Commercial Rent Control

Commercial Rent Control (CRC) is a tool that a few select municipalities in the United States have investigated or implemented to provide stable, affordable commercial space for small businesses facing displacement when market pressures are encouraging higher rents in growing communities. In this page you will learn about the following:

What is Commercial Rent Control?

Many small businesses that operate independently rely on stable, predictable rental rates when seeking commercial space for their business. In markets where the demand for retail or commercial space increases, however, landowners may raise the rental rates by a significant amount in order to boost their income. Leaseholders may be unable to meet this new rate or may not even be offered the opportunity for lease renewal, if the landowner chooses to evict instead. Businesses in this situation must either relocate to a new market or file for bankruptcy.

iStock_000014103329Medium-Copy
“Landlord-Tenant Law in Massachusetts.” [28]

Commercial Rent Control (CRC) is a general tool that municipalities can apply to impose limits on landlords when it comes to the lease renewal process for existing businesses. The goal is often to provide existing small businesses with legislative support for keeping their rents affordable while allowing for additional negotiation rights during the lease renewal process. The exact mechanisms through which CRCs work depend on which aspect(s) of lease renewal that the legislation chooses to address.

Commercial Rent Control’s origins in the United States began back in World War II when federal rent control limits, as well as price and wage control limits, were imposed to keep material and labor occupied on the war effort. In the absence of rent control limits, landlords in urban centers may have been able to increase rents substantially as demand for housing for workers increased. These limits ended in 1945, though New York continued a version of it through 1963 [1].

The tool gained more prominence in the 1980’s, when several large municipalities in the United States investigated or attempted to impose regulations on commercial rental increases and renewal offers in order to protect small businesses and prevent business displacement. As of 2015, there are no cases in which CRC’s are in effect in the United States.

How does Commercial Rent Control work?

CRCs can be organized in a number of ways:

  • As a restriction on future rent increases; [2]
  • As a rebate from commercial landlords through a percentage of property tax savings;
  • As a set of “strong eviction protections to prevent the displacement of local businesses”; [3] and
  • As a program of “mandatory mediation and arbitration to determine commercial rent levels”.

Restrictions on Rent Increases

The most common interpretation of rent control is inherent in the name – a control on the amount of rent that a landlord can require for occupancy of their property by a leaseholder. These restrictions are not based on set dollar amounts, as properties are not “created equal” and differences in commercial space as well as their locations must be taken into consideration. The restrictions are often set as percentages of other figures instead.

In one case, Berkeley, California residents approved an initiative in 1978 that restricted “future rent increases to cost pass-throughs in excess of the landlords’ twenty percent share” of the property tax savings from Proposition 13, a statewide initiative approved earlier that same year that provided substantial property tax breaks to California property owners. [4] This initiative was only in effect for one year, however.

In New York City, rent control has been proposed as a limit on the amount that rent may be increased by as a percentage of the existing lease’s rent. In some legislation, it’s capped at 15% in total for the length of the lease. In others, it’s based on maximum percentages for annual increases, regardless of the length of the lease.

The key provision is that existing small businesses not be expected to pay upwards of 100% or more in increases on their existing leases regardless of how market speculation is affecting prices on surrounding commercial spaces.

Rebates

The same 1978 initiative that Berkeley voters accepted commercial rent control for, also required both residential and commercial landlords to rebate eighty percent of their Proposition 13 property tax savings to their tenants [5]. The effect here was not to prevent small business displacement, but to provide financial relief to tenants from the property tax savings that owners were receiving from the state. The city was sued in 1983 in the case Rue-Ell Enterprises, Inc. v. City of Berkeley as a result of this rebate, but the court found that “the ordinance did not substantially impair a commercial landlord’s preexisting leases because it was in effect for only one year and entitled the tenants to only a partial rebate of property tax windfalls.”

Rebates are not a traditional form of CRC. However, it has been argued that if commercial landlords can receive tax abatements or zoning variances from municipalities to either subsidize the cost of their operations or approve lucrative uses that would otherwise not be allowed in a neighborhood with increasing profitability, they may be expected to share any subsidies they receive from the government with tenants [6].

Eviction Protections

The most modest CRC proposals call for additional protections for tenants against immediate evictions. In some cases, it is an extension of notification requirements from thirty days’ notice to 180 days’ notice. The idea is to provide small businesses with enough time to find alternative locations for their business before having to close their doors. Eviction protections of this kind don’t prevent small business displacement but mitigate the impacts of gentrification to help businesses to continue in another location.

