Proposed Rent Control Regulations Raise Many Questions

As noted in our prior Alert, the Montgomery County Department of Housing and Community Affairs (DHCA) published draft regulations on February 1 to implement the County’s new rent control law. By its terms, the rent control law will take effect when the regulations are adopted—based upon anticipated review and comment times, this could be May 2024 or later. The regulations are subject to public comment until the end of February (unless extended), and are then subject to approval of the County Council. The draft regulations address the provisions from the rent control law that were expressly made subject to the terms of the regulations. Key provisions of the regulations are outlined below along with issues and questions raised by the draft regulations.

Troubled or At-Risk Properties

The rent control law provides that the owner of any property designated as “troubled” or “at-risk” by the County cannot increase rents in excess of an amount that DHCA determines is necessary to cover costs required to improve habitability. This limitation prohibits all rent increases unless approved by DHCA for these properties. In order to request a rent increase, the owner of a “troubled” or “at-risk” property must submit an application under the “fair return” provision of the regulations (see fair return discussion below). If the application is approved, the owner can increase rent in the amount approved by the fair return application. This raises many questions, including the following:

1. The fair return formula is gross income minus operating expenses. It does not account for capital expenditures that may be necessary to address the property issues.
2. What happens when a property designated as “troubled” or “at-risk” loses such designation? Does that mean the owner is no longer eligible for fair return?
3. When the “troubled” or “at-risk” designation is removed, the units are eligible for rent increases within the requirements of the rent control law. If rent increases have been prohibited in connection with the “troubled” or “at-risk” property lists, then is the owner ever able to recover increases that were not allowed during the period of “troubled” or “at-risk” designation? If such foregone amounts are not treated as banked amounts under rent control law (permitting limited owner recovery), then the practical result is that the property (including vacant units) will always have rent rates below that of other properties—likely making it difficult for the owner to stay ahead of the issues that resulted in the designation to begin with.
4. The County’s statutory scheme regarding the “troubled” and “at-risk” property designations is relatively new. A review of the County’s published “troubled” and “at-risk” property lists clearly shows that many properties are caught up in this process. The process for getting off the list is not clear, and the requirements are often outside the owner’s control. The County controls the inspections and scheduling, and owners are cited for issues that may not be the landlord’s responsibility. Tying these designations into rent control necessitates that the County focus on implementation of the property designations and provide clear processes, guidance, and responses to owners who are trying to navigate this.

Capital Improvements Surcharge

The rent control law permits a limited capital improvements surcharge if approved by DHCA, with the surcharge limited to the amount DHCA determines is reasonably necessary to cover the costs of the capital improvements to the unit. If approved, the surcharge cannot take effect until the capital improvements are completed. If the capital improvements are for all units, the cost is divided equally amount all units, prorated over 96 months and capped at 20% of base rent. If the capital improvements relate to less than all units, the surcharge is divided equally among all affected units and prorated over 60 months and capped at 15% of base rent. This provision relates only to landlord’s recovery of its costs—not to a return on investment—which requires an additional “fair return” application (see below).

1. The draft regulations suggest that for improvements to qualify, they must be improvements to units. Any capital improvements for project components outside of the rental units (e.g., common area mechanical systems and other improvements, roofs, structural items, and amenity areas, parking lots, etc.) may not be eligible for this surcharge.
2. The County recently promulgated sweeping Building Energy Improvement Standards that require owners to undertake significant building improvements at the landlord’s cost. Although the capital improvements surcharge could be applied to capital improvements required to comply with County energy requirements, that is only the case if DHCA approves it. If DHCA denies a petition for capital improvement surcharge, the owner must still perform the required energy improvements.
3. An owner can submit a petition for a capital improvement surcharge, and there are strict deadlines on owner’s obligations to deliver multiple tenant notices by first class mail, but there are no deadlines on DHCA’s obligation to respond to or decide on a petition. This is made even worse by the fact that by law, except for emergency cases, an owner cannot recover a capital improvement surcharge if the improvements are performed before the petition is granted. Reading these provisions together, an owner could wait indefinitely for a County response, or decide to move forward at its own cost.
4. An owner’s petition for a capital improvements surcharge must include documentation of application or issuance (conflicting provisions in regulations) for required permits. For most owners, it would make no sense to prepare plans and apply for permits when the owner has no assurance that it will be able to increase rents in connection with the capital improvements.

