KAVANAU v. LEWIS

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Court of Appeal, Second District, Division 7, California.

Earl W. KAVANAU, Appellant, v. SANTA MONICA RENT CONTROL BOARD, Respondent. Tamara LEWIS, et al., Real Parties in Interest.

No. B049032.

Decided: August 28, 1991

Craig Mordoh, Los Angeles, for appellant. Anthony A. Trendacosta, General Counsel, Los Angeles and Gilbert H. Friedman, Staff Atty., for respondent. No appearance for real parties in interest.

Appellant landlord appeals from the superior court judgment denying his petition for a peremptory writ of mandate to order respondent Santa Monica Rent Control Board (Board) to permit him to implement all of the rent increase to which the Board found he was entitled. Pursuant to a Board regulation limiting annual rent increases to 12 percent, the Board phased the increase in over a period of five to six years. Appellant contends that action by the Board deprived him of a fair return on his property. We disagree and affirm.

FACTS AND PROCEEDINGS BELOW

In 1979, the electorate of the City of Santa Monica approved a charter amendment which established a comprehensive rent control system for Santa Monica (the Rent Control Law).1 The purpose of the Rent Control Law, which was amended in 1984, is “to regulate rentals in the City of Santa Monica so that rents will not be increased unreasonably and so that landlords will receive no more than a fair return.” (§ 1800.)

The Rent Control Law established as the maximum lawful rent for all affected rental units, the monthly rent in effect on April 10, 1978, a date 12 months before the adoption of the charter amendment. (§ 1804(b).)

The Rent Control Law provides for automatic rent increases for all controlled units on a yearly basis. Pursuant to section 1805(b), each year the Board is required to permit rental property owners to increase their rents in order to adjust for actual increases in taxes, utilities and maintenance expenses.

The Rent Control Law also contains a provision for property owners to petition for increased rents for individual property to allow the owner to achieve a fair return. (§ 1805(c).) Board regulations 4100 through 4111, adopted in accordance with the Rent Control Law, establish a standard maintenance of net operating income (NOI) formula for determining whether a rental property owner is receiving a fair return or is entitled to a rent increase in order to achieve a fair return.

In general, the NOI formula assumes that a rental property owner's net operating income, which generally is defined as gross income, minus certain operating expenses, during the base year of 1978 provides the owner with a fair return. (Regs. 4101 & 4102.) The NOI standard is designed to preserve this presumptive fair return from the property during the base year into future years and allows owners who experience declining NOI to obtain rent increases.

Regulation 4106 provides that: “the Board may permit rent increases, unless otherwise proscribed by law such that the landlord's (“NOI”) will be increased at the rate of forty percent (40%) of the increase in the Consumer Price Index (“CPI”) over the Base Year.” According to appellant,2 the growth of 40% of the CPI is the threshold for determining whether or not a rental property owner is achieving a fair return under the Rent Control Law. If the rate of increase is less than that amount, the owner is not making a fair return. If the rate of increase is more than that amount, the owner is making a fair return. In the former case, the owner is entitled to a rent increase in order to bring the rents up to that threshold level, and in the latter case, no increase is warranted.

Appellant, Earl W. Kavanau, is the owner of residential rental property consisting of seven units (Property) located in Santa Monica, California. On February 1, 1989, appellant filed with the Board an application for an individual rent increase in which he requested that: (1) on a permanent basis, he be allowed to raise the rents charged the tenants on the Property in order to keep up with the rise in expenses since the base year, and (2) he be allowed a temporary rent increase to reimburse himself for money actually spent on capital improvements and money proposed to be spent on specific future capital improvements.

On March 7, 1989, the Board's hearing examiner held an evidentiary hearing to determine whether appellant was entitled to a rent increase in order to receive a just and reasonable return. In the May 17, 1989, decision, the hearing examiner granted the application and made findings of fact and conclusions of law regarding the petition for the then current year of 1988.

