Rent Stabilization Due Diligence for Multi-Family Acquisitions

ITKOWITZ PLLCs

Rent Stabilization Due Diligence

For Multi-Family Acquisitions

Itkowitz PLLC

www.itkowitz.com

Rent Stabilization Due Diligence for Multi-Family Acquisitions; Copyright 2015 by Michelle Maratto Itkowitz, Itkowitz PLLC; Itkowitz.com

RENT STABILIZATION DUE DILIGENCE FOR MULTI-FAMILY ACQUISITIONS

1. What is Rent Stabilization Due Diligence? Why do I need it for a multi-family acquisitions? 2

2. Why cant I just wait to worry about the tenancies after the closing? 3 3. I already do due diligence, what are you adding? 4 4. Will my transactional lawyer feel threatened by you? Will my broker!? 4 5. The seller will not give me much information. Can you find information online?

What information should I ask the seller for? 4 6. I have seen free-market tenants try to say that they are Rent Stabilized. Can you

give me information on that as part of the Rent Stabilization Due Diligence Analysis? 5

7. Wait a minute. Why is it so hard to tell if a tenant is Rent Stabilized? 5 8. Can I see a sample Rent Stabilization Due Diligence Analysis? How will you

communicate your findings to me and my team? 6 9. The investors I represent are terrified of Rent Stabilization so we are staying away

from multi-family acquisitions. Can you help with that? 6 10. How much does this cost? 6 APPENDIX -- sample Rent Stabilization Due Diligence Analysis for a prospective multi-

family purchase 7

By Michelle Maratto Itkowitz, Esq.

ITKOWITZ PLLC 26 Broadway, 21st Floor

New York, New York 10007 (646) 822-1805

www.itkowitz.com [email protected]

Copyright 2015 by Michelle Maratto Itkowitz

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By the way: YES! This is legal advertising. And we hope it works!

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RENT STABILIZATION DUE DILIGENCE FOR MULTI-FAMILY ACQUISITIONS

Frequently Asked Questions

1. What is Rent Stabilization Due Diligence? Why do I need it for a Multi-Family

Acquisitions? The old saying goes that the three most important things about real estate are: location, location, and location. Keeping that rule in mind, one should add our rule about the three other most important things about multi-family real estate in New York City, and those things are: the tenancies, the tenancies, and the tenancies. A building's value is a function of the tenancies. How do you know, before you buy, that the tenancies are what the seller says they are? How, for that matter, can the seller be sure? Everyone can be a lot surer by having a landlord and tenant litigator with tremendous experience (like Itkowitz PLLC) conduct a Rent Stabilization Due Diligence Assessment.

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2. Why cant I just wait to worry about the tenancies after the closing?

Our clients often retain us after they buy buildings to deal with their landlord and tenant legal problems. And thats terrific. But the sooner you come to us, the more we can do for you. Consider the following example.

EXAMPLE Two guys in Brooklyn bought an eight family building with only three Rent Stabilized apartments occupied. One of the occupied Rent Stabilized apartments was clearly not being used by the tenant as her primary residence. In fact, the tenant lived elsewhere and she was using the apartment solely as an office for her party-planning business. The new owners were excited to start a case against this tenant. But they could not! The tenants Rent Stabilized lease had long ago expired. You can ONLY do a non-primary residence case by first sending what is known as a Golub Notice, a special notice of non-renewal that can only be tendered between 150 and 90 days of the lease expiration. If there is NO LEASE, the lease cant end. NO ENDING DATE means no Golub Period. NO GOLUB PERIOD means NO NON-PRIMARY RESIDENCE CASE. The only thing these new owners could do was to send this tenant, who was so clearly not living there, a new Rent Stabilized lease and wait two years to do a non-primary residence case! IF THEY HAD COME TO US BEFORE (or even during) the contract, we could have advised that the lease should be immediately renewed, and therefore, shaved months off the project.

Revelation of the problem also could have become a negotiating point. At the very least knowing weak points ahead of time helps a purchaser plan better.

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3. I already do due diligence, what are you adding?

We can look at a building and see it in a way that an engineer, architect or tax or transactional lawyer cannot. We see what is at the heart of the building - the tenancies and the ability of those tenancies to create or to stymie revenue generation. If your due diligence protocol does not include highly experienced landlord and tenant counsel, then you are missing a huge piece of due diligence. You hire an engineer so you can know that the bricks and mortar are sound. Why wouldnt you hire a landlord and tenant litigator with tremendous experience (like Itkowitz PLLC) to tell you whether the tenancies are sound?

4. Will my transactional lawyer feel threatened by you? Will my broker!? We do not want to handle your closing! Or ruin your deal! We come in peace -- to help everyone make better deals and to add value. We work closely with transactional counsel to help get the deal done.

5. The seller will not give me much information. Can you find information online?

What information should I ask the seller for? Sellers will sometimes give you more information than you think they will. You need to start by asking. We prefer to have:

the lease the full tenant files a New York State Division of Housing and Community Renewal (DHCR)

authorization from the Seller, and a bunch of other things we can tell you about if you are interested

We can also learn some things from looking online. The more information we have ahead of time, the better.

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6. I have seen Free-Market Tenants try to say that they are Rent Stabilized. Can you give me information on that as part of the Rent Stabilization Due Diligence Analysis? Absolutely. The Rent Stabilization Due Diligence Analysis looks for two major things: (A) How can the existing Rent Stabilized tenancies be eliminated, or moved towards

elimination?

(B) Are the Free-Market tenancies REALLY Free-Market tenancies? Just because the Seller says a tenancy is not subject to Rent Stabilization doesnt make it so.

