Deregulation Under The New Rent Laws
By Adam Leitman Bailey and Dov Treiman
Adam Leitman Bailey and Dov Treiman discuss the “Housing Stability and Tenant Protection Act of 2019,” signed into law by the governor on June 14, which sent New York landlords “reeling.”
On June 14, 2019, the governor signed into law Chapter 36 of the laws of 2019, known as the “Housing Stability and Tenant Protection Act of 2019,” (“HSTPA”). New York State landlords were sent reeling. While the HSTPA undoubtedly cut profitability in residential housing, contrary to common perceptions, the HSTPA did not remove all paths out of rent regulation.
Exit paths HSTPA left untouched were demolition; substantial rehabilitation and conversion to residential use; new construction; conversion to and from commercial use; and economic infeasability.
While merely a path to market rate rents in a regulated building, the doctrine of first rents is also finding interest amongst landowners. Long dormant in the RSC has been the doctrine of “alternative hardship,” whereby a landlord remains inside rent stabilization, but upon showing inadequate return on investment, a landlord can theoretically receive a rent increase building-wide.
RSC §2524.5(a)(2) authorizes an owner to remove from rent regulation a building that it is going to “demolish.” In Peckham v. Calogero, 12 N.Y.3d 424 (2009) sought to some extent to bring definition to what does and does not constitute demolition. The court avoided a sweeping definition of the term under the mistaken belief that the DHCR was about to amend the RSC to give definition to the word. That amendment did not come. Instead, the Division of Housing and Community Renewal (DHCR) issued a new Operational Bulletin 2009-1 (OpB2009-1) still not giving definition to “demolition,” but focusing on the landlord’s proof of financial ability to effect the demolition and to relocate and furnish stipends to the displaced tenants. However, these proceedings before the DHCR are normally painfully slow. Left to its own timing, DHCR typically makes such procedures last five years, but vigorously holding the agency’s feet to the fire in Supreme Court mandamus proceedings can substantially speed things along.
Peckham gives little guidance on its view of the definition of demolition, except to observe that an “intent to gut the interior of the building, while leaving the walls intact, has been held as sufficient” and the applicant does not have to show an intent to “raze the structure to the ground.”
In order to sustain a demolition application, the owner must have all the architectural plans and contracts in place, both for the removal of the old building and for the construction of the new one. If the building has a rent controlled unit in it, the new building must normally have at least 20% more units than were contained in the old building. (NYC Administrative Code §26-408). The owner must also show that the entity or a closely related entity has ready access to the funds for the demolition, construction, and required stipends, payments for moving expenses, and other charges DHCR imposes. If these are underestimated, the DHCR will deny the application. Porter v. DHCR, 51 A.D.3d 417 (2008). The owner must evaluate whether it can offer tenants alternative housing at the same or lower rents in the neighborhood. The owner must also serve a notice of nonrenewal on the tenants, setting forth allegations required in OpB2009-1. While the RSC confusingly describes the calculation of the stipends, actual comprehensible dollar figures appear in the Operational Bulletin. All of the stipends are one time payments. Tenants can refuse to accept the payments, but once the DHCR issues a demolition order, there is no defense to the ensuing summary proceeding. OpB2009-1 moves nearly all the disputes to DHCR processing.
The Rent Stabilization Code’s (RSC or 9 NYCRR Part 2520 et seq) fairly sparse description of “substantial rehabilitation,” (RSC §2520.11(e)), is considerably fleshed out in Operational Bulletin 95-2 (https://hcr.ny.gov/system/files/documents/2018/09/operationalbulletin952substantialrehabilitation.pdf, which the courts and DHCR treat as if it had the authority of law, (see, e.g. Gonzalez v. DHCR, 95 A.D.3d 681 1st Dep’t 2012) even though it is a mere interpretation of the law. In H.M. Village Realty v. DHCR, 304 A.D.2d 346 (2003), the First Department put its imprimatur on acceptance of the authority of 95-2.
In H.M. Village, the court makes clear that in order to qualify for substantial rehabilitation treatment, “at least 75% of the building-wide and apartment systems had been totally replaced.”
