Rent Control ~ St. Paul's Leap
Untangling the Impacts of a Policy with Consequences
A Brief History
Recent client work has given me reason to look under the hood of Saint Paul’s 2022 Rent Stabilization Ordinance (RSO). Like every rent control scheme, this one has strong supporters and critics but – like it or not – it’s on the books for the foreseeable future. Within that context, I thought it might be worthwhile to look at the Ordinance’s history, how it’s supposed to work, why so many developers and property owners find it problematic and how property owners can find modest success by engaging with the Ordinance, rather than ignoring it, given its likely continuation.
The origins of the Ordinance can be traced back to 2021, when COVID was finally loosening its grip on the economy and a sharp rise in inflation – and regional rents – prompted a coalition of neighborhood groups and affordable housing advocates in St. Paul, Minnesota to formulate a rent control policy that found its way on to the November 2021 election ballot.
To the surprise of many, the referendum passed (53%), causing the City to move ahead with an Ordinance restricting rental rate growth in the City to no more than 3% annually. After a five-month policy-development period, the Ordinance took effect on May 1, 2022, but was amended seven months later in response to continued concerns from local developers and investors who feared (correctly) that the Ordinance as implemented would stifle rental rate growth and hence delivery of needed new rental supply, a key mechanism to keeping rents affordable. (Of note, Minneapolis’ policy goal of encouraging development, and restraining efforts to pass rent control legislation to date, are reasons why rents haven’t grown as swiftly there as they have throughout the region.)
Even with the amendment, Saint Paul still has one of the most stringent rent control policies in the nation.[1] And, because this was a voter-approved referendum, the only way to sand-down the edges of the Ordinance is through the City Council amendment process. Eliminating the Ordinance in its entirety would require another vote of the citizens, or State legislative action. Short of either occurring, this Ordinance is here to stay.
How It’s Supposed to Work - (hang in there, it’s involved…)
For existing rental properties there are three methods for increasing rent with limited or no City approval required (new construction is exempt for 20 years):
Limited or No City Approval Required
1. Annual 3% increase. Landlords can simply increase rents on occupied units upon renewal by up to 3% annually with no requirement to inform the City or submit paperwork – a straightforward option.
2. Self-Certification. Landlords can “self-certify” and request up to an 8% annual increase property wide (for occupied units) upon completing an on-line form, which relies on the landlord’s completion of a Maintenance of Net Operating Income (MNOI) Worksheet (a detailed income and expense statement comparing a “Base Year” (starting with 2019) with the most recently completed year (the “Current Year”)), and submission of four (4) financial elements from the completed worksheet. The purpose of this exercise is to showcase how Net Operating Income has failed to keep pace with changes in the Consumer Price Index (CPI).
In most instances (as of now) the City will approve the increase and notify tenants of the approved increase. The completed Worksheet serves both the Self-Certification process as well as The Reasonable Return Standard described below. For Self-Certification, the Worksheet also serves as the backup proof needed in the event a tenant files an appeal (as described further below in the Reasonable Return Standard provision).
3. Just Cause Vacancy. Assuming one of ten conditions is met, landlords can increase rents on newly vacant units by up to the difference in CPI +8% upon proving to the City that the unit has been vacated for Just Cause; the staff accepts a range of reasonable proofs that the vacancy was not the result of coercion. (The Rules are silent on how to actually calculate this; is it the difference in CPI from the date of the original lease, or simply last year’s lease?)
Exceptions Requiring City Review and Approval
For landlords requesting increases greater than 8% for occupied units, there are two (2) additional methodologies for requesting an increase:
1. The Reasonable Return Standard. If a landlord is requesting an increase greater than 8%, then the landlord may apply for an increase using the Maintenance of Net Operating Income Reasonable Return Standard.
The below steps outline the process for submitting an application….
