Buy-Out Policy

The Real Estate Attorneys of Steven Adair MacDonald & Partners, P.C. quite literally wrote the book on landlord-tenant law in San Francisco. Steven Adair MacDonald is the author of both Landlord-Tenant Solutions in California and The San Francisco Rent Board User’s Guide, widely recognized books on the subject of landlord-tenant law in the Bay Area. Our legal team has plenty of experience dealing with all things real estate, including but certainly not limited to buy-out policy. In this post, our attorneys will answer your questions regarding buy-out policy and what you may be able to expect in such a scenario.

What is a Buy-Out?

A buy-out is a scenario wherein a landlord lacks a practicable “just cause” for termination of a tenancy as determined under San Francisco’s rent and eviction control law, yet wishes to do so nonetheless. As a last resort, an owner may decide to invoke the Ellis Act. Proceeding with an Ellis Act eviction is invariably complicated with negative consequences, prompting many landlords to offer a tenant a sum of money in exchange for the tenant’s agreement to vacate the property voluntarily. This is where buy-out policy comes in.

Why Might a Landlord Be Interested in a Buy-Out? 

The financial benefit he or she could gain from putting a rent-controlled unit back on the market at current rental rates is substantial. Many tenancies under rent control date back 30 years or more. This results in artificially deflated rent that is disadvantageous to the owner. A buy-out allows for a new tenant paying market rent or a new owner using the unit as he or she chooses. Under certain circumstances, “protected” tenants cannot be otherwise evicted, even in the case of a good faith owner-move-in. 

Why Might a Tenant be Interested in a Buy-Out?

When a landlord is considering invoking the Ellis Act and has stated their intention to proceed, a tenant needs to evaluate the financial possibilities under that process versus what he or she might gain under voluntary negotiations. In any event, an owner should gladly pay more than the legally required minimum relocation money to obtain the vacancy free and clear of the potential constraints we will be discussing. 

In our legal community, there are also references to a hybrid type of negotiation. The fact is, there are many cases in which the landlord may have an independent “just cause” to terminate the tenancy. One example includes a breach of lease due to the tenant having too many roommates or for consistently late payment of rent. Sometimes, the owner will initiate such an action while hoping to negotiate a settlement before trial. 

At Steven Adair MacDonald & Partners, we like to treat these matters separately, in explicitly distinct ways. A legitimate just cause eviction should be litigated and negotiated according to its strengths. To initiate such an action in bad faith with the hope of turning the situation into something more like a buy-out is generally viewed as unethical. 

From the tenant’s perspective, the value of the unit is the difference in the monthly rent he or she is presently paying under rent control compared to with what the market rent would be. Additionally, there are non-economic, subjective factors to be considered. 

People often find moving highly stressful, and in some instances, even traumatic. For purposes of clarification, let us examine a hypothetical situation in which the tenant’s current rent is $1,000.00 per month below market. Let’s say the tenancy is worth $12,000.00 per year. If the tenant expects to live there for the rest of their life, then the present value can be considered to be $120,000.00 using a ten year time period. 

In a larger building of six to ten units, a tenant can usually live free from fear of eviction by owner-move-in or even by the Ellis Act. The constraints of the Ellis Act, as explained below, are typically too severe to employ it for a larger building under most economic circumstances. Moreover, such a building is commonly purchased as an investment property, not as a home for the buyer. This makes owner-move-in cases rare. 

Conversely, a unit in a smaller building, say two to four units, is often the subject of an owner-move-in case. This is a frequent occurrence, particularly by a new owner, unless the tenant is protected due to severe disability or is over 60 years of age and has resided there for more than 10 years. In smaller buildings like this, tenants cannot reasonably assume that their tenancy will last a lifetime. Therefore, while there is no scientific way to precisely evaluate the potential longevity of a given residential tenancy, there are certain logical guidelines. These criteria can lead us to adopt an assumption, for purposes of valuation analysis, that there may only be a few years or even several decades left in a given tenancy. 

From the landlord’s perspective, the valuation process is reverse. Additional rent is gained when a new tenant moves in and pays market rent. The investment value of the building would substantially rise by the increased rent roll. Further, if sold, the unit being empty would supremely enhance the marketability of the building. If the tenant being bought-out is protected, then his voluntary move-out avoids additional constraints affecting condominium conversion and the re-renting of vacated units.  

Tense Negotiations

How the pie is split up beyond the basic threshold elements is frequently the crux of heated negotiations. Situations can escalate to the extreme where the landlord’s attorney is asserting that no more money is available for the buy-out, and that the owner is determined to immediately serve the eviction notice. Meanwhile, tenants (having enjoyed the benefits of rent control for years or possibly decades) and elderly or disabled people living on limited income may feel trapped. They may recognize that tens of thousands of dollars will be exhausted in a relatively short amount of time and may hope that the landlord is merely bluffing. It is typical for debates like these to carry on for many weeks or even months. Luckily, our real estate mediation attorneys specialize in mediation and negotiation for precisely these kinds of disputes. 

What is the Threshold, Minimum Value?

There is a great deal of nuance and artistry involved in the analysis and calculation of the buy-out value. Nevertheless, common sense dictates that the value of a tenancy begins with the basic mandatory relocation money that an eviction such as the Ellis Act would require. Owner-move-in cases have a different analysis.

