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					IN THE MATTER OF THE APPLICATION OF 7-C TENANT OWNERS

NEW YORK CITY
LOFT BOARD

In the Matter of the Application of                  Loft Board Order No. 2132
                                                     Re: 125 Fifth Avenue
7-C Tenant Owners                                         IMD No. 10360
                                                          Docket No. LH-0001

Order

       The Loft Board accepts the recommendation of Director of Hearings Howard
Friedman. The hardship application filed by the owners of the premises located at 125
Fifth Avenue is denied.

Dated:         AUGUST 28, 1997


Date Loft Board Order Mailed:


Members Concurring: DeLaney, Gulotta, Navaretta, Schill, Shaw, Wilde, Biebel (7)

Members Abstaining: Lansden (1)

Members Absent: Chairman Klasfeld (1)



NEW YORK CITY
LOFT BOARD

In the Matter of the Application of                  REPORT AND
                                                     RECOMMENDATION
7-C Tenant Owners
                                                     Docket No. LH-0001
                                                     125 Fifth Avenue
                                                     New York, New York

HOWARD FRIEDMAN, Director of Hearings

      The owners of the interim multiple dwelling located at 125 Fifth Avenue, New
York, New York, have applied — pursuant to section 285(2) of the Multiple Dwelling
Law (MDL) and the Loft Board’s hardship regulations, section 2-03 of Title 29 of the
Rules of the City of New York (RCNY) — for an exemption for the building from the
requirements of MDL Article 7-C on the ground that the costs of compliance with Article
7-C would render legal residential conversion financially infeasible. For the reasons
stated below, I recommend that this application be denied.

I. PROCEDURAL AND FACTUAL BACKGROUND

        According to the owners’ application, 125 Fifth Avenue was a five-story building
that had been residentially occupied on all floors above the first (with the exception of
one-half of the third floor) since approximately 1976.1 Until shortly before the
application, the building had been owned by Newboro Realty Corp. Then, on May 26,
1983, title to the building was transferred to five of the seven families residentially
occupying the building; the transfer was made to the families as tenants-in-common. A
partnership, VVV Partnership, was also one of the transferees as a tenant-in-common.
All of the partners of VVV Partnership live in the building.2 The tenant-respondents in
this proceeding are Rudolph Mishaan and James Joern, the occupants of units 5NF and
5S, respectively.

        According to their application, the current owners purchased the building “in the
belief and expectation that their ownership of the building would best enable them to
ensure its legalization and would best secure their rights to remain in their homes of many
years standing.” However, according to the application:

               after a careful review of the zoning and code compliance
               issues associated with legalization, as well as of the books
               reflecting the building’s operation and maintenance costs,
               [the owners] have concluded that legalization may not be
               reasonably possible without causing extreme financial
               hardship. In addition, as a result of zoning requirements, it
               presently appears impossible to accommodate the


1
   The owners filed a hardship application on June 21, 1983, pursuant to MDL §285(2).
Upon receipt of the application, the Board notified the owners that it was in the process of
developing rules pertaining to hardship exemptions and that, upon adoption of the rules,
the owners would be provided with additional instructions to enable them to complete the
application. The subsequent rules provided that all notices of application for exemption
due to hardship had to be submitted by June 30, 1983, and that the application had to be
perfected no later than October 31, 1983. See 29 RCNY §2-03(a)(2). The owners
perfected their application in a timely manner. Unless otherwise indicated, the terms
“application” or “hardship application” refer to the owners’ October 31, 1983, filing.
2
    According to the application, the names and units of the owners were as follows:
James and Laurie Bottomley, unit 3N; Benjamin Lira and Francisca Sutil, unit 3S;
Malcolm Varon, unit 4N; Nalla Wollen, unit 4S; and Regina Vaccarella and Stephen
Hruby, unit 5NR.


                                             2
               occupancy rights of all the present residential families in
               the building.

        The alteration application attached to the owners’ hardship application, altered
building application number 1212/83, showed that the cellar, ground floor, and second
floor were “to be altered to accommodate retail commercial,” while the third through fifth
floors were “to be altered to legalize the present residential occupancy.”

       The owners’ hardship application described in detail the work the owners claimed
was necessary to legalize the building and to comply with the applicable zoning
requirements. The owners then argued in their application that — in light of the
building’s expenses, its limited income, and the $350,000 to $500,000 estimated cost of
code compliance — legalization of the residential use would be financially infeasible.

        In support of this position, the owners submitted voluminous documentary
evidence. Pursuant to the Loft Board’s hardship rules, the owners selected November 1,
1982, to October 31, 1983, as the representative consecutive twelve month period
(hereinafter the “representative year”) to show net annual return for the building. See 29
RCNY §2-03(b)(2)(ii). The owners selected November 1, 1983, to October 31, 1984, as
the projected period following legalization (hereinafter “projected year”). See id.

        The owners listed total operating expenses during the representative year as
$107,901.93. They estimated that the total operating expenses during the projected year
would be $172,479.89. The owners listed the total earned income during the
representative year as $80,152.50, all of which was derived from rental income. They
estimated that the total earned income during the projected year would be $95,343.26,
again all from rental income. On June 5, 1984, the Loft Board received an amendment to
the application in which the owners changed this figure to $123,584.00.

