RSO Commission Recommends No Change in the Max Rent Increase

The Rent Stabilization Commission at its July meeting discussed a recommendation to City Council that could amend the rent stabilization ordinance to allow certain pass-through charges and make a potential adjustment to the way the maximum allowable annual rent increase is calculated. Commissioners agreed to recommend an 8% cap on the annual rent increase for all rent-stabilized households in Beverly Hills but deferred action on pass-throughs until August. It was another circuitous and frustrating discussion in the commission’s marathon effort to work though the fundamental concepts behind the rent stabilization ordinance.

Up for continued discussion were two concepts that together determine the amount that the rent is allowed to rise on an annual basis for rent-stabilized households: 1) the maximum percentage allowed and 2) the landlord’s costs of providing housing that may be passed-through to tenants on top of the monthly base rent. The commission first began to discuss these concepts at its regular monthly meeting back in April. With a break for June this is the third time back to the commission on these topics.

The 292-page staff report summarized the commission’s task:

Staff seeks recommendations from the Rent Stabilization Commission (Commission) to the City Council regarding possible amendments to the Rent Stabilization Ordinance (RSO) for both Chapter 5 and Chapter 6 of Title 4 of the Beverly Hills Municipal Code (BHMC) regarding surcharges that allow housing providers to pass through costs to tenants relating to water service penalties and/or surcharges, refuse fees, and for Chapter 5 tenants only, capital expenditures, improvement expenses mandated by law, including seismic retrofit, utility expense, and for additional tenants. Staff also seeks recommendations from the Commission to the City Council regarding possible amendments to Chapters 5 and 6 regarding the amount of the maximum allowable annual rent increases. — staff report p. 2-3

The percentage increase and pass-through components are regulated individually in the rent stabilization ordinance which is itself divided into two chapters: Chapter 5 regulates tenancies that originated at a rent of $600 or less, which are longtime tenants that comprise just a few percent of the city’s total 7,700 rent-stabilized tenancies; and Chapter 6 which covers the remainder of multifamily tenancies (except rented condominiums and units in a few post–1995 structures).

Rent Increase Percentage

The allowable percentage rent increase in the base rent is calculated differently for Chapter 5 and Chapter 6 tenants though in both cases the allowed annual increase reflects the full annual change in consumer costs in our region.

The allowable annual rent increase for Chapter 6 tenants is the same percentage as the annual May-to-may percentage change in consumer prices (CPI) for our region, which is otherwise known as 100% of CPI. If inflation is measured at 5% by CPI in May then the Chapter 6 rent increase can be as much as 5%. The maximum rent increase for Chapter 6 is updated annually and posted online each July by the Rent Stabilization Office.

A related issue is the band within which the Chapter 6 annual rent increase percentage can fluctuate. There is a floor of 3% for the Chapter 6 rent increase so when inflation is zero the landlord can still demand a 3% rent increase. Yet because the ordinance imposes no ceiling, the percentage can rise with inflation to a maximum of 10% (limited by the state’s Tenant Protection Act).

In contrast, the allowable annual rent increase for Chapter 5 is calculated monthly using a complicated formula described in rent stabilization ordinance section 4–5–303(A). The formula is intended to moderate cyclical changes in CPI but, like Chapter 6, it is still 100% of CPI. Over the long run the landlord can  still demand rent increases more or less equal to the percentage rise in inflation.

Unlike Chapter 6, the Chapter 5 rent increase has no floor — meaning the percentage can follow inflation down to zero (better for these longtime tenants) and it it is capped at 8% (better still). That 8% cap is a ceiling that, in times of high inflation, protects tenants from high inflation.

By revisiting how the Chapter 5 and Chapter 6 rent increases are calculated, the commission had an opportunity to harmonize these two different methods of calculating the percentage and perhaps rethink whether 100% of CPI (a rent increase equal to inflation) is prudent. Notably West Hollywood, Santa Monica, and other rent-control jurisdictions allow an annual increase of less than 100% of CPI because 100% of CPI is an unnecessary enrichment. Landlords, these cities have said, can earn their right of fair return on less.

Commissioner Lou Milkowski advocated for an amendment to limit the allowed rent increase for all rent-stabilized tenants to 75% of CPI. That was the best recommendation we heard all evening.

Lou Milkowsky at Rent Stabilization Commission 2022-7-6
At-large commissioner Lou Milkowski suggests the commission consider an annual rent increase limited to 75% of CPI — the percentage used in Santa Monica and West Hollywood.

After adamant resistance from the two landlord commissioners, Frances Miller and Neal Baseman, the Rent Stabilization Commission decided not to make any change in the formulae used to calculate the increase. The commissioner kept to 100% of CPI (as exists in the ordinance today) but fumbled into a recommendation to extend the 8% cap in Chapter 5 to all rent-stabilized households — a modest but reasonable recommendation that will benefit tenants when inflation is sky-high.

