The opinion of the Court was delivered by O'HERN, J.
These cases present challenges to certain rent control provisions found in two municipal ordinances. Both ordinances use an investment-based formula to determine adjustments of allowable rents to assure a fair return to the owners. In both cases the Law Division upheld the ordinances and the Appellate Division affirmed substantially for the reasons stated by the trial court. We granted certification in these two cases, 102 N.J. 318 (1985), because of an apparent conflict in the decisions below as to whether an investment-based formula for determining fair return requires an adjustment of the investment figure for inflation. The cases were argued together and this opinion disposes of both.
Because the provisions of the two ordinances are otherwise so dissimilar in context and effect, we find no inherent conflict in the decisions. Because neither record below demonstrates that either ordinance
The Weehawken case involves a challenge to rent allowances for the years 1979 and 1980. The property involved is a 57-unit, eight-story apartment building constructed in 1964. The average monthly rentals for the relevant years were approximately $289 to $300 per apartment. The building is uniquely located with a skyline view of Manhattan.
Plaintiff Hamilton Towers, Inc. is the owner of the apartment building, which is operated by plaintiff Fulton House Associates. For purposes of analysis, the plaintiffs' expenses were combined to constitute the landlord's expenses.
Weehawken adopted a rent control ordinance effective January 1, 1974. At the time of plaintiffs' application, the ordinance allowed (1) an automatic inflationary increase of four percent a year in base rent, (2) tax surcharges to tenants for increases in municipal property taxes, and (3) a hardship increase if the landlord cannot (a) meet operating expenses or (b) make a fair return on investment. The Weehawken ordinance defines a fair return on investment as up to six percent above available passbook interest rates applied essentially to the owner's cash investment in the property.
The Jackson Township case involves an application for rental increases for a 165-space mobile home park. The average monthly rentals allowed for the park for 1982 were $143.61 on 150 spaces and $148.83 on nine spaces in the park.
Both ordinances contain provisions for additional rental charges for one-time capital improvements, as well as procedures for requesting hardship increases.
We shall state the principles generally as to judicial control of rent control decisions, apply them to the two records before us, and, finally, offer certain suggestions with respect to any recurring litigation in this field.
Stating the general principle applicable to these cases is easy. "[A] rent control ordinance must permit an efficient landlord to realize a `just and reasonable return' on [the] property." Helmsley v. Borough of Fort Lee, 78 N.J. 200, 210 (1978), appeal dismissed, 440 U.S. 978, 99 S.Ct. 1782, 60 L.Ed.2d 237 (1979) (quoting Hutton Park Gardens v. Town Council of West Orange, 68 N.J. 543, 568 (1975)). Deciding what is a "just and reasonable return" in a given case can be very difficult.
The varied methods that may be used to determine fair return are described by Kenneth Baar in Guidelines for Drafting Rent Control Laws: Lessons of a Decade, 35 Rutgers L. Rev. 723 (1983):
In this case, both ordinances purported to use the return-on-equity standard. Under the formula as used in these ordinances, allowable rent appears to cover at least operating expenses, mortgage interest payments, and a percentage of cash investment. The Weehawken and Jackson ordinances use investment-based approaches to determining fair return on equity. The use of such a formula was presaged in Helmsley, supra. In that case the Court noted:
Facial challenges to investment-based formulas assert a discrepancy in that similarly-situated operators would be authorized to receive different rents under the same rent control
In Cotati, the court rejected a constitutional challenge to the ordinance because it was a valid form of economic regulation reasonably related to a legitimate public purpose; moreover, the court stated that "[t]he investment-based standard, unlike a value-based standard, ensures that inflationary factors will not be built into a rent control ordinance's rent ceiling adjustment mechanism, and thereby ensures the integrity of the entire rent control scheme." Id. at 292, 195 Cal. Rptr. at 833. The appellate court rejected the landlord's contention, which had been accepted by the trial court, "that a `return on value' standard is mandated in order for a rent control ordinance to pass constitutional muster." Id. at 287, 195 Cal. Rptr. at 829. It cited favorably this Court's decision in Helmsley v. Borough of Fort Lee, supra, particularly the notion that "`[o]nce income is controlled, * * * using capitalization of income to determine value to regulate future income is a circular process.'" Cotati, 148 Cal. App.3d at 287, 195 Cal. Rptr. at 830 (quoting Helmsley, supra, 78 N.J. at 214). It noted that "[r]eturn on investment has been characterized as the `governing standard' in Massachusetts * * *." 148 Cal. App.3d at 288, 195 Cal. Rptr. at 830 (citing Zussman v. Rent Control Bd. of Brookline, 371 Mass. 632, 638, 359 N.E.2d 29, 32 (1976)).
