Rent Stabilization Commission Warms to Pass-Through Surcharges

October 3, 2022July 5, 2024 Mark Elliot pass-through, Rent Stabilization Commission

The Beverly Hills Rent Stabilization Commission at the September meeting indicated that it may recommend landlords be allowed to pass-through to tenants certain costs of doing business in addition to the rent. Commissioners seemed inclined to OK some or all of the bill for city-mandated seismic retrofit, for example, which could add $60-$120 per month to the rent. Pass-throughs could include other capital improvements like the cost of a new roof. And that’s on top of the cost of utilities that many tenants pay. To what extent should pass-throughs be allowed — and should the cumulative cost of pass-throughs be capped?

Background

Several years ago City Council tasked the Rent Stabilization Commission with recommending possible amendments to the city’s rent stabilization ordinance. The commission was proposed to mediate tenant-landlord disputes but instead City Council simply handed this new commission the council’s in-basket: lots of unfinished business around rent stabilization. That includes the relocation fee, the maximum allowable annual rent increase for rent-stabilized tenants, and pass-throughs (among other issues). All await a commission recommendation to City Council.

Since April the commission has been discussing pass-throughs. On the agenda for October is a consideration of pass-throughs. Today two pass-throughs affect most Chapter 6 rent stabilization tenants: the landlord’s cost for refuse collection and city-issued water penalties (if imposed). Chapter 5 rent stabilization tenants (only a couple of hundred households under also can pay additional surcharges to reflect the cost of capital improvements, like a roof, as well as the differential between the percentage rent annual increase and the actual rate of increase of essential utilities. Yes, it is complicated!

For Chapter 5 tenants the greatest concern is a surcharge for a capital improvement and an improvement mandated by law. The latter encompasses the cost of seismic retrofit which is mandated by the city. City Council has indicated some interest to pass the cost of retrofit to all tenants (and landlords agree!) and that’s why pass-throughs are topping the commission’s agenda now.

The question for the Rent Stabilization Commission is what to recommend to City Council on pass-throughs. Should pass-throughs be made uniform for all rent-stabilized tenants — which would expand the pass-throughs that can be paid by most households? Should there continue to be different restrict pass-throughs for Chapter 5 and Chapter 6 households? Should there be a cap on the cumulative total monthly surcharge for pass-through(s)?

The question of pass-throughs is especially important now because rent-stabilized households are likely to see higher allowed rent increases in coming years. Add one or more potential surcharges and the monthly cost of housing can increase by as much as 10% over that cost today.

Recommendation for Seismic Retrofit Pass-Through Looks Likely

City Hall seems to want the commission to recommend that the city allow landlords to pass-through some of all of their expense for seismic retrofit. In 2018 Council mandated retrofit for ‘soft story’ residential buildings that are more vulnerable to collapse in an earthquake (soft-story buildings feature dwellings situated above open parking). Shortly afterward, Council in a quick poll agreed on a pass-through but no formal action was taken. Four years later, much of that work is completed and landlords want to share the cost. So now it’s on the commission’s agenda.

The commission already discussed the seismic retrofit pass-through at some length in August and September; tentatively commissioners agreed that tenants should share at least half of the cost. Their rationale was twofold: this is an expense for an improvement mandated by the city and it is only ‘fair’ that renting households share the cost; and landlords are enduring some hardship while tenants can afford to pay their fair share.

“If we want buildings that are safe, and buildings that are up to present day standards, then this is important,” Commission chair Donna Tryfman said in September. “This is legally mandated…it’s got a deadline…it’s necessary and it will benefit both the landlord and tenant.” Tryfman was appointed as an at-large representative and in theory she is neutral, however in her time on the commission has tended to take the landlords’ perspective.

Landlords of course are eager to pass-through the retrofit expense to tenants. Landlord commissioner Remmie Maden pointed to commission support for a retrofit pass-through in September. “Last time there was some degree of comfort with the pass-through…the issue was whether there should be a 50–50 split.” That prior month commissioners were broadly receptive to a ‘fairness’ argument; and they agreed that tenants should share the cost because they benefit. (Read more about the commission’s discussion: RSO Commission Recommends a ‘Seismic’ Pass-Through to Tenants.)

