Not such a capital idea

As we pointed out in our last column, the theory underlying the rent ordinance to be voted on by Council next Tuesday is that the City can discourage landlords from engaging in activities to which tenants object by making it harder for landlords to do them.

Impose a rent increase greater than five per cent?  Not unless a landlord whose building can be made subject to rent control under the Costa-Hawkins Act goes through a hearing before the Rent Review Advisory Committee and, perhaps, another hearing before a “Rent Dispute Hearing Officer.”

Evict tenants for “no cause”?  Not unless the landlord pays $1,500 in moving expenses and as much as four months’ rent to the current tenant, and charges rent no higher than five percent more than the present rent to the new tenant.

But there is another activity – as yet little discussed – that one supposes the City would want to encourage a landlord to undertake:  making capital improvements to her property.  After all, performing work that enhances the property’s value or extends its useful life – the usual definition of “capital improvement” – benefits not only the landlord who owns the building but the tenants who live there.

Unfortunately, if Council passes the ordinance and adopts the accompanying policy statement proposed by staff, it is likely to create so much uncertainty and confusion that landlords actually may balk at taking actions the policy-makers want to promote.

Before embarking on a capital improvement project, the typical landlord likely will want to know:

  • Can she recover her costs by raising the rent to her current and future tenants?
  • Can she recover possession of one or more rental units if necessary to get the work done?

Woe to the landlord who asks these questions if her building is located in the City of Alameda.  She’ll need a flow chart, a lawyer, and either a Jesuit priest or a Talmudic scholar to guide her through the muddle created by the drafters in the City Attorney’s office.

Start with the rent increase question.

Section 6-58.50(B) of the ordinance appears to furnish the answer.  It states:  “A Housing Provider shall receive a Rent Increase in connection with Capital Improvements only as provided by an approved Capital Improvement Plan.” (emphasis supplied)

Each of the capitalized words is a defined term.  “Housing Provider,” of course, is what the ordinance calls a landlord.  The definition of “Rent Increase” cross-references two other definitions, but the phrase seems to have its ordinary meaning.  The definition of “Capital Improvement” makes things a bit more complicated by referring to I.R.S. depreciation rules, but the gist is still pretty clear.

Then the real fun begins.  The definition of “Capital Improvement Plan” provides, in haec verba,

“Capital Improvement Plan” means a plan that meets the criteria of a Capital Improvement and meets the following four criteria: (1) is submitted by a Housing Provider (a) on the Housing Provider’s own initiative or (b) as a result of the Housing Provider’s obligation to comply with an order of a local, state or federal regulatory agency, such as the City’s building or fire department, or (c) in order for the Housing Provider to repair damage to the property as a result of fire, flood, earthquake or other natural disaster, (2) the cost of which improvement is not less than the product of eight times the amount of the monthly Rent multiplied by the number of Rental Units to be improved, (3) the implementation of which may render one or more Rental Units uninhabitable and (4) is approved by the City.

If you plug the definitions into section 6-58.50(B), the ordinance appears to say that a landlord is entitled to a rent increase to cover the cost of capital improvements only if she submits, and the City approves, a plan meeting the four specified criteria.

Sound fair?  Well, maybe.  But suppose the landlord is considering making capital improvements that cost less than eight times the monthly rent multiplied by the number of units.  Or suppose performance of the work does not “render” any rental unit “uninhabitable.”

In each of these instances, since the intended work doesn’t meet the “criteria” for inclusion in a C.I.P., the landlord can’t prepare the plan required by the ordinance.  Does that mean she can’t get any rent increase to cover her costs of capital improvements?  So the ordinance appears to say.

If so, the ordinance creates a disincentive for landlords, especially those who own small buildings, to perform modest yet still salutary capital improvement projects.

For a 20-unit building with average monthly rents per unit of $1,400, the work being considered must cost $224,000 to enable the landlord to prepare the required C.I.P.  We suspect that there are a lot of projects that would benefit the property (and the tenants) that cost less than $224,000.  (Such projects also might not render any units “uninhabitable”).  But the landlord might not go ahead with these projects if she can’t raise rents to cover her costs.

Now consider a duplex with two units renting for the same $1,400 a month.  Only if the work being considered costs $22,400 and renders one of the units “uninhabitable” will the landlord be able to come up with the C.I.P. necessary to qualify for a rent increase.  Even a new roof might not meet this test.  So the landlord owning the duplex might decide not to do the work after all.

Councilman Tony Daysog, champion of the “mom-and-pop” landlord, please take note.