7. Wait a minute. Why is it so hard to tell if a tenant is Rent Stabilized?

There is no official list somewhere that definitively tells the world which apartments are subject to Rent Stabilization and which are not. The DHCR has jurisdiction over matters relating to Rent Stabilization and DHCR maintains certain records. But the records DHCR maintains contain information that is largely self-reported by landlords and that is not controlling with regard to an apartments Rent Stabilization status. Therefore, year after year a landlord can report to DHCR that an apartment is permanently exempt, but that does not make it so. Moreover, a current or former tenant may have signed a document acknowledging that an apartment is not subject to Rent Stabilization. But this, also, does not make it so. Parties may not contract in or out of Rent Stabilization coverage.1 Why is this so complicated? Because it is. There are many statutes and mountains of case law that, when woven together, make up the rent regulatory scheme in New York City. There are rules, and exceptions to the rules, and exceptions to the exceptions to the rules. This is life in the proverbial Big City.

1 Thornton v. Baron, 5 N.Y.3d 175 (2005).

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8. Can I see a sample Rent Stabilization Due Diligence Analysis? How will you communicate your findings to me and my team? The analysis will be in writing for you to share with your team. The bulk of this booklet is a sample analysis that begins in the Appendix on the next page. This Rent Stabilization Due Diligence process is about more than just getting a report. The due diligence process is an interactive one. Once your team gets the Rent Stabilization Due Diligence Analysis, they can take time to digest the information. Then you can ask questions and/or schedule an in person meeting. If you provide us with additional information, then we will update the analysis accordingly.

9. The investors I represent are terrified of Rent Stabilization so we are staying away from multi-family acquisitions. Can you help with that? Yes, in several ways. In addition to providing you with a Rent Stabilization Due Diligence Analysis, and all the followup thereto, we can also do things like offer you and your team private classes to educate you about Rent Stabilization. We find that there is way too much mystery out there regarding Rent Stabilization, and we can help increase your understanding of this area.

10. How much does this cost? We have been billing for this service on a flat rate basis, by the number of units in a building. Pricing is flexible.

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APPENDIX -- SAMPLE RENT STABILIZATION DUE DILIGENCE ANALYSIS FOR A PROSPECTIVE MULTI-FAMILY PURCHASE

On the next pages is an actual Rent Stabilization Due Diligence Analysis letter that Itkowitz PLLC prepared for a client, before the client purchased a building. We have redacted the document throughout to remove any information that would identify the client or the subject building.

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CONFIDENTIAL: ATTORNEY AND CLIENT PRIVILEGE1

May 28, 2015

PDF BY EMAIL [email protected] Client Redacted Redacted Company LLC 1 Main Street New York, New York 12345

Re: 123 Sycamore Street, Brooklyn, New York2 Rent Stabilization Due Diligence

Our File No. 12345 Dear Mr. Redacted:

This is what our firm calls a Rent Stabilization Due Diligence Analysis, and its purpose is to analyze the above-referenced building, which your company is in contract to purchase, by examining the tenancies and the ability of those tenancies to create or to stymie revenue generation with respect to the Rent Stabilization Law. This letter does not constitute a due diligence analysis with respect to any other area of due diligence, including but not limited to these types of issues: architectural, engineering, environmental, litigation, title, tax, and/or financial.

You are in contract to purchase the 123 Sycamore Street, Brooklyn, New York

Block 12345, and Lot 67 (the Building) pursuant to a contract of sale dated March 2015 between the sellers and 123 Sycamore, LLC, which, I assume, is your entity (the Contract). 1 This was an actual Rent Stabilization Due Diligence Letter prepared for a client who was post-contact, pre-closing. The letter has, obviously, been changed and redacted to protect the clients privacy. 2 This is not the real address.

ITKOWITZ PLLC 26 BROADWAY 21ST FLOOR NEW YORK, NEW YORK 10004 www.itkowitz.com

Michelle Maratto Itkowitz Main: (212) 822-1400 Partner Direct: (646) 822-1805

[email protected]

Fax: (212) 822-1401

Appendix Page 1

ITKOWITZ PLLC Redacted Client May 28, 2015 Page 2 of 25 I. PURCHASERS GOALS

You stated your goal for 123 Sycamore in your email to me dated May 13, 2015

and I will repeat it here: We are aiming to do buyouts here, with a goal of three buyouts in the first year in addition to the owner-occupied unit which is temporarily exempt from Rent Stabilization status and which we have agreed to lease back to the seller for a maximum of 8 months at $2100/month. There are currently no fair market units in the building. We have a buyout fund with approximately $50k available per unit. Thats our game plan in a nutshell.

II. GENERAL BACKGROUND INFORMATION FOUND ONLINE I checked the status of the below items because these are the things that, if not in

the proper order, can affect an owners ability to manage current tenancies and/or evict tenants.

A. The Certificate of Occupancy

The Building has no certificate of occupancy (CO) on file with the New York City Department of Buildings (DOB).

I concern myself with the status of the certificate of occupancy when I do Rent

Stabilization Due Diligence because all too common in New York City is the phenomena where the certificate of occupancy says that the building is a six-family, but the owner or previous owner divided two apartments and now eight families are actually living in the building. Under this circumstance, none of the tenants in the building have to pay rent, and a summary proceeding may not be maintained against the occupants. It is well settled that a landlord may not remove a tenant on the ground of illegal occupancy where: (1) the landlord created the illegality3, or (2) where the landlord took title with notice of an illegality created by a predecessor in title4.

Multiple Dwelling Law 302(b) states: 1. a. If any dwelling or structure be occupied in whole or in part for human habitation in violation of section three hundred one [Certificate of Occupancy], during such unlawful occupation any bond or note secured

3 See 816 Fifth Ave., Inc. v Purdy, 127 N.Y.S.2d 695 (First Dept 1951). 4 See In the Matter of K&G Co. v Reyes, 52 Misc 2d 606 (N.Y. Civ. Ct. 1966).

Appendix Page 2

ITKOWITZ PLLC Redacted Client May 28, 2015 Page 3 of 25

by a mortgage upon said dwelling or structure, or the lot upon which it stands, may be declared due at the option of the mortgagee. b. No rent shall be recovered by the owner of such premises for said period, and no action or special proceeding shall be maintained therefor, or for possession of said premises for nonpayment of such rent. Emphasis supplied. How will a judge decide how many apartments are in a building? By asking these

common sense questions: How many separate apartments are in the building? How many apartment

front doors with separate locks? How many families are living in the building? How many kitchens and bathrooms have been installed in the building? Paragraph 16(b) of the Contract states that the sellers must deliver you a valid

certificate of occupancy authorizing the Buildings use as an eight (8) family dwelling. Please make sure that you get that.

