarm bells finally begun to ring due to social friction and exploitation of students by landlords due to housing crunch..
But while an impact to family-neighborhood sustainability is obvious, the economic and environmental impacts are less discussed.
Single-family homes are not designed for rentals, so they require…per unit …much more “reinvestment” and maintenance than an apartment complex with its economies of scale. This means to compete the apartment complex rental prices mini-dorm landlords must under-invest in upkeep, repairs and energy improvements—or stuff in extra, often illegal, bedrooms and car parking. This is unlike a homeowner who gets benefits from such spending via improved aesthetics or savings in their PGE bill.
The fact is mini-dorm investments usually only pay off if they exploit tax laws that allow them to shelter income taxes via tax credits, depreciation and mortgage deductions in ways not available to home owners. And they can take tax-free profit from appreciated home value by refinancing or 1031 exchanges instead of being taxed on the realized capital gains. They can even permanently avoid income taxes by step-up in basis value that is part of the inheritance tax system.
They also hurt local government sustainability by locking in lower property tax rate under Prop 13—which they can uniquely benefit from as they often hold the properties for decades…unlike owner-occupied homes that turn over more frequently when a family moves and the property tax value is stepped up. The DJUSD School Board’s new Parcel tax assessment also gave apartments another tax break relative to homeowners — a hit of hundreds of thousands of dollars to our school’s budget.
No wonder the city and schools have a financial problem: Our City’s largest industry has a tax subsidy relative to owner-occupied home owners. (And no wonder the middle class is in decline: paging Bernie Sanders.)
Is The Proposed Mini-Dorm Ordinance A Good Start?
The invisibility of this issue to date is unique to Davis: we are the ONLY significant college town without even the most basic renters-rights or Mini-dorm ordinance.
Tuesday’s Council Meeting is the first step to change this. But it remains to be seen if Council has enough courage to fully take on this industry…and if City staff is on board.
Though as I write this the Tuesday City Council Agenda, final rental regulation and staff report is not public, there is some concern as City staff has not been forthcoming about details after months of discussion and meetings that lead up to this point.
For example, I have been asking for a week now for the list of the insider group — mostly landlords I gather– who city recruited to guide the writing of the regulation. No response so far. I have also asked for the minutes of those city meetings with insider group, and was told they these minutes were “still in draft” so they did not have to be released. Convenient.
I have also heard from Brett Lee that draft regulation has been endorsed by the regional land lord/investor association, the Sacramento Rental Housing Association. That signals what we will see is a rental-industry acceptable compromise, not an aggressive stance to protect neighborhoods and renters in the unique Davis zero-vacancy market.
One test of the ordinance is to see what city staff finally decides to focus on, or omits, in its staff report. For example:
- Does report show note all the problems we are having re mini-dorms and renter exploitation so we can compare the ordinance against what it needs to do….and identify any gaps or unresolved issues for renters and neighbors?
- Does staff report highlight what was left out of the ordinance—i.e. regulations that other cities have but was not included for Davis?
- Were any of the other sustainability issues noted above discussed? For example, setting minimal energy efficiency and maintenance standards for rental housing?
- Has City staff has done any outreach to neighborhoods and renters in the ordinance drafting process, or only worked with insiders. Who exactly represented Neighborhood interests in the “insider” groups?
- Who funds enforcement mechanism? Are landlords paying enough fees to cover its upfront cost, or is the city general fund (i.e. residents) being asked to subsidize this industry—or is general fund “fronting” the cost on hope fines was will reimburse the costs.
- Is city planning to hire new staff up to begin to enforce the regulation, or is enforcement just being added to existing staff duties: Regulations are nice, but if no one’s primary job is to enforce them, they are just political eye candy.
- Is there a “next step” discussed to address other impacts of Mini-dorms industry?
The one thing is clear though: unless home owners and renters write council – or show up to testify – the City will only hear from investors and landlord and the status quo will continue.
Is Davis For Investors…or Residents?
I strongly supported Nishi due to its construction of needed student housing. I also believe providing rental housing for UC students and faculty is a core purpose—a moral purpose— for the existence of the City Davis. But there is no requirement that mini-dorm style housing be economically viable investment, particularly considering its negative environmental and social impacts and their tax-drag on our community’s finances.