As of March 1st, 2012, the relocation money is $5,157.27 per person, maxing at three people per unit. Additionally, and without any limitation on the number of people, if one or more of the tenants is over 62 years of age or disabled, then they will be provided with additional relocation funds – each in the amount of $3,438.17. Thus, in analyzing the bare threshold, a landlord would calculate what would be the non-negotiable mandatory relocation money necessary to provide if an Ellis notice was served. This can range anywhere from $5,157.27 to an amount exceeding $29,000.00 if there are a large number of elderly or disabled tenants living in one particular unit. 

Now, if the owner wishes the tenants to vacate sooner than they would be required to under the Ellis Act, the landlord is expected to pay the rent differential for those months. For example, if one of the tenants is over 62 years of age or has a slight disability, they would be entitled to twelve months under the Ellis Act rather than four. If the landlord wants the tenants to vacate in sixty days, then he or she is asking them to move ten months before the law requires. Additionally, the tenants are being asked to sacrifice the discounted rent (in our example, $1,000.00 per month) for ten months. These two elements would constitute the threshold for the negotiations. Ergo, if two tenants – one protected – were living in the unit for $1,000.00 per month below market, they would be entitled to a total of $13,752.71, and should expect another $10,000.00 if they are asked to vacate in two months rather than twelve. Hence, the bargaining in this example would start at $23,752.71. 

Why Would an Owner Pay More?

There are many sound financial reasons for an owner (particularly if selling) to opt to pay more than the bare threshold. Quite often, it is because of the following reasons:

1. The seller’s agent is free to consistently show the vacant property, without restrictions to the time of day, on weekdays or weekends and without dealing with tenants in occupancy.
2. Buyers know they can move in immediately. 
3. There are no relocation payments to be provided to any tenants. 
4. Legal fees otherwise needed to evict are avoided.
5. There is no fear of prolonged litigation.
6. The stress of making monthly mortgage payments without occupancy or rental income is eliminated. 
7. The risk of actually being denied recovery of the unit by a court decision is avoided. 
8. The chance of being sued by the tenant is eliminated.
9. Convertibility to condominiums is preserved.
10. The unit can be rented out at market rent. In fact, if the unit qualifies as a single family home, there is a permanent exemption from rent control. (Note: if there is also an in-law unit, it is considered two units.) Naturally, the current owner would be free to do as they please with the unit as well, even if they are not selling the building. 

Is There Some “Rule of Thumb” to Gauge the Buy-Out Value?

Each case rests on its particular facts and the legal constraints that may apply. While no such “rule of thumb” exists, there may be a formula to help provide logic to the analysis:

1. Start at the bare threshold, determining the mandatory relocation money;
2. Add the rent differential for an early move-out compared to the amount of time that is otherwise allowed by law (four months or twelve months under the Ellis Act);
3. Consider the value avoiding the re-renting prohibition adds to the occupied units in the building. (Under the Ellis Act, a previously occupied unit cannot be re-rented at market rent for five years. This covers all such units in the building);
4. Compute the value that avoiding the re-renting constraints adds to other empty units. (If the Ellis Act had been invoked, even empty units are constrained in that they cannot be re-rented for two years);
5. Add the value that preserving condo-convertibility adds to each unit in the building. (If more than one unit was recovered through the Ellis Act, or if even one elderly or disabled tenant was evicted, then the condo-convertibility is effectively forfeited). 

It is sensible to start with the threshold amount to which the tenants are legally entitled. However, the considerations detailed above, which contribute much more value, should be calculated. These additional amounts may then be shared between the landlord and tenants. In the hypothetical situation described, with one of the two tenants disabled or elderly, the threshold will be well over $23,000.00 if the tenants move out ten months early. Depending on the size of the building (i.e. how many units are to be affected by the Ellis Act), the location of the building, and so forth, the factors detailed above may contribute hundreds of thousands of dollars to the value of the building. 

This increase in value applies across the board as an investment property, either to the current owner or in the eyes of a buyer. No owner wants a building left vacant for years to come. These enhanced values can literally be “banked” on, since lending institutions analyze the rent rolls when appraising the value of an asset, and can contribute hundreds of thousands of dollars to the price of the building. 

In Conclusion…

Most of these negotiations result in settlement. When they do, they can truly be a win-win for all parties involved. The landlord has added value to their building, which they can reap for years to come through additional rent or on a profitable sale to a buyer. The tenant wins in that he or she receives money in excess of the mandatory relocation funds that they would be entitled to if the landlord had proceeded with the Ellis Act. The premium is paid by the buyer or by new tenants paying market rent.

We have also seen lose-lose scenarios, as well. An unfortunate outcome happens when the tenant calls the landlord’s perceived bluff and the landlord proceeds to invoke the Ellis Act. The tenant loses in that they only got the minimum relocation money; the landlord lost in that, while still obtaining the vacancy, the value of the building was deflated by the constraints explained above. 

No statistics are available on the exact percentage of these negotiations resulting in a settlement. However, it is my distinct impression that a very high proportion after skilled but tense negotiations result in a buy-out of the tenancy. Competent legal counsel is required to ensure that each side gets its fair share and that they ultimately receive exactly what they bargained for. 

San Francisco Real Estate Attorneys

At Steven Adair MacDonald & Partners, P.C., our team of lawyers brings many decades of experience in real estate law either to the negotiation table or the courtroom. We pride ourselves in finding creative solutions to complicated scenarios. Our San Francisco real estate attorneys use a variety of conflict resolution strategies to help our clients achieve the best possible outcome for the least possible cost, including mediation, negotiation, and litigation. Give us a call at 415-956-6488 or complete our online intake form to schedule your consultation today.