But let’s assume the capital improvement project is large enough, and disruptive enough, that the landlord is able to prepare the required C.I.P.  What happens next?

The ordinance states that the City must approve the C.I.P., but it is silent about when or how.  Is City approval required for any rent increase based on capital improvements – section 6.58-50(B) seems to say so – or just for rent increases exceeding five per cent?  And if it’s the latter, what procedures must the landlord follow to obtain approval?

One section of the ordinance – section 6-58.75(A) – appears to require any landlord who wants – for whatever reason – to raise rents by more than five percent to take the steps laid out in the ordinance:  Start with the RRAC, then, if dissatisfied, petition for a hearing before a Rent Dispute Hearing Officer.  But another section – section 6-58.50(B) again – states that a landlord who submits a C.I.P. need not serve notice on the tenant that she has sought review by the RRAC.  Does that mean that, if the landlord wants to raise rents more than five per cent to cover the costs of capital improvements, she is excused from the usual process altogether?

One might have hoped that the “Policy Concerning Capital Improvement Plans” drafted by the City Attorney, which was published only last week and which Council has never discussed, would clear up some of these questions.  In fact, it just makes things worse.

The Policy contains two paragraphs addressing rent increases based on the cost of capital improvements.  The first states that “rent may be increased” for work that “qualifies as a Capital Improvement,” but the definition of Capital Improvement in the Policy is different from the one in the ordinance.  The next paragraph then states that “expenditures for any major long term improvements or repairs” listed thereafter – there are seven of them – “may qualify for a permanent Rent Increase. . . .”

The Policy appears to distinguish between mere “Capital Improvements” and “major long term improvements or repairs,” with only the latter justifying a “permanent” rent increase.  But it doesn’t establish different rules for “minor” versus “major,” or “short-term” versus “long-term,” capital improvements.  Yet if no distinction was intended, why say the same thing twice?

In either case, the Policy permits rent increases only where the work costs eight times the monthly rent multiplied by the number of units.  It thus raises the same dollar threshold issues as the C.I.P. requirement in the ordinance itself:  What about capital improvement projects that cost less?  Is no rent increase at all permitted?  Not just Mr. Daysog’s mom-and-pop landlord friends but all landlords undoubtedly would like to know.

Finally, although the Policy describes how to document the costs of capital improvements, it never identifies what kind of costs can be included in the computation.  Conspicuously absent is any reference to debt service.  What if the landlord borrows money to pay for the work?  Is the interest paid on the debt recoverable?

(This is more than an accounting question.  As our regular readers know, the politicians like to tell the public that the new Emergency Operations Center and fire station will “cost” $8 million to build – but if you include debt service, the figure rises to $14.5 million).

Then comes the procedural section.

No approval by the City is required if the landlord wants to raise rents by less than five per cent “based on Capital Improvements.”  But if she is seeking a rent increase of more than five per cent, she is required to “file a request in writing with the Program Administrator” along with “supporting documentation.”  The “Program Administrator” – a City bureaucrat – reviews the request and supporting documentation and “determine[s] whether the documentation is adequate and sufficient.”

This is, of course, not the procedure established by the ordinance for other rent increases of more than five percent.  Where the landlord seeks such an increase based on capital improvements, there is no requirement under the Policy for an evidentiary hearing.  There is no role for the affected tenant.  And there is no right to judicial review.  Why not?

The answers to the typical landlord’s second question – under what circumstances can she recover possession of one or more rental units? – are just as muddy.

Section 6-58.140(H) of the ordinance permits evictions if the landlord “seeks in good faith to terminate a tenancy in order to carry out an approved Capital Improvement Plan.”  If the landlord exercises this right, section 6-58.150(A) requires her to pay “relocation assistance.”

Since the ordinance ties evictions, like rent increases, to submission and approval of a C.I.P., the same issues arise in both situations.  If the landlord can’t meet the dollar threshold, she apparently can’t terminate anyone’s tenancy because she can’t prepare a C.I.P.  Moreover, the ordinance requires the landlord to serve the tenant whom she wants to move out with a notice stating that the City has approved the C.I.P.  But it doesn’t tell her how to get the necessary City approval.

And the Policy?  It establishes an entirely different regime altogether.

If the capital improvement project “cannot be accomplished reasonably and safely with the Rental Unit occupied,” the landlord must relocate a tenant who wants to re-occupy her unit eventually (at a higher rent) to a “comparable” unit in the same building while the work is being done.  The landlord can evict the tenant only if the tenant doesn’t want to return to her unit after the work is complete, or if no “comparable” unit is “available” in the meantime.  In the latter case – and maybe in the former; the “revised” version of the Policy is different from the one originally posted on the City website – the landlord must pay relocation benefits.

