The law of unintended consequences is more than a popular turn of phrase. It's a fundament of economics describing a situation in which government policies reverberate into unplanned, inadvertent mayhem.
More policies may emerge to cure the havoc. And these may cause more difficulties still. Lawmakers are left with the option of doing away with the policy that's at fault. But they almost never do. Instead, officials through the centuries have gone the patchwork route. The result can be a web of attempted solutions and problems so extensive and dense that turning back ceases to be a serious possibility.
The Iraq debacle is an example. So are SUVs, as carlike trucks skirted 1990s mileage requirements. In the 1950s, World War II income-tax increases spawned the tax-shelter industry. And as far back as the 1600s, philosopher John Locke argued that interest-rate caps would make credit available only to the well connected.
History may have never seen a greater thicket of problems begat by the consequences of official solutions, however, than in San Francisco. One of these brambles is a 1979 rent-control law passed to protect the poor.
During the ensuing years, scholars wrote libraries of descriptions of ways rent-control laws, San Francisco's included, help push apartments out of the reach of people who need them most. Laws such as S.F.'s cause landlords to take units off the market. They encourage people to squat in cheap units far larger than they need. They motivate people to live decades in the same apartments, and thus never free up space for new tenants. And they have spawned a pied-à-terre culture, in which many S.F. residents retain their in-town rent-controlled apartments while buying country homes, thus keeping cheap apartments from people who truly need them.
In 2006 however, 1970s rent control and its repercussions, combined with an ongoing real-estate boom, have combined to create a real-estate-price tipping point, that has in turn generated a new and disastrous phenomenon. Speculators and aspiring home-buyers are lining up to take advantage of the huge gap between the relatively low cash value of rent-controlled apartment buildings and the high value of privately owned apartments.
“If we talk about next year, I think over 2,000 buildings are going to be converted,” says S.F. mortgage broker Paul Walker. “By looking at real estate agents' multiple listings service, and by looking at buildings for sale that are six units or less, you can bet that most of those are going to be converted.”
A good number of these deals will involve evictions.
Chris Daly last week made headlines for winning preliminary Board of Supervisors approval for two pieces of legislation falsely touted as “tenant protection measures.” Daly's legislation does nothing to stop this jetsam of S.F. humanity being thrown onto the street. To make matters worse, Daly's bills have the theoretical potential to actually increase evictions.
By reducing the possibility that owners can convert their tenancy-in-common units to condominiums, Daly may actually increase demand for a type of pseudo-condominium loan that allows owners to live in a tenancy-in-common agreement without being tied to their partners financially. (Tenancy in common is a way several owners can get together and buy a multiunit building. This typically involves taking out a single bank loan and signing an agreement saying which owner gets to live in which apartment.) In the long run, the proliferation of this type of loan could accelerate the already rapid advance of tenancy-in-common deals, and the evictions that sometimes accompany them.
“Where we think our business will really take off is because of Chris Daly's ill-advised legislation,” says Walker, principal of FIL Mortgage Consulting, a start-up dedicated to helping borrowers obtain a new type of loan designed to make tenancies in common more like condominiums.
“There'll be more demand, and more banks will sell more product. As it becomes more commonplace, banks can sell these loans as a portfolio to investors. The loans will become cheaper. And tenancy-in-common development projects will become cheaper to do,” says Tony Paulson, Walker's business partner.
“It's kind of counter to what Daly's trying to do,” Paulson adds. “But developers will say, 'Sweeeet.'”
In 1979 San Francisco was suffering through a blend of inflation and recession called stagflation, an unintended consequence of Richard Nixon's earlier wage and price controls. A single local landlord raised rents on 5,000 apartments. Renters protested. And then-Mayor Dianne Feinstein enacted temporary rent controls designed to endure only with the inflationary era. The rent-control law's aims were desirable — to help the lives of the elderly, poor, and middle class. The law never went away, though inflation did. Instead, it became stronger as it was amended multiple times.
Fast-forward to 2006, when a change in real estate prices has motivated thousands of people during the last year to sell, or attempt to sell, apartments as tenancies in common.
Theses developers and brokers are motivated by simple math.
A San Francisco building for sale whose apartments will be rented to tenants, many of whose rent increases are limited to 60 percent of the annual consumer price index starting the day they move in, fetches about $204,000 per unit.
After a decade of double-digit San Francisco residential real-estate price increases, meanwhile, an individual condominium in the city fetches an average $767,000.
Tenancy-in-common apartments occupy a middle ground in this mammoth price spread. Because they're so complicated, and require groups of otherwise unrelated people to link together financially, TIC units average just over $640,000.
By buying a building at around $200,000 a unit and selling it for $640,000 a unit, speculators are able to cover their financing costs and make a tidy profit. So many of them have entered this line of business, and they've driven up prices and made buildings so expensive, that it's unprofitable to buy a building and rent the apartments out. As a result, buying a small apartment building in San Francisco these days only makes financial sense if you're planning to kick out the tenants and create a tenancy in common.
In other words, if you're a tenant in a rent-controlled building of three units or fewer, and that building goes on the market, it's almost certainly going to be turned into a tenancy in common, and you're sure to be thrown out.
“The sellers of the smaller buildings, they understand it's all market driven. They understand the game, and they have priced those units up considerably in the last 18 months,” says Patrick McCarty, chief credit officer at Circle Bank of Novato, which specializes in making tenancy-in-common loans on San Francisco buildings.
Until now, people living in larger apartment buildings have been relatively safe from eviction. That's because it's extremely difficult to round up more than two or three home-buyers to jointly take out a tenancy-in-common loan.
That could change for the worse, possibly with the help of unintended consequences from Daly's anti-condo conversion bills.
Walker and Paulson's pseudo-condominium TIC loan, which allows a bank to lend money separately to individual tenancy-in-common buyers, could also help change all that.
Two institutions, Marin Bank and Circle Bank, have taken an interest, setting aside $20 million each for such loans.
But the product hasn't really taken off. Circle Bank has so far loaned $5 million, with three tenancy-in-common projects under way whose individual apartment loans may total another $5 million. The loans are expensive — 7.35 percent versus 6.25 percent typical for a joint TIC loan.
McCarty says the price will go down if more banks get into the business of this type of loan, perhaps interesting more buyers.
And according to Walker, that's where Chris Daly's bogus anti-eviction bill comes in. Walker is counting on the anti-condominium legislation to boost interest in his pseudo-condo loans.
Last week the Board of Supervisors gave initial approval to Daly's two condo-related bills, one requiring property owners and real estate agents to tell potential buyers of condominiums whether someone had been evicted under the California State Ellis Act, which allows landlords to exit the rental business. The other requires the Planning Commission to hold special hearings whenever buildings of two or more units are converted into condominiums.
Desperate to untether themselves from their co-owners, yet unable to turn their apartments into condominiums, tenancy-in-common owners will eventually begin turning to pseudo-condo loans, Walker says.
“His legislation will actually help us,” Walker says.
If the loans become hot, more banks will offer them, the interest rates will drop, and speculators will begin seeing profit in ever-larger buildings, evicting tenants as they go.
For tenants, this is not an attractive prospect. Unintended consequences rarely are.