        Based on the total operating expenses and income, the owners calculated the net
income during the representative year as minus $27,749.43, yielding a net annual return
of minus 25.7 percent. For the projected year, the owners calculated that the net income
would be minus $77,136.63, and the net annual return would be minus 44.7 percent. As
part of the amendment to the application received by the Loft Board on June 5, 1984, the
owners changed this figure to minus 28.35 percent.3

        Tenants Rudolph Mishaan and James Joern filed identical answers through their
respective counsel, Peter Kolodny and Jeffrey S. Ween, on May 10, 1984. In their
answers, they put forth several grounds on which the application should be denied,
including: that the alleged hardship was self-created; that certain of the operating

3
    As discussed below, the owners were granted permission, during the hearing, to
substitute the legalization costs testified to by their expert, Anthony Caine, for those
contained in their application. Therefore, the owners’ figures relating to infeasible cost
were substantially modified.


                                            3
expenses listed in the application were “not to be included as normal operating expenses,”
and that certain other operating expenses were “highly inflated”; that the owners were
inappropriately attributing maintenance costs to legalization; and that a proper
consideration of fair market value for certain of the units would yield a great increase in
income. For all of these reasons, the tenants argued that the application should be denied
because the owners could not show an inability to earn a reasonable rate of return.

       On December 31, 1984, Mishaan filed a supplemental answer through his counsel,
Peter Kolodny. In this answer, Mishaan expanded on the argument that the Loft Board
must impute a fair market value to the owner-occupied units and pointed to the portion of
the Board’s rules requiring that only the minimum relief necessary to relieve the hardship
be granted.

       On April 16, 1984, the tenant owners, James and Laurie Bottomley, Malcolm
Varon, Nalla Wollen, Benjamin Lira, Francisca Sutil, Steve Hruby, and Regina
Vaccarella filed answers to their own hardship application, setting forth their personal
reasons for seeking a determination of hardship.

         Conferences on the application were held on October 4, 1984, and November 14,
1985. At the October 4, 1984, conference, the owners alleged that Jeffrey Ween had a
conflict of interest in representing Joern. The hearing officer at that time concluded that
Ween had no conflict. On December 12, 1985, the owners filed a motion for an order
disqualifying Ween from representing any non-owner tenant of the premises in this
application. The owners based their motion on Ween’s prior representation of them in
their attempts to purchase the premises. The owners contended that, both at the October
4, 1984, conference and in his preparation for this proceeding, Ween had relied on
confidential information obtained during his representation of the owners. In an answer
filed December 13, 1985, Ween denied that he represented the owners in their purchase
attempt, but rather had represented them in their effort to determine their status, in 1981,
under the Rent Stabilization Law. He maintained that there was no relationship between
knowledge gained in his prior representation of the owners and his current representation
of Joern. Subsequent to the hearing officer informing the parties that the conflict issue
could not be the subject of a dispositive ruling by the Loft Board, counsel for the owners,
Deirdre A. Carson, informed the hearing officer by letter dated December 17, 1985, that
the owners had decided to waive their objection to any conflict of interest, both in this
proceeding and in any potential subsequent litigation challenging any Loft Board
determination.

       Based on the owners’ original hardship application and on additional materials
requested by the Loft Board’s auditor, the auditor prepared a report, dated November 7,
1985, setting forth the accepted operating expenses and income for the representative and




                                             4
projected years.4 The auditor’s figures for the representative year were as follows: total
expenses — $92,543.36; total income — $101,330.00. The auditor’s figures for the
projected year were as follows: total expenses — $190,051.25; total income —
$157,206.64. These figures resulted, according to the auditor, to a net rate of return of
positive nine percent in the actual year, but negative 17 percent in the projected year.
However, at the hearing, the hearing officer accepted in evidence a report by Anthony
Caine, the owners’ expert witness on legalization costs, as a substitute for the owners’
earlier submission as to anticipated legalization costs. In response to one of the tenants’
objections to the admission of Caine’s report, the hearing officer also directed that it be
audited by the Board’s auditor and that a revised report as to accepted expenses and
income be prepared.

         Prior to Caine’s cross-examination, the Board’s auditor completed her audit of
Caine’s report; the results of the audit were sent to the parties. According to the cover
letter from the hearing officer, dated July 3, 1986, the auditor reviewed “Caine’s report
and confirmed that each item described as being in the Schedule of Costs is listed there,
and that the cost provided in the report for each such item accurately reflects the cost
indicated in the Schedule.” The hearing officer further stated that “[t]he only other new
revisions in the figures [compared to the November 7, 1985, report] are the concomitant
changes in financing costs resulting from the increased projections and the increases in
rent adjustments which also follow.” Finally, the hearing officer noted that he had asked
the auditor to break down the rents on a per unit, rather than per floor, basis.

       The auditor’s figures for the representative year based on Caine’s report were as
follows:

           ITEM                    SUBMITTED             AUDITOR’S          ACCEPTED
                                                        ADJUSTMENT

OPERATING EXPENSES
1. Fuel                                      5016.78                              5016.78
2. Labor                                    22420.33                             22420.33
3. Utilities                                 7544.67             (750.00)         6794.67
4. R/E taxes                                15917.38                             15917.38
5. Fees and permits                         17828.00           (6495.72)           463.99
                                                               (8694.73)          2173.66
6. Service contracts                          135.31                               135.31
7. Repairs and maintenance                   3077.82                              3077.82
8. Insurance                                10648.77                             10648.77
9. Parts and supplies                         324.00                               324.00
10. Management fees                          1225.00                              1225.00

4
   The auditor originally produced a report on October 29, 1985. This report was then
revised; the revised report was dated November 7, 1985. Both reports were sent to the
parties.