No formal vote was taken in August about the retrofit pass-through. In September, landlords were pressing on for the win.

Maden said that longtime tenants pay lower rents and many have not paid a rent increase since the start of the pandemic anyway. “Those rents would not cover the [seismic] expenditure,” she said.

Neal Baseman, another landlord representative on this commission, agreed. “It seems fair to share the cost with the tenants on a 50/50 basis because the tenant is benefitting.” Compared to other possible pass-throughs, he said, “This is an easy one.”

Landlords are appointed to represent landlord interests, however Commissioner Basement didn’t mention that has a horse in this race. In fact he has two horses: his family owns two rental properties in the city and each is undergoing seismic retrofit. According to city permits the total estimated cost is $110,000.

At that valuation, Baseman’s renting households would pay roughly half of the cost were the commission’s preliminary recommendation supported by Council. His tenants might pay about $25 additional each month over ten years; tenants at other retrofit properties could pay much more. It depends on the percentage cost-share (50–50 or 100% of the cost), the size of the retrofit bill, and the number of units at the property over which the cost is allocated. On average, city estimates say, tenants at a retrofit property would expect to pay an additional $62.50 monthly if the tenant cost-share was 50%.

Culver City Model

Rent Stabilization commissioners in the past have looked to Culver City for a model for Beverly Hills. Landlord commissioner Frances Miller characterizes it as the most ‘modern’ because Culver City enacted rent control only in the last couple of years. But that is because Culver City rent control is much weaker tea than long-established rent control programs in West Hollywood and Santa Monica. She calls those programs as too radical.

The difference in approaches is very significant to tenants: Culver City passes-through more of the costs, allows a higher annual rent increase relative to inflation, and affords fewer tenant protections. Culver City also has a relatively weak rent board. It is a model that landlords tend to favor.

Landlords have largely limited their scope to Culver City. The September staff report for example highlighted the key aspects of Culver City’s seismic retrofit pass-through to the exclusion of other city approaches. Culver City includes retrofit in the city’s broader allowance for passing-through all costs related to capital improvements which includes:

50% of the expense can be passed-through through as a monthly surcharge prorated on a square-foot basis and amortized over a period determined by the city;
A tenant may appeal the surcharge (the appeal is heard by a hearing officer);
Low-income tenants may petition for an exemption if they demonstrate economic hardship;
The cumulative cost of all surcharges (including seismic retrofit) may not exceed 3% of the base rent and if they do then the payback period is extended; and,
The surcharge terminates when the unit is vacated.

Culver City hasn’t yet finalized pass-through guidelines and thus it seems premature to use it as a model for Beverly Hills. But landlord and at-large commissioners weren’t dissuaded. What wasn’t discussed is why West Hollywood and Santa Monica chose to allow none of the retrofit cost to be passed through to tenants.

Tenant-alternate Commissioner Kandace Lindsey-Cerqueira asked at the September meeting why only look at Culver City.

“We honed-in on Culver City because the commission’s discussion centered on the Culver City model,” replied Helen Morales, deputy director of the rent stabilization division.

Looking over our notes and the meeting video, we found no discussion by the commission about West Hollywood or Santa Monica much less why exactly those cities decided that landlords could afford to retrofit their properties. If they suffer hardship it is the landlord that must demonstrate need in order to pass through the cost. The commission would put the burden on to tenants to demonstrate hardship if they can’t pay.

Defining Low-Income to the Disadvantage of Tenants

Culver City exempts low-income households from the pass-through. But what does that mean exactly? We don’t know because Culver City has not yet published eligibility guidelines. The staff report to our commission in September noted that Culver City uses federal Housing and Urban Development (HUD) guidelines to establish low-income eligibility which is generally defined as below 80% of area median income (a threshold that will be familiar to tenants who have filed a county moratorium declaration).

