Maintenance of Net Operating Income

DEFINITION

This Author strongly recommends that a maintenance of net operating income (M-NOI) approach be used. (Net operating income = gross income - net operating expenses).(1)

Under the M-NOI approach, the park owner’s pre-rent control net operating income is maintained, with some adjustment for inflation.  For example, a fair net operating income may be defined as base year net operating income adjusted by 50% of the rate of increase in the Consumer Price Index.  Thus, if the base year net operating income of a property was $100,000.00 and the CPI has increased by 30% since the base year, a fair net operating income would be calculated at $115,000.00.

ADVANTAGES

The advantage of this formula is that it is consistent with the basic purpose of rent controls:  to allow rent increases which are adequate to cover operating cost increases, without permitting excessive increases. This approach is simple in comparison to other fair return approaches, because it does not require complicated determinations of investment, adequate rate of return, and/or value. Instead of undertaking the very subjective task of determining what rates of return might be fair, it presumes that the pre-regulation level of net operating income was fair and preserves that profit level. Also, this approach is not subject to manipulation through purchase and sales of parks and changes in financing arrangements (2).

PERMITTED AND EXCLUDED EXPENSES

Net operating income standards in ordinances should contain a list of permitted and excluded expenses. 

Debt service, which is the mortgage interest expense incurred by the park owner, is excluded. This exclusion is an inherent and vital part of the net operating income approach, since net operating income is defined as income before debt service.

Ground lease expenses are commonly, but not universally, excluded. Some ordinances only allow "involuntary" increases in ground lease expenses which result from arrangements entered into before the adoption of the rent control ordinance. Courts have upheld the exclusion of ground lease expenses, on the ground that lease payments are an investment expense rather than an operating expense.

LEGAL REVIEW

The M-NOI approach is used by at least twenty (20) California jurisdictions.  While courts continually reiterate that rent boards do not have to use a particular type of fair return standard, they commonly use trends in net operating income as the benchmark in evaluating whether a fair return has been permitted (3). In Rainbow v. City of Escondido (1998) 64 Cal. App. 4^th 1159, 1172, the Court of Appeal held that the MNOI standard is a “fairly constructed formula” and upheld its use.

REFERENCES

1. Detailed justification for a net operating income approach is set forth in Baar, Guidelines for Drafting Rent Control Laws: Lessons of a Decade, 35 Rutgers L.Rev. 721, pp. 809-816.

2. Fisher v. City of Berkeley, supra; Helmsley v. Borough of Fort Lee, supra; Mayes v. Jackson TD, Rent Leveling Bd (N.J. 1986) 511 A.2d 589.

3. A number of appellate court opinions in rent control cases have concluded that permissible rent levels should not vary depending on the particular financing arrangements of the property owner.  See Helmsley v, Borough of Fort Lee (N.J. Supreme  Court 1978) 394 A.2d 65; Palomar Mobilehome Park Assn. v. Mobilehome Rent Review Commission (1993) 16 Cal.App.4th 481 [___ Cal.Rptr.2d ___].

Source: The GSMOL Mobilehome Rent Stabilization Ordinance Handbook, Second Edition: Guidelines for Drafting and Enacting a Mobilehome Rent Stabilization Ordinance

Prepared by: Bruce Stanton, Esq., Corporate Counsel

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