Maybe if the landlords were forced to pay their true costs mini-dorms would no longer be so financially attractive.
And then maybe investors might sell them back to families.
I think this is what most Davis homeowners would think of as the ideal outcome.
And if Council and UC approved some new apartment complexes, I think students would be on board with that too.
According to the staff report (now available on the city’s website), the inspection fee is a flat $20 per year for a single-family rental unit. It seems to me that provision should be made for cost recovery in the event that repeat inspections are required in a given year. The problem landlords shouldn’t be subsidized by the taxpayers.
Has anyone attempted to quantify how many “mini-dorms” currently exist within the City, or even come up with a good definition for what constitutes a “mini-dorm?”
The ordinance on the agenda for Tuesday doesn’t mention mini-dorm, it is an “Ordinance adopting the Housing Rental Regulations and Residential
Rental Registration and Inspection Program.”
Right. I’ve read the ordinance and it doesn’t seem unreasonable. But the author wants an ordinance that deals with mini-dorms. So, I’d like to know what a mini-dorm is, and how many of them there are.
Seek (on the internet) and yee shall find, knock and the door shall be opened unto you:
Berkeley Municipal Code
13.42.020. Definitions
A. “Mini-dorm” means any building in an R-1, R-1A, R-2 R-2A or R-3 Zoning District that contains a dwelling unit that is occupied by six or more unrelated persons over the age of eighteen years. Permitted and Legal non-conforming Sororities, Fraternities, and Student Co-ops shall not be considered Mini-Dorms, as long as they have a resident manager.
I’ve seen some of these beautiful old houses converted and it is sad to see some stately old houses treated such.
Great article Alan, and I agree that an ordinance to be able to deal with the mini-dorm situation has been long overdue. I also hope that it is effective enough and enforceable.
Also, I agree with Jim. I am not understanding how only $20 can cover the staffing and enforcement of this ordinance. With the windfall profits that landlords are making on leasing out homes, $20 annually is certainly affordable. The City should not need to subsidize this program. I am not certain what other cities charge, but hopefully the City is not undercharging with this very modest fee, to make this ordinance enforceable.
Apologies if I may be a little off topic, but why aren’t AirBnb rentals included in this discussion. A single family three bed, one bath house that is now AirBnB on my street advertises capacity for three persons per room. That is nine people with one bathroom and kitchen. The fact that they are coming and going on a daily or weekly basis doesn’t change the intensity of use, traffic or other factors associated with a mini-dorm. In fact impacts are greater, but the quality of the housing and density issues are the same.
David.
AIRBNB It may have been reviewed once in past…unclear on this)
BUT won’t be (again) unless their is a strong community showing on this “baby step” ordinance for minidorm before council on Tuesday, reviewing the externalities AirBNB won’t ever be considered.
With AirBNB and Mini-dorms we have Mini-Sterling apartment complexes appearing on every block in Davis….with traffic and other impacts.
Does the community, working thru our city Government, manage the Commons –or continue current laisse fare attitude rule?
Private property right vs community rights are in conflict….home many people will show up at council speaking for Neighborhood preservation. /community values and how many will come to speak in favor of their right to profit from private property? Stay tuned…..
Dave G received a personal email noting some mistake in my piece above which he forwarded to me.
Thank you!
This is his/her critique…and my responses…..I seem to have made some mistakes in my knowledge of tax law and try to acknowledge the errors, as noted below.
But I real estate, including mini-dorm investments, are tax advantaged, i.e. subsidized, in many ways compare to owner-occupied housing. These tricks are how Trump avoided paying taxes….
Alan H
This person wrote: (san serif font)
1. There are no tax credits that are available to rental property owners that are not also available to home owners so that would not shelter any additional income taxes. (ie. Solar)
Response. I believe investment tax credit is for business machines. for a Fridge and other personal property in minidorm are business machine for a mini-dorm. And maybe the mini-dorm mogel decides they needs a car he tell the IRA is only used for business…Investment tax credit here….and depreciate the car….
2. Depreciation that is deducted is then recaptured and taxed at the owner’s regular income tax rates, not lower capital gains rates, when the home is sold. So there is no “shelter”.
RESPONSE: As CPA’s say: Taxes differed are taxes avoided.