Fair Return

Under the rent control law, DHCA must grant an owner’s application for rent increase in excess of that allowed by rent control only if DHCA finds that the increase is necessary for the owner to obtain a fair return on investment. 

1. For purposes of calculating gross income, the amount includes the total rental income the landlord could have received if all vacant rental units had been rented for the highest lawful rent for the entire year and if the actual rent assessed to all occupied rental units had been paid. This approach does not match the realities of multifamily property operations. Owners do not and cannot rely on every unit to be leased for 12 months per year. And given the eviction hurdles in the County, it’s not practical for an owner to receive payment of 100% of the assessed rents.
2. Although the capital improvements surcharge and the fair return are entirely different concepts (one recovers actual costs for capital work, and the other recovers operating shortfalls of return on investment), the language of the regulations suggest that it could be difficult for an owner to obtain relief under both provisions.
3. The regulations include illogical restrictions on future fair return applications. If a fair return is granted, the owner cannot request another one for 24 months. If a property meets the requirements for fair return, this limitation only seeks to limit the County’s burden by having fewer applications to review, while requiring the owner to shoulder the economic burden during this period. Similarly, it’s not clear why a denied fair return application precludes an owner for submitting another one for a year. This is particularly problematic given the vast number of application criteria that are subject to DHCA’s discretion.
4. Any fair return resulting in rent increase of more than 15% must be phased in over consecutive years. The regulations include complicated and at times contradictory provisions regarding implementation of the increase relative to vacant units.

Substantial Renovation

The law stipulates that a building that was substantially renovated within the prior 23 years is exempt from rent control if it not in violation of other County laws. Perhaps the County intends to treat buildings that are substantially renovated similar to new construction, with a rolling 23 year exemption, but that is far from clear in the regulations. The law defines a substantial renovation as permanent alterations to a building that are intended to enhance the value of the building and cost at least 40% of the building’s assessed value. The regulations set forth a complicated and detailed process for an owner to apply for an exemption under the substantial renovation provision, but it is unclear how the “substantially renovated within the prior 23 years” requirement applies to proposed renovations or what is required for renovations completed during the prior 23 years.

Fees

The regulations provide that the landlord of a regulated unit may only collect the following fees:

1. an application fee not to exceed $50 per household;
2. late fee in an amount subject to County law if payment is 10 days late;
3. lost key fee of up to $25 plus the actual cost of duplication;(iv) lock-out fee up to $25;
4. secure storage fee not to exceed $3 per square foot per month;
5. limited internet and cable television fees;
6. limited vehicle parking fees based on the type of parking provided (e.g., covered, reserved); and
7. limited bicycle parking fees.

No pet fees are permitted, however an owner may require tenants with pets to post an additional deposit of up to $100. The regulations do not provide any mechanism for adjustment of the foregoing fees over time (e.g., Consumer Price Index). Except to the extent governed by other County or State laws, these fee restrictions do not apply to units that are exempt from rent control.

We have scheduled a virtual meeting with many stakeholders on February 15 from 10-11AM ET to discuss these proposed regulations and to identify potential collective next steps. This is a follow-up to the ULI Washington Executive Conversation last week with Montgomery County President Andrew Friedson, where there much discussion about the need for coalition building and sustained advocacy. As noted in these two WSJ pieces, rent control has significant impacts on financing, too. If you would like to join this meeting, please contact us at CondoMultifamilyTeam@ballardspahr.com.

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