The Capital Expense Pass-Through Petition
by: Merrie Turner Lightner

• Published Originally January 1994
• San Francisco Apartment Association Magazine

Whether it’s due to earthquake, fire, storm damage or just plain old age, all income property will need major repairs during its life­time. It’s a fact of property life. After paying for the repairs, an owner will natu­rally want to raise rents to help defray the costs. Outside of rent control, the landlord’s ability to increase rents for this reason is governed only by the forces of supply and demand. But this isn’t the case in San Francisco.

The City’s Rent Ordinance regulates a landlord’s ability to recover the cost of capital improvements through rental in­creases. The law requires a property owner to petition the Rent Board for the right to do so through a process called, “The Capital Expense Pass-Through Petition.” This column outlines this process and provides some essential guidelines on how to do it successfully.

The “Capital Expense Pass-Through Petition” is set forth in the Rent Ordinance, Section 37.7 and in the Rules and Regula­tions at Part 7. In general, the law allows a property owner to increase rents to recover the cost of capital improvements when the improvement(s) benefit the units in ques­tion and the improvements were not neces­sitated by the current owner’s neglect or failure to maintain the property. A capital expense can affect all the units in a build­ing, some of the units in a building, or just one unit in a building.

Generally, the San Francisco law al­lows a landlord to recover the cost of the improvement(s) over a 7-year or 10-year period, depending upon amortization schedules published by the Rent Board. In addition to the direct cost of improve­ments, an owner is allowed to collect im­puted interest at the rate of 10% per annum, regardless of the actual interest the owner may be paying on the money spent for the improvement.

There are additional limitations. The improvements must have been completed within five years of filing the petition and no matter how much the improvements cost, the amount of the pass-through can be no more than 10% of a resident’s base rent or $30 per month, whichever is greater. Increases certified beyond that amount must be “banked” for a future year’s increase.

The pass-through amount, once ap­proved, is NOT added to a tenant’s base rent, but instead becomes a separate part of the rental payment. Annual cost-of-living rental increases are NOT calculated upon the entire rental amount, but only on the base rent (the rental amount less any capi­tal expense pass-through). Many owners get into trouble by mistakenly calculating rental increases using the full rent. Be careful to use just the base rental rate. Once the amortization period of each “pass-­through” is completed, the capital expense portion of a tenant’s rent terminates and their monthly rent is decreased accord­ingly.

Many owners operate under the mis­conception that as long as they follow the guidelines of the Rent Ordinance and their tenants have agreed to an increase, they don’t need to formally petition the Rent board for a “pass-through” increase. Wrong! Any unapproved rental increase that is over the annual cost-of-living in­crease allowed by the Ordinance is null and void, even if the tenant has agreed to the increase and actually pays it! Even a tenant who has gone along with an unapproved increase may ask the Board to compel you to return the money paid at any time.

Recently, the Rules and Regulations were amended so that a Hearing Officer can award a rent refund which results from any null and void increases dating back for no more than three years from the date of filing the petition, plus the time it takes for the decision to be mailed. However, the commission has the ability to grant awards dating back to any null and void increase which occurred on or after April 1, 1982, if it is in the interest of fairness and justice. In order to protect yourself, you must go through the formal process.

As anyone who has gone through this process will attest, the more documents you can produce to support your petition, the better. If you are planning capital improvements and want to file a petition for a capital expense pass-through, it is best to follow these guidelines during the renovation process:

1. TAKE “BEFORE” AND “AF­TER” PICTURES of the areas to be im­proved. It is not uncommon for tenants to argue that the work was not necessary or done poorly. Pictures will assist you in proving why the repairs were necessary and that the work was done in a workman­like manner.

2. OBTAIN MORE THAN ONE BID for all the work done. This is generally a good business practice anyway. The bids will also be good evidence in the event there is a dispute as to the value of the work performed.

3. ENTER INTO A WRITTEN CON­TRACTUAL AGREEMENT with the contractor you choose to do the work. Make sure that the work to be done is fully detailed in the contract and that the loca­tion where the work to be done is stated in the contract. Again, this is just good busi­ness practice. It will also help to detail the cost of the work in the petition.

