A WARNING ABOUT RENT REBATES AND INCENTIVES
In the midst of our Great Recession, rents in the City have finally begun to soften. As jobs disappear and bonuses dry up, the vacancy rate persistently inches upwards. Ever eager to fill empty units and to compete for quality tenants, owners around town have begun, once again, the campaigns of rent gimmicks, incentives, freebies, and the like. Most commonly, an owner will list the unit for a higher-than-market rent with the promise of a free month for a one year signing or some other type of rebate incentive.
For example, a unit becomes available that, a year or so ago, would have fetched $2,000 per month after one week on Craigslist. Owner knows, by comparables in the neighborhood, that she would be lucky to land someone willing to pay $1,500. However, owner believes, as do we all, that one day, hopefully soon, the business climate will warm up and the world will return back to normal. When this happens in 2010 or 2011, the tenant who rented the $2,000 will have hit the jackpot if the base rent is $1,500.
To avoid such perceived unfairness, owner advertises the unit for $2,000, with the incentive of the first month rent free. Based on an amortization of the one-month credit, tenant is actually paying about $1,800 per month. Tenant is therefore encouraged to sign the lease, which states that base rent is $2,000, with the first month of rent free only for year 1. Owner is happy because, in 2010, when the market is healthier, she can discontinue the rebate and collect $2,000 per month for every month of the second year and each year thereafter. In almost every other county in the country, this form of marketing would be fine: tenant gets a free month of rent in exchange for signing a one-year lease at last year’s rent level while owner preserves the ability to adjust the rent back up to where it should be, absent the economic calamity.
But in our universe, logic must oftentimes cede to a harsher reality. Several years ago, the Rent Board tackled the incentives issue when a large apartment owner handed over rent credits at lease signing in order to entice customers when the market was soft. The lease clearly stated that the incentive program could be discontinued at any time, and, after a few years when demand picked up, everyone stopped receiving their annual gift package. Outrage quickly ensued, and a large volume of petitions were filed at the Rent Board alleging that rent had been unlawfully increased by discontinuation of the rent credits.
For months, Rent Board judges heard arguments from the tenants and the apartment owner’s attorneys. At the end of the day, a decision was issued that essentially set forth the following rule: If an owner gives incentives in the form of rent credits or rebates to a tenant in order to reduce rent to a level more reflective of real market conditions, then the stated base rent is not correct, but instead must be amended to account for the credit in all subsequent years of the tenancy. The Rent Board reasoned that landlords could not “cheat the system” by writing a lease with a higher-than-market rental rate, subsidizing that amount until the actual market caught up with the stated rent, and then revoking the subsidy. To do so created an unlawful rent increase. (In the example cited at the beginning of this article, the tenant pays an extra $2,000 per year, or about $170 more per month, in addition to the annual allowable increase.)
While all of rent control may be distasteful, the Rent Board’s decision was the correct one. Under our longstanding rent law, initial base rent is what a tenant is actually required to pay at the inception of the tenancy. Any increase of this amount is subject to the rent regulations. When given a financial incentive such as a free month of rent in exchange for a 12-month term, the tenant is actually paying well below the stated base rent. Thus, the Rent Board looks at the reality of the situation, not the fiction created by the owner.
Landlords have tried every conceivable permutation of the incentive program so as to avoid this rule. For instance, some owners require full payment of the rent, and then slip the tenant $100 in cash each month. Others will draft language in a lease addendum professing that the owner declines to accept full payment of rent for a period of time. Regardless of the creativity employed, you run the risk of permanent modification of the stated base rent when you embark upon the incentive program to entice tenants into your building in down times.
Another common situation that is arising today involves existing tenants who know that they can rent the same unit in the same building for a lower amount. Most all of us owners have been receiving requests from our long term tenants asking for a rent reduction, especially if they had rented from us three or four years ago when times were good and they now see advertisements all over the neighborhood for the same, or even better, unit at a lower price.
The Rent Board may be more lenient when rent reductions are given to existing tenants. I say “may” because there is no clearly defined policy at the present time, and hopefully the Rent Board Commissioners will enact such a policy in the near future. Traditionally, if a particular tenant is experiencing financial or other personal hardship, the owner could, upon the tenant’s request, agree to temporarily reduce the tenant’s rent. This happens in both good and bad economic times, as the request emanates not from the fact that the marketplace no longer justifies a tenant’s rent, but because a particular tenant is in need.
Therefore, if your tenant seeks lower rent solely because the building next door is offering the same unit at 20% less, the reduction of rent may be deemed to be permanent, meaning that your acquiescence to allow the tenant to pay less could become a lease modification to your detriment. On the other hand, keeping a tenant in his unit with a rental concession because of a job lay-off, salary reduction, or illness does not always become irrevocable.
When lowering the rent because of a tenant’s personal issue, owners should take the following steps. First, there should be a written agreement signed by both the landlord and tenant. The agreement should spell out, clearly, that the tenant requested a temporary rent forgiveness because of the tenant’s own personal hardship. The circumstance should be clearly defined: I lost my job, my salary was cut, I am sick, I am caring for a loved one. Second, the term for the forgiveness cannot be open-ended; rather, there must be a defined end date. (“Landlord and Tenant agree that the lesser rent shall be accepted by landlord for six months only, and thereafter Tenant shall be required to pay the base rent in full.”) Third, the addendum must be clear that base rent is not being reduced, but because of a tenant’s particular and legitimate need, the owner is willing to accept a lesser amount. Finally, the addendum must be as personal as possible, meaning “form addendums” for rent reductions are usually not acceptable. Remember, reducing the rent solely to keep a tenant in your building probably means that the current rent is over market, and the rent law doesn’t afford landlords the luxury of contracting around market rent so as to preserve impositions of market level increases at a later time.
Finally, some owners offer enticements such as free Plasma televisions, a weekend at Tahoe, or a gift card at Macy’s. These types of lures are probably not problematic, unless the owner promises to deliver the goods with each lease renewal, in which case a contractual obligation is created. Unlike a rent concession, which diminishes actual rent paid during the entire first lease term, a thank you present does not undermine or affect the tenant’s financial obligation to the landlord.
In sum, employ common sense during this economy. If rents have fallen, then you should be offering the unit to prospective tenants at the current market amount. Drafting the lease to reflect yesterday’s pricing, with a temporary subsidy to make the deal palpable, is a falsehood that will be undone at the Rent Board. For current tenants, if they demand lower rent because they can get a better deal elsewhere, either let them go or be prepared to accept a permanent diminution of their rent. Lastly, for the tenants who are experiencing hardship, and many of them do legitimately fall into this category, draft a clear and concise addendum outlining the tenant’s particular hardship, that rent is not being reduced but rather a portion of it is being forgiven, and establish a timeline as to when this favor is being terminated. Unfortunately, rent control has never been a two-way street. Tenants constantly extract benefits from owners during bad times, but landlords cannot employ just any marketing strategy to fill their buildings without exposing themselves to serious risks.