The Policy establishes rights and obligations beyond those created by the ordinance itself, which says nothing about temporary relocation, and it narrows the grounds upon which a landlord may terminate a tenancy to facilitate capital improvements.  Moreover, it seems better suited to multi-unit buildings than to the duplexes and four-plexes owned by mom and pop, who may not have a “comparable” unit in the same building “available” to offer a tenant while the work is being performed.

We suspect that, when Council considers the rent ordinance next Tuesday, it will focus on the provisions dealing with “excessive” rent increases and “no-cause” evictions, since those are the issues that have animated the public discussion.  But we hope that someone on Council will pay attention as well to how the ordinance and the accompanying policy treat capital improvements.  Surely, our elected officials wouldn’t want to rubber-stamp a badly drafted law that deters landlords from engaging in what both owners and renters should agree is socially desirable behavior.

Sources:

Proposed rent ordinance: 2016-02-16 Ordinance – Rent2016-02-16 Ordinance – Rent – REVISED

Proposed capital-improvement policy: 2016-02-16 Resolution – CIP2016-02-16 Resolution – CIP – REVISED

About Robert Sullwold

Partner, Sullwold & Hughes Specializes in investment litigation
This entry was posted in City Council, Housing and tagged , . Bookmark the permalink.

8 Responses to Not such a capital idea

  1. barbara thomas says:

    Excellent article! I would like to add that the historic buildings and character of Alameda are governed by additional constraints created by the City Council. Alameda’s Charter and Historic Preservation Ordinance require owners of historic buildings to comply with additional requirements when making repairs to Historic buildings. Not only does one have to get planning, construction permits, etc, one has to get Historic Preservation Board approval as well. There is no provision in the proposed ordinance as to how to recoup costs mandated to maintain historical correctness while making repairs or doing rehabilitation on historic properties. In a City with over 10,000 buildings over one hundred years old this is a major failure. The California Environmental Quality Act (hereinafter “CEQA”)is designed to force cities to analyze the possible degradation to the environment by actions BEFORE THE CITY TAKES ENACTS SUCH AN ORDINANCE. CEQA defines “historic” as one of the environmental qualities it is designed to protect. This ordinance will not pass muster under CEQA unless exceptions are made before its adoption.

  2. BMac says:

    ” the ordinance creates a disincentive for landlords, especially those who own small buildings, to perform modest yet still salutary capital improvement projects.”

    That is what folks in the rest of the universe call “maintenance costs.” If preserving property value and the value of future revenue streams received for providing adequate housing to consumers of said housing is not enough motivation to repaint and fix the roof, that landlord has bigger problems than only getting 5% increases annually.

    If any cost of running the business can be passed on to tenants who otherwise have modestly stabilized rents (5% per annum is a far cry from 65% of CPI), then there is no point in having a rent stabilization policy in the first place. All units have operating costs that landlords need to take into account when deciding to purchase a property or not. If you are willingly operating a business that relies on 100 year olds sticks for your revenue, you would be wise to factor that into the equation. The market is perfectly capable of assigning an economic cost of these limitations on rent increases and business expenses. If you inherited your rental properties or have owned them for a long period of time, there is no excuse for not being able to properly maintain your buildings without increases above those prescribed in the ordinance. If these burdens are too onerous for you, there are lots of people willing to pay a premium for the right to take over your business.

    Many Alameda landlords seem to think that they have a right, simply by belonging to the club of landowners, to the same cash returns above maintenance costs on a 120 year building, as the owner of a brand new building still under warranty. That is not how it works.

  3. MP says:

    I haven’t heard many landlords claiming rights to particular returns based on membership in a club. True, the dues paid to gain “membership” vary greatly from inheritance, to passive investment, to merely giving up weekends or the hours after 9-5, and all the way up to the truly backbreaking, but none of it, I would guess, with an expectation of a “right” to any particular return.

    • BMac says:

      It is implied to me when I hear that because the business you purchased/inherited (an old structure for renting out) has higher costs, you are entitled to extract higher rent increases than business owners w/ lower costs.

      If the business you are buying is expensive to run compared to another business, presumably you should have seen that reflected in the purchase price and not also be exempt from modest guidelines on appropriate annual rent increases.

  4. dave says:

    I hope this doesn’t seem forward, Bmac, but could you describe for reader your experience in business? What industry and have you been an employee, an owner, or both?

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