B. No Violations

There are no open or closed DOB violations or New York City Environmental

Control Board (ECB) violations. There has not been any DOB permit or job activity on this Building since the 1930s.

According to the New York City Department of Housing Preservation and

Development (HPD) the Building has four (4) stories and eight (8) apartments and is properly registered with HPD through September 1, 2015. There are NO open (or closed) HPD violations against the Building.

I assume your architect and/or engineer is examining the physical aspects of the Building for you. From a landlord-and-tenant-law perspective, however, I almost never encounter a building that is as free of any negative history as this Building. I am going to guess that the Building was owned by a family that has cared for it well.

C. Litigation

In 2009, one seller sued three of the other sellers. The purpose of the law suit was to force all sellers to agree to sell the Building and split to proceeds (A v. B, Sup. Ct. Kings Cty. Index No. XXXX/2009). I sent my paralegal to the Kings County Supreme Court to see the disposition of the case, because it was not available online. The case was dismissed on December 23, 2009 and does not affect your situation.

Appendix Page 3


We checked at New York City Civil Court, Landlord and Tenant Clerks Office in

Brooklyn, and did not find any pending or former landlord and tenant cases involving the Building.

D. Tax Abatements

According to the New York City Department of Finance website, the Building is

not receiving any tax exemptions or abatements.

III. OVERCHARGE RISK AND ANALYSIS OF INDIVIDUAL TENANCIES

A. The Individual Tenancies

The next part of this analysis addresses overcharge risk assessment and provides a

survey of the individual tenancies. Seller provided you with a March 12, 2015 New York State Division of Housing

and Community Renewal (DHCR) Office of Rent Administration Building Report. We were also provided with the Registration Rent Roll Reports for 2011 2014 (Rent Roll). This is probably adequate. Rent overcharge claims are generally subject to a four-year statute of limitations.5 This rule, however, is not without exceptions. A colorable claim of fraud by the landlord will overcome statute limitations in an overcharge case.6

We were also provided with either the most recent lease or most recent renewal

form for each of the seven tenants in the Building (one unit is owner occupied). Ideally, we would have been provided with the entire lease chain for each tenant.

I review each individual apartment below and then provide you with one chart

pulling all of the information together and drawing some conclusions.

5 Rent Stabilization Law of 1969 (Administrative Code of City of NY) 26-516, as amended by the Rent Regulation Reform Act of 1997. 6 Matter of Grimm v DHCR, 15 N.Y.3d 358 (2010); Bogatin v. Windermere, 98 AD3d 869 (1st Dept. 2012).

Appendix Page 4


1LDebowskaitem status notes

2011rent $962.53leaseended 2/28/2012

increasesforoneyearleasesending2/12/2012

order43 3.75%permissibleincrease $36.09permissiblerent $998.62

2012rentactual $962.53rentok;listedas"$761.27

preferential"leaseended 3/31/2013


order44 2.00%or$20.00whicheveris

greaterpermissibleincrease $19.25permissiblerent $982.53

2013rentactual $982.53rentok;listedas"$816.00


increasesfortwoyearleasesending3/31/2014

order45 7.75%permissibleincrease $76.15permissiblerent $1,058.68

2014rentactual $1,058.67sofarsogood,no

overchargesleaseended 4/30/2015



2015rentactual $879.74

RENTOK;butIhavenoideawhytherentinthisrenewalissomuchlowerthanwhatisrecordedintheDHCRRent

Roll.

We only have the February 1, 2014 lease renewal. We have no earlier pieces of the lease chain. All other information comes from the DHCR Rent Roll.

Appendix Page 5


1RKostujitem status notes

2011rent $1,325.00leaseended 12/31/2011



2012rentactual $1,374.69rentok;listedas"$1141.25




greaterpermissibleincrease $27.49permissiblerent $1,402.18

2013rentactual $1,402.18rentok;listedas"$1141.25




2014rentactual $1,510.84sofarsogood,no

overchargesleaseended 9/30/2014



2015rentactual $1,219.00


Roll.

We only have the July 1, 2014 lease renewal. We have no earlier pieces of the lease chain. All other information comes from the DHCR Rent Roll.

Appendix Page 6


2LRydzikitem status notes

2011rent $950.00leaseended 8/31/2011


order42 2.25%permissibleincrease $21.38permissiblerent $971.382012rentactual $971.38 rentokleaseended 8/31/2012


order43 7.25%permissibleincrease $70.43permissiblerent $1,041.812013rentactual $1,041.81leaseended 8/31/2014

rentasof8/8/2014 $1,041.81rentokaccordingtoDHCR

RentRollbutrentintheactual2013

lease $1,046.66 tinyovercharge $4.85


Appendix Page 7


2RWilkitem status notes notes

2011rent $700.00listedas"RS"and"owneroccupiedemployee" wasthisafiredsuper?

leaseended 3/31/2012increasesforoneyearleasesending3/31/2012

order43 3.75%permissibleincrease $26.25permissiblerent $726.252012rentactual $710.00 rentokLeaseended 3/31/2013


order44 2% or$20,whicheverisgreaterpermissibleincrease $14.20permissiblerent $730.00 $20increase2013rentactual $730.00 rentokleaseended 3/31/2014



2014rentactual $786.57rentokaccordingtoDHCR

RentRoll

butrentintheactual2014lease $820.49

overcharge;suspiciousthatDHCRRentRollisdifferentfromactualleaserenewal $33.92

We only have the February 1, 2014 lease renewal. We have no earlier pieces of

the lease chain. All other information comes from the DHCR Rent Roll.

