NYC Multifamily Owners – Beware the TPU!

I’ve been to quite a number of industry meetings the last several months, notably those hosted by RSA and CHIP, where there have been warnings about the new Tenant Protection Unit or TPU. This is a new group within the New York State Homes and Community Renewal agency (formerly DHCR), created last year by Governor Andrew Cuomo to proactively increase and enforce compliance with the New York State Rent Stabilization Law.

New kitchen

I had heard that the initial focus of the unit was on looking for owners who hadn’t properly registered regulated units over the past four years. At least, as an owner, if you know you’ve properly registered all your regulated apartments consistently, you should be free of any harassment on this front. The other area of focus has been on individual apartment improvements (IAIs). As many of my readers will know, one can gain rent increases by making certain improvements to an apartment. The allowable increase is equal to 1/40th of what was spent on the improvement if your building has 35 or fewer units and 1/60th for those buildings larger than 35 units. This lesser benefit for larger buildings was a new twist passed last year. If someone is living in an apartment, he/she has to preapprove such an improvement and the resulting rent hike in advance. Since most tenants will never agree to any improvement that is going to increase rent, most IAIs happen when there is a vacancy, at which point the landlord can do whatever he/she wants in terms of upgrades.

Kitchen “Before”

In 2011 we got back a low rent apartment after a bit of a battle. The tenant of record had moved to Florida, which we could prove, but her estranged husband then tried to argue that he had rights to the apartment and could allow it to be used by an unrelated female acquaintance and her thug boyfriend. Eventually we got an eviction and proceeded to fully renovate the apartment. Before and after photos punctuate this blog post. The legal rent went from below $900 to around $2300, which I guess made us a ripe target for the algorithm that is triggering a TPU audit, since the rent went up by much more than the typical 20% vacancy increase.

I first got a letter dated 3/19/13 stating that I had to comply with the TPU audit requirements. I had been told by the folks at RSA that the key thing is to just respond quickly with as much information as possible, so I started working diligently on it, having my assistant gather information as well. A couple of days later, I got another letter from TPU stating that I was still being audited, but they had referenced the wrong rent registration years in their first letter. That same day, I got yet another letter that read exactly the same as the one I got on 3/19. So, this unit has now contacted me three times about the same IAI. Efficient government at work!

New Open Layout

The core of what one has to do to comply is as follows:

Please submit all supporting documents that justify the cost of the IAI. This would include, but not be limited to: leases, bills, cancelled checks, receipts, contracts and invoices from contractors. In addition, please include the date the work was completed and the calculation of the new legal regulated rent (including the prior tenant’s last rent, the vacancy allowance, any longevity allowance, and the increase due to the IAI). If you do not have a contractor’s itemized breakdown of costs, you must submit a notarized Owner’s Affidavit which must contain the following information: (1) a detailed description/explanation of the work performed; (2) the installation dates of the work; (3) the identity of the coutractors/subcontractors; and (4) a breakdown of the cost of the work. Please note that all costs claimed for the IAI need to be broken down and itemized. Many renovations include non-allowable costs which our staff will be unable to segregate if a complete breakdown is not submitted. If the TPU cannot determine which items are allowable, it could result in the entire IAI being found unacceptable, which, in turn, may lead to a finding that the rent is too high and further administrative or legal remedies. Please mail all documents back to the Tenant Protection Unit with a copy of this letter and a cover letter, at the address indicated above. You may also submit these documents to us electronically at the following email address: tpuiairesponse@nyshcr.org.

Luckily I keep very good records and had copies of everything. Additionally, because we also have a design/build business, I have accounting software that allows me to accurately track job costing. So, at least I was able to run a single report and see every cost that was applied to this renovation, grab check numbers, vendors, etc. Still, organizing everything for TPU was quite a pain and consumed many hours on the part of my assistant and me. We scanned every contract, bill, and credit card statement we had that pertained to the job. Then, since no one gets back cancelled checks per se, we create PDFs of all the bank statements that pertained to any checks that had been written and cross referenced them to a spreadsheet listing each expense. Though not requested, I sent some before and after photos as visual proof of the work done. I also had to write an affidavit giving a “detailed cost breakdown,” a list of all our contractors, etc. and get it notarized. The alternative to this is having your GC breakdown all the costs, but who is to say that he’d be able to do that in a manner that would be satisfying to TPU. Given that there are no real guidelines as to what’s expected in an itemized cost breakdown, it feels a bit like they are making this all up as they go along.

New bedroom finishes

That said, there certainly are some less than reputable characters out there in the multifamily ownership world who I’m sure are playing a little loose with the IAI increase rules. So, I understand the motivation behind what TPU is doing. However, I’m sure that such individuals would have little trouble creating a paper trail sufficient to get whatever legal rent they needed to get to. For people like us, who are doing the right thing, by the books, these audits are just one more regulatory burden to be subject to, one that doesn’t even prove that the actual work done matches the claimed dollars spent.

 

 

Rent Controlled vs. Rent Stabilized — Don’t Fear Rent Controlled Units

It’s funny. Those buying into the regulated multifamily market often fear rent controlled apartments as though they are dead units. A landlord might have a 30-unit building with a few rent controlled apartments, in many cases paying less than $250 per month, and treat those apartments as having a frozen rent until the passing of the typically elderly tenant. This is not true.