It is only recapture when the property is sold…if ever.
Getting the cash now and paying later is a great deal given inflation …and you can use the cash-that-someday-must-be-paid-in-taxes” to generate even more income now. How many of use would like to pay down our credit card today by having withholding taken out next year…and maybe next year you re unemployed so your tax rate is lower….?
With privately held business lot of way to get cash out. Many mini-dorm owner hire same contractor to fix their personal homes up and then charge bill against mini-dorm…and then depreciate this false or overpriced improvement. Unauditable.
Or maybe the minidorm owner decides they need cash for an new car “for the business. ”
Having mini-dorm in an Estate means basis is stepped up on death of owner tax free. (Note: you will pay any estate tax if you assets are over $5 Million). Taxes Avoided for most folks.
3. You are able to deduct the interest on both your rental property and as a homeowner so that would not shelter any additional income taxes as the author states.
RESPONSE: 2nd mortgage, loans for home improvements, and line for credit secured by liens on property are not deductible for owner occupied homes, but are for business/mini-dorms. Mini-dorm owner can use this cash for other real estate or related investments that yield income to him instead of paying taxes on it. Leveraging option not available for home owners.
4. You can’t take tax-free profits from appreciated home value by refinancing. If you refinance your rental property you would not be able to deduct the additional interest paid unless you specifically used those funds to improve the property. The only advantage to having rental property in this situation is you now have an asset to borrow against, but it would not be tax free.
RESPONSE: You may be right….I may be wrong! Can’t cash from loan on one property at least be used to invest in another? Esp if in a corporation?
5. A 1031 exchange allows someone to trade like kind property without paying for the appreciation on the property being sold. So if you had a $1,000,000 rental house in Davis you could purchase two $500,000 rental houses in Woodland. If you did receive any “profits”, they would not be tax free, they would be taxed. So it is impossible to take tax free profits by doing a 1031 exchange.
RESPONSE Yes, but most folks typically step up and buy a more expensive property. Leverage to get more income.
And is the price you are paying for this new property “fair” of did the seller also rebate some cash and or other benefit as part of the deal? Say you or a family member sold a personally held property to your mini-dorm corporation…easy to “road up” and claim “fair market value” here. Profit is now taxed at low Cap tax rate not recapture tax….
6. Using the author’s own example of Andrew Dowling and assuming that what he states is true, if Mr. Dowling has $10,000,000 in rental property as his only assets and dies he would pay almost $4,000,000 in taxes. That is far from “permanently avoid(ing) income taxes”.
RESPONSE True. But does Mr Dowling have a good tax accountant that did adequate estate tax planning —and maybe even rolled his Mini-dorm into a IRA or Roth or similar to avoid taxes (like Mitt Romney as his $100 Million IRA) ….and done some inter-generational shifting of assets. Taxes differed are taxes avoided rule still holds.
7. The author also failed to mention that when a married couple sell their primary residence they get to exclude up to $500,000 of the gain on the sale if they have lived in the property for two of the last five years. A rental property owner gets no exclusion. That exclusion makes it more tax advantageous to own a home as a primary residence rather than as a piece of rental property not the other way around as the author claims.
RESPONSE Yeah this is true….but tax free “profit” is a paper gain if people want to continue to live in Davis. They have reinvest the “tax free” profit to buy a replacement house in same inflated Davis home market….only have “Tax Free Profit” less leave Davis for, say cheaper homes Woodland, or Costa-Rica?
Your personal home is not an investment until the sad day you no longer want to own your home in your community of choice…and want to flee or downsize/pay for a nursing home.
That the tax-system seems to encourage..even demand older people to flee their communities where they have history so have some money for retirement…..by allowing tax-free cash vs rolling over the investment is worth examining.
Thanks for the corrections!
You still have so many errors/untruths… even your responses have errors/untruths… significant ones… but given the mode you appear to be in, will not waste time/effort to refute/correct… but folks, there is much untruth in the original narrative, and in the responses to ‘corrections’…
Find other sources to the truth on taxes, etc., if those are important to you…
Now here’s a thought… mini-dorms can be viewed as in-fill… perhaps there should be a $1-3 /night/ bedroom (or maybe even person) fee assessed, paid to the city, to benefit the neighborhoods where the mini-dorms are located.