a. The applicant files an on-line in-take form through the on-line portal (“Request for Increase Greater than 3% - Landlord Application”);
b. Upon receipt, the City will email to the Applicant (within a day or two, assuming during the work week) a request to submit/upload: 1) an occupied unit roster (in essence a mailing list); and 2) a Completed MNOI Worksheet;
c. The City will send a notice (Notice #1) to each of the occupied units in the property stating that an application has been received from the landlord requesting an increase in the rent. It can take between one to two weeks from the time the City receives a unit roster and completed MNOI Worksheet to the time the City notifies an occupied unit that a submission has been received;
d. The City will then analyze the landlord’s submission (taking one to two weeks more) and possibly ask questions and clarifications from the landlord to understand the magnitude of expense increases generating the requested increase (the logic being that if expense growth outpaces income growth, then the landlord shall have the opportunity to “make-up” that difference compared to CPI (the “Reasonable Return” concept). The City may ask for additional backup as well (paid invoices, etc. In particular, escalating insurance and real estate tax expenses have been significant expense drivers);
e. If the increase is approved, the City will send a second notification (Notice #2) to each occupied unit stating that the City has approved an x% increase in rent, and that tenants have 45 days to appeal the approval before the increase takes effect;
i. If no appeals are received, then the increase may be implemented immediately (for upcoming lease renewals);
ii. If a tenant appeals, the appeal will be heard by the Legislative Hearing Officer in consultation with the RSO staff (currently consisting of two individuals), the tenant and the landlord. The Hearing Officer will make a recommendation to resolve the matter; if either the tenant or the landlord disagrees with the recommendation, then the application will be referred to the City Council for a final hearing;
Assuming there are no appeals, the time from initial intake to the Department of Safety & Inspections approval is likely to be two, but likely no more than three months. A tenant appeal will add time of indeterminate length (degree of disagreement, City Council schedules/agendas, etc.). Of note, tenants who chose not to appeal will be subject to the approved rental rate increase, irrespective of the actions taken by those who did appeal.
2. Amortization of Capital Expenses. This is one of the more confusing elements of the City’s Ordinance. The City recognizes that to encourage capital investment in property, landlords need the opportunity to achieve a reasonable return on that capital. Yet, it’s confusing due to its inclusion as a line-item element in the MNOI comparison worksheet, while also appearing as a stand-alone concept for analysis on its own. Conceptually, a landlord should be able to increase rents to cover the costs for new roofs, parking lots, kitchen remodels, appliances, carpet and any other capital improvement that prolongs/enhances the utility and condition of the property. Fair enough.
Complications arise from two (2) factors: 1) The City’s designated amortization periods for an array of improvements (from 5 to 20 years, which in many instances do not correspond to their actual useful lives); and 2) The requirement that rents be reduced by the increased amount once the amortization period is over.
No two projects are ever alike and the myriad of outcomes from trying to comply with this provision create distortions that may yield, mathematically, outrageous rental rate increase opportunities, which in turn dissuades property owners from re-investing in their properties. The maintenance of improvement records, costs, amortization schedules and other data, on a building-wide and per-unit basis is also burdensome. Discussions with city staff on the issue suggest an understanding of the ramifications of these prescriptive policies yet the lack of clarity prevents most owners from engaging with this element of the Ordinance.
Why Investors Don’t Like It
I outlined the steps above in detail to provide a sense of the Ordinance’s complexity. Complexity is one reason investors chose not to develop or buy in markets where rent stabilization ordinances are on the books but far from the only one. Among the other reasons are:
1. Compliance is time and manpower intensive. It takes time to review the Ordinance, research its application, question/learn from others who are also wrestling with it and finally develop the correct property-specific strategy for applying the Ordinance. Further, an application is no guarantee of success, and an appeal can expose a landlord to more resource demands.
2. Disclosure of Confidential Information. A fully completed MNOI worksheet and submission of financial data exposes a landlord to public disclosure of highly confidential information; very few landlords are willing to provide such information to anyone other than trusted advisors or lenders.
3. Uncertainty Regarding Future Regulation and Changes to the Administrative Interpretation of the Rules. This is perhaps the most critical reason: investors seek certainty and transparency regarding regulation, and the possibility that future rent stabilization measures become more stringent introduces a risk factor that few investors wish to assume.
4. Is it constitutional? Many wonder whether rent stabilization ordinances are constitutional when looked at through the lens of the Fifth Amendment’s “Takings Clause.” Nationwide, however, the argument has not gained much traction; as recently as last year, the Supreme Court declined to take up the issue. Nonetheless, the issue lingers.
As a Result…..
As the chart below indicates, new rental supply in St. Paul has dropped precipitously. While currently elevated costs of construction and capital (both debt and equity) are primary drivers, the condition is particularly acute here where rent stabilization has collided with these macroeconomic factors. It has been cited as a key reason why the Highland Bridge project has not produced as much housing as planned. Overall, the data from the City supports this:
Source: Housing Production in the City of St. Paul, 2010 thru Q3 2024
The net effect of the Ordinance has been to deter capital from investing in new construction, which is an essential element to helping maintain a healthy and naturally rent-stabilized market. More supply, of all types, helps to alleviate increases in rent, more so than well-intentioned rent stabilization measures. And it is understandable why rent stabilization has gained support, primarily due to the immediacy of its impact. In contrast to the years it takes to introduce new supply, it satisfies the immediate desire “to do something” to help balance the perceived imbalance between the landlord and tenant relationship. Nonetheless, rent stabilization represents a roadblock that many capital participants do not wish to navigate. As a result, the new supply spigot has slowed to a trickle.
