Real Estate Leaders React to Rent Reform Blow

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A day of reckoning has arrived.

SEE ALSO: Real Estate Groups to File Lawsuit If Rent Reform Passes

On Tuesday night, the Democrat-controlled New York State legislature reached a deal on a drastic rent reform package, which was passed by the senate this afternoon. Governor Cuomo committed to signing it Wednesday and is expected to do so before the week is over. 

The legislation contains most of the changes that tenant advocates and progressive politicians have been clamoring for—and that the real estate industry dreads.

The legislation was designed to dramatically reduce the number of units that were leaving the rent-regulated system, by abolishing or limiting vacancy decontrol, vacancy bonuses, high-income decontrol and preferential rents, among a swath of additional tenant protections. It also extends the protections to other counties that choose to opt in and are facing a housing emergency.

It was, in no uncertain terms, a defeat for the real estate industry, the latest since the Democrats took control of both state houses in November. It demonstrated the loss of the industry’s decades-long influence in Albany.

“I have to sneak through the halls of the capital,” said Scott Rechler, CEO of RXR Realty and a former board member for the Metropolitan Transit Authority. Legislators, wary of being seen with a real estate executive, would only meet him after office hours, he said during a Commercial Observer event earlier this week.

Real estate players have indicated that they’re ready for a fight and are prepared to sue the state if the legislation is signed into law. “The industry is prepared to file a lawsuit as early as Monday challenging provisions of the legislation, if it were to pass,” an industry representative told Commercial Observer.

It’s a “bugle call” for the industry, Rechler said, and time for its leaders to step up. “Historically, the real estate industry were the leaders that helped our city navigate these challenges,” he lamented. “Now, rather than being seen as leaders we’re being seen as villains.”

Like Rechler, many industry leaders believe that the reforms are not only bad for the industry, but for the city.

John Banks, the president of the Real Estate Board of New York, the industry’s lobbying organization, did not hold back. “The legislation put forward [on Tuesday] will be a disaster for the city’s future,” he said in a prepared statement. “The governor and the legislature are consigning hundreds of thousands of tenants to buildings that [will] soon fall into disrepair,” he predicted.

“If we continue to make this a hostile environment for people who want to be here now, that’s not going to end well,” said Steve Meringoff, managing partner at Himmel + Meringoff Properties during a panel at CO’s Midtown Forum Wednesday.

“My biggest concern about the risk real estate faces—our political risk—is if we have single party government in 2020,” said Tommy Craig, senior managing director at Hines. “[If] it is elected on a platform of addressing income inequality and breaking up big tech, it will have very adverse consequences on New York City.”

The reform package was designed to alter what tenant advocates felt was a system tilted in favor of landlords, and to stem the depletion of the city’s regulated housing stock. Since 1993, when the Rent Regulation Reform Act (passed by a Republican-controlled legislature) instituted several ways in which units can be deregulated, the city lost a total of 290,958 units, according to the 2018 annual report from the city’s Rent Guidelines Board. With the addition of roughly 143,000 new units during the same time, the net loss to the city is around 147,000 units, for a current count of 966,000 rent-regulated apartments, according to the report.

Two of the headline items in the package were the elimination of vacancy bonuses and vacancy decontrol. The former allows landlords to increase rent by 20 percent when a rent-stabilized unit is vacated, and the latter deregulates a unit that exceeds a certain rent threshold (currently $2,775) once it is vacated. Tenant advocates have long claimed that both incentivize owners to push rents up and push tenants out.

“Under the law as it is currently, landlords get a huge windfall if they can remove tenants from apartments,” said Ellen Davidson, a lawyer with the Legal Aid Society, one of the advocacy groups that supported the reforms. “Addressing [vacancy decontrol] will end the incentive for landlords to harass their tenants out of their homes.”

Another set of rules targeted two programs that allos landlords to raise rents above the yearly threshold set by the Rent Guidelines Board in exchange for improvements to the property, known as individual apartment improvements (IAIs) and major capital improvements (MCIs). The new rules severely limit both, but fall short of banning them, which is what many tenant advocates hoped for.