Other proposals for eviction protection have added stipulations for mandatory one-year lease renewal options with a maximum percentage increase for situations where the landlord intends to replace the existing tenant with market rate tenants. As with the notification extension, this proposal doesn’t prevent small business displacement in the long-term, but provides existing businesses with substantially more time for relocation assistance.

Mandatory Negotiation, Mediation, and/or Arbitration

Advocates for small business retention have claimed that mandatory negotiation, mediation, and arbitration requirements are not a form of commercial rent control because they do not stipulate a specific limit on rents based on any percentage. Instead, the idea is to require the tenant and landlord to enter into negotiations on new terms for a lease, up to six months (180 days) in advance, with one of a number of possible outcomes:

  • The landlord makes an offer and the tenant makes a counter-offer. The landlord has 180 days (six months) to find a new tenant to match the landlord’s offer. If they find a new tenant, the existing tenant has the right of first refusal to match the offer, or walk away. [7]
  • If negotiations are unsuccessful after ninety days, an independent arbitrator decides the new terms based on a number of physical and locational criteria that only the tenant can walk away from.

The first option provides some eviction protections without completely removing the free market from the equation. The second option removes the free market by forcing landlords to negotiate their asking price. Tenants may still find the space no longer affordable if the arbitrator determines a price that is weighed more heavily on market factors, but arbitration is more likely to at least result in a price between what the tenant can afford and what the landlord is seeking.

Where has Commercial Rent Control been used in the United States?

Commercial Rent Controls are not in use today. In the United States, the city of Berkeley, California tested the waters with commercial rent control in the 1980’s. New York City has also flirted with the idea of commercial rent controls, but no legislation has ever been approved. The two case studies below briefly explain the history of this affordability tool in each city.

Berkeley, California Case Study

In June 1982, Berkeley voters approved the “Elmwood Commercial Rent Stabilization and Eviction for Good Cause Ordinance…by an impressive 58% to 42% margin” [8]. The ordinance was intended

“to protect commercial tenants in the Elmwood district from rent increases which are not justified by landlord’s cost increases; to enable those tenants to continue serving residents of the Elmwood district without undue price increases, expansion of tradeor going out of business; and to test the viability of commercial rent stabilization as a means of preserving businesses which serve the needs of local residents in Berkeley neighborhoods, outside the downtown business district” [9].

The Elmwood Ordinance was applied to a two-block area of the Elmwood neighborhood and included both new and rehabilitated commercial spaces [10]. Its rent increase and eviction protection provisions did not affect existing leases, but applied once the existing leases expired. Landlords were “entitled to charge a base rent (set at a certain date) plus increases based on maintenance and operating expenses, property taxes, fees, and improvements.” The base rent date was subject to flexibility if the existing or previous leases did not include rent increases. Debt service (loan payments) could be passed onto tenants if used for capital improvements, but not for purchase financing or refinancing. The ordinance also included a guarantee for landlords of a “fair and reasonable return on investment” and the right to increase rents after “giving tenants thirty-day written notice and informing them of the cost increases involved” [11].

Moes
“Moes Books on Telegraph Avenue.”[29]
Berkeley followed the Elmwood Ordinance with the Telegraph Avenue Ordinance, which applied to the neighborhood commercial area of the same name. This ordinance did not include a rent ceiling, but mandated negotiation and arbitration requirements between tenants and landlords. Rent increases were excluded if they “did not exceed the Consumer Price Index for the Oakland/San Francisco Standard Metropolitan Statistical Area” or if the property was vacated by the tenant at the end of the lease [12]. Otherwise, rent increases were subject to an independent arbitrator’s assessment based on eighteen criteria, including: [13]

  • The extent to which a business contributes to the uniqueness and diversity of…and to the availability of goods and services in the Telegraph Avenue Area and the city;
  • Business location;
  • Size of rented space;
  • Services provided by the landlord and tenant;
  • Condition of the unit;
  • Rent increases in the present or most recently expired rental agreement;
  • History of tenant performance of lease obligations;
  • Liabilities tied to the tenant’s occupancy;
  • The terms of the existing lease;
  • The amortized cost of “reasonable capital improvements” by the landlord or tenant;
  • Good will built up for the business by the tenant;
  • Changed circumstances since the previous lease was executed;
  • The market rent for similar commercial spaces;
  • The market rent for similar commercial uses;
  • Existing rent for comparable uses and spaces in the area;
  • The availability of reasonable relocation opportunities in the Telegraph Avenue area or in reasonably close proximity to the area;
  • Rent received by the tenant from subtenants; and
  • All other relevant factors.

