To understand the rent discount known as preferential rent, you'll need a good grasp of rental regulations, which are in place in several cities and states across America. This is because preferential rent exists only in conjunction with rent regulations.
In a nutshell, the two types of rent regulations are rent control and rent stabilization, both government policies designed to control prices, limiting how much landlords can charge for rent. Preferential rent, at the time of this writing, has only been used in New York in rent-stabilized apartments, but the practice could happen in any area with rent laws.
What is preferential rent?
With preferential rent, landlords charge less than the legal regulated rent rate set by rent stabilization, often to the tune of hundreds or even thousands of dollars less per month -- in other words, a substantial discount. That concept might take a minute to sink in: Some landlords are charging less than the allowable rate. So why would landlords choose to charge less?
The answer is to get tenants. A scenario could occur with rent regulation whereby the amount the landlord is legally allowed to charge is actually more than what the market would likely support.
Let's say a tenant occupied a rent-stabilized unit for many years with the landlord taking advantage of allowable rent increases each year, but the tenant decided to move one day. Unless the landlord kept the rent-stabilized apartment up to the standards that would warrant the rent amount they were charging, they might not be able to attract a new tenant at that price. This could also happen if the neighborhood declined. Rather than face a vacancy, the landlord might offer preferential rent -- a rent discount -- to attract a new tenant.
How preferential rent housing works with rent stabilization
Preferential rent at face value benefits tenants since the rent is lower than what it legally could be. Landlords benefit as well by making money off an apartment that could stand some upgrades or that might sit in an undesirable location.
In New York, landlords need to state in the lease what the legally regulated rent for the apartment is and the preferential rent the tenant is actually being charged. This has led to another issue in New York, which we'll get into below.
Rent control vs. rent stabilization
Rent control is a cap on how much rent landlords can charge for a particular rental unit. Rent control came about before rent stabilization, and some cities and states are phasing out rent control in preference of rent stabilization.
Rent stabilization, like rent control, gives tenants the benefit of living in an expensive area while paying below-market rent. But with rent stabilization, rather than rent being capped, rent can increase but only based on certain percentages allowed by the jurisdiction. Both rent control and rent-stabilization laws also dictate when landlords can and cannot evict a tenant.
Rent regulations, whether rent control or rent stabilization, often lead landlords to find loopholes so they can do what any other businessperson strives to do: make as much money as the market will bear. And landlords found such a loophole through preferential rent.
The unintended consequence of preferential rent
Landlords discovered a way to game the system. As with any government program meant to do good, there are often unintended consequences. Rent control and rent stabilization provide affordable housing for people in extremely expensive real estate markets and offer some tenant protection if they remain in the same rent-regulated apartments. But suppressing a landlord's ability to charge market rate for their product leads many landlords to try to circumvent the rules.
Using a preferential-rent loophole, landlords in New York found a way to get low-paying tenants in when they needed them and then out when they could likely get maximum rent for their apartment. Maybe they made the necessary capital improvements, or maybe the area gentrified. In either case, once landlords believed they could get top dollar, they would revoke preferential rent and implement the allowable maximum, which resulted in a steep rate hike that better reflected market rate rent. But steep rent hikes are what rent-stabilization efforts were meant to curtail.
Many tenants, unaware of what exactly revoking the preferential rent meant, were just happy about the great deal they were getting and signed the lease. When the preferential rent was revoked, however, these tenants were often blindsided, now needing to come up with enough money to cover the higher rent or leave.
Pros and cons of preferential rent for tenants
The pros of preferential rent for tenants are obvious: They get to live in an apartment in an expensive market for a reduced rent. But there are also cons. Remember the part about New York landlords stating the maximum legal rent? That's where the steep rent hike issue comes into play.
New York landlords need to state in the lease what the legal rent for the apartment is and what the preferential rent will be. But here's the catch: There is no good way for tenants in New York to know or verify what the legal rent for the apartment is in the first place. Yes, you read that correctly.
Here's how this part of rent stabilization works in New York: In a fox-guarding-the-hen-house manner, the landlord, every year, submits the maximum legal month's rent to New York's Division of Housing and Community Renewal (DHCR), the rent guidelines board. The legal rent amount is supposed to be based on the apartment's rental history and improvements.
But in true bureaucratic manner, the DHCR does not check the veracity of that submission; however, it does make tenants aware of this. Now if a tenant suspects the maximum allowable rent stated by the landlord is too high, they can always hire a lawyer to look into this, but that can be a rather difficult and off-putting option.
When a tenant is paying the maximum legal rent under rent-stabilization law, it's fairly easy to determine whether the landlord is charging the correct rent, since the maximum allowable rent is based on the history of rent charged.
But with preferential rent, it can become more difficult to determine what the legal maximum is since the rental history reflects a number lower than the maximum legal rent. Therefore, preferential rent can make it easier for landlords to inflate the maximum legal amount to the DHCR. The only thing stopping landlords from doing this is the risk of being audited and penalized if caught in a lie.
An increase in preferential rent
Preferential rent in New York experienced a steady increase from the years 2000 through 2015 because of a 2003 law that allowed landlords to revoke the discounted rent at lease renewal time. Only 62 apartment leases had a preferential rent rider in 2000, and by 2015, more than 266,000 leases had one. A 2015 online survey conducted by ProPublica on the biggest complaint tenants had revealed it was preferential rent.
Landlords and tenants in a rent-regulated area need to pay attention
It is politics that creates rent control, rent stabilization, and preferential rent. So the pendulum constantly swings one way or the other on whether the laws favor landlords or tenants, typically depending on which party controls the state legislature.
If you don't have rent regulations and the possibility of preferential rent in your jurisdiction now, you might have it someday, and if you care one way or the other, it could pay to make your voice heard.
Preferential rent benefits tenants who pay a lower rent and landlords who need to offer a rent discount, ideally on a temporary basis. But it has also been used as a way to get tenants out once an area gentrifies or to hide the real maximum legal rent. It remains to be seen what the future of preferential rent will be.