Appendix Page 8


3RRosenbergitem status notes notes

2011rent $1,400.00leaseended 6/30/2011



2012rentactual $1,452.50rentNOTok;listedas"$1245.00preferential" notreallyovercharge

leaseended 10/31/2012increasesforoneyear

leasesending10/31/2012order44 2.00%

or$20.00whicheverisgreater

permissibleincrease $29.05permissiblerent $1,472.50

2013rentactual $1,481.55rentNOTok;listedas"$1269.90preferential" notreallyovercharge

leaseended 10/31/2013increasesfortwoyear

leasesending10/31/2013order45 7.75%

permissibleincrease $114.82permissiblerent $1,596.37

2014rentactual $1,596.37rentokaccordingtoDHCR

RentRoll

butrentintheactual2014lease $1,307.74


Roll.


Appendix Page 9


4LSuski/Slackitem status notes notes

2011rent $775.38leaseended 3/31/2012


order43 3.75%permissibleincrease $29.08permissiblerent $804.462012rentactual $831.60 rentovercharge $27.14leaseended 3/31/2013



greaterpermissibleincrease $16.63permissiblerent $851.60


rentok;butnotreallybecauseitsanovercharge;

rentshouldbe= $824.46

leaseended 3/31/2014listedas"722.95preferential"




rentoverchargeduetotheabovecalculations;butthis

tenantisgone! $917.60

newtenantGemmaSlack;newlease 8/16/2014

Theleasesaysthereisariderbutwewerenotprovided

withit.Vacancyincreaseforoneyearleasebeginning

8/16/2014 18.25%permissibleincrease $167.46permissiblerent $1,085.06

actualrent $1,450.00significantmonthly

overcharge= $364.94

We have the August 16, 2014 lease. The lease mentions a rider but we were not provided with one.

Jane Doe

Appendix Page 10


4RSzymanskaitem status notes

2011rent $885.96leaseended 12/31/2013



greaterpermissibleincrease $35.44permissiblerent $925.96 rentok2013rentactual $925.96 rentok

leaseended 4/30/2014

Thisistheonlyleaserenewalwehavetheactualdocumentfor;alltheotherdatacamefromtheDHCRRentRollandwecan'tseetheleases.




RENTOK;butAGAINIhavenoideawhytherentinthisrenewalissomuchlower

thanwhatisrecordedintheDHCRRentRoll;Thereis,however,mentionofthefactthatthistenantisonSCRIEseeexplanationin

letter.legalrentin2014lease

$884.80

We only have the February 1, 2014 lease renewal. We have no earlier pieces of the lease chain. All other information comes from the DHCR Rent Roll.

SCRIE is an acronym for the NYC Rent Freeze Program for Seniors. SCRIE is

for certain low-income tenants over 62 years old, and causes a tenants rent to be permanently frozen (see more at http://www1.nyc.gov/site/finance/benefits/tenants-scrie.page). The difference between the legally regulated rent for an apartment and the frozen rent comes back to a building owner in the form of tax credits.

Finally, Apartment 3L is occupied by one of the Sellers and thus not currently

subject to Rent Stabilization.


The following chart sums the eight apartments up:

APARTMENT RENTSTATUS ACTUALRENT

LEGALRENT(whatyoureallyshouldbecharging)

1L

rentok;butIhavenoideawhytherentinthisrenewalissomuchlowerthan

whatisrecordedintheDHCRRentRoll;ThisisNOTlistedasapreferentialrent.Youcan'tincreasewhatyouarecharging

them. $879.74 $879.74

1R



them. $1,219.00 $1,219.002L tinyovercharge $1,046.66 $1,041.81

2R

overcharge;suspiciousthatDHCRRentRollisdifferentfromactuallease

renewal $820.49 $786.573L owneroccupied $ $

3R



them. $1,307.74 $1,307.744L significantmonthlyovercharge $1,450.00 $1,085.06

4R

rentok;butAGAINIhavenoideawhytherentinthisrenewalissomuchlowerthanwhatisrecordedintheDHCRRentRoll;Thereis,however,

mentionofthefactthatthistenantisonSCRIEseeexplanationinletter. $632.42 $632.42 difference

totals/difference $7,356.05 $6,952.34 $403.71 By the way, this chart agrees with the chart of rents in the Contract, except for 4R,

which is listed in the Contract for the full rent, as opposed to the SCRIE rent. You are actually getting the full rent, but you are not collecting it monthly, you are getting it back in a tax abatement.

Here is the basic problem. The DHCR Rent Roll is in great shape. It makes total

sense. On the DHCR Rent Roll the rents go up just as they should. I was very happy when I was reviewing the DHCR Rent Roll. The problem starts when you look at the actual leases. The leases (which reflect the reality of what the tenants are paying) tell a totally different story.

Appendix Page 12


Thus, the tenancies can be separated in to three categories, as follows: The Preferential Rent Tenants (Green) The Overcharge Tenants (Red) The Seller Who Will Remain After the Closing (Yellow)

B. The Preferential Rent Tenants Four of the seven leases show that the tenants are paying much less than what the

legally registered rents are with DHCR. This would make sense if the rents in the leases were deemed preferential rents, a concept discussed below. For three of the apartments the lower rents are NOT preferential. Therefore, it is unfortunate that the rent that you can charge for those three apartments is the lower rent contained in the lease renewal forms.

A Preferential Rent is a rent that an owner agrees to charge a tenant, which is lower than the legally regulated rent that the owner could lawfully collect for that Rent Stabilized apartment. Rent Stabilization Code 2521.2 states:

(a) Where the amount of rent charged to and paid by the tenant is less than the legal regulated rent for the housing accommodation such rent shall be known as the preferential rent. The amount of rent for such housing accommodation which may be charged upon renewal or vacancy thereof may, at the option of the owner, be based upon either such preferential rent or an amount not more than the previously established legal regulated rent, as adjusted by the most recent applicable guidelines increases and other increases authorized by law. (b) Such legal regulated rent as well as preferential rent shall be set forth in the vacancy lease or renewal lease pursuant to which the preferential rent is charged. (c) Where the amount of the legal regulated rent is set forth either in a vacancy lease or renewal lease where a preferential rent is charged, the owner shall be required to maintain, and submit where required to by DHCR, the rental history of the housing accommodation immediately preceding such preferential rent to the present which may be prior to the four-year period preceding the filing of a complaint. A tenant's lease should specify whether a rent concession is intended for a

particular timeframe or lease term. Otherwise, a landlord may be required to offer the same concession with each renewal. See Century Operating Corp. v. Popolizio, 90 A.D.2d 731 (1st Dep't 1982), order rev'd on other grounds 60 N.Y.2d 483 (1983) (Since landlord gave tenant two-month rent concession in vacancy lease and Rent Stabilization Code provision required that renewal leases be offered on same terms and conditions as vacancy lease, landlord was compelled to grant two-month rent concession upon lease renewal.); but see Cromwell Associates v. Ortega, 12 Misc. 3d 141(A), (App. Term 2006) (While an express agreement