Both the tenant and landlord were entitled to appeal the arbitrator’s decision within sixty days. As the assessment was based on all these factors, there were no predetermined rent ceiling or percentage increases acting as a form of rent control.

All of Berkeley’s ordinances instituted a requirement of “good cause” for eviction or lack of lease renewal, which included causes such as “failure to pay rent; substantial lease violation; committing a nuisance on the premises; using the premises for an illegal purpose; refusal to renew or extend an expired lease; and refusal to provide the landlord access to make repairs or improvements or to show the premises to prospective buyers or tenants” [14]. Owner-occupancy was not originally included as a “good cause” due to concerns that owners could use it as a loophole and sublet to new tenants at uncontrolled rental prices, but was subsequently included after the city lost a lawsuit.

The Costa-Keene-Seymour Commercial Property Investment Act of 1987 banned California municipalities from “enacting or enforcing any type of rent or eviction controls, including mandatory arbitration and mediation, on commercial property,” effectively eliminating commercial rent control as a tool for affordable commercial real estate in the Golden State permanently [15].

New York City, New York Case Study

Commercial rent control is not new to New York City. In effect only between 1945 and 1963, the tool has been reintroduced repeatedly in affordability discussions at the City Council level for the past thirty years.

Former NYC mayor Ed Koch and the NY City Council formed the Small Retail Business Study Commission in May of 1985 to consider “the extent to which rising commercial rents are generating significant hardships for New York City consumers and retail merchants, and to appraise the policy options for ameliorating such hardships” [16].

Then-councilwoman Ruth Messinger introduced legislation in 1987 – the “Small Business Preservation Act” – that called for an automatic right to lease renewal and a maximum allowable annual increase of 10% per year, as well as provisions for owner-occupied usage of property and no rent control if the existing tenant chose to leave [17]. In Messinger’s words, the issue was that for small businesses, when “their leases expire…either they are hit with requests for increases from 300 to 800 percent or they are denied any right to renew.”

Koch vetoed the legislation, stifling the conversation for over two decades until October 2008, when Upper Manhattan Councilmember Robert Jackson introduced a new CRC bill requiring “small businesses and landlords to submit to arbitration in negotiating lease renewals if both parties can’t agree on a fair rent” [18]. His proposal included a minimum lease renewal option of 10 years unless the tenant and landlord agreed to another set of terms. Arbitration would be instituted if the rent-increase rates, proposed at “no more than a 3 percent rent increase the first year; no more than a 15 percent increase by the last year of the lease over the previous lease; and no more than 3 percent incremental increases each year of the lease,” were disputed.

Coined the “Small Business Survival Act,” the bill was pulled from being voted on in 2009 by then Council Speaker Christine Quinn [19]. The bill survived and has been reintroduced several times ever since, but it has never gone to a vote. Gale Brewer, who worked for Messinger in the 1980’s, is the current Manhattan Borough President and the latest advocate for a similar version of the bill. In her version, however, if “no agreement can be reached in arbitration, an automatic one-year lease extension at 15% higher rent would be imposed, giving tenants more time – longer than the typical 30 days’ notice of lease expiration – to find a new location” [20]. She has stated publicly that her version of the bill has been met with less support from small business advocates, but the difference is that the removal of the 10-year minimum term makes it much more acceptable for developers and the terms are easier to build into an investor’s projected income.

There has been no official vote or resolution on the subject of commercial rent controls in New York City at this time, but understanding the process that the discussion has gone through offers insight into the implementation of a similar tool in other markets.

former_Punta_Cana_siite
“Until last month, this Washington Heights building housed a barbershop, an income-tax preparer, a clothing store, and the Punta Cana restaurant.”[30]
What are the disadvantages of Commercial Rent Control?

The advantages of CRC are fairly simple. Commercial tenants benefit from predictable and affordable rents and stable lease terms. The reason that CRCs aren’t utilized that often are that they are highly controversial and may have negative long-term consequences on an area’s economic growth. Some of the considerations against CRC mechanisms are listed below.

Political

While CRC’s may be lauded for their goals of preserving small businesses, they are often reacted to with hostility by property rights’ advocates for how they disrupt the tenant-landlord relationship in a free economic market. The real estate lobby also has a significant pull in most political environments and any attempt to interfere with the traditional capitalist, free market economy will most certainly be met with harsh criticism.

Many of the other mechanisms listed in this guide have avoided this concern by establishing tools that may be implemented between either a tenant and governmental agency or a tenant and a nonprofit organization, without any additional regulations imposed on landowners uninterested in small business retention.