                                            5
11. Legal fees                           10354.90                         10354.90
12. Administrative costs                  2783.97                          2783.97
13. Mortgage interest                    10625.00                         10625.00
    Total Expenses                      107901.93        (15940.35)       91961.58

INCOME
   Store 1N                              16800.00                         16800.00
   Store 1S                              16200.00                         16200.00
   2nd Floor N                           10025.00                         10025.00
   2nd Floor S                            8700.00                          8700.00
   3rd Floor N                            8535.00                          8535.00
   3rd Floor S                            7170.00                          7170.00
   4th Floor N                            8750.00                          8750.00
   4th Floor S                            8850.00                          8850.00
   5th Floor NR                           5850.00                          5850.00
   5th Floor NF                           3600.00                          3600.00
   5th Floor S                            6850.00                          6850.00
  Miscellaneous income                       0.00                             0.00
  Total Income                          101330.00                        101330.00

NET CASH FLOW +(-)           (in dollars) (6571.93)                        9368.42
                             (percentage) (6.09%)                             10%

       The auditor’s figures for the projected year based on Caine’s report were as
follows:

          ITEM                SUBMITTED           AUDITOR’S           ACCEPTED
                                                 ADJUSTMENT

OPERATING EXPENSES
1. Fuel                               8525.16                              8525.16
2. Labor                             23541.40                             23541.40
3. Utilities                          5343.59                              5343.59
4. R/E taxes                         21320.38                             21320.38
5. Fees and permits                   6495.72          (6031.73)            463.99
                                      8694.63          (6520.97)           2173.66
6. Service contracts                  3150.00                              3150.00
7. Repairs and maintenance            7500.00                              7500.00
8. Insurance                         20088.00                             20088.00
9. Parts and supplies                  518.00                               518.00
10. Management fees                   1286.25                              1286.25
11. Legal fees                       11335.73                             11335.73
12. Administrative costs              3400.00                              3400.00
13. Mortgage interest                63750.00         (24466.00)          94427.57
                                     24466.00           30677.57


                                         6
    Total Expenses                     209414.86            (6341.13)           203073.73

INCOME
   Store 1N                             32200.00                                 32200.00
   Store 1S                             16800.00                                 16800.00
   2nd Floor N                          16500.00                                 16500.00
   2nd Floor S                          16020.00                                 16020.00
   3rd Floor N                          12600.00             (600.00)            12000.00
   3rd Floor S                          12600.00             (600.00)            12000.00
   4th Floor N                          12600.00             (600.00)            12000.00
   4th Floor S                          12600.00             (600.00)            12000.00
   5th Floor NR                          9450.00                                  9450.00
   5th Floor NF                          9367.44                                  9367.44
   5th Floor S                          12421.80                                 12421.80
   Miscellaneous income                     0.00                                     0.00
   Total Income                        163159.24            (2400.00)           160759.24

NET CASE FLOW +(-)                    (46255.62)                               (42314.49)
                                          (23%)                                    (21%)

         The hearing on the hardship application was held on the following dates: March
24, 25, and 27, 1986; April 24, 25, and 28, 1986; June 12, 17, 19, and 27, 1986; July 8, 9,
16, and 25, 1986; October 10, 22, and 27, 1986; November 6 and 20, 1986; and March
26, 1987. The hearing officers were David F. Yahner on the first three dates and Lee
Fawkes on the remainder of the dates. At the hearing, Eugene Hegy testified as an expert
witness on behalf of the owners on the issues of commercial and residential fair market
values, and on the issue of operating expenses. As stated, Anthony Caine testified as an
expert witness on behalf of the owners on the issue of the legalization of the subject
building. The owners presented no other witnesses.5 For the tenants, David Duffy
testified as an expert witness on the issues of commercial fair market value and operating
expenses. Gordon Riesner testified on behalf of the tenants as an expert witness on the
issue of residential fair market value. Finally, Arthur Atlas testified on behalf of the
tenants as an expert witness on the issue of legalization.




5
   On June 27, 1986, Regina Vaccarella — one of the applicant-owners and the principal
of the VVV Partnership, which was responsible for the management of the building —
testified on behalf of the owners. She gave a portion of her direct examination.
However, on March 25, 1987, the day on which she was to continue, the subject matter of
her continued testimony was objected to by tenants’ counsel. The hearing officer
sustained the objection, ruling that, under the circumstances of how the hearing had
proceeded (i.e., where the tenants’ witnesses had testified before the owners’ witnesses
had finished), Vaccarella’s testimony would constitute inappropriate rebuttal. Owners’
counsel therefore requested that Vaccarella’s prior testimony be stricken.


                                            7
       The owners’ post-hearing memorandum — submitted by their counsel, Deirdre A.
Carson, Esq. — was received by the Loft Board on August 17, 1988. The tenants’
post-hearing memorandum — submitted by Jeffrey S. Ween, Esq. — was received by the
Loft Board on October 20, 1988. The owners’ reply memorandum was received by the
Loft Board on November 4, 1988, and the tenants’ reply memorandum was received on
November 9, 1988.