Frances Miller at Rent Stabilization Commission 2022-7-6
Landlord commissioner Frances Miller holds the line against anything that looks like “radical” Santa Monica. “Why do we always punitize the landlord?”

However the discussion showed that some commissioners were still a bit shaky in their grasp of the rent stabilization ordinance and how the rent increase is currently calculated. Check out the video of the commission meeting under the leadership of at-large commissioner Donna Tryfman.

In the discussion there emerged some confusion between the 8% cap and the hypothetical 8% rent increase that would have been allowed for Chapter 6 tenants in July due to high inflation. The discussion got off-track and if you were following at home you will be forgiven for loosing the plot. To address that possible confusion we recently posted a clarification: Confusion Persists About the Maximum Allowable Annual Rent Increase.

Pass-Through Charges

The other item on the July 6th agenda for the Rent Stabilization Commission was a consideration of pass-through charges. That issue was described in the staff report:

…surcharges allow housing providers to pass through costs to tenants relating to water service penalties and/or surcharges, refuse fees, and for Chapter 5 tenants only, capital expenditures, improvement expenses mandated by law, including seismic retrofit, utility expense, and for additional tenants….

Chapter 6 tenants can pay with a monthly surcharge 90% of the water service penalties paid by the landlord and 100% of the cost of refuse that is paid by the landlord. (The refuse charge must be allowed to be passed-through by the rental agreement. Read more: How Much Can My Landlord Bill Me for Trash Pickup?)

Chapter 5 pass-through charges have been added by City Council over the years to additionally include:

  • Capital expenditures annualized in accordance with IRS depreciation schedules at a rate no greater than 4% of the base rent;
  • The cost of improvements mandated by law (including seismic retrofit) as annualized according to IRS depreciation schedules plus the cost of the landlord’s interest on capital (up to 18% annualized);
  • The difference between the percentage increase in “basic and essential utility” costs, including electricity, gas, or water, and the allowed percentage rent increase — such as when utility costs rise faster than the rent is allowed to rise; and,
  • A surcharge of 10% of the base rent when the landlord permits an additional tenant to occupy the premises.

These surcharges are codified in Chapter 5 sections 4–5–304 to 4–5–309 and Chapter 6 sections 4–6–7 and 4–6–8 of the rent stabilization ordinance.

Pass-through charges can be an important determinant of overall housing costs because they are added to the base rent. For example, if the landlord is able to pass through a charge for refuse, then a Chapter 5 or 6 household would pay an additional $40.36 monthly. Chapter 5 households can shoulder the landlord’s seismic retrofit cost. For the average 6-unit apartment building that could add about $70 per month over a 7-year period.

Again, pass-throughs are a component of housing cost but are regulated separately from the maximum allowable annual rent increase. Since the Rent Stabilization Commission is not recommending any change in the formulae for calculating the rent increase, the pass-through will be discussed as a standalone issue in August. Find the agenda posted online the Friday before.

Our Take

Nearly fifty years ago City Council chose a formula for determining the Chapter 5 rent increase percentage that was complicated and nearly impossible for most tenants to verify. The percentage was posted each month and, over the decades, Chapter 5 tenants paid annual rent increases based on the percentage available for the month in which the rent was raised. We plugged those historical percentages into a spreadsheet with the government’s CPI data and found that the posted percentages were incorrect: it seems like the city had been improperly applying the formula for decades.

In the big picture it suggested the need to revisit the whole concept: the formulas the city used to calculate annual rent increases and even the precept of allowing a rent increase equal to inflation.

The key legal concept is ‘fair return’: the landlord’s right to earn a profit on rental operations so that he can continue to operate. What contributes to a landlord’s fair return has been adjudicated by the courts. It includes rents, ancillary income, tax advantages and even appreciation of the underlying land; from it one subtracts operating expenses and related costs but not the cost of the mortgage financing. Many rent-control cities have assessed these factors and determined what magnitude of rent increase would contribute to fair return…but not Beverly Hills.

The Rent Stabilization Commission has passed up an opportunity to dig into this key concept and, more specifically, to discuss the important relationship between the rate of inflation and the maximum allowable annual rent increase as established by the city. Instead the commission only punted by recommending a uniform 8% cap on the annual rent increase (and left the rest unchanged).

Up next the commission will discuss potential changes to the allowed pass-through charges for Chapter 5 and Chapter 6 tenants. Based on prior discussions going back to April, we don’t have high hopes for a thorough and reasoned analysis; instead we expect a poorly-informed discussion and seat-of-the-pants reasoning. However well-intentioned the commissioners, we will wind up with a box checked rather than a thoughtfully-considered recommendation. And that won’t inform City Council’s eventual discussion which was the key task for this commission.

Additional Reading

Rent Stabilization Commission staff report (2022-7-6)

Rent Stabilization Commission meeting video (July 6, 2022)

Chapter 5 rent stabilization ordinance maximum rent increase (subsection 4-5-303)

Chapter 6 rent stabilization ordinance maximum rent increase (subsection 4-6-3)