But some landlord commissioners weren’t buying the accepted definition for low-income. Commissioner Maden for example asked if that includes assets. “During COVID we had people who applied for financial relief but they had a significant amount of money in the bank,” she said. Assets should disqualify a tenant’s exemption, she said. “Eighty percent AMI without assets — that’s important to me.”

Commissioner Tryfman agreed. She said Beverly Hills should change the Culver City eligibility criterion from “low income” to “inability to pay.” She continued:

If there are assets that could be utilized then, by definition, that person is not low-income….If there is an asset, and a landlord needs to be paid, then the person with the asset needs to liquidate it or to borrow against it, or it’s not fair to the landlord.

Commissioner Maden clarified: “Can we say ‘low-income’ based on assets and ability to pay?

Commissioner Tryfman agreed. “I don’t like ‘low-income. In the criminal justice system ability to pay is universal.” The attorney hastened to add, “I’m not equating tenants with criminals.” Maden also suggested excluding senior and disabled status as potential criteria for obtaining an exemption from paying the retrofit surcharge.

Helen Morales, deputy director of the rent stabilization division, said the commission could include those provisions in future exemption guidelines (which would also be used in a proceeding before a hearing officer if a denied exemption goes to appeal).

The approach embraced by landlord and at-large commissioners turns on its head the process used by West Hollywood and Santa Monica which presumes the landlord can afford to pay for retrofit and sends the landlord to a hearing officer to demonstrate hardship.

Here the commission would put the burden on the tenant to demonstrate hardship — which would include a full consideration of assets as well as income. As Chair Tryfman said, “the person with the asset needs to liquidate it or to borrow against it” before their exemption from the retrofit surcharge is granted. For example, a tenant with a 401k or a car would have to sell or liquidate those assets in order to qualify for an exemption. That is an extreme position in the context of qualifying for assistance.

What About Fair Return?

Tenant commissioner (and vice-chair) Kathy Bronte raised an important question: “What about fair return?”

‘Fair return’ refers to a concept in state law that requires any locality that controls the price of rent to allow the landlord to earn a profit on rental operations. They must be able to cover costs, and earn a return, or else they must be able to petition for a rent increase to earn a fair return. Every rent control locality provides for a rent adjustment process wherein the landlord can demonstrate economic hardship and ask for a higher rent increase.

West Hollywood and Santa Monica found that landlords can afford seismic retrofit and at the same time earn a fair return on operations. Those cities require the landlord to petition for a rent increase if they can’t afford the cost of retrofit. That was never considered by this commission even though Beverly Hills already has an established process (see section 4–6–11 of the rent stabilization ordinance).

The fair return question wouldn’t get a real hearing at the September meeting, though. To Commissioner Bronte’s question Tryfman shot back, “What does fair return have to do with it?” In fact fair return has everything to do with whether the cost of retrofit is paid by landlords or passed-through to tenants. At least that’s how West Hollywood and Santa Monica see it.

What’s on Tap for October?

At the upcoming October 3rd meeting Rent Stabilization commissioners will continue to discuss whether the cost of improvements mandated by law (like retrofit) should be passed-through. But that’s not all! Also up for discussion are these other potential pass-throughs:

Surcharge for capital improvements (roof, appliances, AC, landscaping, etc. — any major improvement inside the unit or outside but excluding ordinary maintenance);
Surcharge for refuse fees (about $40.36 monthly per unit for alley pickup as billed by the city);
Surcharge for ‘essential’ utility expenses (the dollar equivalence of the percentage change in utility rates paid by the landlord minus the percentage annual rent increase allowed by the city);
Surcharge for water service penalty (if assessed by the city for excessive water use);
Surcharge for additional tenants (which would be additional rent for an additional occupant subject to landlord approval);
Surcharge for administration of the RSO program (at the current $59.00 the monthly allocation per-unit is $2.46).