Appellant appealed the hearing examiner's decision, and a hearing was held before the Board in July of 1989. The Board voted to adopt the decision of the hearing examiner, with slight modifications. The Board decision made findings of fact and conclusions of law which in turn incorporated certain tables attached to the decision.

The Board concluded that appellant was entitled to a NOI increase at 40% of the increase in the CPI from April 1978 to the date the petition was filed. The Board found that table 5 set out the NOI and capital improvement rent increases allowed by its decision. Table 5 shows that the Board gave appellant permanent NOI rent increases of $195 per month per unit and granted temporary rent increases for capital improvements averaging $145 per month per unit.3 Thus, the total rent increases granted by the Board average $340 per month per unit, or 73% greater than the prior rents.

The Board concluded that regulation 4107 required limiting the annual rent increase to twice the Employment Cost Index (ECI) or 12% and applied regulation 4107 to limit the amount of the increase that could be implemented by appellant and found that table 6 set out the rent increase allowed according to ECI limits. The Board phased the increase in at the rate of 12% per year. According to table 6, it will take from 5 to 6 years or until 1994 before the increase may be fully implemented for all seven units.

Appellant filed a petition for a writ of administrative mandamus pursuant to Code of Civil Procedure section 1094.5 on August 30, 1989. Appellant subsequently brought the matter on for hearing by filing a notice of motion for peremptory writ of mandate.

The superior court ruled that regulation 4107 was constitutional, was not confiscatory, and did not constitute a taking without due process of law as applied to the facts of this case.

On January 17, 1990, the court signed a written judgment denying the motion for a peremptory writ of mandate. Appellant filed a timely notice of appeal from the judgment.

DISCUSSION

Appellant contends that as applied to him, regulation 4107 is confiscatory as it denied him a fair return on his Property. Regulation 4107 provides that: “Notwithstanding any other provisions of this regulation, no upward rent adjustment may be authorized for any given year in an amount in excess of twelve percent (12%) or twice the Employment Cost Index (“ECI”) whichever is greater․ If the amount of any individual adjustment otherwise justified under this regulation is greater than said limit, the full justified amount shall be granted over a period of years such that the rent does not increase by greater than the said limits in any given year. The annual rent limitation shall be inclusive of the general adjustment.”

The Board states it simply applied regulations 4106 and 4107 in order to achieve the purpose of the Rent Control Law to ensure owners a fair return while protecting tenants from unreasonably increased rents as regulation 4106 protects landlords and regulation 4107 protects tenants.

“The scope of our review of an administrative agency's regulations is limited: we consider whether the challenged provisions are consistent and not in conflict with the enabling statute and reasonably necessary to effectuate its purpose. [Citation.] As a general proposition, administrative regulations are said to be ‘shielded by a presumption of regularity’ [citation] and presumed to be ‘reasonable and lawful.’ [Citation.] The party challenging such regulations has the burden of proving otherwise.” (Fox v. San Francisco Residential Rent etc. Bd. (1985) 169 Cal.App.3d 651, 655, 215 Cal.Rptr. 565; emphasis deleted.)

Generally, in enacting rules and regulations, a board is empowered to fill in the details of the enabling legislation, and the court's role is simply to decide whether in enacting the specific rule, the board reasonably interpreted the legislative mandate. (Id. at p. 656, 215 Cal.Rptr. 565.) However, rules and regulations, such as that at issue in this case, are subjected to the same test as to validity as an act of the Legislature. (Knudsen Creamery Co. v. Brock (1951) 37 Cal.2d 485, 494, 234 P.2d 26.)

This appeal presents the issue not of the validity of the Rent Control Law, but rather whether regulation 4107, with its 12% yearly limitation on rent increases, is confiscatory and therefore unconstitutional. “[A]n ordinance restrictive of property use will be upheld, against due process attack, unless its provisions ‘are clearly arbitrary and unreasonable, having no substantial relation to the public health, safety, morals, or general welfare.”’ (Nash v. City of Santa Monica (1984) 37 Cal.3d 97, 103, 207 Cal.Rptr. 285, 688 P.2d 894; italics added.)

