The Impact of NY’s New Rent Regulation Law on Industry, Lenders, Tenants and the Trade

By Abe Schlisselfeld  |  July 9, 2019

Did you feel that earthquake? No, not that major jolt out in California’s Mojave Desert, but the one in mid-June that was centered in Albany but which quickly rippled through New York City (and other major urban areas) causing damages the real estate media is describing as “crippling, and devastating.” Of course I’m referring to the Rent Regulation law just passed by the New York State legislature, which caught almost the entire real estate industry by surprise. You might say that their disaster preparedness plan was missing in action.

In this post I’m not going to dwell on the details of the law – as they have been well reported – but rather to make a few observations about the law’s impact on the key constituents. But, because I am a tax accountant, let me at least paint a brief picture of the key changes made by legislators that are causing such angst and anxiety.

First up – Major Capital Improvements (MCI) are those made by landlords that directly or indirectly affect all tenants – think a new boiler. Under the old MCI regulations, landlords could pass along these costs – according to a formula that had a six percent annual cap. The new regulation not only significantly narrowed the scope of improvements that qualify for MCI, it reduced the possible rent increase cap to two percent. The regulation also tightened enforcement of those rules by requiring that 25 percent of MCIs be inspected and audited.  Furthermore, MCI increases will be eliminated after 30 years, instead of being permanent, as was previously the case.

Next up - Individual Apartment Improvements (IAIs) are those that a landlord makes to upgrade a vacant apartment. A fraction of the costs can be passed on to the incoming tenant. Under the old regime there was no set limit on the amount of money a landlord could claim was spent on an IAI - theoretically tens of thousands of dollars per apartment during a vacancy. Under the new rules there is a limit of $15,000 per apartment over a 15-year period, and the rent change ratio has been reduced from 1/40 to a meager 1/168.

Then there are the changes to the rules covering vacancy and deregulation – for these details I suggest you read the wide-ranging coverage this story has received and is still receiving.

Now, to the impact. Let’s look at whose oxen are being gored.

Landlords & owners of multi-unit apartment buildings. Customary and ordinary work that needs to be done to maintain the common areas of a property will no longer be so customary and ordinary. If money spent on repairs cannot be recouped, the motivation to invest drops to near zero. Further, many (if not most) larger landlords are active investors in properties. They often buy buildings using credit, make improvement, refinance and sell – with this process often repeated many times. If the improvements are not made, there is no refinancing and no sale and a subsequent loss of underlying value…which brings us to the next impact.

Lenders. Here the potential for serious damage is purported to be very grave. In short, banks have outstanding mortgages on buildings that, under the new regulation, will now lose value due to the reasons cited above. When these mortgages come due, there is no basis for a revaluation and hence no support for re-financing. The result: landlords’ defaults soar, and banks are left with portfolios of underperforming real estate assets – the last thing their investors want to see on the balance sheets.

Ready for one more? The impact on the trade and those allied to it. If improvements stop being made, the impact on the supply chain and labor market will be instantly felt. Already there are anecdotal reports of layoffs by landlords of carpenters, plumbers and maintenance staffs. Lumberyards, electrical suppliers, virtually every business selling to the building trade will be hurt. Then, don’t overlook the impact on real estate businesses – title shops, brokers and real estate law firms will all feel the pinch.

The Marks Paneth Real Estate Group is watching the situation closely. This doom and gloom is being widely predicted, but will it really materialize?  In truth, no one is positive about the outcome yet. There are however, certain indications that every landlord and tenant group should be keeping an eye out for. First of all, are customary improvements still being made? Has there indeed been any sign of a precipitous drop-off in improvements? If there have been, then this might be the canary in the coalmine. If there is deterioration, then what I foresee is a rush to the courthouse with tenant groups filing suits with the potential of a flood of litigation that might – just might – spur the legislature to take a fresh look at what it has unleashed on this vitally important industry.

About Abe Schlisselfeld

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