Also up for discussion is whether there should be a cumulative cap on pass-through surcharges if the commission does recommend to keep today’s pass-throughs or to modify them. Because pass-throughs are added to the rent, and important respects are like rent, there is concern about pass-through surcharges stacking-up atop what may already be large percentage rent increases in the future for rent-stabilized households.

For example, the maximum allowed annual rent increase is indexed to inflation. Chapter 5 households can see a rent increase as high as 8% under the current rent stabilization ordinance; Chapter 6 households can see a maximum rent increase of 10% if inflation is that high. Should surcharges be added to high-percentage rent increases? And even if inflation moderates to say 4%, should households pay another two to six percentage points in additional rent in the form pass-through surcharges?

One proposal presented to the commission at the October meeting is a 2% cumulative cap on surcharges for improvements mandated by law (including retrofit), capital improvements, refuse fees and the utility rate differential surcharge. (Surcharges for the RSO administrative fee, water penalties, and the additional tenant, which is unique in that it is the tenant’s option, would be outside the cap.) There are so many ways to dice-and-slice this complicated issue and our concern is that the commission has not thoroughly analyzed it. Instead the majority stepped on the gas in favor of the Culver City model while tenant representatives on the commission tapped the brakes.

For more about surcharges and how they affect tenants read our explainer: Pass-Throughs and Surcharges: What You Need to Know. Read the October 3, 2022 staff report for more information about the commission discussion. It is linked from the agenda which also includes meeting participation instructions.

Our Take

The landlords can afford to improve their property. This is a general statement, but on the whole landlords are earning more than a fair return and it should be invested in renewing (and making safe) the rental housing. That’s why tenants pay rent! But the prevailing view among landlords is that tenants should pay rent plus any additional business expenses the landlord has to pay. Why should the cost of a safety measure like seismic retrofit, or for that matter discretionary improvements like landscaping and installation of central air conditioning, be shouldered by the tenant?

Available evidence shows that a landlord on average earns at least 60–70 cents in net operating income for every rent dollar collected. (That’s what the city’s consultant estimated in 2018 and it is what we see in recent sales prospectus for properties on the market in September.) If landlords are earning 60 or more cents on each rent dollar, then they can afford to improve their property. After all it adds value to their asset.

That’s why West Hollywood and Santa Monica found that landlords should not be able to pass-through the cost of seismic retrofit: net income from rental operations can cover it. Moreover, those cities put the burden of appeal on the landlord if they suffer hardship — not on the tenant as this commission would have it.

Fact is that rents are rising at a double-digit rate year-over-year, according to industry reports, and asset prices higher than they have ever been. Arguably there as never been a better time to put the cost of retrofit on the landlord.

Tenants on the whole can’t afford to pick up any more of the landlord’s cost of doing business. The commission knows that inflation is at a three-decade high in our region. But landlords have claimed that inflation and economic hardship is shared equally by landlords and tenants. But in reality high inflation affects landlords and tenants differently!

Let’s look at the inflation rate (aka CPI). The Bureau of Labor Statistics gives disproportionate consideration to the cost of housing and energy when calculating the rate. Each of those costs makes up a big share of the household budget and the consumer price index (CPI) reflects that by giving each proportionally greater weight when tallying-up the cost of an ‘all-items basket’ of consumer goods.

Let’s look at energy first. This volatile cost is something that both households and landlords bear. Landlords pay to heat (and sometimes cool) buildings and provide building power. But tenants are also likely to pay for their own utility use. Contrary to what landlords would have us think, they are not bearing the entire burden of higher energy costs. They can point to the high inflation rate but they get something of a pass on the especially steep rise in energy costs because the cost of energy is already effectively passed-through to most tenants.

The Bureau of Labor Statistics also gives disproportionate weight to the cost of housing when tallying-up the all-items basket of consumer goods and services.That’s because housing claims an outsized portion of the average household’s budget. However it means the cost of housing also has a disproportionate impact on the rate of inflation as measured by the Bureau: when rents rise fast that cost pushes higher the rate of inflation.