Construed either as a constitutional challenge or a claim of denial of statutory rights, appellant's lawsuit must fail. He has failed to prove the 12% percent cap on annual upward adjustments in rent necessarily deprives him of the minimum return the constitution requires. Meantime the statutory “fair return” standard is calculated according to a formula which includes the 12% cap on annual rent increases and thus by definition is satisfied when this limit is imposed.

I. THE STATUTORY FORMULA FOR FAIR RETURN ESTABLISHED BY SANTA MONICA'S RENT CONTROL LAW IS NOT NECESSARILY THE BARE MINIMUM WHICH IS CONSTITUTIONALLY PERMISSIBLE.

In determining whether or not a landlord is receiving a fair return, there is no exact definition as to what constitutes a “just and reasonable” rate of return. The California Supreme Court has held a rent control ordinance must be such that it will permit those who administer it to avoid confiscatory results. (Birkenfeld v. City of Berkeley (1976) 17 Cal.3d 129, 165, 130 Cal.Rptr. 465, 550 P.2d 1001.) The terms “just and reasonable” and “confiscatory” are not precise formulations. (Hutton Park Gardens v. Town Council of West Orange, N.J. (1975) 68 N.J. 543, 350 A.2d 1, 15.) Thus, there is “a range of possible rents--all of which rents would allow the owner a return sufficiently ‘just and reasonable’ as to not be constitutionally confiscatory.” (San Marcos Mobile Park Owners Association v. City of San Marcos (1987) 192 Cal.App.3d 1492, 1503, 238 Cal.Rptr. 290, rev. den. 9-23-87.) Only when government holds rents to such a low level they fall below the minimum courts would deem “just and reasonable” and enter the zone where they are “confiscatory” is there a constitutional violation. (West Hollywood Concerned Citizens v. City of West Hollywood (1991) 232 Cal.App.3d 486, 497-499, 283 Cal.Rptr. 470.

Appellant contends regulation 4107 is unconstitutional if not facially, then as applied to him. He claims the 12% cap is applied after the Board determines a fair return and not as part of the decision as to what constitutes a fair return. Even if this were true, regulation 4107 does not run afoul of the Constitution unless the statutory formula for fair return equals the bare minimum which is constitutionally permissible. There is no evidence in the record indicating this is so. Appellant simply labels the cap “unconstitutional” because he must wait several years for his rental increases to be fully implemented. However, if the statutory fair return is anywhere above the threshold for a constitutionally fair return, phasing in rental increases is not automatically confiscatory. The Constitution does not require annual rent increases each and every year. It only requires that rent control agencies “not indefinitely freeze profit.” (Fisher v. City of Berkeley (1984) 37 Cal.3d 644, 681-683, 209 Cal.Rptr. 682, 693 P.2d 261.)

In the absence of any concrete evidence appellant is not receiving the constitutionally mandated fair return, appellant's theory appears to rest on two propositions. First, appellant assumes the “base rents” the city fixed at the inception of its rent control program in 1978 represented the minimum rent levels permissible under the constitutional requirement of a “just and reasonable” return. Secondly, appellant assumes the statutory formula which granted him additional rental increases in amounts 73% greater than prior rents must be implemented immediately in order for him to maintain the minimally permissible rate of return on his property.

The “base rent” set in 1978 did not necessarily represent the minimum rent level necessary to fulfill the constitutional mandate of a “just and reasonable” rate of return. It is true the Santa Monica Rent Control Law was enacted to ensure landlords received no more than a fair return. However, it is not necessarily true the base rents established in 1978 represent the minimum which would be constitutionally permissible. For, as the New Jersey Supreme Court pointed out: “The return which landlords were obtaining at the base rent levels may well have been so far above the just and reasonable mark that the present diminished rate of return may still be more than just and reasonable even if current cost increases are outpacing permissible rent increases.” (Hutton Park Gardens v. Town Council of West Orange N.J., supra, 350 A.2d 1, 16.)

