Rent Stabilization: Preserving Low and Middle-Income Housing

Image credit: Jeff Hopkins/CityLaw

Image credit: Jeff Hopkins/CityLaw

Rent regulation is not a new issue for New York City. But the headlines in June 2015 were far larger and the reactions more contentious than at any time in recent memory. For the first time in its 46-year history, the Rent Guidelines Board decided that there would be no increase in rents for one-year renewals on rent-stabilized apartments; it also limited increases on two year renewals to two-percent. Not surprisingly, tenants hailed the decision and landlords decried it.

Mayor Bill de Blasio has made the creation of new affordable housing for low and moderate income people one of his highest priorities. Unfortunately, several indicators suggest that, while the Mayor’s strategy may create additional apartments, the rent freeze will continue to make the housing problem worse.

Affordable apartments are leaving the stabilization system through deregulation. The State and City’s primary incentives for creating affordable and middle income housing, however, are not triggering enough new housing starts to compensate for those leaving the system. It is like trying to fill a bucket with water, but ignoring holes in the bottom.

How We Got Here

Rent regulation laws in New York essentially began with the Emergency Rent Laws of 1920, which were passed by the state legislature in the wake of a World War I housing shortage. Under the law, landlords had to justify proposed rent increases through a bill of particulars that detailed their revenues and expenses. Tenants could challenge the reasonableness of the increase in court, a loose standard that was subject to interpretation and political influence.

To spur housing construction in the post-World War I period, the City exempted all new housing built between 1920 and 1926 from property taxes until 1932. The vacancy rate went from 1% to 8%, and the rent regulations were phased out.

Another housing shortage occurred during World War II. Rent controls were imposed on New York between 1943 and 1946 by the federal government’s Office of Price Administration. The State, anticipating that federal controls would expire before the crisis could be alleviated, implemented “stand-by” legislation. In 1951 the administration of 2.1 million rent controlled apartments was shifted from the federal government to the state. Eleven years later, in 1962, the state shifted responsibility for rent regulation to the City – along with the power to enact local controls through the creation of the Emergency Housing Rent Control Act.

A combination of a falling vacancy rate and rising rents prompted Mayor John V. Lindsay to push through the establishment of the Rent Guidelines Board and the Rent Stabilization Law of 1969. Some 325,000 apartments that had been built after February 1, 1947, plus an additional 75,000 apartments that had previously been decontrolled came under the new City law.

Over the next few years there were several efforts at decontrol – and re-control. In 1974, the legislature passed the Emergency Tenant Protection Act of 1974. This allowed municipalities to declare a housing emergency where vacancy rates were less than five percent. This 5 percent rule has been the trigger on which New York City has relied to maintain rent regulation ever since: the Rent Guidelines Board calculated the 2014 vacancy rate to be 3.45 percent.

In 1983, the legislature pulled back much of the authority it had given the City and shifted it to the New York State Division of Housing and Community Renewal, an arrangement that still prevails. The Rent Guidelines Board retained the authority to set the annual rent increases for renewals of rent stabilized apartments, but the State agency holds the power for almost everything else: luxury decontrol, vacancy decontrol, allowing landlords to recoup the cost of capital improvements, and even whether the Rent Guidelines Board can maintain stabilization rent increase limits. In each successive re-enactment of the governing legislation – 1993, 1997, 2003, and 2011 – the State modified the regulation in relatively small increments, including continuing the City’s authority to set the annual increases on lease renewals.

In 2011 the state legislature renewed rent regulations, but with a few changes. Apartments with monthly rent of $2,500 would come out from stabilization, up from $2,000. Apartments could also become de-regulated if the tenant’s annual income exceeded $200,000, up from $175,000. These were both considered tenant-friendly reforms.

