City Council recently discussed the maximum allowed annual rent increase and the good news is that we are keeping it indexed to consumer prices (CPI). A real win for tenants: inflation dictates the increase. The not-so-good news is that Council may agree to a 3.5% floor on the increase. That would give landlords an extra half-percent above the 3% floor today in low-inflation years. Why does Beverly Hills need a floor on the allowed increase at all?
The Federal Reserve Bank of New York recently forecast a 1-in-6 chance of a US recession by November of 2019. The Cleveland Fed calculated the probability at 1-in-4 by that December. These are uncomfortably short odds for tenants concerned about paying the rent. Downward pressure on wages makes things especially dicey in our hot market for rental housing because the current rent stabilization ordinance allows a 3% floor on the maximum allowable annual rent increase.
When inflation pushes wages and consumer prices down, to between 1% and 2% recently, the 3% floor allows the landlord more headroom to raise rents. Council’s recent discussion about raising that floor to 3.5% suggested the need to explain why that is even worse for tenants: it simply pads the landlord’s operating profit at a time when tenants can least afford it.
Some Background on the Rent Increase
There are two components to the maximum allowed annual rent increase: the percentage allowed in any year however it may be calculated; and the range within which the allowed rate of increase is able to fluctuate. The way the increase is calculated varies for Chapter 5 and Chapter 6, and so does the range in which they fluctuate. It’s complicated!
Chapter 6 rent increases under the old system were limited to a maximum of 10% and not limited by a range; it was a fixed percentage. Chapter 5 rent increases, in contrast, were always indexed to consumer prices and recalculated monthly according to an arcane formula (and not always correctly). There was a ceiling of 8% so it couldn’t rise higher but no floor. The maximum increase could then float downward with low inflation.
The approach changed with the RSO changes starting in January of 2017. Today Chapter 6 is indexed at 100% of CPI like Chapter 5. They are still calculated differently, though, and moreover Chapter 5 still has that ceiling of 8% whereas Chapter 6 tenants have no ceiling; the allowed increase will float upward with inflation. However Chapter 6 tenants have a floor on the increase. As the Municipal Code section 4-6-3 (B) says,
Such increases shall not exceed the greater of: 1) three percent (3%) of the rental rate then in effect, or 2) the percentage equal to the percentage increase, if any, of the Consumer Price Index...
That means when consumer prices change at a rate below 3%, that “greater of” clause kicks in to keep the allowable maximum rent increase at 3%. As the chart at the top shows, over time that 3% floor really adds up when compared to an allowed increase at the same rate-of-change as CPI.
What Did City Council Talk About?
When City Council discussed the allowed increase again at the November 20th study session, there was some debate about the fluctuation range. While still pegged to 100% of CPI (despite our pleas to make it 80% of CPI), should it be allowed to range between 3% and 7% — or between 4% and 8%? Vice-Mayor John Mirisch and Councilmember Lili Bosse both wanted the 3-to–7 percent range while Mayor Julian Gold and Councilmember Bob Wunderlich wanted a higher range of 4-to–8 percent.
Councilmembers spent exactly three minutes discussing this important aspect of the rent increase! A solution was offered by Councilmember Les Friedman: “Like Solomon: 3.5% to 7.5%.” Councilmember Wunderlich agreed: “Split the baby.”
Had councilmembers spent an extra minute to discuss it they would have realized that splitting the baby will disadvantage Chapter 6 tenants especially in times of low inflation. That is because the ‘compromise’ range would establish a new floor of 3.5% (instead of today’s floor of 3%) that, over time, will push the rent significantly higher should the landlord reach for the maximum increase each year.
Because a 4% maximum was also on the table, the 3.5% – 7.5% range was sold as a compromise. The purported tenant benefit is the 7.5% ceiling (down from 8% in the 4%-8% range). The theory is that the 7.5% ceiling is a half-percent lower for tenants, so that when inflation is high, the ceiling kicks in. No increase will exceed 7.5%.
But that purported tenant benefit is a fiction. We haven’t seen inflation that high in three decades! However we have seen a lot of low inflation. In reality the 7.5% (lower) ceiling may never kick-in while the 3.5% (higher) floor often will kick in.
Just look at how a 3% floor can push rents up beyond the change in consumer prices in the hypothetical example at the top. In that chart, the past ten years of actual CPI were projected ten years into the future. And boy did the 3% floor drive up that hypothetical rent!
The 3.5% floor is a half-percent giveaway above what we have today. It’s a false compromise.
The maximum allowed annual increase has been central in the concerns of tenants throughout the rent stabilization policy process. That is because it is the key to sustainability. Seniors know that because they see their fixed-incomes lagging behind the change in rent. Families with children know that because they pay among the highest rents for larger apartments. The percentage increase on a high rent amounts to a very significant jump. Indeed all tenants should be concerned with the maximum allowed annual increase precisely because it compounds year-over-year unlike earnings. A higher floor can only harm us.
The best way to address the rent burden or affordability gap is to follow the lead of our municipal neighbors and set that allowed increase at 80% or less of CPI. City Council has a chance to do that on December 18th. Contact City Council and let them know.