Rent Regulation Exit Strategy: Changes to Substantial Rehab Law in the Works
A proposed bill wouldn’t block the exit—but it would require a formal approval process.
Owners’ ability to deregulate apartments and be exempt from rent stabilization requirements were severely eroded with the passage of the Housing Stability and Tenant Protection Act (HSTPA) in June 2019. The HSTPA implemented a series of historic reforms to rent laws that included repealing high-rent vacancy and high-rent/high-income deregulation.
While the HSTPA also limited the profitability of rent-stabilized apartments, it didn’t eliminate all potential exits from rent regulation. Condo and co-op conversions remain legal, but post-HSTPA, 51 percent of all current tenants must sign on to enable a non-evict conversion (where residents may remain as tenants if they don’t wish to buy their units), as opposed to 15 percent under the old law.
Owners also can still demolish a property with rent-regulated units and build a new market-rate project in its place. Demolitions of rent-regulated buildings require DHCR approval, with the DHCR requiring not only relocation assistance to tenants, but also monthly stipends.
Another avenue for deregulation is through substantial rehabilitations or gut rehabs. If you make major renovations, it’s still possible that your building may no longer be covered under rent stabilization. The substantial rehabilitation exemption law says that buildings “substantially rehabilitated” as “family units” on or after Jan. 1, 1974, are exempt from rent stabilization.
However, there’s a bill, NY State Senate Bill 7213-A, that’s currently in the rules committee that specifically addresses exemptions from rent stabilization on the basis of substantial rehabilitation. We’ll go over the current law regarding gut rehabs and what kinds of foreseeable changes that we might expect to see to this method of becoming exempt from rent stabilization.
Substantial Rehab Basics
The DHCR’s Operational Bulletin 95-2 establishes the circumstances under which the agency will find that a building has been substantially rehabilitated within the meaning of the Emergency Tenant Protection Regulations Section 2500.9(e) and Rent Stabilization Code Section 2520.11(e).
Replacement of major systems. The DHCR will find that a building has been substantially rehabbed if at least 75 percent of the building-wide and apartment systems contained on the following list have been completely replaced with new systems. Additionally, all ceilings, flooring, and plasterboard or wall surfaces in common areas must have been replaced; and ceiling, wall, and floor surfaces in apartments, if not replaced, must have been made as new as determined by the DHCR.
The list of building-wide and apartment systems include:
- Gas Supply;
- Electrical Wiring;
- Incinerators or Waste Compactors;
- Fire Escapes;
- Interior Stairways;
- Ceilings and Wall Surfaces;
- Pointing or Exterior Surface Repair as needed; and
- All Doors and Frames, including the replacement of non-fire-rated items with fire-rated ones.
In buildings that don’t contain all 17 of the systems listed, the owner need only replace 75 percent of the systems preexisting in the building in order to be eligible for the exemption.
Substandard condition or seriously deteriorated. In addition to requiring replacement of 75 percent or more of building-wide systems, the rehab must also have been “commenced in a building that was in a substandard or seriously deteriorated condition.” According to the DHCR, the extent to which the building was vacant of residential tenants is indicative of whether the building was in fact in such condition. If the rehab was started in a building that was at least 80 percent vacant of residential tenants, the DHCR says that in this case, it will presume that the building was substandard or seriously deteriorated at that time.
Prior advisory opinion. Under current law, owners have the option to request a DHCR advisory opinion as to whether or not the building qualifies as exempt from rent stabilization due to substantial rehab. Technically, buildings are simply considered to be exempt when the substantial rehab requirements are fulfilled. But tenants can challenge the exemption.
If you obtain an advisory prior opinion before you begin the rehab project to see if it will qualify the building for exemption from rent stabilization laws, the DHCR will evaluate your rehab plan, based on your contracts, applications for building permits, blueprints, etc., and determine if it meets the scope of work necessary to constitute substantial rehab.
Required documentation. According to the advisory opinion, the following documentation is required from owners in support of a claim of substantial rehab. And owners are advised to maintain records related to the rehab. If you don’t obtain a prior advisory opinion and a tenant challenges your substantial rehab claim, these records will help prove fulfillment of the substantial rehab requirements.
Records demonstrating the scope of the work actually performed in the building include:
- An itemized description of replacements and installations;
- Copies of approved building plans;
- Architect’s or general contractor’s statements;
- Contracts for work performed;
- Appropriate government approvals; and
- Photographs of conditions before, during, and after the work was performed.
Proof of payment by the owner for the rehab work may be required.
Possible Legislative Changes
Under Senate Bill 7213A, if passed, owners would be required to apply to the DHCR for an exemption from rent stabilization within one year of the completion of a substantial rehabilitation project. Instead of proving exemption through substantial rehab when a tenant makes challenges, the bill would require an owner to proactively file an application for approval to obtain a substantial rehab designation.
In addition, the bill would make owners of previously substantially rehabbed buildings go through a formal approval process. Owners of any building previously alleged to have been substantially rehabbed before the introduction of the bill would have to seek approval of the exemption from the DHCR within six months after the bill’s enactment into law.
Under the bill exemption applications would be denied on one or more of four grounds:
- The owner or owner’s predecessors engaged in harassment of the building’s tenants within the five years preceding completion of the substantial rehab project;
- The building wasn’t in a seriously deteriorated condition requiring substantial rehab;
- The owner or its predecessors failed to maintain the building and this materially contributed to its deteriorated condition prior to rehab; or
- The substantial rehab work was performed in a piecemeal fashion rather than within a reasonable amount of time while the building was at least 80 percent vacant.
Keep Proper Records
These possible changes to the substantial rehabilitation process may indicate increased attention from lawmakers to the few remaining ways owners can deregulate a rent-regulated apartment. If you own substantially rehabbed buildings or are currently rehabilitating your buildings, you should be meticulous in organizing and maintaining all the proper documentation of the substantial rehab.
In some recent cases, the DHCR has pointed to DOB records and filings to show a building wasn’t substantially rehabbed. For example, an owner bought a building in 2015 and claimed that the building was in seriously deteriorated condition. It filed alteration plans with DOB, completed a gut renovation by 2017, and no prior tenants re-occupied any previous apartments. The owner also claimed that at least 80 percent of the building and apartment systems listed in DHCR Operational Bulletin 95-2 had been replaced.
The District Rent Administrator (DRA) ruled against owner, who appealed and lost. The DHCR found that DOB job records didn’t support a finding that the building was substantially rehabbed. In DOB documents, the owner answered “no” to questions as to whether it was performing work in 50 percent or more of the building area and whether it was demolishing 50 percent or more of the area of the building. Also, the DRA’s consideration of the PW3: Cost Affidavit form filed with DOB was appropriate. The DRA found that the owner’s two PW3 cost affidavits grossly underestimated the total job cost, tainted the DOB permit and approval process, and didn’t support a finding of substantial rehabilitation [398 Crescent LLC: DHCR Adm. Rev. Docket No. JN210030RO, June 2021].