Under current law, landlords can increase rent in a regulated apartment after making physical improvements, by 2.5 percent or 1.67 percent of the costs of the improvements. The new rules would make the increases temporary, reversing a 1993-rule that landlords and tenant advocates battled over for a decade, and caps the total IAI spend to $15,000 over 15 years. As for MCIs, the new rules allow landlords to increase rents by 2 percent each year to pay for major building-wide improvements, down from 6 percent previously.

While MCIs require review from the state’s Division of Housing and Community Renewal, IAIs have no review process or oversight of any kind. IAIs especially can drastically drive up rents, which not only makes units less affordable, but also pushes apartments closer to the threshold where they are deregulated. In the last decade, there have been many cases alleging fraud in both programs, in which landlords claim inflated costs that are then passed on to tenants.

Because of frequent abuse of the program, everyone agrees that they need to be adjusted, but real estate critics say the proposed legislation will disincentivize owners from investing in their properties beyond what’s required. That will affect tenants as well as the contractors who carry out the work.

“I understand that [the legislators] are protecting the average renter and the average citizen, but they also need to understand that they just harmed a whole swath of the working class, who have been fixing floors, redoing plumbing, rebuilding kitchens,” said Darcy Stacom, a commercial broker with CBRE.

“I don’t want our city to get really old and decrepit, so that the young people don’t want to be here and then the corporations don’t want to be here,” she added.

Tenant advocates have countered that the returns to landlords for improvements were far beyond what they invested, and that the profit margins for rent-stabilized buildings are healthy enough without being supplemented by rent increases. In fact, net operating income has increased every year since 2004, with income growth outpacing the increase in costs, according to the Rent Guidelines Board’s annual report, released in April.

Don Peebles, a developer and founder of The Peebles Corporation, said the rules would impact the real estate industry, but there would be no doomsday scenario as some players depicted. “There’s still money to be made in real estate,” he said. “They’ll just have to be more creative and work harder.”

In addition to the measures already listed, the legislation also addresses a wide array of tenant protections including limiting security deposits, making unlawful eviction a crime and tightening rules around converting stabilized units to condos or co-ops.

From the industry’s perspective, the legislation will not only disincentivize owners to improve the existing housing stock, it will stifle construction of additional affordable units. “We are deeply concerned about exacerbating the affordability crisis in the future if developers have no financial incentive to produce more affordable units for our growing population,” said Banks.

It is clear that something needs to change if the real estate industry wants to regain its foothold in Albany. The emboldened Democrats are likely to continue their push for reforms that are less business-friendly than their Republican counterparts. Already on the docket is a bill that would drastically increase the number of developments subject to the prevailing wage requirement, by redefining public works as any project that receives public funding, including tax subsidies.

Peebles said the progressive wave that brought the Democrats to power is in part a backlash to the wealth and income inequality in the city, an issue in which the real estate industry has been complicit. “The industry does not provide an environment of upward mobility,” Peebles said. “Unless they become more inclusive, this business model is unsustainable.”

The sense of urgency has pompted industry leaders to call for action from the real estate community.

“More than one person in REBNY has talked about real estate being under an existential threat,” said Meringoff during the CO event. “The music won’t go on forever. Take the opportunity to be active politically,” he urged the crowd.

RXR’s Rechler said that REBNY, the industry’s leading advocacy group, will have to adjust to the new reality. “REBNY is going to have to come out of this and, as an industry, take a look and say, ‘Okay, what did we do right? What did we do wrong? There’s a new playing field. How do we adapt our playbook for that new playing field and make sure that that REBNY as our leading industry advocacy group is positioned to do that?’”

Peebles had a word of advice for them on how to accomplish that. “REBNY ought to be a part of the solution to making the city cleaner and more attractive,” he said. “REBNY’s dollars would be better deployed by encouraging our elected officials to do their job and not just elect people that will carry their water on regulatory issues.”