II. ANALYSIS

       A. Applicable Law and Rules

        Pursuant to MDL §285(2)(ii), an owner of an interim multiple dwelling may apply
to the Loft Board for an exemption from Article 7-C on the ground, inter alia, that
“obtaining a legal residential certificate of occupancy would cause an unjustifiable
hardship . . . because . . . the cost of compliance renders legal residential conversion
infeasible.” See also 29 RCNY §2-03(b). Under MDL §285(2), “the test for cost
infeasibility shall be that of a reasonable return on the owner's investment not maximum
return on investment.” See also 29 RCNY §2-03(b)(2)(ii).

       Under 29 RCNY §2-03(b)(2)(ii)(A), reasonable rate of return is defined as “a net
annual return of five percent or more where net annual return is the percentage amount by
which the annual earned income from the building exceeds the annual operating expenses
of the building.” In this regard, the Board’s rules define both “earned income” and
“operating expenses.” Under section 2-03(b)(2)(ii)(B), earned income is defined as:

              the maximum collectible rent for the building, including any and
              all escalators, for both residential and non-residential units, plus
              miscellaneous income from all other sources in the building . . . .
              The Loft Board shall impute a rental value for vacant units or units
              occupied either residentially or non-residentially by the landlord,
              any member of the landlord’s family or an employee of the
              landlord, at the fair market value for the space, or if subject to
              Article 7-C at the maximum legal rent.

Operating expenses are defined under section 2-03(b)(2)(ii)(C) as follows:

              the actual, reasonable cost of: fuel, labor, utilities, taxes other than
              income or corporate franchise taxes, fees, permits, necessary
              contracted services and non-capital repairs, insurance, parts and
              supplies, management fees and other administrative costs and
              interest on a bona fide mortgage. Criteria to be considered in
              determining a bona fide mortgage other than an institutional
              mortgage shall include: condition of the property, location of the
              property, the existing mortgage market at the time the mortgage is
              placed, the term of the mortgage, the amortization rate, the


                                             8
               principal amount of the mortgage, security and other terms and
               conditions of the mortgage.

        Section 2-03(b)(2)(ii) also sets forth certain evidence that an owner must produce
as part of an economic hardship claim. Specifically, an owner must produce, “as part of
the application, evidence, subject to audit, based on a representative consecutive 12
month period beginning no earlier than January 1, 1982 . . . of the current net annual
return for the building and the projected net annual return following legalization
including, but not limited to, current and projected earned income, operating expenses
and equity information.”

       The burden of proof in a hardship application is upon the owner of the premises.
See Application of Feierstein, Loft Board Order No. 1945, at 65, 16 LBR 149, 183 (Apr.
25, 1996) (upheld in Feierstein v. N.Y.C. Loft Board, Index No. 115122/96 (Sup. Ct.
N.Y. Co., Mar. 13, 1997)). Furthermore, an application may not be granted if the
hardship was self-created. MDL §285(2); 29 RCNY §2-03(b)(3)(i).

       B. Preliminary Issues

        Analysis of an infeasible costs hardship application requires the Loft Board to
make findings regarding the owners’ actual and projected costs of operating the building
and the actual and projected income. Application of Feierstein, Loft Board Order No.
1945, at 65, 16 LBR at 183. The staff audit is the starting point in the analysis, but the
parties have raised numerous arguments as to why the Board should find certain costs or
incomes different from those contained in the audit. These arguments will be addressed
below.

       Certain of the owners’ arguments are applicable to the entire analysis or large
portions of it, and are therefore properly addressed prior to a discussion of any particular
expense or income item.

        Use of the building — In addressing the issue of income in the projected year, the
owners — both during the hearing and in their post-hearing memorandum — considered
a variety of alternate scenarios for the use of the building. For example, Hegy testified on
behalf of the owners not only about the residential fair market value of the
owner-occupied units, but also about the commercial fair market value for those units.
Similarly, owners’ counsel, in the post-hearing memorandum, calculated projected year
expenses and income under three scenarios: if all the existing residential units were
legalized for residential use; if only the respondents’ units were legalized for residential
use; and if the building were converted to all commercial use. I believe that the
appropriate approach is to analyze projected year costs and income assuming that all the
existing residential units were legalized for residential use, consistent with the owners’
alteration application. Projected year figures assuming all commercial use appear to be
irrelevant to the question of whether residential legalization under Article 7-C would
create a hardship. Furthermore, while analysis of projected year figures following


                                             9
legalization of only the respondents’ units might be relevant to the issue of granting the
minimum relief necessary were a hardship to be found, pursuant to MDL §285(2), such
an analysis is not the appropriate one when determining whether the owners have proven
a hardship in the first place.