ITKOWITZ PLLC Redacted Client May 28, 2015 Page 14 of 25 between a landlord and tenant that a preferential rent will apply throughout the tenancy is enforceable, in this case the parties' agreement explicitly limited the rent preference to the then current lease term and one renewal term, allowing the landlord to resume the legal regulated rent thereafter.) I mention these cases to demonstrate that in some instances the landlord gets stuck with the preferential rent and in some instances landlord can sloth off the preferential rent in subsequent leases and tenancies.

Three of the above seven tenancies have LOWER rents in the current

renewal lease than are registered with DHCR. Unfortunately, however, the renewal leases for those tenants do NOT indicate that the lower rents are preferential and that there is actually a higher rent that may be charged in the future.

One of the preferential rents is actually protected that for 4R, the SCRIE tenant.

I include the actual renewal lease below. Notice how the lease renewal says on it that the $632.42 rent is preferential and the legal rent is $884.80. I circled the important parts in red below. The other three preferential rent tenancies do NOT indicate anything about preferential rents in item number 5.


C. The Overcharge Tenants

There are two rent overcharges 2R and 4L. (Actually, there are three but 2Ls overcharge is so tiny it is no big deal). Here is a chart summing up the situation so far:

overchargeamount months totalovercharge

2ROvercharge $33.92 14 $474.884LOvercharge $364.94 10 $3,649.39

Again, these are very suspicious situations because whoever was doing the

paperwork for the Seller filed records with DHCR saying that all of the rent jumps were legal. The math is very well done. Yet the leases have different, higher rents, which are not legal.

Overall, these are not such huge overcharges. If 4L were found to be overcharged

through today and such overcharge were found to be was willful, then the damages could be trebled (tripled), causing you liability in the vicinity of $11k (through today).7 Indeed, these overcharges could be deemed willful because, as I explained, someone knew the correct math because they filed correctly with DHCR.

4L is unique in that the tenant is the only new tenant in any of the apartments (we

have the DHCR Rent Roll history back to 2011). My guess is that the turnover gave the Seller the opportunity to seek a much higher rent the rent went up $364.00 more than it should have.

Moreover, 4L is the kind of tenant that I would be cautious of. All of the other

tenants appear to: (a) have last names of polish derivation; (b) pay relatively low rents; and (c) have been there for a long time. These are the type of hard-working, long-term tenants who seldom file an overcharge complaint against their landlord, in my personal experience and opinion. Jane Doe8 in 4L meets none of those three criteria. I took the liberty of looking her up online, inasmuch as her name seemed like it would not be so common. Indeed, if this is the correct Jane Doe from Brooklyn, then she is a creative director who allegedly consults for global clients in the fashion and music industries (https://www.linkedin.com/pub/redacted-link-to-jane-does-profile). This is exactly the type of tenant who ascertains her rights and files an overcharge complaint against her landlord.

Keeping an open mind -- maybe there is an explanation for the huge 4L jump in

the rent? May I ask Seller about these two overcharge tenancies prior to closing? Please note that you, not the previous owner, would be liable for these damages.9

7 RSC 2526.1. 8 Name was changed to protect clients and tenants privacy. 9 500 West End Ave. Owners, L.P. v. New York State Div. of Housing and Community Renewal 185 Misc.2d 179 (Sup. Ct. NY Cty. 2000).

Appendix Page 15


The second Rider to Contract at 2 states the following: Supplementing Section 11 Seller makes the following representations, warranties and covenants: (f) Seller has registered with the D.H.C.R. all apartments required to be registered with it or will prior to Closing register such apartments and prior to the closing of title, will produce evidence from such agency indicating such statutes. There are no applications, orders, protests or complaints with reference to rents, services or equipment, pending with any rental authority or court; that there has been no diminution of services and/or equipment and none will be suffered by the Seller until the Closing Date; that no tenant has been given any concession or consideration for the rental of any space; that no utilities are included in any rent; that none of the apartments are rented furnished or for professional purposes other than a law office as shown on the schedule of rents; each tenant pays for his own gas and electricity; all documents required to establish MBR rents have been or will be filed with the required administrative body and copies of same will be delivered at Closing. All the MBR filing fees and rent stabilization fees have been paid or will be paid to the appropriate authorities and copies of all documents required to be furnished to tenants have been furnished. The Order of Eligibility for 2014/2015 and 2015/2016 MBR' s has been, or will prior to closing be issued for all controlled apartments. (g) There are no leases or other agreements or parties that have any rights to the Property except for the leases set forth on the Rental Schedule (the "Leases"), true and correct copies of which have been delivered to Purchaser; (h) There are no brokerage commissions or tenant allowances or abatements due in connection with any of the Leases and no such commissions, tenant allowances or abatements will be due after Closing in connection with any of the Leases; It shall be a condition to Purchaser's obligation to close that all of the representations, warranties and covenants of Seller contained in this Agreement are true and correct as of the date hereof and the Closing Date. Furthermore, the terms of Section 11 of the Contract and this Section 2 shall survive the Closing for one (1) year unless another time period is expressly specified.

You will notice, however, that none of this language protects you, as purchaser,

from liability for sellers overcharges. Your transactional lawyer did a good job. No contract protects purchaser from sellers overcharges. This Contract, in fact, goes farther than most in

Appendix Page 16

ITKOWITZ PLLC Redacted Client May 28, 2015 Page 17 of 25 protecting a purchaser. Nothing, however, will protect you from liability for seller overcharges.10

It is premature for us to provide you with advice about what to do about these overcharges. This should be discussed in the context of your overall approach.

