City Has Been Incorrectly Calculating Chapter 5 Increases

A couple of months ago we got to thinking about how Beverly Hills calculates the maximum allowable annual rent increase for Chapter 5 tenants. It kept increases very low for many years; some years it dipped below 1%. Then in a reviving economy it jumped to 1.7% and now will double again to 3.3% for August. What’s going on with the Chapter 5 increase?

As the city’s website explains, Chapter 5 rent stabilization was enacted in 1979 for tenancies established at a rent of $600 or less per month. For those tenancies, which represent 3% of all renting households today, the rent stabilization ordinance capped the maximum allowed annual rent increase at 100% of the annual change in consumer prices for our region.

Low inflation for decades kept the allowed rent increase for Chapter 5 low. Sometimes it was less than 1% per year.

At the same time, Chapter 6 rent stabilization enacted in 1985 allowed a 10% annual rent increase for all other households in rental housing. Over time the two-tier rent stabilization led to a great disparity in rents paid by Chapter 5 and Chapter 6 households. These are the figures for average Chapter 5 and Chapter 6 rents according to the rental unit registry.

Unit size Chapter 5
average rent
Chapter 6
average rent
Disparity
Studio $612.39 $1,389.68 127%
1-BR $970.69 $1,934.18 99%
2-BR $1,129.11 $2,795.84 148%
3-BR $1,665.33 $3,872.18 133%

That’s quite a difference! Chapter 6 tenants may be interested to know that on average across all unit sizes they are paying more than double the rent paid by their Chapter 5 neighbors. That’s the legacy of a two-tiered rent stabilization system!

Looking More Closely at the Chapter 5 Rent Increase

The very low rents paid by Chapter 5 tenants got us thinking: exactly how is the Chapter 5 increase calculated? That’s no secret: the formula for calculating the Chapter 5 maximum allowed annual rent increase is contained in the rent stabilization ordinance itself. Fundamentally it ties the allowed percentage to the annual change in consumer prices (CPI). If consumer prices rise 3% year-over-year, the Chapter 5 allowed increase should also increase that much because it is indexed to 100% of the CPI.

Of course it’s not so straightforward as that. The Chapter 5 increase is not calculated annually (like Chapter 6) but is recalculated each month. For reference:

The proper method for computing such an increase in the CPI shall be as follows: The latest published CPI figure shall be added along with such figures for the preceding eleven (11) individual months, and, from the sum reached, there shall be deducted the sum of such figures for the twelve (12) months further preceding the last such twelve (12) months. That remainder shall then be divided by the lower of the two (2) sums heretofore mentioned, and the resulting figure shall indicate the permissible maximum percentage by which the base rent may be increased by virtue of the rise in the CPI. — Municipal Code § 5–5–303

The city’s rent stabilization program website posts the allowed Chapter 5 rent increase in a sidebar. Today the sidebar shows that landlords can increase Chapter 5 tenants by 3.3% (if they have not been increased in the prior 12 months).

Because the CPI is calculated monthly, it represents the latest change in consumer prices for our region according to the Bureau of Labor Statistics. But the magnitude of the current Chapter 5 rent increase will be a surprise to households who have grown accustomed to much more moderate increases. Many years those households saw an increase of about 1%-1.5%.

The 3.3% jump for August was a surprise to Renters Alliance too. After all consumer prices certainly did not double from one month to the next. But the allowed Chapter 5 increase did double. What gives?

We got to wondering about how the Chapter 5 increase is calculated, and how it has been calculated over time. So we fetched the relevant historical consumer price data from the Bureau of Labor Statistics and plugged it into the city’s formula.

We expected to generate the same allowed Chapter 5 rent increase as posted by the city and calculated monthly. But we could not replicate the city’s figures. Here is what our analysis showed.

CPI Formula % Posted %
2017 Jan 252.373 1.8% 1%
2017 Feb 253.815 1.8% 1%
2017 Mar 254.525 1.9% 1%
2017 Apr 254.971 2.0% 1%
2017 May 255.674 2.1% 1%
2017 Jun 255.275 2.1% 1%
2017 Jul 256.023 2.2% 1%
2017 Aug 256.739 2.3% 1%
2017 Sep 257.890 2.4% 1%
2017 Oct 258.883 2.5% 1%
2017 Nov 259.135 2.7% 1%
2017 Dec 259.220 2.8% 1.6%
2018 Jan 261.235 2.9% 1.7%
2018 Feb 263.012 3.0% 1.7%
2018 Mar 264.158 3.1% 1.8%
2018 Apr 265.095 3.2% 1.7%
2018 May 266.148 3.3% 1.7%
2018 Jun 265.522 3.5% 1.7%
2018 Jul 266.007 3.6% 1.7%

Why were posted allowed annual increases trailing the actual output from the formula? We double-checked the correct historical price data and double-checked the formula in the spreadsheet. Consistently it produced percentages that did not match the city’s posted figures.