The Legality of Eviction Protections: In Ross vs. the City of Berkeley, the court ruled that eviction protections can curtail a property owners’ rights if it prevents the property owners from reentering their property at the end of the renter’s lease term and are thus unconstitutional. Berkeley addressed this in the short-term by allowing evictions if the space will be occupied by the property owner [21].

Due Process Concerns

In rent arbitration proceedings, a landlord and tenant mediate before an independent arbiter. Depending on the amount of proceedings before a board, a landlord may be subject to the same below-market rents until such time that there case may be heard. This has been argued in residential rent control cases as a possible Due Process violation [22].

In Birkenfeld v. City of Berkeley (1976), the California Supreme Court held that California cities and counties could enact both rent and eviction controls… so long as the ordinance gave landlords a fair shot at getting a rent increase within a reasonable time. The rent control ordinance proposed in the case failed this test, “because the failure to provide hearing officers or automatic yearly increases meant that some Berkeley landlords would have to eat cost increases for years before getting their hearings before the board” [23].

Impacts on Investments

Realtors, landowners, and investors argue that CRCs deter investment in commercial real estate because they limit the amount of income that a property can be expected to generate for a potential investor. In a free market, an investor can account for market rents when an existing lease expires (provided it contains no renewal clauses). Arbitration regulations and rent increase limits add a level of uncertainty that can increase the risk for an investor. In the Berkeley case, language used in the ordinances included a guarantee for landlords of a “fair and reasonable return on investment,” but this was never defined.

The Elmwood Ordinance in Berkeley allowed landlords to pass on the costs from capital improvements for building rehabilitation to tenants, but excluded debt service for refinancing the building. If a potential investor cannot pass on debt service to tenants, they may not be able to receive the return they need to justify the investment and would thus be discouraged from purchasing the property.

Reductions in financial returns on investment may increase the risk of adding ground floor retail space to mixed-use developments, discouraging more walkable, higher density neighborhoods that have been encouraged in modern city planning. A reduction in available commercial space over time could hurt new small businesses through further competition for limit space.

Another related impact is that properties are appraised based on the assumptions that a typical investor would make for purchasing a property. Rent control measures can result in a reduction in the appraised value of the property, which can in turn reduce the amount of taxes that may be collected for the same property.

Former California State Senator Barry Keene, who co-authored the legislation in 1987 that effectively banned CRC regulations in the state, argued, “A patchwork quilt of local rules will paralyze new commercial real estate investment” [24].

Potential Increase in Deferred Maintenance

The income that a property is able to generate is required to cover all operating expenses before a property owner can recover a profit. Caps on rents may result in the payment of immediate expenses at the expense of future maintenance and rehabilitation. Municipalities do not benefit if the existing supply of commercial space reaches the end of its effective economic life early and results in a lack of available commercial space.

Once the current improvements (structures) on a property reach the end of their economic life, the value of the land “if vacant” becomes higher than the value of the land “as improved”. It would be questionable practice for existing tenants to “continue paying increasing rents to cover increasing operating expenses even when the building itself no longer contributes value to the overall property” [25]. Financially, a property in this economic state warrants redevelopment, which may not favor small businesses either if the new structure converts the property to its highest and best use.

Loss in New Small Businesses

CRC ordinances benefit existing businesses occupying a leased space at the expense of potential future businesses. Eviction measures may prevent chain stores from taking on new leases as well as new small businesses. As rent controls apply to all existing businesses, they effectively provide an existing chain with a subsidy as well, hurting small business competition [26].

Impacts of Long-Term Leases

When proposals for CRC apply minimum ten-year lease terms, landlords may be subject to financial losses if the economic circumstances in a particular location change during the period of the lease. In shorter leases, rents may be adjusted to account for inflation or other economic conditions, such as recessions or neighborhood disinvestment.

Establishment of “Fair Return on Investment”

Any CRC legislation that promises a “fair return on investment” as part of its language needs to define what this is. A municipality may effectively be treating real estate as a public utility if it guarantees the landowner a certain return on their investment above operating costs [27].

Conclusion

Many of the tools discussed in this research apply between tenants and governmental agencies, tenants and banks, or between tenants and nonprofits. Each of these parties has a stake in the continued success of local small businesses. Commercial rent control is essentially the only tool that disrupts the process between a tenant and a private landlord, who has no stake in the success of the tenant’s business beyond its impact on their ability to earn a profit. It is accordingly the most challenging tool to implement politically as well as the most difficult to justify rationally without potentially infringing on legal rights.

If CRC legislation is able to navigate the political blowback that would inevitably occur, it not only can help maintain the “character” of a neighborhood, but help support existing businesses that serve basic local needs that chain stores and luxury boutiques can’t provide. Without rent controls, higher rents inevitably pass onto the customer and increase the likelihood of both business and neighborhood displacement.