The court in Cotati was able to sustain the ordinance because the undefined return-on-investment standard afforded the
The California Supreme Court recently sustained these principles, holding that the City of Berkeley's fair-return-on-investment standard would not preclude the board from avoiding confiscatory results. Fisher v. City of Berkeley, 37 Cal.3d 644, 682, 693 P.2d 261, 291, 209 Cal.Rptr. 682, 712 (1984) (en banc), aff'd on other grounds, 475 U.S. ___, 106 S.Ct. 1045, 89 L.Ed.2d 206 (1986). It reiterated "that selection of an administrative standard by which to set rent ceilings is a task for local governments — in this case the voters themselves — and not the courts." 37 Cal.3d at 681, 693 P.2d at 291, 209 Cal. Rptr. at 712. The court's only concern was whether the "defendants'
It will be seen at once that neither California decision advances the underlying question of what indeed is a fair return.
This Court has stated that it is inappropriate for a community to adopt a rent control ordinance without definitive standards. See, e.g., Troy Hills Village v. Township Council of Parsippany-Troy Hills, 68 N.J. 604, 620-21 (1975) (rent control ordinances should set forth standards and criteria by which the parties, the local rent control agency, and reviewing tribunals can be guided in determining adequacy of returns actually received under the ordinance). Hence, we believe that the attempts of these two municipalities are preferable to the kind of open-ended approach found in the Cotati case. Nonetheless, neither ordinance answers the ultimate constitutional question of what is a fair return. That question remains for a judicial determination of whether, as applied, the ordinance affords the investor the constitutional minimum. It is to this that we must address ourselves.
The central challenge to the Jackson rent control ordinance is that its flat seven and one-half percent limit on return fails to respond to true market conditions and is therefore inherently confiscatory. However, as a result of companion
In addition, although we do not have before us the full record made in the United Mobile Homes case that enabled the trial court to conclude that, as amended, the ordinance would not be confiscatory, we believe that enough appears to sustain that court's reasoning. In that case the court further modified the ordinance to permit the use of updated expense information. On the record before us, the plaintiff undertook to demonstrate by replacement-cost analysis or income-based analysis that comparable mobile home trailer parks operating in an unregulated economy would warrant monthly rent of $211. Plaintiff pointed to the illogic of an ordinance that limited him to a seven-percent return on cash investment when current market rates for certificates of deposit and passbook savings accounts were as much as sixteen percent. The trial judge noted that in United Mobile Homes it upheld the seven and one-half percent increase "notwithstanding the testimony of experts that in other types of investments rates of return in the 16 to 20 percent level could be realized without the type of risk associated with mobile homes." Plaintiff further pointed to a seemingly inconsistent provision of the ordinance that would have permitted an investor to loan money to the corporation instead of investing it and receiving the higher rates of current passbook accounts; the trial court interpreted this as merely a limit or cap on the interest rate that could be charged by a stockholder to his corporation and not a modification of the "clearly established 7 1/2 percent rate." In sum, in this case the trial court applied a
Turning then to the question of whether a seven and one-half percent return on adjusted investment is confiscatory, the trial court in United Mobile Homes concluded that real estate investors would not necessarily expect the same return as those in fixed-face amount investments such as certificates of deposit or treasury bills. It noted that the real estate investor has other commercial benefits, including, in some situations, tax shelter and an appreciating asset. We note in passing that some current government mortgage financing regulations contemplate an eight-percent return on equity. See, e.g., N.J.S.A. 55:16-5 (Limited-Dividend Nonprofit Housing Corporations or Associations Law limits repayment of investment to a sum equal to the shareholder's "investment plus cumulative dividends at a rate not to exceed 8% per annum"). In rental-apartment-assessment cases for contemporary taxable years, some capitalization rates for equity were set at eight percent, River Drive Village v. City of Garfield, 7 N.J.Tax 632, 642 (Tax Ct. 1985), and nine and one-quarter percent, Petrizzo v. Borough of Edgewater, 2 N.J.Tax 197, 204 (Tax Ct. 1981). The trial court noted that even if plaintiff Joe Mayes' investment base were adjusted for inflation, it would not require an increase above that allowed by the automatic inflationary process. We are unable to say that the trial court clearly erred in concluding the rate-of-return permitted under the ordinance was not confiscatory after the changes the court made. While reviewing courts remain free to rule on ultimate constitutional determinations, considerable deference remains to be paid to a trial court finding. Zussman v. Rent Control Bd. of Brookline, supra, 371 Mass. at 368, 359 N.E.2d at 32.