        Schedule of legalization costs — In their memorandum, the owners argued that
the Board should consider the actual costs of legalization in determining whether
legalization would create a hardship, rather than the costs listed in the Board’s code
compliance rules (29 RCNY §2-01(p)) or permitted in determining rent adjustments.
Although the owners acknowledged that the Board had rejected this approach in a similar
situation, see Application of EEE Holding Corp., Loft Board Order No. 503, 5 LBR 12
(Jan. 8, 1987), they nonetheless argued for its adoption. The owners first noted that their
offers of proof regarding the relationship between actual costs and the Board’s schedule
of costs — including expert testimony that the schedule represented only 60 to 65 percent
of actual costs — were rejected, but that the cross-examination of Duffy regarding the
cost of installing an elevator supported the owners’ contention. Next, the owners argued
that the Loft Law does not compel the position adopted in EEE Holding and that the
Board should overrule its decision. Specifically, the owners noted that, while rent
adjustments under MDL §286(5) must be determined “pursuant to a schedule of
reasonable costs,” section 285(2) provides for the granting of a hardship exemption
simply if “the cost of compliance renders legal residential conversion infeasible”; section
285(2) does not limit costs to those contained in the schedule. The owners argued that
the hardship determination should be governed by actual costs because the purposes
served by MDL §§285(2) and 286(2) were different. Specifically, according to the
owners, it was reasonable that rent adjustments be governed by a schedule, even if it did
not reflect actual costs, because the rent adjustments were part of a system whereby
tenants could “assist in paying the cost of . . . legalization without being forced to
relocate.” MDL §280. The hardship exemption, on the other hand, was created “to
provide a constitutional safety valve in cases where the economics of a building make
compliance ‘infeasible.’” Failure to recognize actual costs, according to the owners,
would place “in issue the constitutionality” of the Loft Board’s determination of the
application.

        The Board should determine projected year legalization costs pursuant to the
Board’s schedule of costs contained in 29 RCNY §2-01(p), to the extent the schedule is
applicable. As the owners note, the Board has already held that legalization costs should
be computed pursuant to the schedule of costs and not according to (projected) actual
costs. As the Board held in EEE Holding Corp., Loft Board Order No. 503, at 3, 5 LBR
at 13-14, use of the schedule of costs, “[w]hile not specifically mandated . . . seems
reasonable and appropriate, in that the schedule of costs was promulgated specifically to
aid in the Board’s determination of the necessary and reasonable cost of obtaining a
residential certificate of occupancy.” Furthermore, as it is proper to use the schedule of
costs in final rent adjustment applications to determine the amount of actual, documented
code compliance costs to be passed to the tenants, it is even more appropriate to use the




                                            10
schedule of costs in the context of a hardship application, where the “actual” costs of
legalization are not known, but are simply the subject of conflicting expert opinion.

        Rent level for owner-occupied units — The owners argued in their
memorandum that it would be unfair to impute fair market rental values to the units they
occupied. According to the owners, imputing fair market value to their units was
discriminatory because, absent this hardship application, the units would be subject to
Article 7-C and therefore, if an outsider owned the building, only the regulated rents
would be considered. This situation was considered to be wrongly discriminatory
because it would thus be much more likely that a hardship would be found in the case of
an outsider owner filing an application for such a finding. The owners further noted that,
in the analogous rent stabilization situation, DHCR is required to set the rent for owner-
occupied units at either a regulated rent or at a rent consistent with other rents in the
building. Finally, the owners noted that 29 RCNY §2-03(b)(2)(ii)(B) explicitly requires
owner-occupied units “if subject to Article 7-C [to be valued] at the maximum legal
rent.” For these reasons, the owners argued that the rent levels for the owners’ units,
assuming they were to be occupied residentially, should be limited to their regulated
levels, or to levels consistent with the respondent-tenants’ rents.

        In response, the tenants argued, in the context of arguing that the alleged hardship
was self-created, that it was not unfair to impute fair market value to the owner-occupied
units. The tenants argued that the “discrimination” claimed by the owners (because they
were being treated differently from owners who were not also occupants) was rationally
related to the rule against granting hardship applications where the hardship was
self-created. Furthermore, the tenants argued that the owners were simply trying to
“foster a fiction” by trying to “claim that they should continue to be viewed as tenants”
for the purpose of imputing only the regulated rent to their units. The tenants noted that
the owners, as owners, could not be considered tenants. Furthermore, the tenants argued
that MDL §286(8) deregulates rent in cooperative units occupied by owners. As,
according to the tenants, General Business Law §352(e) “defines a cooperative so as to
include virtually any joint interest in real estate,” the partnership structure by which the
owners owned the building was sufficient to deregulate the owners’ units. Therefore,
imputation of fair market rents to these units was appropriate.

        Fair market value rents must be imputed to the owner-occupied units in
determining projected year income. Under 29 RCNY §2-03(b)(2)(ii)(B), the Loft Board
is expressly required to impute a fair market value for owner-occupied units. While the
owners seek to seize on the language of that section that sets some rents at the maximum
legal regulated rent (“or if subject to Article 7-C at the maximum legal rent”), that
language does not apply to them; the other phrase in that portion of the rule is the one that
applies (“to units occupied either residentially or non-residentially by the landlord . . . at
the fair market value for the space”). Moreover, the owners — who indisputably own the
building — simply cannot be “owners” for the purpose of bringing a hardship application
but “tenants” for the purpose of imputing the rents for their units. My conclusion avoids
the internal inconsistency of the owners’ position. Furthermore, this result is not wrongly


                                             11
discriminatory, because owner-occupancy of certain units creates income issues not
presented when the owner does not live in a building. In addition, the analogy to
DHCR’s rules is not applicable, in light of the Board’s own specific rules on the subject.6

        The owners argued that, assuming the Board were to apply a fair market value
analysis, it would be unfair to ignore the amount the owners would actually be able to
collect in the projected period. This argument was explicitly rejected in Application of
Feierstein, Loft Board Order No. 1945, at 74 n.10, 16 LBR at 188 n.10, in light of the
provisions of 29 RCNY §2-03(b)(2)(ii)(B), which defines earned income in terms of the
“maximum annual collectible rent for the building” (emphasis added).