In fact, the City of Santa Monica set the initial base rents at the market rates prevailing 12 months before the Rent Control Law became effective. In many instances, the unregulated market allows rentals substantially in excess of those required by the constitutionally guaranteed “just and reasonable” return. There is nothing in the record indicating the base rent levels in this case represented the minimum which was constitutionally acceptable. In fact, another court has determined the opposite to be true as a general rule in Santa Monica. “[P]rior to the enactment of the Rent Control Law in Santa Monica, ‘double-digit annual rent increases that [were] related more to avarice than operating costs and reasonable profit abound[ed].”’ (Schnuck v. City of Santa Monica (9th Cir.1991) 935 F.2d 171, 175.)

Even were we to accept the improbable assumption the initial base rates represented the constitutional minimums for all or most of Santa Monica landlords, this does not mean phased in rental increases as a matter of law will necessarily deprive appellant of the inflation adjustments needed to maintain that minimum return. The formula for general and individual annual adjustments does not necessarily produce only those annual rent increments which are necessary to maintain a “just and reasonable” return. “As was true of the ‘base rent’, it may well be these annual increments are in excess of what would be needed to keep rent levels at the constitutional minimum. Thus, over the years, what started as a constitutionally minimum base rent may evolve into a schedule of maximum rents which yields returns substantially above the just and reasonable mark the Constitution requires.” (West Hollywood Concerned Citizens v. City of West Hollywood, supra, 232 Cal.App.3d 486, 498, 283 Cal.Rptr. 470.

Once again, there is a failure of proof. In addition to reimbursing landlords for capital improvements, the city grants permanent annual adjustments to reflect increases in taxes, utilities and maintenance. Additionally beyond that, landlords can petition for permanent rent increases to ensure their NOI4 increases at a rate equal to a 40% increase in the Consumer Price Index (CPI) over the base year. There is no evidence in the record indicating this statutory formula is calculated to produce only the bare minimum necessary to maintain the constitutionally guaranteed “just and reasonable” return. On the record before this court it is not possible to hold as a matter of law the increase of 40% of the CPI each year represents the bare minimum required to satisfy the constitutional mandate.

Between a base rate which may have been in excess of the constitutional minimum and a series of annual increases which may also have exceeded the constitutional minimum, appellant may have accumulated a “surplus” return substantially above the constitutional minimum. If that were the case, any reduced return appellant experienced in the year he incurred these additional costs for repairs and improvements would merely decrease this accumulated “surplus” and not push him below the constitutional minimum.

However, even accepting appellant's unsupported assumptions about the initial base rate and the annual adjustments allowed in Santa Monica's Rent Control Law, the 12% annual cap does not necessarily violate the constitution. For the moment, assume the initial base rents were set at the precise constitutional minimum and the formula for annual adjustments allows the precise increase necessary to maintain rent levels at the constitutional minimum. As discussed more thoroughly in the next section, nothing in this annual limit on rent increases precludes the city from granting a series of annual increases sufficient to make appellant whole, in the medium run, for these sizable one time expenditures for repairs and improvements. And nothing in the constitution guarantees that landlords can recoup the entire cost of a major investment in repairs and improvements out of a single year's increase in rents. The constitution “only requires that rent control agencies ‘not indefinitely freeze ․ profits.’ Fisher v. City of Berkeley (1984) 37 Cal.3d 644, 683 [209 Cal.Rptr. 682, 693 P.2d 261.]” (West Hollywood Concerned Citizens v. City of West Hollywood, supra, 232 Cal.App.3d at 498-499, 283 Cal.Rptr. 470. The costs of those one-time investments can be amortized over a number of years and so can the rent increases necessary to pay for them.

To sum up, the record does not support the conclusion the base rent and annual rent adjustment formula represented the minimums required to satisfy the constitutional requirement landlords receive a “just and reasonable” rate of return. Even assuming they did, the 12% annual cap would not preclude appellant from recouping his one-time investment through an aggregate of rent increases over the succeeding few years. Accordingly, we cannot say that phasing in this increase so rents are not raised more than 12% per annum or twice the Employment Cost Index will deprive appellant of his constitutionally guaranteed “just and reasonable” return.