D. The Seller Who Will Remain After the Closing

The first Rider to Contract deals with the right of one of the sellers, Hang-Around

Seller11, to remain in the apartment she currently occupies, Apartment 3L, until eight months after closing for a rent of $2,100.00 per month. You are directed to give her a lease with these terms at or prior to closing.

I do not like the way this section of the Contract was handled. Once Hang-

Around Seller sells and you accept rent from her for apartment 3L, she legally becomes a Rent Stabilized tenant, entitled to perpetual occupancy. If she does not get out after eight months, you will be forced to sue her. You may NOT just lock her out.12 When and if you do go to court with her, she may very well have a defense that she is the Rent Stabilized tenant of the apartment.

The way I would have preferred that this be handled and the way I have seen it

handled in other deals is as follows. She should have been allowed to remain in the apartment in exchange for an adjustment to the closing price in purchasers favor, that way no rent changes hands, giving rise to a landlord and tenant relationship. Moreover, at closing, Hang-Around Seller should have been required to execute the paperwork necessary for what we call a friendly holdover, a landlord and tenant case that would have allowed you to obtain a judgment of possession and a warrant of eviction against Hang-Around Seller, with execution of the warrant to be held in abeyance for six months. That way if Hang-Around Seller does not get out in six months, then you could have the marshal execute the warrant.

It may be possible to correct this issue in the contract by offering Hang-Around

Seller a slightly lower rent.

10 I suspect the law office tenant referred to in the contract above was just a typo, carried over from another contract? Please check that. 11 Name was changed to protect clients and tenants privacy. 12 In New York State, in the context of a residential tenancy, a landlord is forbidden from resorting to self-help under any circumstances and can be subject to compensatory, punitive, and treble damages. RPAPL 853; Romanello v. Hirschfeld, 98 A.D.2d 657, 658 (1st Dept 1983).

ITKOWITZ PLLC Redacted Client May 28, 2015 Page 18 of 25 IV. CREATING VACANCIES IN RENT STABILIZED APARTMENTS AND

SUBSEQUENT HIGH RENT VACANCY DEREGULATION This section is provided for informational purposes. You want to exponentially raise the rent roll on the Building, which is currently

filled with Rent Stabilized apartments. Please correct me if I am wrong about that. There are two parts to this process (1) creating the vacancy, and (2) high

rent vacancy deregulation.

A. Creating a Vacancy in a Rent Stabilized Apartment There are two general approaches to creating a vacancy in a Rent Stabilized

apartment. You could incentivize and/or pressure the tenant to move voluntarily, or you could, if circumstances permit, evict the tenant.

Most real estate professionals are familiar with the concept of the buyout

paying a tenant to leave sooner than they legally have to. I represent both landlords and tenants in residential lease buyout negotiations. I think my ability to represent each is enhanced by the fact that I represent both sides and know how to think like my opposition.

1. Financial Incentives

Achieving a buyout can be a financial balancing act how much is enough money

to get the tenant to go, but not so much that paying does not obviate the reason for getting the tenant out in the first place?

Appendix Page 18


Consider two different tenancies in a hypothetical example below. Tenant #1: Rent: $2,400.00 per month Bedrooms: One Length of Tenancy: 2 years Tenant Age: 31 Other Occupants: None Tenants Profession: Tech. Made a company. Doing well the last two years.

Future uncertain. Credit Score: Decent Neighborhood Ties: Likes the neighborhood and the cool bars and restaurants,

but does not see himself raising a family there. May move back to where family is in Philadelphia, depends on his job. Sees himself owning a home one day.

Tenant #2: Rent: $879.74 per month Bedrooms: Two Length of Tenancy: 15 years Tenant Age: 59 Other Occupants: Tenants daughter and granddaughter Tenants Profession: Works for the City Credit Score: Low. Neighborhood Ties: Goes to Polish speaking church in neighborhood, lots of

friends there, grew up in the area, has rented all her life. Now let us assume that it does not make sense for the landlord to offer either

tenant a dime more than $50,000.00 to get out of the way. Obviously, Tenant #1 is more likely to take the buyout than Tenant #2. Tenant #1 pays more rent than Tenant #2, and is less attached to the neighborhood than Tenant #2. Tenant #1 is younger and more nimble than Tenant #2. Additionally, Tenant #1 has a much better chance than Tenant #2 of being able to take the $50k and get a mortgage for a nice co-op or condo because he has a better credit score and has made more money over the last 24 months. Fundamentally, Tenant #1 sees himself as a temporary renter and a homeowner someday. Tenant #2 already has the perfect living situation, i.e. a two-bedroom, affordable, Rent Stabilized apartment that she can pass on to her daughter.

Appendix Page 19


Now let us do the math for Tenant #2.

CurrentRentStabilzedMonthlyRent $879.74

NewMonthlyRentforSameApartmentintheNeighborhood $2,500.00

BuyoutAmount $50,000.00Taxes $7,500.00Moving $10,000.00

NetBuyout $32,500.00Numberoftimesthenewrent$2,500.00goesintoNet

Buyout 13 The chart indicates that a $50,000.00 buyout buys Tenant #2 about a year in a

similar market-rate apartment in the same neighborhood. Why would she do that? I made many assumptions in my example above about Tenant #2. However, I

assert that Tenant #2 is a lot like your tenants; in fact I used the actual rent for Apartment 1L in the example.