       C. Operating Expenses

       Undisputed expenses — In their memorandum, the owners correctly noted that a
number of the audited operating expenses were not disputed by the tenants. These items
were fuel, utilities, real estate taxes, and insurance. In addition, the tenants did not
dispute the audited figure for parts and supplies. Furthermore, the parties did not
challenge the auditor’s determination to increase the projected year costs, for items that
were unaffected by other factors (such as legalization), by five percent over the
representative year figures. Thus, the representative and projected year figures, as
audited, should be accepted for fuel, utilities, real estate taxes, insurance, and parts and
supplies.

        Labor — The owners argued that the audited projected year labor cost of
$23,541.40 should be accepted by the Board. The auditor arrived at that figure by adding
five percent to the actual costs from the representative year attributable to the building’s
one employee who, among other things, ran the building’s manual elevator. In their
memorandum, the tenants argued — based on the testimony of Duffy, their expert — that
only $3,000.00 per year was required for labor costs, as that would be the cost for a
“traveling superintendent.” The tenants argued that a traveling superintendent would be
sufficient because both sides’ legalization experts testified that the elevator would have to
be removed to legalize the building. The owners argued that elimination of the employee
would depress the projected fair market values for the commercial and owner-occupied
units, because of the need to keep the front door of the (at least partially) commercial
building locked, that it was desirable to have a doorman in a residential building, and that

6
  In their post-hearing memorandum, the owners also argue that, if regulated rents are not
to be imputed to the owner-occupied units, the value of the units should be computed
assuming “new tenants who acquired possession of the owner-occupied units through a
fixture purchase.” This alternative must be rejected. If the owners’ intent is to add some
sort of premium to the regulated rents, the proposal is improper because fair market rental
values, not an adjusted regulated rent, must be imputed to the owner-occupied units. If
the owners’ intent is to ensure that the value of the improvements in the units is included
in determining fair market value, the experts, as discussed below, did consider the state of
the lofts themselves.


                                             12
someone was needed (other than a “traveling superintendent”) to clean the public toilets.
The owners also argued that it was unclear, under the relevant union contract, whether the
existing employee’s job could be eliminated.

        The Board should accept a labor cost of $18,000.00 per year for the projected
year. While Duffy did testify that a traveling superintendent could be hired for $3,000.00
per year, the tenants have not shown that a traveling superintendent would be sufficient
for all the needs of the building, even accounting for elimination of the elevator.
However, the owners have not shown that it would be necessary to employ a
superintendent at the representative year rate of pay once the elevator operation duty was
eliminated. Therefore, I find a labor cost of $18,000.00 per year for the projected year to
be a reasonable amount, representing the cost of a full-time superintendent with fewer
responsibilities than the one employed in the representative year.

         Fees and permits — In their application, the owners submitted documentation of
$17,828.00 for representative year fees and permits. This figure consisted of $17,500.00
in architectural fees paid to Architects Unlimited and $328.00 in fees paid to the Fire
Department and the City Collector. Documentation attached to a September 6, 1985,
letter from owners’ counsel to the hearing officer at that time shows that Stephen Hruby,
one of the applicants herein, was a principal of Architects Unlimited. In her audit, the
Board’s auditor rejected this amount as a proper representative year expense. However,
she did allow a certain portion of this amount, as follows: The auditor allowed the
municipal filing fees. She also accepted four percent of the total audited legalization
costs as architectural fees, pursuant to the Board’s schedule of costs in effect at the time
of the audit. She then amortized this amount over 15 years, pursuant to 29 RCNY
§2-01(k)(2), and allocated the amortized yearly amount ($463.99) to both the
representative and projected years. Finally, however, after not allowing the portion of the
submitted $17,500.00 in architectural fees that was above the four percent, she accepted
“the full amount remaining . . . as a valid expense of organization to be amortized over a
five year period.” The reason given by the auditor for this action was “[i]n order to give
recognition to unusual and extraordinary expenses involved with the owner’s efforts to
comply with the Loft Board regulations.” The amortized yearly amount for the
extraordinary architectural fees, added to both the representative and projected years, was
$2,173.66.

        In support of the auditor’s approach to the architectural fees, the owners noted that
the tenants did not submit any evidence that the architectural fees were not incurred.
They also argued that the documentary evidence of the expenditure for the architectural
fees, plus Caine’s testimony that he usually charged more than four percent of the cost of
legalization for loft legalizations, was sufficient to support the auditor’s decision to give
full credit, as amortized, to the owners for their actual architectural fee expenses. The
tenants, on the other hand, argued that no credit should be given for the “extraordinary
architectural fees,” because: (1) the Board’s hardship rule on operating expenses did not
refer to such a category; (2) the standard architectural expenses were separately accounted
for; (3) the owners did not provide any evidence at the hearing to justify the expense; and


                                             13
(4) Atlas’s testimony about certain conversations he allegedly had with Vaccarella and
Hruby showed that the extra efforts of Vaccarella and Hruby through Architects
Unlimited should not justify the expense, because they were made in an effort to avoid
legalizing the building. In reply, the owners argued that no “conspiracy,” as described by
Atlas existed, and that the Board should not limit itself to the its own schedule of costs
when determining a hardship application. Furthermore, the owners argued that the
recognition of the extraordinary fees was appropriate because of the difficulty of
legalizing interim multiple dwellings.