II. REGULATION 4107 MUST BE EVALUATED AS PART OF A COMPREHENSIVE STATUTORY FORMULA WHICH PROTECTS THE INTERESTS OF LANDLORDS AND TENANTS ALIKE.

It is well settled that “rent control agencies are not obliged by either the state or federal Constitution to fix rents by application of any particular method or formula.” (Carson Mobilehome Park Owners v. Carson (1983) 35 Cal.3d 184, 191, 197 Cal.Rptr. 284, 672 P.2d 1297.) Furthermore, a rent control board may consider the hardship on tenants as a result of an increase. (Pennell v. City of San Jose (1988) 485 U.S. 1, 13, 108 S.Ct. 849, 858, 99 L.Ed.2d 1.) Thus, Santa Monica properly considered tenant hardship in its Statement of Purpose which ensures “that rents will not be increased unreasonably and ․ that landlords will receive no more than a fair return.” (§ 1800; italics added.)

Nevertheless, appellant objects to regulation 4107 because “it does not consider tenant hardship at all, but rather imposes an arbitrary limit of 12 percent on all increases․” However, regulation 4107 must be evaluated in the proper context. Because the city's rent control law provides no parallel limit on the amount of increases which may be granted in any particular case, it is clear regulation 4107 is the only provision which truly protects tenants from sudden and unreasonable rent increases. When reimbursements for capital expenditures are combined with individual and general annual adjustments, landlords could theoretically double rents overnight. Without the safeguard of regulation 4107, landlords would have the ability to thwart the purpose behind the rent control law which ensures “that rents will not be increased unreasonably.” (Id., italics added.)

Contrary to appellant's contention, the 12% annual cap is far from arbitrary. The cap is calculated so rents will not increase at a rate of more than twice the Employment Cost Index. Although the financial condition of each and every tenant is not considered, it is reasonable to conclude a rental increase in excess of this rate in a single year would cause considerable hardship for almost any tenant. Under the rent control laws in Santa Monica and under the constitution, a governmental body is empowered to take account of tenant hardship of this nature in constructing a formula that will be “just and reasonable.” Indeed as a matter of statutory right the 12% cap is part and parcel of the calculation of a fair return for a given year.

Furthermore, the 12% cap only applies to the maximum increase allowed each year. Nothing precludes a series of annual 12% increases until appellant has accumulated additional rents sufficient to recapture all of the cost of the repairs and capital improvements he made. In the medium run appellant can realize the same net return as if he had not felt compelled to make these repairs and improvements. Thus, nothing in the 12% annual cap precludes appellant from achieving in the medium run the statutory “fair return.”

When regulation 4107 is applied to the facts of this case, it is clear this provision is reasonable in light of the entire statutory formula. Once again, although the financial condition of each and every tenant is not considered, it would be difficult to imagine a situation where an overnight rental increase of 73% would not result in hardship. Santa Monica's Rent Control Law was designed with the dual purpose of providing landlords with a fair return and at the same time, protecting tenants from unreasonable rent increases. This formula represents “a rational attempt to accommodate the conflicting interests of protecting tenants from burdensome rent increases while at the same time ensuring that landlords are guaranteed a fair return on their investment.” (Pennell v. City of San Jose, supra, 485 U.S. 1, 13, 108 S.Ct. 849, 858, 99 L.Ed.2d 1.)

It is wholly consistent with the purposes and provisions of the Santa Monica Rent Control Law to require landlords to wait a few years to recapture the full cost of expensive repairs and improvements in order to cushion the financial impact on their tenants. For reasons discussed earlier, appellant landlord has not demonstrated this eminently reasonable measure denies him the minimum “just and reasonable” rate of return the constitution requires.

Accordingly, we affirm the decision of the trial court.

DISPOSITION

The judgment is affirmed.