2. Non-Financial Incentives

The above does not, of course, mean that achieving a buyout of any of the

tenants in the Building for $50k or less is impossible. What I have learned from representing many tenants in buyout negotiations is this you never know what is going on in an individual tenants life. For all you know, the tenant WANTS to leave the apartment, for reasons having nothing to do with the possibility of a buyout windfall. The last three tenants I represented and obtained buyouts for moved for these reasons:

the tenant was moving in with her boyfriend and leaving the apartment

anyway the tenant was retiring and did not want to be in Manhattan anymore the tenant has emphysema and did not want to live in a fifth floor walk up

anymore Here is one more example. We represented a landlord in a case where a tenant

stood in the way of a development project in Manhattan. The tenant wanted money to get out, but the parties could not agree on a number. The tenant was in his late thirties. By talking to the tenant, we discovered that one of his biggest reasons for holding on the apartment was because it was in a good school district and he had three small children. He did not want to pay three

Appendix Page 20

ITKOWITZ PLLC Redacted Client May 28, 2015 Page 21 of 25 private school tuitions. The landlord ended up helping to relocate the tenant on a certain block in Park Slope that was also situated in a coveted school district. In this way, an appropriate buyout number was reached and the tenant moved.

Therefore, my conclusion is as follows it cannot hurt to ASK (nicely) if any of

the tenants of the Building want to leave in exchange for a little financial help in doing so. If you offer all seven tenants a buyout and have only a 15% success rate, that still means that you get at least one of the seven out. It is worth asking.

Keep in mind that the people in the Building are used to it being well-kept and the

owner living on premises. When you purchase the Building, you will seem like interlopers and the tenants will be suspicious of you. My approach would be to attempt to seem like good guys. You get more flies with honey than you do with vinegar. You need to figure out what moves people, and/or what vulnerabilities they have. You are better situated to do that if you are perceived as good guys.

3. Pressuring a Tenant to Leave You may not harass tenants in any way in an attempt to get them out. In my

opinion, even if that approach was not morally reprehensible, it ends up costing a landlord more money in the end to play games like withholding of services.

Again, by utilizing an approach of being good guys staying close to a building

and keeping lines of communication open with the tenants, you will be better able to identify opportunities for leverage.

Appendix Page 21


Here is a chart of the most common ways to remove a Rent Stabilized tenant, other than for non-payment of rent.

METHODS REQUIREMENTS

EFFECTIVENESS OF PRESSURE

FOR A BUY OUT NOTE

Owner Occupancy

Building must be owned in an individuals name. The landlord needs

to really prove that he or a family member is going to live there. Then the family member has to live there for at

least three years.

GOOD IF ITS TRUE

Most buildings are not owned in an individual

name. Standard of proof is high and involves

testimony of multiple people.

Demolition

The landlord must demonstrate that plans for the new building have been

filed with, or approved by, the appropriate governmental agency and must further demonstrate a financial ability to complete the project. An

order granting the landlord's demolition application may provide for the

payment of relocation expenses and stipends to the tenants.

NOT GREAT

Expensive, complicated, time-consuming. Project

needs to be large and lucrative to justify.

Non-Primary Residence

Most common avenue for Rent Stabilized eviction. Its shocking how many people do not really primarily

reside in their apartments.

GOOD -- IF YOU REALLY

SUSPECT NON-PRIMARY

RESIDENCE

But you either have these circumstances or you

don't.

Unauthorized Alterations

The breach of a covenant which restricts alterations may constitute a

significant lease violation. Alterations which are non-structural, easily

removable, and consistent with the contemplated use of the premises, may not be sufficiently substantial so as to

justify a tenancy's forfeiture.

GOOD -- IF THEY REALLY DID

UNAUTHORIZED ALTERATIONS

Do you know if any of these tenants are in default either in paying the rent or a non-monetary default?

Appendix Page 22


Please note, however, that Rent Stabilized tenancies are subject to succession, which means that, under certain circumstances, a family member can inherit an apartment form a Rent Stabilized tenant who dies or moves.13

B. High Rent Vacancy Deregulation

Once an apartment is vacant, that does NOT mean that it automatically

becomes Free Market. The rent must legally hit $2,500.00. So how do rents that are, in some cases under $1,000.00, legally advance to over $2,500.00, in such a way that if the jump is questioned anytime within the four year statute of limitations (or beyond) that the increase will be defensible? We explore that below.

A landlord may secure a rent increase based on a substantial modification or

enlargement of dwelling space and/or upon provision of additional services, improvements, equipment, furniture, or furnishings to a Rent Stabilized unit.14 This is referred to as an Individual Apartment Improvement (IAI). No tenant consent is required when the IAI is made during a vacancy.15 The DHCR distinguishes between improvements and repairs or maintenance in determining whether the work qualifies for increase. Other cost issues may be decided on a case-by-case basis.16

In a building with thirty-five (35) or fewer apartments, a landlord may add to a

Rent Stabilized tenants rent the equivalent of one-fortieth (1/40) of the cost of the new service or equipment, including installation costs, but not finance charges. For example, if a new refrigerator is installed in an apartment and the landlords expense is $320.00, then the tenants monthly rent may be increased by $8.00 (1/40 x $320).

Ordinary maintenance and repairs do not qualify for an IAI rent increase.17

13 Riverton Associates v. Knibb, 11 Misc.3d 14 (App. Term 1st 2005). 14 (RSL) New York City Administrative Code 26-511(c)(13); (RSC) 9 NYCRR 2522.4(a)(1). 15 (RSL) New York City Administrative Code 26-511(c)(3); (RSC) 9 NYCRR 2522.4(a)(1). 16 Rockaway One Co., LLC v. Wiggins, 9 Misc. 3d 12 (App. Term 2004), order revd on other grounds, 35 A.D.3d 36 (2d Dept 2006). 17 See, e.g., 425 3rd Ave. Realty Co. ex rel. Mayerhauser Realty, Inc. v. DHCR, 29 A.D.3d 332 (1st Dept 2006) (Invoices for painting, plastering and floor polishing, among other things, were correctly disallowed because they were ordinary maintenance and repair, rather than for improvements.); 201 East 81st Street Associates v. DHCR, 288 A.D.2d 89 (1st Dept 2001); Mayfair York Company v. DHCR, 240 A.D.2d 158 (1st Dept 1997) ([D]isallowed work was for painting, skim coating, partial floor replacement and partial rewiring.); Linden v. New York State Div. of Housing and Community Renewal, 217 A.D.2d 407 (1st Dept. 1995) (Maintenance work did not qualify as IAI.); Graham Court Owners Corp. v. Green, 11 Misc. 3d 131(A) (App. Term 2006); PWV Acquisition, LLC v. Toscano, 10 Misc. 3d 126(A) (App. Term 2005).