        The Board should reject the auditor’s recognition of the “extraordinary
architectural fees.” As discussed previously, the Board has already held that it is
appropriate to follow the legalization schedule of costs, contained in 29 RCNY §2-01(p),
in determining whether an alleged hardship exists. Therefore, it is appropriate to accept a
percentage of legalization costs as architectural fees for the representative and projected
year operating expenses. However, no valid justification has been presented for accepting
the remainder of the submitted architectural expenses. The owners have made no
showing that the efforts of their architect in the representative period — who was in fact
one of the owners — were extraordinary. While it may have been difficult to create
legalization plans, that mere fact cannot justify “extraordinary” fees because, based on
that argument, all architectural fees for Article 7-C buildings would have to be considered
extraordinary. Such a result would undercut the Board’s decision, contained in 29 RCNY
§2-01(p), to limit allowable architectural fees to a percentage of accepted legalization
expenses. For this reason, the owners’ arguments as to the level of architectural fees
actually incurred are irrelevant to the issue of the “extraordinary” fees. Finally, while 29
RCNY §2-01(p) provides for “extraordinary costs of legalization,” the examples listed in
the rule — construction management fees; overtime costs for alterations required to be
done after hours; and excessive costs above scheduled allowance resulting from
individual building characteristics — do not for the most part relate at all to the
architectural fees at issue here. Only the “excessive costs above scheduled allowance”
example is arguably relevant and, as discussed, the owners have made no showing that
the building’s characteristics were unusual or that the architect’s efforts were in any way
out of the ordinary.

       In light of this conclusion, the “fees and permits” operating expense should be
computed as follows: As discussed in Section IIF of this report (at page 62), the total
allowable hard costs of code compliance are $61,973.45. Four percent of that amount, or
$2,478.94 should be allowed for the representative year, to reflect the efforts of the
owners’ architect in that year; the same amount should be allowed for the projected year,
pursuant to 29 RCNY §2-01(p), as an allowable cost of code compliance.7 In addition,
the $328.00 in municipal fees actually incurred in the representative year should be

7
   At the time of the representative and projected years, the percentage of accepted
legalization costs allowable as architectural fees was four percent. This amount was
changed in 1991 to seven percent, which is the amount currently provided for in 29
RCNY §2-01(p).


                                            14
allowed. For the projected year, $344.40 should be allowed for municipal fees, reflecting
the five percent increase, already discussed, over representative year figures for otherwise
unaffected items.

         Service contracts — The auditor accepted a projected year cost of $3,150.00,
based on the owners’ projection of $150.00 for a sprinkler maintenance contract,
$1,200.00 for an elevator service contract, and $1,800.00 for an extermination contract.
In their memorandum, the owners revised their position based on the legalization
testimony that the elevator needed to be eliminated; they conceded that the $1,200.00
expenditure for an elevator service contract was unnecessary. The owners argued,
however, that at least $1,150.00 should be accepted for service contracts because of the
testimony (by Duffy, the tenants’ expert) that an extermination contract would cost
between $300.00 and $420.00 per year and because the sprinkler maintenance contract
would cost, in fact, $750.00 per year, based on Duffy’s testimony, once sprinklering for
the entire building was accounted for.8 The tenants argued simply that the projected year
cost for service contracts should be reduced to the level suggested by Duffy. Duffy
testified that residential exterminator service should be $20.00-$25.00 per month and that
none was needed for commercial tenancies. He also testified that the sprinkler contract
should be $5.00 per sprinkler head per year plus $50.00. Caine’s report on legalizing the
building did not clearly indicate the total number of sprinkler heads he proposed.
However, owners’ counsel estimated in her memorandum that the building would require
140 sprinkler heads; this estimate was not disputed by tenants’ counsel.

        The projected year service contract cost should be $1,050.00. Based on Duffy’s
testimony, the extermination contract would cost $300.00 per year, calculated on a cost of
$25.00 per month. Based on Duffy’s testimony and the unrebutted estimate of owners’
counsel, the sprinkler maintenance contract would cost $750.00 per year. Based on the
legalization testimony, no elevator service contract would be necessary because the
elevator will need to be removed. The representative year service contract cost, as
audited, of $135.31 is undisputed and should be accepted.

       Repairs and maintenance — The projected year cost for repairs and
maintenance accepted by the auditor was $7,500.00. The owners argued that this figure
should be accepted by the Board because the testimony by Hegy, the owners’ expert,
supporting this figure was more credible than that of Duffy, who testified on behalf of the
tenants that $4,500.00 per year was a reasonable amount. Hegy testified that the
$7,500.00 figure was reasonable in light of the building’s condition and income. In

8
    While the initial $150.00 per year estimate assumed that sprinklers would be placed
only in the cellar, Caine testified on behalf of the owners that the best way of dealing with
the “second means of egress” issue was to install sprinklers throughout the building.
Although the tenants challenged Caine’s conclusion, and proposed an actual second
means of egress that would obviate the need for building-wide sprinklering, I recommend
that Caine’s approach be accepted for the purpose of this application. See the discussion
of code compliance costs infra, Section IIF, at pages 46-48.