95-2 lists seventeen specific building systems such as plumbing, heating, etc. The phrase “75% of the systems are totally replaced,” means that the qualification cannot entail 75% of the building, but rather 75% of the number of systems. This is “at least 75% of seventeen systems” and not “at least thirteen systems?” because not all buildings have all seventeen of the listed systems and there is no requirement that they first acquire them in order to qualify for “substantial rehabilitation.” Commonly absent systems include elevators and incinerators. Thus, “at least 75% of building systems” means “75% of the systems the building has.” If the only system on the list lacking were an elevator, there would be sixteen systems and the “at least 75%” would be twelve. Thus, the fewer systems a building had prior to the rehabilitation, the fewer replacements it took to qualify for the exemption.
In The 12th Co. LLC v. DHCR, 303 A.D.2d 328 (2003), the First Department upheld 95-2’s exception from deregulation of tenants in units that remained occupied an unaffected during the construction of the substantial rehabilitation. Deregulation applies to the subsequent tenant to come into occupancy.
Conversion from Commercial
RSC §2520.11(e & o) exempt brand new construction (after January 1, 1974) from rent regulation. However, buildings converted to residential use from commercial use post-1/1/74 are also exempt from rent regulation. In this, the First and Second Departments agree that such conversion after January 1, 1974 makes the residential units exempt from regulation.
In 22 CPS Owner LLC v. Carter, 84 A.D.3d 456 (2011), the First Department looks at a building that was converted from purely residential use to include 23 residential units and held that such a conversion was a “substantial rehabilitation” because “the purpose of the exemption from rent stabilization based on the substantial rehabilitation of a building is to encourage landlords to renovate buildings and add new residential units to the housing stock.” Thus, the Appellate Division focused not on what happened to the building, but that there was an addition of brand new residential units to the housing stock. However, it did not consider in this case what the legal effect of using air rights to add 23 residential units on top of a building that was already entirely residential and subject to rent stabilization.
In Bartis v. Harbor Tech, LLC, 147 A.D.3d 51 (2016), the Second Department, citing to 22 CPS and giving far more analysis, looks away from the 75% of building systems criterion completely and says that those criteria are meant only to apply to upgrading of residential buildings to better residential buildings. Where, as in Bartis, a building was a warehouse that was transformed to residential use, it falls inside another analytical framework: the creation of new housing altogether. Such conversions are still a “substantial rehabilitation,” but one based on RSC 2520.11(o) rather than 2520.11(e), thus being more akin to brand new construction than to making an old residential building better.
Conversion to Commercial Use
While the HSTPA placed serious restrictions on the as-of-right process of capturing an apartment for the personal use of a natural person landlord or their family, it left untouched an analogous provision in RSC §2524.5 whereby a landlord can capture premises “for his or her own use in connection with a business which he or she owns and operates.” While the personal use provision has newly enacted severe penalties for failing to use the premises for the designated purpose, no such changes were made to the commercial use provision, although the RSC’s requirement of a demonstration of “good faith” remains in effect. However, the owner may clearly have good faith to acquire the premises for commercial use, but that does not mean that the owner is thereby consigned to forever thereafter using the premises for that purpose. If thereafter, the landlord returns the premises to residential use, it will be to rent regulated residential use, but once the premises have been captured for the owner’s own business use, there is nothing in the Code to prevent the premises after the passage of time being shifted over to the commercial use of some other enterprise to whom the owner rents.
Closely related concepts are the constitutional doctrine of “economic infeasibility” and the rent stabilization provision for the same. Both doctrines rely on the idea that a landlord should not be compelled to run a building at a loss. The key concept here is “compelled.” While in other industries, proprietors can simply leave the business if they cannot make a go of it, landlords can face crippling fines or even prison if they lack the resources to make their building work. Economic Infeasability is the safety valves that permits the landlord to exit the residential rental market altogether, freeing up the land upon which the building sits for some other kind of development.
Under Eyedent v. Vickers Management and HPD, 150 AD2d 202 (AD1 1989), the courts recognized that under the correct circumstances, the Fifth Amendment prohibits compelling a landlord to repair a building at greater expense than the building would be worth once the repairs were completed. Thus, when a building is in such disrepair at no fault of the landlord, as a matter of common law, the landlord will be allowed to tear down the building and replace it with new construction free of any regulation.