Resources and Notes

[1] Rosenberg, Margot A. “Commercial Rent Regulation: Preserving the Diversity of Neighborhood Commercial Districts.” Ecology Law Quarterly, 15.2 (1988): 287. Available WWW: http://scholarship.law.berkeley.edu/elq/vol15/iss2/3.

[2] Ibid, 287.

[3] Ibid, 283.

[4] Rosenberg, Margot A. “Commercial Rent Regulation: Preserving the Diversity of Neighborhood Commercial Districts,” 287.

[5] Ibid, 287.

[6] “PRO & CON: SHOULD THE CITY HAVE COMMERCIAL RENT CONTROL?; CROISSANTS, COBBLERS AND FREE-MARKET FORCES.” The New York Times, July 7, 1985.

[7] “PRO & CON: SHOULD THE CITY HAVE COMMERCIAL RENT CONTROL?; CROISSANTS, COBBLERS AND FREE-MARKET FORCES.” The New York Times, July 7, 1985.

[8] Rosenberg, Margot A. “Commercial Rent Regulation: Preserving the Diversity of Neighborhood Commercial Districts,” 288.

[9] Ibid, 289.

[10] Ibid, 291.

[11] Ibid, 292.

[12] Ibid, 292.

[13] Rosenberg, Margot A. “Commercial Rent Regulation: Preserving the Diversity of Neighborhood Commercial Districts,” 292.

[14] Ibid, 293.

[15] Ibid, 283.

[16] Rosenberg, Margot A. “Commercial Rent Regulation: Preserving the Diversity of Neighborhood Commercial Districts,” 286.

[17] “PRO & CON: SHOULD THE CITY HAVE COMMERCIAL RENT CONTROL?; CROISSANTS, COBBLERS AND FREE-MARKET FORCES.” The New York Times, July 7, 1985.

[18] Hengels, Adam. “Retail Rent Control.” Market Urbanism.. October 15, 2008. Available WWW: http://marketurbanism.com/ 2008/10/15/retail-rent-control/.

[19] Hedlund, Patrick. “Retail rent-control bill fades as Quinn queries its legality.” The Villager, 79.29 (2009). Available WWW: http://thevillager.com/villager_347/retailrent.html.

[20] Brewer, Gale. “Brewer: Why the SBJSA Can’t Pass.” Our Town. May 14, 2015. Available WWW: http://www.ourtownny.com/columnsop-ed/20150513/brewer-why-the-sbjsa-cant-pass#sthash.cOu9SB5P.dpuf.

[21] Rosenberg, Margot A. “Commercial Rent Regulation: Preserving the Diversity of Neighborhood Commercial Districts,” 283.

[22] Moskovitz, Myron. “The Great Rent Control War.” Digital Commons: the Legal Scholarship Repository @ Golden Gate University School of Law, (2010). Publications. Paper 159, p. 4. Available WWW: http://digitalcommons.law.ggu.edu/pubs/159.

[23] Ibid 5.

[24] Rosenberg, Margot A. “Commercial Rent Regulation: Preserving the Diversity of Neighborhood Commercial Districts,” 286.

[25] Heddleson, Linda Koch. “Commercial Rent Control: A Solution for the Preservation of Neighborhoods?” The Appraisal Journal, October 1983, pp 596.

[26] Rosenberg, Margot A. “Commercial Rent Regulation: Preserving the Diversity of Neighborhood Commercial Districts,” 286.

[27] “PRO & CON: SHOULD THE CITY HAVE COMMERCIAL RENT CONTROL?; CROISSANTS, COBBLERS AND FREE-MARKET FORCES.” The New York Times, July 7, 1985.

[28] “Landlord-Tenant Law in Massachusetts.” NextPhaseLegal, 2014. Available WWW: http://nextphaselegal.com/wp-content/uploads/2014/01/iStock_000014103329Medium-Copy.jpg.

[29] “Berkeley’s Telegraph Avenue’s Unique & Unusual Stores.” Photo by Louis Cuneo. Last Updated 2012. Available WWW: http://telegraphave.org/pages/merchants.html.

[30] “Until last month, this Washington Heights building housed a barbershop, an income-tax preparer, a clothing store, and the Punta Cana restaurant.” Metropolitan Council on Housing. Photo by Steven Wishnia. September 2015. Available WWW: http://metcouncilonhousing.org/news_and_issues/tenant_newspaper/2015/september/why_new_york_needs_commercial_rent_control.