On certification to the Superior Court, Appellate Division.
For affirmance -- Chief Justice Wilentz and Justices Clifford, Handler, Pollock, O'Hern and Stein. For reversal -- None. 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*fn1 as applied fails to provide a fair return to the owner, we affirm the two judgments.
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.*fn2
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.
Jackson Township adopted an ordinance applicable to mobile home rentals in 1973. The ordinance permits (1) automatic inflationary adjustments based upon a portion of the percentage increase in the Consumer Price Index,*fn3 (2) automatic tax surcharges based on increases in municipal property taxes, and (3) hardship increases whenever rental and other income from operation of the park is insufficient to provide for interest payments on mortgages, reasonable and necessary expenses incurred in connection with the operation of the mobile home park, and "a return on the owner's actual balance of such investment in the mobile home park in an amount not to exceed seven and one-half percent."*fn4 The Jackson Township ordinance does not define "actual balance of such investment"; it was interpreted by the Rent Leveling Board "to mean the owner's actual cash investment in the park after deducting that portion of the owner's investment which has been financed through mortgages."
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):
The most commonly used fair return standards are return on value, return on equity, return on gross rent, percentage net operating income, cash flow, and maintenance of net operating income. There are substantial differences in the manner in which each of these formulas operates and in the classes of landlords and tenants which they benefit. [ Id. at 784.]
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:
In view of the lack of evidence concerning plaintiffs' investment, we offer no comments on investment-based criteria for determining confiscation. Our silence does not, however, denote disapproval. Other jurisdictions have employed such criteria. See, e.g., Marshal House, Inc. v. Rent Control Bd. of Brookline, 358 Mass. 686, 266 N.E. 2d 876, 888 (1971). Although an investment-based standard may not be as easy to apply as some income-based criteria, there are no obvious theoretical obstacles to using an investment-based standard. [78 N.J. at 216 n. 8.]
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
scheme depending upon when and how much owners originally invested in the property. This point was raised in Cotati Alliance for Better Hous. v. City of Cotati, 148 Cal.App. 3d 280, 195 Cal.Rptr. 825 (Ct.App.1983). In Cotati, a California intermediate court rejected a facial challenge to an ordinance that used an investment-based standard, holding that
a local rent control ordinance which requires that landlords receive a fair and reasonable return on their investment is constitutionally valid on its face as a form of economic regulation reasonably related to the furtherance of a legitimate governmental purpose. Further[more], * * * provisions of the ordinance fixing the maximum rent which can be charged are reasonably calculated to eliminate excessive rents and, at the same time, provide landlords with a just and reasonable return on their property * * *. [ Id. at 283, 195 Cal.Rptr. at 827.]
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 ...