Similarly, under RSC 2524.5(a)(1) an owner may petition the DHCR to remove a building from rent regulation when:
substantial violations which constitute fire hazards or conditions dangerous or detrimental to the life or health of the tenants have been filed against the structure containing the housing accommodations by governmental agencies having jurisdiction over such matters and that the cost of removing such violations would substantially equal or exceed the assessed valuation of the structure.
Since most believe HSTPA reduced the value of residential housing by roughly 20% of actual value, invoking RSC 2524.5(a)(1) should first do a tax certiorari proceeding.
Apartments authorized under rent stabilization to have a “first rent” are at rents set by agreement of the parties, rather than by maxima established by law. Such rents are for apartments first coming under rent stabilization, although prior to the abolition of luxury decontrol, if the rent could legally be above the statutory maxima, the apartment was completely free of regulation. With the abolition of such decontrol, the rents remain freely negotiated, setting the basis of what the rents will be when they are raised as authorized increases according to guideline orders.
In order to qualify for a first rent, an apartment must be in some manner new. It is clear that neither the moving around of walls inside an existing apartment nor the addition of a modest number of new square feet will qualify for first rent treatment. (Roker Realty Corp. v. Gross, 23 HCR 16B, NYLJ 1/9/95, 27:2 (AT1)). In 300 W. 49th St. Assoc. v. DHCR, 212 AD2d (1995), the court wrote, “In order for an owner to qualify for a ‘first rent,’ the apartment alterations must be so substantial as to create a new unit. DHCR policy and numerous precedents state that in order to qualify for a first stabilization rent the owner must change the outer dimensions of the apartment.” Dixon v. 105 West 75th Street LLC, 148 A.D.3d 623, (2017) explains:
A landlord may charge first rent, pursuant to the Rent Stabilization Code, where the landlord substantially alters the outer dimensions of a vacant housing accommodation…. Stated somewhat differently, first rent is permitted when the perimeter walls of the apartment have been substantially moved and changed and where the previous apartment, essentially, ceases to exist, thereby rendering its rental history meaningless. This Court has described the test for whether alterations qualify for first rent as reconfiguration plus obliteration of the prior apartment’s particular identity. (citations omitted)
Ruxton Towers, LP v. Floratos, 23 Misc3d 22 (AT1 2009) prohibits first rents when it is the tenant who combines two rent stabilized apartments, but it appears to allow for the landlord’s combination of two vacant apartments so as to achieve a first rent. A number of landlords have seen fit to combine two apartments, but the state of the law with regard to such combination as qualifying for first rent is unclear. Clearly if the merger does not include such basic things as removing the physical barriers between the apartments and eliminating one of the kitchens, it will not qualify. While it is clear that adding a story to an existing apartment will qualify it for first rents, it is unclear whether taking existing common space of some significant square footage (such as a corridor) and adding it to an existing apartment would also qualify for first rent. We believe that the sufficiency of such square footage would depend less on how many square feet are added as on what percentage those square feet are of the previously existing apartment. The higher the percentage, the more likely the apartment is to be held subject to first rent. While untested, it would appear that the combination of a rent regulated unit with an unregulated unit would result in an unregulated unit as the unregulated unit could be said to have swallowed the regulated unit.
300 W. 49th Assocs. v. DHCR, 212 A.D.2d 250 (1995) gave examples of the types of alterations contemplated by the policy—namely, a two-bedroom apartment being split into two studio apartments, or two units being combined into one larger apartment. Both of these were disallowed from charging first rents. Dixon v. 105, supra, reaffirms this holding.
Thanks, no doubt, to the ability until June, 2019, of landlords to realize profits under rent stabilization, the RSC provision for “alternative hardship” (RSC §2522.4(c)) has seen no reported decisions in this Century. Under this provision, an owner who does not “maintain an annual gross rent income collectible for such building which exceeds the annual operating expenses of such building by a sum equal to at least five percent of such annual gross rent income collectible” may apply to the DHCR for a rent increase. If, as appears to be the case, the complaints of the landlords post-HSTPA are correct, this provision may have new viability.
The HSTPA was designed to remove a good deal of profitability from the ownership of regulated housing in New York City. In that, it no doubt succeeds. However, the law left untouched a number of areas that were unused or underused during the time that rent stabilization was profitable for owners. This may be a time of substantial renaissance for those less well known provisions of the law.
*The authors are partners in the Manhattan real estate law firm, Adam Leitman Bailey, P.C.