How Widespread is Abuse of the Individual Apartment Improvement Increase Loophole?

With the creation of the HCR’s special Tenant Protection Unit (TPU) in 2012, the agency began to conduct a small amount of retroactive auditing of IAI increases. What they have found is cause for concern:

• The New York Times reported that a 2014 audit by the Tenant Protection Unit “found through more than 1,100 landlord audits that, in as many as 40 percent of cases, landlords did not have proof of apartment improvements used to justify rent increases, state officials said.”
• While the TPU does not regularly share information publicly, it consistently reports successful enforcement actions against landlords charged with abusing the IAI program.

While it is troubling that there may be fraud in a significant percentage of IAI cases, recent data from the housing watchdog group Housing Rights Initiative (HRI) points to an even more fundamental problem with the IAI system. 

As part of their investigative work, which has led to multiple class action lawsuits, HRI recently began collecting official HCR rent histories for apartments where HRI had reason to believe that the landlord had used an IAI to collect a rent increase during a recent vacancy. HRI’s rent history database is unusually large, and the HCR only releases rent histories on request of the actual current tenant of an apartment, so they are difficult to collect. HRI’s database of 118 apartment rent histories, collected from 52 separate buildings owned by three different landlords shows that the average starting rent was $1,089 and the average new rent was $2,149, representing a 107.5% increase that averaged $1,060.

This finding from the HRI data suggests that landlords are not using IAIs to make modest physical improvements – they are using them to drive major rent increases, even doubling rent levels.

It appears that the IAI formula itself actively incentivizes landlords to significantly increase rents and remove apartments from rent regulation. Even if the IAI loophole is used with no fraud, the formula allows a major, sudden, permanent increase in rent for a relatively small investment in the apartment.

“Specifically, Gluck entered into a fraudulent secret arrangement with contractors performing renovations on the apartments ... pursuant to which the contractors inflated the prices charged for the renovations. The difference between the actual costs and the inflated costs -- approximately $40,000 per apartment -- was credited to Gluck to be used at his discretion…. 4. Additionally, in furtherance and in aid of this scheme, at Gluck’s direction and under his supervision, employees of Stellar Management assisted Gluck in concealing this secret arrangement by keeping a second set of financial records tracking the overpayments made in connection with [the subject buildings] the true value of the services, and how funds were reallocated to other ventures. 5. The [subject buildings] are not the only instance where Gluck has perpetrated this fraudulent scheme. 

An example of a rent history from one tenant in a Stellar Management building shows what a de-regulated rent history looks like in the image to the left.

As this rent history shows, the last registered legal rent was $896.29. “Exempt” indicates that the apartment was removed from rent stabilization. According to the class action lawsuit, for Stellar Management to have legally exempted this apartment, it would have had to have performed considerable apartment improvements to get the rent over $2,700, which was the deregulation threshold at the time. To calculate an individual apartment improvement claim, you first take into account the maximum non-IAI vacancy allowances. In the case of this apartment, the difference is between the legal rent and the $2,700 deregulation threshold – which could only be explained by IAIs –and Stellar Management would have had to have done $90,000+ in apartment improvements.

The HRI class action lawsuit asserts that the expense claims for the apartments in the lawsuit are suspicious because of:           

• Lack of visual evidence of improvements in the apartments in question;
• Building permits that appear insufficient to justify the full scope of the work; and
• Questionable invoices submitted to the court by Stellar Management through the discovery process fail to justify the full costs.

HRI research, as reported in The Real Deal, also found evidence of at least five shell companies used by Stellar to further exploit the IAI system. As recent New York Times expose on the fraudulent real estate practices of Donald Trump’s father Fred Trump shows some landlords have routinely created shell construction companies through which they pay themselves to perform inflated or fictitious apartment improvements. If a tenant files an overcharge complaint, the landlord can justify those improvements and subsequent rent increases by furnishing fake or padded invoices and canceled checks made out to their shell companies.