Appendix Page 23


The DHCR requires qualifying documentation of the new equipments costs and payments.18 Any claimed cost may be established by way of:

canceled check(s) contemporaneous with the works completion date; an invoice or receipt marked paid in full contemporaneous with the

works completion; a signed contract or agreement; or a contractors affidavit indicating that the installation was completed and

paid in full. Thus, in order for the rent for your Apartment 1L (currently $880.00) to jump to

$2,500.00, an increase of $1,620.00, the math would have to work like this:

RentNeededforDeregulation $2,500.00CurrentRent $880.00Difference $1,620.00

20%VacancyIncrease $176.00TotalRentAfterApplying20%VacancyIncrease $1,056.00Stillneededtogetto

$2500.00 $1,444.00

2.5%(1/40)of$X=$1,444.00 $57,760.00

In other words, AFTER paying whatever you need to pay to get the Apartment 1L vacant, then you need to add $58k of improvements (real improvements, not repairs) and document this, in order to arrive at a deregulated apartment. But there is also more to do.

When an apartment is High Rent Vacancy Deregulated the owner must provide

the first tenant of such newly deregulated apartment with a DHCR promulgated notice detailing the last legal rent, the reason for deregulation and detailed calculations, including Individual Apartment Improvements and costs, of the rent qualifying for deregulation. In addition, the owner must serve DHCR and the tenant with a DHCR registration form indicating the deregulation. This is a new regulation and it is very important that you follow it. There is no case law yet that tells us what happens if an owner misses this step.

There are various other ways to raise the rent also that are beyond the scope of

this informational section. The landlord can, for example, obtain a Major Capital Improvement (MCI) building-wide rent increase. When owners make improvements or installations to a building subject to the rent stabilization or rent control laws, they can apply to the DHCR for 18 New York DHCR Policy Statement No. 90-10.

Appendix Page 24

ITKOWITZ PLLC Redacted Client May 28, 2015 Page 25 of 25 approval to raise the rents of the tenants based on the actual, verified cost of improvement or installation. Some examples of MCI items include boilers, windows, electrical rewiring, plumbing and roofs.19

V. CONCLUSIONS AND TO DOS Here is a consolidated list of tasks that I suggested throughout the letter: (1) Paragraph 16(b) of the Contract states that the sellers must deliver you a

valid certificate of occupancy authorizing the Buildings use as an eight (8) family dwelling. Please make sure that you get that.

(2) Maybe there is an explanation for the huge 4L jump in the rent? May I ask Seller about these two overcharge tenancies prior to closing?

(3) Before closing, it may be possible to correct this issue in the contract

regarding Hang-Around Seller getting a lease and possibly having Rent Stabilization rights.

(4) Do you know if any of these tenants are in default either in paying the

rent or a non-monetary default?

My intention is not to be a downer here. Rather, I think a realistic understanding of the Building will best prepare you to try to maximize the returns on this asset.

Based upon our experience, the Building is not an obvious candidate for fast

buyouts and High Rent Vacancy Deregulation. This is more of a buy and hold kind of building. Having said that, there is nothing to prevent you from taking the information here and the information that you gather after the closing as you get acquainted with the Building, and making a strategic plan to achieve your goals.

It has been a pleasure to prepare this analysis for you and I am happy to discuss it

at your convenience.

Very truly yours, /s/ Michelle Maratto Itkowitz

61124/10045.doc

19 http://www.nyshcr.org/Rent/factsheets/orafac24.htm.

Appendix Page 25


ABOUT THE AUTHOR Michelle Maratto Itkowitz, a partner at Itkowitz PLLC, practices real estate litigation. Michelle has over twenty years of experience, and is best known for her work in the area of commercial and complex-residential landlord and Tenant law in the City of New York. She also is very experienced in general commercial litigation and all manner of real estate transactions. See our Accomplishments section to get an idea of the breadth of Michelle's work. Michelle publishes and speaks frequently on legal issues in real estate. The groups that Michelle has written for and/or presented to include: Lawline.com; The Columbia Society of Real Estate Appraisers; LandlordsNY; Lorman Education Services; The Association of the Bar of the City of New York; The New York State Bar Association, Real Property Section, Commercial Leasing Committee; Thompson Reuters; The Cooperator; The New York State Bar Association CLE Publications; The TerraCRG Brooklyn Real Estate Summits; The Association of the Bar of the City of New York; and BisNow Michelle regularly creates and shares original and useful content on real estate and law, including booklets, videos, podcasts, and articles. She is frequently quoted in the press on a variety of real estate and legal issues. As the Legal Expert for LandlordsNY.com, the first social platform exclusively for landlords and property managers, Michelle answers member's questions, guest blogs, and teaches. Michelle recently developed a six-part, seven-hour continuing legal education curriculum for Lawline.com entitled "New York Landlord and Tenant Litigation". Over 16,000 lawyers have purchased Michelle and Jay Itkowitzs earlier CLE classes from Lawline.com, and the programs have met with the highest reviews. Jay and Michelle are currently co-authoring a chapter on lease remedy clauses for the New York State Bar Association, Real Property Section, Commercial Leasing Committee. Michelle is admitted to practice in New York State and the United States District Court for the Southern District of New York. She received a Bachelor of Arts in Political Science in 1989 from Union College, and a Juris Doctor in 1992 from Brooklyn Law School. She began her legal career at Cullen & Dykman. There are many ways to keep up with Michelle. When Michelle tweets, which is not an obnoxious amount, she does so in an easy to understand manner about useful stuff regarding real estate, business, the legal industry, and organic herb gardening. Feel free to contact Michelle; she would be happy to speak to you.

Michelle Maratto Itkowitz Itkowitz PLLC itkowitz.com 26 Broadway, 21st Floor New York, New York 10004 [email protected] twitter: @m_maratto

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Rent Stabilization Due Diligence for Multi-Family Acquisitions

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