In one of my buildings in Washington Heights, the combined rent from our three rent controlled units, when we purchased the building, was approximately $750 per month. Incredible, huh? Now, about 10 years later, with the same tenants in place, our combined rent for these three units is over $2350. That’s equivalent to 12% annual rent growth without a vacancy. It also probably equates to a $200K increase in the value of the building.

How was this possible? Through a combination of MBRs and MCIs and fuel cost adjustments. For those not savvy with the acronyms of DHCR (Division of Housing and Community Renewal which I think has now been rebranded as HCR, Housing & Community Renewal), MBR stands for Maximum Base Rent and MCI stands for Major Capital Improvements. Underlying the MBR law is an understanding by New York State that a landlord can’t properly maintain a building/apartment if the rent never goes up. Under the law, there is a formula that establishes the maximum rent that can be charged on a rent controlled apartment as a result of the increases I’m about to describe (this is different from the actual rent being charged and generally much higher). And so, you can take advantage of MBRs and MCIs until you hit this maximum base rent. The dollar amount is specific to each particularly apartment and is determined by a rather convoluted process beyond the scope of this blog, however once established, it is registered with DHCR and continues to go up every year by a published adjustment (which is more inline with the annual rent control board increases well below the 7.5% figure described below). On our three units that I described earlier, our maximum base rents are all above $1100, so it will be years, if ever, before I ever risk hitting that ceiling.

MBR Increases
MBR increases are typically 7.5% per year. They are approved for a two-year cycle based on an application that must be submitted to DHCR. Many months after submitting your application, you get a Maximum Base Rent Order of Eligibility which gives you legal permission to charge the increases. We use an outside consulting firm to file for us as they have greater expertise than we do and their fee is well offset by my not having to do it myself. Plus, I only pay the fee once, a percentage of my rent increase in the year granted, but I get the benefit forever. The increase compounds over time, so using a firm to file ends up being a reasonable upfront cost. If your increase doesn’t get approved until after January of the first year of the two-year cycle (which is always the case since, like every NY/NYC agency, they are backed up), you can then charge the tenant retroactively for any missed increases. On year two of the cycle, you already have your approval in hand, so on January 1 of the 2nd year of the cycle you automatically can take your second 7.5% increase.

What else do you need to know? Your building has to be relatively clean, i.e. fairly free of HPD violations. In fact, you must be able to show that you’ve removed 100% of rent impairing violations (C violations) and at least 80% of the other prior year’s violations. You don’t, however, have to invite HPD in to inspect and clear them of record, though that is not a bad idea at some point. You can simply have a licensed architect write an affidavit that affirms that you have removed enough violations.

As an aside, I was at an RSA meeting this past week where I heard the horror story of a gentleman who had invested in regulated units within a co-op, where some tenants at time of conversion had remained as renters, which clearly was their right. This fellow owned at least one rent controlled unit in this co-op. However, he couldn’t get MBRs because the building had too many violations. He was in the unfortunate position of owning in a building with terrible management, who had no incentive to fix violations. As a result, the apartment owner’s rent was frozen, seemingly forever! I believe his monthly maintenance fee to the co-op now exceeds the rent he gets. I really felt for the guy. He’s in a terrible position. At least I learned the lesson to not own rent controlled units in a building that is controlled by someone else.

MCI Increases
State rent laws allow you to gain rent increases across all regulated apartments for a specific list of major capital improvements done to your building. These include new boiler, windows, doors, electrical, plumbing systems, roof, etc. I’ll leave the nuances of doing MCIs for a future blog, but the bottom line is that you are allowed to amortize your investment over 7 years, or 84 months. The expense gets spread across all your apartments based on the proportionate number of rooms in each apartment relative to the building. One restriction is that if you do a really big MCI you are restricted as to how much you can pass through as a rent increase in one single year in order to not slam the tenants to hard in a single year (though you can carry forward excess amounts and capture them in future years). On rent stabilized apartments that annual cap is 6% of the base rent of the unit. For rent controlled units, however, it is 15%! And realize that if you do a reasonably expensive improvement, and your rent controlled apartments have very low rents, it’s not that hard to reach this 15% level.

What does this mean? In those years where you have significant MCIs as well as file successfully for MBRs, you stand to get 22.5% increases on the rent in your rent controlled units. Not bad, huh?

You can add further to this by annually filing for Fuel Cost Adjustments. Unfortunately, these adjustments only look at increases going forward, so if you never filed before, you can’t get the benefit of all the cost increases in the last several years. Still, going forward, you at least know you will get a rent kick if your fuel costs go up. I’m not sure how effective this will be for us in the future, now that we are heating with gas, but with #2 oil, our fuel surcharges have been adding a good 15% to the rent of the tenants.

The bottom line is that, in many ways, a rent controlled unit in your multifamily building has better rent growth potential than a low priced rent stabilized unit. In fact, within a couple more years, in the building of ours I used as an example, we are going to see the rents in our rent controlled units exceed those of our lowest stabilized units. Though brokers will always pitch you about a building’s upside if rents are low, if they are too low, people never leave (unless they are open to an expensive buyout). Thus, if we look only at those units where the tenant is never going to leave, you stand to increase your rent roll faster with units that are rent controlled rather than with ones that are rent stabilized.