DHCR Tightens Up (Re-Post from 2022)

Editor’s Note: Reposting this from Fall 2022 because many of the same principles continue to apply today. Some owners are still unclear that vacancy increases, combining apartments, and sub rehabs either don’t exist anymore or just don’t work in the same profitable capacity as they did before.

The narrative explained in the piece below today hasn’t changed much in today’s environment. Bad policies follow bad policy; as a result, rents continue to soar. Given the option to embrace a compromising policy, NY officials takes options that, on some level, may sound like they’re in the name of preserving affordability, but what they do is heighten scarcity in the system (by discouraging build-for-rent properties) and contribute to soaring rents, which then incentivize further government legislation to abate.

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In April of 2022, owner groups rallied together to demand that NY’s Housing & Community Renewal (HCR) soften its iron grip on rent control policies. Lead by Jay Martin, Executive Director of CHIP, owners asked to obtain increases in rent due to vacancy and to mark their apartment rents up to market levels once leased up – two things not currently possible for rent stabilized (RS) apartments.

In exchange for this demand being met, Martin claimed he could deliver ~20,000 apartments back into service in NYC. Under current rules set in 2019, empty apartments in rent stabilized properties cannot see any rent raises greater than 5%. Investors and owners sought a return to the old policies that would allow owners to spend money on apartments and be rewarded with commensurate rent increases. The response by the city of NY was a resounding silence… Or was it?

It took them four months, but the leaders of NY’s HCR pushed back hard against Martin’s proposition. No concessions, no compromising, just facts (no printer). HCR leaders drafted 3 important alterations to rent stabilization laws:

1. Closed the loophole around the combining and separating of apartments.

   Owners with two contiguous vacant RS units were sometimes opting to merge these into ‘Frankenstein apartments,’ for the privilege of charging a ‘first-rent,’ a market rent unfettered by rent ceilings. HCR is scrapping this. Instead of using market data to come up with rent numbers, owners would have to use addition – add the two rents of the former units to arrive at the new rent.

2. No more blanket approvals for sub. rehab. projects based on vacancy levels.

   In a post 2019 HSTPA world, the last way to escape the specter of rent stabilization and shoot for lofty rents is to have an empty, or near empty, building and renovate it thoroughly – HVAC, plumbing, electricals the whole nine yards. The reward for doing the renovation is a sparkling new building with rents far higher than what rent stabilization would otherwise allow for. Completing a good reno and leasing the units up can sometime double the value of the property. This isn’t going away totally under the new proposal, but it would mean HCR could use its discretion to deny these projects. It could claim that a building did not *need* substantial rehabilitation, that the building systems worked fine, and a building would be prevented from raising rents to the market level. Scary.

3. Reinforcing succession rights.

   There has been ambiguity over when the necessary 2 years of cohabitation starts for someone to gain rights to succeed the original leaseholder of a rent regulated apartment. The new changes would add clarity and give some flexibility to tenants who may have misunderstood the rule.

Jay Martin & CHIP made an offer in April and HCR spent four months drafting its own set of principles / rules it wanted to implement. HCR’s stated goal is to create and preserve good quality affordable housing across NY State and the agency’s leaders appear to be acting to support this. DHCR leaders had three options in how the responded to Martin and CHIP:

1) Propose no changes to existing rent controls in NY

2) Agree to CHIP’s proposition and loosen regulations

3) Come up with its own set of policy directives and tighten regulations

With reports about rent regulation loopholes being exploited in NYC, it’s understandable why option 1 was not viable, but why go for option 3 instead of working with housing providers on something for everyone? Option 3 gives landlords the stick instead of the carrot. That said, by removing the policy tools available today, HCR strips away the incentives for owners to keep apartments vacant. Why lose money today on a vacant apartment if I’ll never be able to achieve significantly higher rent on it tomorrow?

Well played, HCR.

What happens if these changes pass?

These changes have been proposed only and nothing is set in stone. Stakeholders have up until November 20th to draft comments and submit them here. Looking out in the future, downstream effects of this ruling could be:

1. Value of vacant units decreases- vacant apartments may become liabilities, where having empty units lowers building valuations, like in most US markets. Occupancy levels below 90% on rent stabilized assets will spell collection or lease-up issues.

2. Value of vacant buildings declines -if the ability to achieve market rents through substantial rehabilitation isn’t guaranteed, valuing empty rent stabilized assets will become harder. If a subjective party is deciding whether a given building is old and dusty enough to merit a revamping, that’s a problem. Buyers will want to pay commensurately with the non-zero probability that their application gets denied and their building’s rents cannot be elevated.

3. More apartments delivered to NYC market - removing any incentives to keep apartments vacant is aggressive, but it could work. With nothing to gain, owners will strictly be losing out on a monthly rent check by keeping apartments vacant, without any benefit. This will push many owners to re-lease their apartments. Kind of like when someone you don’t like suggests the least bad idea. The upshot here is that more apartments will come online, and this will make NYC slightly more affordable. It’s this last piece that is most important for HCR in terms of their ability to get this package of proposals inserted in the rulebook. The steps taken here demonstrate a coherent effort towards unlocking more apartment availability for residents of NYC.

According to James Marino from landlord & tenant firm Kucker Marino Winiarsky & Bittens LLP, these proposals will likely become officialized. In 2014, HCR proposed a series of changes like these that were passed into law. Building owners balked and opted to litigate against the changes. Marino’s firm represented the owners who tried to reverse the tide, but ultimately their quest was unsuccessful. Put differently, because of the events that unfolded in 2014, there is case law that says HCR can go ahead and make these changes so long as there is a “rational basis.”

Prep for the worst?

What can you do as an owner? The good news is that as an owner, the state of NY has messed with you and your buildings so much with 2019 ‘s HSTPA that today nothing can hurt you. Sticks and stones have broken your bones, but words and ‘proposed amendments’ cannot hurt you. I am only half-kidding here.

This is a frightening prospect, but it will only affect a fraction of owners. As a reminder- this change would only apply to rent stabilized buildings and apartments. Most of NY’s rental apartments are immune from this because they are free market. Second, few owners can afford to warehouse units -especially through the pandemic when tenants may have not paid rent or been slow to come up with funding. For the small minority of owners who have built business plans around vacancies in the last two years, the idea is to act quickly. Make plans for a sale, a reno & lease up, or file that substantial rehab application you have been sitting on! You want to embrace the possibility of this happening now that way the next three months can be spent preparing for it.

The proposed changes can be found on this document on pages 21-29, mostly on page 29.

Sources: Law 360, Gothamist, The Real Deal