And this is really how inflation as measured by CPI affects tenants and landlords differently. For tenants, fast-rising housing costs represent a disproportionately large part of the household budget; the inflation rate reflects that rising cost and that means real pain for households when it comes time to pay the rent. Landlords, on the other hand, point to the high inflation rate to say “we’re all affected” but it is their high-and-rising rents that are driving the inflation rate higher. Landlords benefit from higher rents and the reported CPI is in part reflecting that gain (which comes at the expense of tenants).

Economists point to the contribution of rising rents to the overall inflation rate and note that it is ‘sticky’ inflation (unlike energy, say) because once rents rise they are locked-in. Landlords don’t call attention to the role of rising rents in high inflation. They merely point to CPI and talk about how everyone is affected by high inflation. Not so! The high rate of inflation we see today is more a reflection of rising rents than the landlord’s rising costs.

Timing is wrong for additional pass-through surcharges. City Council this year established 3.1% as the allowed rent increase from July 2022 to June 2023. But that is a temporary reprieve: councilmembers agreed that in coming years tenants will be asked to repay landlords for lost rent increases during the pandemic. That means higher-than-inflation allowed rent increases in future years.

How high will future allowed rent increases go? We can’t know; City Council will decide. State rent control imposes a 10% ceiling. In future years, imagine high inflation PLUS a higher allowed rent increase PLUS pass-through surcharges. Rent-stabilized households will really be hit hard. Again, is it necessary to pass-through more of the landlord’s costs when most of us already pay for utilities and even refuse collection?

Should tenants pay for seismic retrofit when our city did nothing to help landlords defray the cost? West Hollywood and Santa Monica identified grant and financing opportunities for retrofit. West Hollywood, for example, made grants directly to landlords for seismic-retrofit design and construction; both cities joined the state’s property assessed clean energy (PACE) to make available low-interest PACE funding for seismic retrofit. Beverly Hills took no such step.

Beverly Hills didn’t even join the state’s PACE program to make lower-cost financing available to landlords for retrofit. This issue came up during the September meeting when landlord-representative Mader asked whether rebate programs or financial assistance was made available to landlords. Helen Morales, deputy director of the rent stabilization division replied dryly, “Not at this time.” If not now, when?

The fact is that the city enacted the soft-story seismic retrofit ordinance in late 2018 and at no time stepped-up to help landlords with financing or expenses. Even today you won’t find any mention about grants or financing assistance on the Beverly Hills seismic retrofit webpage. If the city didn’t step up, should tenants have to step up?

What’s Next

At the October meeting the commission is poised to follow the Culver City model: pass-through 50% of the expense of seismic retrofit to tenants with a low-income exemption, perhaps, although details about the Culver City exemption are as yet unknown. But this commission appears ready to take a more extreme position by adding a means test that would take into account assets. That 401k or automobile may count against eligibility unless “liquidated” and counted as income (as commissioners Maden and Tryfman would like).

That’s what Medicaid does: to qualify for nursing home care the recipient must spend-down their assets. to qualify. Chair Tryfman called it “ability to pay.” Does Beverly Hills really expect tenants to liquidate the 401k and sell the car in order to be granted a low-income exemption from paying a seismic retrofit surcharge of $60-$100?

Again we have data that shows landlords on average keep 60 or more cents of each rent dollar collected in net operating income (revenues minus expenses). Shouldn’t ‘fair return’ be the test for whether the landlord can pass-through the cost of retrofit? Heck that operating profit should not only pay for retrofit but should also be used to properly maintain the premises. In our view the landlord should upgrade long-neglected systems like plumbing and electrical on their dime because these fundamental systems were ignored in order to put more money into the landlord’s pocket. That’s something the commission hardly spoke about when talking about habitability.

Ultimately we don’t want to let his commission off the hook with another recommendation based upon suppositions and claims without evidence and general feelings about what’s fair. If they want to recommend that tenants pay for retrofit and all manner of other landlord expenses, then we should have an analysis about whether the landlord’s fair return already covers it. That’s what West Hollywood and Santa Monica did. Why can’t we do that here?