The 2011 law was scheduled to expire on June 15, 2015. Governor Andrew Cuomo and a Democrat-led assembly wanted to strengthen tenant protections and eliminate vacancy decontrol.  The Republican senate bill called for an increase of $100 to $2600 as the decontrol threshold. The real controversy, however, was whether the senate could link an extension of the 421-a affordable housing tax incentive to the rent regulation package.

The 421-a Tax Incentive program is a partial real estate tax exemption for the new construction of multi-family rental housing. To be eligible, owners generally must agree to keep 20 percent of the units affordable to low-income households. The tax benefit remains in place during construction, and for a post-construction period that varies according to a formula based on the increase in real estate taxes resulting from the work, location, and method of construction.  The 421-a tax abatements last between ten and 25 years.

The 2015 compromise package extended rent regulation for four years, with minor tweaks: the vacancy decontrol trigger would rise to $2700, and the amortization period for major capital improvements would lengthen a bit. Following the 2015 re-authorization, and with its renewed authority, the Rent Guidelines Board implemented its zero and two-percent rate hikes.

The On-Going Housing Shortage

According to the 2014 Housing and Vacancy Survey, New Yorkers live in some 3.4 million housing units. Just over one million of those units are owner-occupied. The other two-thirds are rental units – more than 2.2 million of them – and almost two-thirds of those are regulated. Only about 850,000 are free market.   This means that over one million apartments – 47 percent of the rental stock — are rent stabilized, and directly affected by the Rent Guidelines Board’s decree. Most of the other regulated apartments are NYCHA housing or other subsidized units.

The one million rent stabilized apartments, together with the handful (27,000) of rent controlled units, house, on average, 2.3 people each. So, just over 2.4 million people – 27 percent of New York City’s population — are affected by the rent regulations. The largest number of stabilized units are in Brooklyn (306,000), closely followed by Manhattan (285,000).

Apartments typically enter the rent-stabilization world when they are built under a program that gives the developer a tax break for a specified period of years. Apartments exit the rent stabilization system when those tax benefits expire; the rents exceed the vacancy decontrol target; or the tenant’s income exceeds the statutory amount. In 2014, 9,013 housing units left rent stabilization, while 9,182 entered the system through new construction. As a result there was a net increase of stabilized apartments of only 169 units.

The 2014 Vacancy Rate

The Rent Guidelines Board reported that the vacancy rate in 2014 was 3.45 percent. This rate is greater than the vacancy rate in 1975 during the darkest days of New York City’s financial crisis — 2.77 percent. The 2014 vacancy rate is the highest ever reported in the Board’s history, up from 3.12 percent in 2011, the last time it was computed.

During the 1970’s fiscal crisis people were fleeing New York, decreasing demand.  But at the same time, properties were being abandoned, reducing supply. Today, people are flocking to a safer, economically expanding New York City, increasing demand. The NYC Department of City Planning reported that the City’s population increased by 315,900 between April, 2010 and July, 2014. The implication is that the supply outpaced demand, creating a somewhat easier environment in which to find a vacant apartment. That of course did not happen. In fact, there was a net decrease of 7,379 stabilized units between 2011 and 2014.

So how did the vacancy rate in the 2014 Report go up? The U.S. Census Bureau, which conducts the study, estimated that between 2011 and 2014, the number of vacant rental apartments grew to 75,458 from 67,818 – an increase of 7,640 newly vacant units.  At the same time, the total number of rental units only grew by 4,022 apartments. Overall, the City saw an increase of 48,052 units – mostly condos.

The conclusion of the Rent Guidelines Board that the vacancy rate had increased was not necessarily inaccurate; it was just selective. The Rent Guidelines Board could have made totally different calculations and come up with perfectly valid, but different conclusions.  For example, it could have included all new construction, not just rental units. In that case, the vacancy rate would have been 3.6 percent, not 3.45 percent. Or it could just have counted only rent stabilized units, in which case the calculated vacancy rate would have plummeted to 2.12 percent, down from 2.63 percent in 2011.