We reached out to the city to ask: Were we doing it wrong? Weeks passed yet we heard nothing back. Crickets!

Then just yesterday we returned to the sidebar to check for the latest monthly increase percentage and saw that much-higher August 3.3% figure with a note: ‘revised.’ We also saw that the table of allowed Chapter 5 rent increases long posted (included in the right hand column) was now gone. (We had a screenshot.)

It appears that the city has been calculating Chapter 5 allowed annual rent increase percentages incorrectly and is now changing tack!

We surmise the confusion over the calculation goes back to the original formula. It was complex and unorthodox and clearly posed a challenge for whomever set up the mechanism to calculate the Chapter 5 rent increase.

Why the Complex Formula?

The original rent stabilization ordinance adopted in 1979 specified only a rent increase cap tied directly to CPI. There was no complex formula. Something was needed, though, and that could have said simply: “By the same percentage change as the consumer price index for our region.”

Instead we have a complex formula. Digging through dozens of rent stabilization ordinances and resolutions over the past decades shows an ordinance adopted in 1980 to incorporate the current formula into the rent stabilization ordinance.

City Council used an urgency ordinance which took immediate effect. This is what the preamble says as it refers back to the original 1979 ordinance:

WHEREAS, subsequent administration and interpretation of [ordinance No. 79-O–1731] has revealed that certain provisions therein require modification and clarification in order to eliminate confusion in the minds of many people affected by the ordinance, and to reflect the true intent of the Council, and to bring about a just and equitable application of the ordinance

That  “just and equitable application of the ordinance” phrasing could be a clue the landlords wanted a formula that would generate a greater return than simply CPI. And to be sure, the monthly recalculation of the allowed annual increase was probably intended to keep up with fast-increasing inflation in the 1970s.

If the allowed increase percentage was calculated annually, and the landlord wanted to increase the rent but it wasn’t yet time for the recalculation, he would be allowed an increase that reflected last year’s change in costs.

But it wasn’t the monthly recalculation (unusual for rent control cities) that caught our eye. It was a twist in the formula. Here it is with our emphasis:

The proper method for computing such an increase in the CPI shall be as follows: The latest published CPI figure shall be added along with such figures for the preceding eleven (11) individual months, and, from the sum reached, there shall be deducted the sum of such figures for the twelve (12) months further preceding the last such twelve (12) months. That remainder shall then be divided by the lower of the two (2) sums heretofore mentioned, and the resulting figure shall indicate the permissible maximum percentage by which the base rent may be increased by virtue of the rise in the CPI.

It makes no sense that a rent increase formula would incorporate a condition that changes the denominator in the division operation. The formula should calculate the change in CPI from the base period and that means using the base period as the denominator.

As the formula has it, the base period is not used as the denominator during a time of deflation. In that instance it is not the lower figure for the denominator because prices have since decreased.

Take this case from early 2019 which was a period of positive inflation. The sum of 12 months worth of change in the consumer price index (let’s call it the aggregate CPI) for the current period will exceed the sum of 12 month’s worth of CPI for the preceding 12-month period. (That makes sense because prices are rising and the later period will show higher values.)

To calculate the percentage change in consumer prices, according to the formula, the difference in aggregate CPI between the current period and the preceding period is then divided by the preceding period. Again, that is the base on which change is measured. Here are figures from January 2018 as an example.

Latest 12-month
aggregate CPI
Preceding 12-month
aggregate CPI
Difference Percentage
change
3083.385 2996.171 87.214 2.91%

The percentage change is properly calculated as:

 (3083.385-2996.171)/2996.717 = .0291

That month the Chapter 5 rent increase should have been 2.91%. (The actual posted incorrect figure was 1.7% however.) The point is that the preceding period’s aggregate CPI figure would always be the denominator in calculating the change in CPI because it has to be: we are measuring a percentage change from that base period!

What happens when prices decline? The denominator gets swapped out.

The second key point to make about the rent stabilization ordinance is that it does not anticipate any rent reduction. Take for example CPI for December 2009, a post-crisis period that saw a decline in consumer prices.

Latest 12-month
aggregate CPI
Preceding 12-month
aggregate CPI
Difference Percentage
change
2678.622 2700.091 -21.47 -.80%

The percentage change under the formula is calculated as:

 (2678.622-2700.091)/2700.091 = -.0008

Now, swapping the denominator has little effect because the year-over-year change is so small. The larger point is that the formula indicates a rent decrease: minus .08%. Yet the ordinance does not anticipate any rent decrease: “…the resulting figure shall indicate the permissible maximum percentage by which the base rent may be increased…”

Neither the formula nor the ordinance includes no provision to, say, establish zero percent as the allowed increase in deflationary times or set the rent increase floor at 1% or 2% when CPI is zero or less.

So what did the city do in those deflationary years? We don’t know because we don’t have historic Chapter 5 percentages. No doubt mistakes were made!