I concur in part and dissent in part. I agree with the majority that appellant failed to carry his burden of proof in the trial court that he was deprived of a fair and reasonable return on his rental units. However, the majority opinion ventures outside of the record on numerous occasions and I register my disagreement with all such references. For instance, the majority engages in speculating on just how the “base rent” was set in 1978 at the time the Santa Monica Rent Control law was enacted. The speculation in the lead opinion that it is improbable that a “bare minimum” constitutional threshhold was set for rents may very well be accurate, but the record is void of any such evidence.

If the appellant's failure or non-failure to meet his burden of proof in the proceedings below were the only issues on appeal, then I would concur in the judgment as expressed in the lead opinion, but such is not the case. The appellant raises “as applied” and “facial” contentions regarding the constitutionality of regulation 4107.

Even though appellant contends that his constitutional attack on regulation 4107 is based upon its application to his particular case, his attack is also a “facial” one since he argues that the “phasing in” rent limitation as worded per se operates to deprive landlords of any previously determined fair return (albeit this appellant failed in his proof below) thereby constituting a forbidden taking under the 5th and 14th Amendments and the equal protection clause of the United States Constitution.

The regulation, as applied, indicates no constitutional infirmity in this case, in my opinion, since it was apparently feasible for the appellant to avoid the application of regulation 4107 by simply convincing the Board of a need for a waiver of the “phasing in” provision of the section. Although unsupported by the record, the Board claims in its respondent's brief that it has waived application of regulation 4107 on prior occasions when it has been demonstrated that the limit was unreasonable. I am cognizant of appellant's position, in this regard, that he was never informed in any manner of such a right to seek such a waiver. Appellant's contention may very well be true but with use of reasonable diligence such a waiver was probably obtainable, thereby undercutting (barely) any “as applied” attack on the constitutionality of the regulation.

Appellant's “facial” attack on the constitutionality of section 4107, however, spoken colloquially, is a “horse of a different color.”

A New Jersey state court held that an amendment to a city rent control ordinance that limited the total of all rent increases in any 12 month period to 25 percent was invalid. (Cromwell Assocs. v. Newark (1985) 211 N.J.Super. 462, 511 A.2d 1273, 1277-1278.) The court reasoned that the amendment was invalid “because no matter what circumstances are presented to the board, the board cannot grant an effective hardship increase in excess of 19% (25% cap less 6% automatic increase). [¶] When the maximum increase allowable by the rent-control ordinance is insufficient to provide an efficient operator a fair rate of return, the ordinance is unconstitutional on its face.” (Id., 511 A.2d at p. 1277.) One California appellate decision upheld a San Francisco rule imposing an absolute limit on a rent increase. (Fox v. San Francisco Residential Rent etc. Bd., supra, 169 Cal.App.3d 651, 657, 215 Cal.Rptr. 565.) But, unlike the Santa Monica regulation at issue here, the San Francisco rule limited the rent increase to 30 percent of a tenant's base rent and further provided that the limit applied “[e]xcept in extraordinary circumstances.” (Id., at p. 655, fn. 3, 215 Cal.Rptr. 565.)

I would urge the City of Santa Monica and the Rent Control Board to revise the wording of regulation 4107 to state on its face that the Board is permitted to waive its application in “extraordinary circumstances.” Such a revision would be in accordance with its avowed practices as expressed in its brief on appeal. In the interim, I disagree with the majority opinion on the issue of the constitutionality of regulation 4107 and find the regulation as written “facially” unconstitutional.

FOOTNOTES

1.  Unless otherwise indicated, section references are to sections of the Rent Control Law, and “regulation” will be used to refer to regulations passed by the Board pursuant to the Rent Control Law.

2.  The Board does not dispute appellant's characterization of 40% as the threshold for determining fair return.

3.  The Board claims it granted average capital improvement increases of $196 per month. However, by adding up the capital improvement increase column on table 5, the increases total $1,013. When divided by the seven units, the average increase is $145.

4.  Maintenance Net Operating Income is defined as gross income minus certain net operating expenses, not including debt service.

FRED WOODS, J., concurred in part and dissented in part and filed opinion.

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