In the Weehawken case, the challenge was not to the static rate of return on the investment, since Weehawken's rate floated up to six percent over current passbook demand deposit rates. A constitutional challenge was mounted at the trial level. Plaintiffs argued that there was an inherent illogic in an ordinance that allowed widely variant rents depending upon the amount of capital invested in the premises.
The plaintiffs' fair-return challenge was based upon a value-based theory of confiscation. Plaintiffs' expert witness posited a hypothetical investor for the premises and determined what he considered to be the typical market financing of seventy-percent capital and thirty-percent equity. The expert applied an anticipated profit rate to the thirty-percent equity and a predetermined constant to the seventy-percent mortgage to arrive at a weighted capitalization rate of .1207. Dividing this rate into net operating income in order to determine value resulted in the property's showing a considerable decline in value in 1979 and 1980: using this formula, for 1971 the value was $772,800, whereas for the period from July 1, 1979, to June 30, 1980, the value was $518,000.
The municipality's response to this was unexpected, to say the least. Its expert conceded the general validity of the plaintiffs' market data approach but suggested that the expense
The trial court, however, felt itself bound by this Court's decision in Helmsley to conclude that it could not determine confiscation on a value-based standard because of the asserted circularity of the argument, the point being that of course rent control depreciates values. Accordingly, it declined to set aside the findings of the local rent control board on that basis.
Since the date of its decision, we have been informed that the trial court's prophecy was self-fulfilling in that the property
Each of these cases demonstrates, however, the difficulty that local agencies and reviewing courts have experienced in the administration of rent control ordinances. For example, in the Jackson Township case the constitutional challenge was attempted before the rent leveling board. That board, however, was operating pursuant to an ordinance that purported to decide what was a fair return. It is difficult to conceive how a board, under those circumstances, could effectively address a constitutional challenge. It would be arbitrary to depart from the provisions of its own ordinance. Conversely, in the Weehawken case, the constitutional challenge was raised directly in the Superior Court with the plenary trial of those issues being heard by the trial judge. Each of these approaches to determining constitutional return has its disadvantages. A local rent leveling board should have the fullest opportunity to consider all of the evidence bearing on what is a just and reasonable return.
There is a paradox here, as noted, in that we have insisted that municipal bodies act in accordance with standards that are not vague. At the same time, we have insisted that the only true test of the validity of an ordinance will be in its application in particular cases. Troy Hills Village v. Township Council of Parsippany-Troy Hills, supra, 68 N.J. at 621. The ultimate question will always remain whether the ordinance, as applied, has a confiscatory effect upon the property.
Although the financial conditions that prompted the rapid growth of rent control in New Jersey are no longer present, such as the double-digit inflation and oil crises of the 1970's, it appears likely that despite a leveling of inflation and the noninflationary trend of the present economy, rent control will remain a fixture in many New Jersey communities. Rent control is no longer predicated upon a housing emergency. See Brunetti v. Borough of New Milford, 68 N.J. 576, 594 (1975). It may be regarded as a form of governmental regulation in the public interest. Helmsley v. Borough of Fort Lee, supra, 78 N.J. at 243. Significant changes have been made in the economic relationship between landlord and tenant. See, e.g., N.J.S.A. 2A:18-61.1 to -61.21 (Anti-Eviction Act); N.J.S.A.
Nonetheless, new patterns of development in New Jersey have unleashed powerful market forces that have continued to create instability in the rental housing market. Particularly in the fast-growing areas along the Hudson River, so much advantage exists in the new commercial or condominium markets that owners are forcing out existing tenants. Winerip, For Jersey Tenants, Hard Lessons in Real Estate, N.Y. Times, April 1, 1986, at B2, col. 1. These speculative forces threaten the ability of a community to maintain a sound housing balance for its citizens.
It appears likely then that judicial challenges to rent control decisions will continue. The trial court in the Weehawken case remarked that "[w]ith no formula or set of absolutes for trial courts to apply, we are left only with a vague sense of what the outer limits of unfairness are for purposes of constitutional tests." Future litigation might focus more concretely upon additional evidence that will better enable reviewing courts to determine whether a fair return has been achieved.
An aid to a reviewing court would be a record of whether the property's net operating income has been steadily diminishing. This measure is reflected in many rent control ordinances and is in part the theme of Helmsley v. Borough of Fort Lee, supra. In Helmsley, the Court considered the effect of the Fort Lee ordinance against a background of increasing operating expenses and predicted in the operation of the ordinance a continuing diminution in net operating income. 78 N.J. at 220-22.