Both calculations are still below the 5 percent trigger, but they underscore two truths: first, they are estimates based on surveys which have margins of error and potential sampling problems. And second, advocates can choose – or not choose – numbers that support the conclusion they want to make.

The Annual Revenue and Cost Estimate

Every year, the Rent Guidelines Board analyzes the rents and costs associated with operating stabilized properties in a report entitled the Income and Expense Study. This Study serves as the basis for the Board’s rent increases. On the revenue side, the Rent Guidelines Board devotes considerable attention to the fact that many buildings derive income not just from rents, but from commercial activities such as parking, laundry and vending. There are wide differences however between large and small buildings which are not captured in the Board’s calculation.

On the cost side, the Board explicitly excludes debt service. Understandably, it would be almost impossible to include debt service. Owners acquired their properties under an almost infinite combination of dates, purchase prices, interest rates and terms. But by omitting mortgage and interest payments – often the single largest expenditure a landlord has – the Board sends a skewed message to tenants, policymakers, and journalists that landlords are making a far larger profit than they really are. A reader’s tendency will be to look at the “net operating income” and conclude that building owners are making substantial profits.

The 2015 Study (which reported 2013 numbers,) concluded that citywide, per-apartment monthly revenue was $1,337, and costs $856. That meant that every apartment on average yielded a net operating income of $481 per month. A 20-unit building would be throwing off $9,620 per month – which wouldn’t be bad if a mortgage were free.

How large a mortgage would such a cash-flow support? The online calculator projects that a monthly income of $9,620 would support a mortgage of $2,015,020, assuming a 4 percent interest rate and a 30 year fixed mortgage. Few 20-unit apartment buildings in any borough could be purchased for anywhere near that price.

While the annual Income and Expense Study conveys broad-brush changes from year-to-year, it is of little value in helping anyone really understand the actual economics of owning and operating a residential building in New York.

Goals for Stabilization

A vibrant city with affordable housing is more than a noble goal; it is recognition of housing’s importance to continued growth and opportunity. Stabilized apartments form the core of the City’s privately owned middle and low-income housing. The goals for stabilization should be both to keep the units in the program and to keep them in good condition. Unfortunately, the system is not plugging the holes in the leaky bucket, and may indeed be adding to the rust that is creating more.

Placing the economic burden for subsidizing tenants on building owners – rather than on the public treasury – is contentious and for some morally dubious. Yet it is unlikely to change anytime soon; wide-scale deregulation is not in the political cards. But the system could be adjusted to have fewer adverse consequences for the rental housing stock.

First, treat small building owners differently. The City needs to preserve the current housing stock and keep these apartments available. Officials should acknowledge that the economics for small building owners are different from those owning larger buildings. Owners with fewer than ten units (or a similar small number) should not be held to the same rent limits as larger or multi-building owners. Either eliminate the rent increase limitations on these buildings or allow them to levy a modest surcharge.

Second, stop the Rent Guideline Board’s reliance on its annual Study of building revenues and expenses as a basis for rent increases. Its flaws are less egregious than the political cover it provides. An economic estimate that results in a zero-rent-increase has sacrificed its usefulness. Annual rent increases should be pegged to the Consumer Price Index or similar indices. The CPI is more accurate and less politically charged.

Third, eliminate the disincentives that building owners face when they want to upgrade their buildings or individual apartments. The amortization periods for investments are long, capped, and, for individual apartments, subject to tenant approval. Allow all improvements to be recouped in three years.

The Rent Guidelines Board’s zero-increase diverted attention from the greater issue of preservation of the stabilized housing stock. The mayor’s housing policies should begin by recognizing that the current system does not adequately create incentives to stay in the system. Over one million apartments under stabilization are the backbone of the rental market in New York City.  They deserve greater attention and preservation than they are getting under the current rent stabilization laws and practices.

Steve Cohen ’13 is an attorney at Kramer, Dillof, Livingston & Moore.

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