4. KEEP YOUR CANCELLED CHECKS AS EVIDENCE OF YOUR PAYMENT. Most individuals keep these sorts of records for tax reasons anyway. However, you will need your canceled checks as evidence of your payment for the work; it’s a required part of the petition. If your contractor is doing work for you at more than one property location, keep your payments separate. It can be difficult at petition hearings to explain why your payments are different from your contract amount.

5. BE SENSITIVE TO YOUR RESI­DENTS ABOUT SERVICE INTERRUP­TIONS. Many property owners run the risk of a “decrease in services” claim dur­ing a renovation because they fail to give their tenants notice of potential interrup­tions in service during the renovation. Be careful to give your residents advance writ­ten notice of an anticipated interruption in service (for example, the hot water being turned off). You should also do everything reasonable to return services to the tenants promptly after an interruption.

Keep a copy of the notice(s) and keep a diary regarding the time and extent of the interrupted services. It’s a hassle; but the records will serve you in defending against a “decrease in services” claim, if one arises.

6. TAKE CARE OF ANY OUT­STANDING REPAIR REQUESTS. The first complaints tenants will make at a hearing on a “pass-through” petition will be chronic or unanswered repair problems. The simplest way to avoid the harangue is to complete any deferred maintenance or requested repairs prior to the hearing date. If you cannot do so, be prepared to explain why not.

In addition, the Hearing Officer will review the rental increase history for each affected tenant. If an unlawful increase is discovered, the Hearing Officer will cor­rect the base rent and potentially give the affected tenant a monetary award to reim­burse them for the unlawful increases. If you find that you have made a mistake prior to filing your petition, you should try to work something out with your resident for the repayment of the unlawful increase. You won’t be guaranteed that the Hearing Officer won’t still investigate the matter, but it will look much better if you have tried on your own to correct the problem.

7. PROPERLY COMPLETE AND FILE YOUR PETITION. After the reno­vation work is complete and your bills have been paid, you can file your petition with the Board and notify your residents of the increase.

There are a number of individuals who will, for a fee, file the petition for you and attend the hearing as your representa­tive. If you do not feel comfortable with your ability to effectively present your case, using someone who acts as a capital improvement petition specialist can be a cost effective alternative to hiring an attor­ney to attend the hearing.

You should advise your residents not to pay the increase until it is approved by the Rent Board. Once approved, the in­crease will be retroactive to your notice date. In the alternative, you can wait and notify the tenants regarding the increase after your hearing date and your receipt of the approved petition.

THE HEARING PROCESS

Once your petition is filed, the Rent Board will notify you and all of your af­fected residents of the hearing date. At the hearing your tenants will have the right to object to the rental increase and to present evidence supporting their objection on the following grounds:

1. The work claimed was not per­formed;

2. The work claimed was necessitated by the current landlord’s deferred mainte­nance which resulted in a code violation;

3. The costs claimed are not true or reasonable costs; or

4. “Some other reason.” (See general Rules & Regulations, Section 7.15).

At the hearing, all parties are subject to the objection that the evidence being submitted is hearsay and therefore not ad­missible. You should be emotionally and factually prepared to discuss outstanding maintenance or repair problems. It may be helpful to have your resident manager, if you have one, attend the hearing.

APPEALS

Once the decision has been issued by the Rent Board, all parties will have 15 days from the date of the postmark on the envelope to file an appeal. A tenant or landlord can appeal the decision based on fairness, hardship or “promotion of the policies and purposes of the Ordinance.”

Filing a Capital Expense Pass-Through Petition is time-consuming and can be ex­pensive because of filing fees, estimator fees and professional service fees, if you hire someone to assist you. However, under the current law it is one of the few ways you can increase a tenant’s rent beyond the annual cost of living increase, which effective March 1, 1994, will be only 1.3%! Given that your expenses are increasing, it may be time to file that peti­tion, rather than trying to absorb the costs of capital expenses.

Publication Note: This article and information were current at the time of initial publication (1994).  The information contained herein has not been updated since. Readers are cautioned to verify the advice and information, which may have changed since the first publication date.

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