Kenneth Baar and Dennis Keating recommend a maintenance-of-net-operating-income (cost-passthrough) fair return standard. Baar & Keating, Controlling Rent Control, 11 N.J. Reporter 19, 24 (Oct. 1981).
Stated in a formula, it is that
Baar, Guidelines for Drafting Rent Control Laws: Lessons of a Decade, supra, 35 Rutgers L.Rev. at 809. The measure should be kept simple. For purposes of using this analysis, a court need not now require that the operating income be adjusted for inflation. See, e.g., id. at 843 (annual general adjustment standards "that tie annual increases to overall inflation rates may allow for increases which are more or less than adequate to cover operating cost increases"). The analysis was suggested in Helmsley, where the Court noted that "long-term stagnation of profits might [itself] be proved to be confiscatory[,]" although the issue was not before it. 78 N.J. at 218, 223. It would be a rough measure of the ordinance's effectiveness. We do not perceive in New Jersey's rent control
In Fisher v. City of Berkeley, supra, the California Supreme Court noted that a rent control ordinance cannot indefinitely freeze rent ceilings. 37 Cal.3d at 683, 693 P.2d at 292, 209 Cal. Rptr. at 713. The opposite seems necessarily true, that an ordinance cannot indefinitely reduce operating profit without eventually causing confiscatory results. This is the theme of Helmsley, discussed in terms of operating ratios, Helmsley v. Borough of Fort Lee, supra, 78 N.J. at 217-20, as well as in the context of diminishing net operating income, id. at 223 ("[a]t some point, steady erosion of [net operating income] becomes confiscatory") (footnote omitted). But ratios are all subject to divergence. See Baar, Guidelines For Drafting Rent Control
Although there is a difference between operating ratio and maintenance of net operating income, the latter method is less susceptible of manipulation and easier for reviewing courts to employ. It necessarily presupposes that a landlord will maintain and submit to rent leveling boards levels of operating expenses. Of course there will be dispute about whether a chosen base-period rent is a fair rent.
In the Weehawken case, the trial court believed that if an income-based standard had been used in the ordinance, plaintiffs would have been entitled to some relief. By allowing courts to evaluate fair return in this light, we believe that the purposes of rent control in New Jersey will be furthered. If it is thus shown that an ordinance is defeating the purpose of rent control by steadily diminishing income and causing the flight of rental housing from the market, relief would be warranted.
We offer these suggestions not in the belief that they will resolve all the complexities of rent control litigation but in the belief that they will help trial courts and parties in addressing the issues involved. So much has happened since the reappearance of rent control in New Jersey that we believe progress can be made in this sensitive area of municipal economic regulation. The rental shocks of the 1970s have been eased by the abatement of double-digit inflation, high interest rates, and oil embargoes; for how long we do not know. Tenants' and owners' interests may now be better able to coalesce in the maintenance of a viable rental housing market.
As noted, in the cases before us the records do not establish that the ordinances have had a confiscatory effect. The judgments of the Appellate Division are affirmed.
For affirmance — Chief Justice WILENTZ and Justices CLIFFORD, HANDLER, POLLOCK, O'HERN and STEIN — 6.
For reversal — None.
Expressed in Expressed in
1964 Dollars 1980 DollarsCosts and Improvements $764,591.50 Less: Mortgages 600,000.00 ____________ Investment Base 164,591.50 $438,910.66 ____________ ___________ Fair Return Rate 11.25% 11.25% ____________ ___________ Fair Return Amount$ 18,516.54 $ 49,377.45 ____________ ___________ Actual Net Operating Income $ 45,935.00 ___________
In the years since the development of rent control, it has frequently been necessary to evaluate property in New Jersey in light of or even despite rent control ordinances. Courts have striven to ascertain true value. In cases where there is potential for condominium conversion, assessments are beginning to reflect the values that encourage people to remain investors in real estate. See, e.g., Americana Assocs. v. Borough of Fort Lee, 202 N.J.Super. 92, 96 (App.Div.), certif. denied, 102 N.J. 304 (1985) ("fact that property may, as an abstract proposition, have potential conversion value may not be treated as an increment to value unless shown by quantifying evidence to be of meaningful substance").
We realize that there are complexities to this suggestion, not the least of which will be consideration of tax-passthrough features of the ordinance and the appropriate application of the Director's Ratio (L. 1973, c. 123, § 2, repealed by L. 1983, c. 45, § 54:51A-21 (current version at N.J.S.A. 54:51A-6)) to the assessed value, that may invite the same "circular process" disapproved by Helmsley v. Borough of Fort Lee, supra, 78 N.J. at 214. Still, that circularity might be avoided by a properly tailored and limited inquiry as to the relationship of the return to assessed value.