But Is There Opportunity?
The short answer is “maybe.” If one is an existing owner or a bit of a contrarian, there are a few reasons why taking the time to understand the RSO may yield some success:
1. It’s Becoming Supply Constrained. As discussed above, rent stabilization has stymied new development and hampered valuations. One could conclude, in fact, that Saint Paul is evolving to become a supply-constrained market, usually a good investment thesis for investing in or developing property in a given market. The unfortunate irony in St. Paul (for RSO advocates) is that rents will likely go up faster than inflation as a result of its RSO (and the market’s broader adoption of its mechanisms).
In the next breath, though, I would suggest that Saint Paul not be viewed as a market for investment with a short horizon. To fully comprehend the RSO and apply its structure will take time and patience; equity capital should be equally aligned with this approach.
2. Local Participants Will Win. If one has a long-term investment horizon, such as a family enterprise, and can commit to learning the process and perfecting its utilization, one should reasonably be able to achieve market-based growth in income. This favors local participants who have a hyper-understanding of how Saint Paul functions as a market.
3. Value-Add Opportunities Might Work. The RSO does not prevent significant capital investment and commensurate increases in rent. But here’s where knowledge of the Ordinance itself and a keen understanding of which pockets of the City can support such opportunities all come into play. A $15,000 per unit value add strategy, for example, should translate into an approvable rental increase of approximately $228 per month ($15k at 7.5 year avg. amortization at 9%, the approximate currently allowable rate). The questions arise regarding whether it’s even achievable, or more importantly, the requirement to drop this increase after 7.5 years ~ who monitors that? And what about the resale prospects for such an asset? Such questions complicate the process and lead most owners to forego such undertakings, which is bad for the property but truly bad for the neighborhoods. It will be the rare and unique situations where this will work (when viewed on its face, and disregarding the potential for any public subsidy).
4. Finally, if one is to wade into St. Paul, adopt the “Let It Go” approach. To actively invest here, one must let go of the entrepreneurial outrage leveled at having to ask for permission. Asking for permission to raise rents is anathema to most entrepreneurs’ sense of free-market, free-will. Most landlords know that to achieve success they must provide good value and service for a fair price. Many chafe at being overly-regulated in the pursuit of that goal.
However, if one can overcome the mental roadblock of asking for permission AND the notion of divulging confidential operating information (something the lawyers may even need to weigh-in on), the rules of the road provide a narrow pathway to move rents in sync with the broader market, based on property-specific costs. In this light, Saint Paul apartment investing may yield reasonable results but only for those willing to learn the Ordinance and engage with the City.
Finally
Despite this conclusion, the RSO has narrowed severely the universe of market participants who otherwise would have considered investing here. I’m not sure this outcome is what the RSO designers had in mind when the concept was originally conceived. Even so, IF the entire market adopted strict adherence to the full array of RSO levers (unlikely due to the above cited complexities), then the market would theoretically function like any other market where landlords respond to rising costs and capital improvements with targeted opportunities to recoup losses and capital investment. If that were to occur, then one would need to ask, what was actually accomplished?
Instead, new capital has generally decided elsewhere is better, while the remaining participants opt for 3% annual and Just Cause vacancy increases only, all while leasehold value slowly accrues to those who chose to live in their units long term (the difference between what someone is actually paying and the “market rent”). Perhaps this is what the designers of the RSO had in mind all along, which leads me to wonder if we’re witnessing a Taking in the Making. In the meantime, the drop-off in new construction and emerging lack of new supply may favor those existing owners and early-adopters willing to tackle this market-distorting policy.
[1] For in-depth analysis of the topic, check out the Twin Cities Housing Alliance, WSJ, Forbes, Harvard Debate. The Harvard debate is particularly illuminating.
Very helpful tool to untangle a complex system with very real practical implications
Wow. That's a master's class tutorial on the pros and cons of Saint Paul's rent control law - and how investors and property owners can navigate its demands. It is fascinating to see how a two-word phrase - "rent control" - can be unpacked into such a complex topic. Thanks!