                                             15
addition, the owners argued that the $7,500.00 figure, described in terms of percentage of
total expenditures, was only a little more than half the costs described in the 1983 and
1984 reports entitled “The Economics of Loft Housing.” Therefore, the owners argued,
the Loft Board could not accept a figure lower than that accepted by the auditor. The
tenants, on the other hand, argued that Duffy’s testimony as to a typical repair and
maintenance figure should be accepted because the amount of repairs needed in the
subject building was a result of the failure of the prior owner to do proper maintenance.
As the owners, according to the tenants, bought the building with an intimate knowledge
of the condition of the building, the extra needed repair costs represented a self-imposed
hardship for which the owners should not be compensated. In reply, the owners argued
that it would be arbitrary and capricious to not consider the repair and maintenance
expenses associated with a bona fide need for repairs.

        The difference between the $7,500.00 and $4,500.00 figures apparently represents
the difference between what repairs and maintenance in the building would have actually
cost in the projected year and what they should have cost if the building had been
properly maintained by the prior owner. The tenants argue that the $7,500.00 figure
should be rejected because, as the current owners were aware of the building’s condition
when they bought it, the extra repair costs were a self-imposed hardship. This argument
should be rejected. Even assuming that the building is in a dilapidated condition, the
mere purchase of a building with knowledge of that condition cannot be deemed a
self-imposed hardship, particularly where that phrase, as used in the Loft Law, refers to a
hardship resulting from the costs of legalization, not maintenance. Furthermore, the
tenants’ argument notwithstanding, compensation is not the issue here. There is no
question that the cost of deferred maintenance may not be passed to the tenants. See 29
RCNY §2-01(j). However, the question is not whether the cost of doing the deferred
maintenance may be made part of the tenants’ rent, but whether those costs would have
existed in the projected year. As Duffy’s testimony does not appear to contradict Hegy’s
on this issue, the $7,500.00 figure for the projected year should be accepted. The
representative year repair and maintenance cost, as audited, of $3,077.82 is undisputed
and should be accepted.

        Management fees — In her November 7, 1985 (pre-hearing) audit, the Board’s
auditor accepted the owners’ submitted management fee figures of $1,225.00 for the
representative year and $4,007.63 for the projected year. However, in the revised July 3,
1986, audit, the projected year management fees were set at $1,286.25. According to the
auditor’s notes, attached to the July 3, 1986, audit, this figure was set at five percent
above the representative year amount.

        In their memorandum, the owners complained that the auditor’s reduction of the
projected year figure was inexplicable and noted that, under the Loft Board’s instructions
for completing hardship applications, they could have claimed up to $6,822.77 in
management fees, assuming the projected year income of $160,759.24 accepted in the
July 3, 1986 audit report. The owners also argued that the $4,007.63 figure was
supported by the testimony of Hegy, their expert, and was not inconsistent with the


                                            16
testimony of Duffy, the tenants’ expert. Hegy testified that commercial management fees
were generally five percent of the first $100,000 collected, and three percent of the
remainder. Residential management fees were five percent of the first $50,000 collected,
four percent of the next $50,000 collected, and three percent of the remainder. Hegy
testified that the $4,007.63 listed in the application as management fees for the projected
year was very low because, as there would not be commission income from this building,
a manager would be receiving only approximately $350.00 per month. Duffy, on the
other hand, testified that his fee to manage the building would have been $250.00 per
month, or $3,000.00 per year. In their memorandum, the tenants argued that this figure
should be accepted for the projected year.

       Under 29 RCNY §2-03(b)(2)(ii)(C), management fees are listed as an element of
operating expenses to be considered in determining cost infeasibility hardship
applications. While the hardship rules do not explain how to calculate projected year
management fees, instructions provided to hardship applicants by Loft Board staff stated
that such fees were to be based on actual expenses incurred and that the maximum
allowable expense would be five percent of income on the first $100,000.00 of income,
three percent on the next $100,000.00 of income, two percent on income from
$200,000.00 to $500,000.00, and one percent for income above $500,000.00.
Furthermore, the Board has previously upheld the auditor’s determination to set
management fees at five percent of income for the year in question, as adjusted to reflect
any revisions in income determined by the Board following a hearing on the application.
See Application of Hertzoff, Loft Board Order No. 1072, at 17, 11 LBR 99, 108 (July 26,
1990) (income below $100,000.00); Application of Feierstein, Loft Board Order No.
1945, at 66, 68, 16 LBR at 184, 185 (income below $100,000.00).

        Examination of the November 7, 1985, audit in this case indicates that the auditor
followed the staff instructions in accepting the owners’ submitted figure of $1,225.00 for
the representative year as actual expenses incurred in that year, and in accepting the
owners’ submitted figure of $4,007.63 for the projected year. The auditor noted that the
owners’ latter figure was five percent of the actual year income figure contained in the
owners’ original application.9 However, in light of the rules stated above, the auditor
incorrectly reduced the projected year figure to $1,286.25, in the July 3, 1986, audit,
because management fees are not one of the circumstances in which the general five
percent increase over the representative year figure is applicable. Thus, while the actual
year figure of $1,225.00 should be accepted, the figure for the projected year must be set
pursuant to the sliding scale contained in the hardship application instructions.10 As
calculated infra, the projected year income that the Board should accept equals

9
    As noted supra, these figures were modified — prior to the November 7, 1985, audit
— in response to a Loft Board staff request.
10
     Although the Board in Application of Hertzoff and Application of Feierstein simply
set the management fees at five percent of income, the income for the buildings in those
cases was not above $100,000.00. Those cases do not provide a basis for rejecting the
sliding scale approach adopted in the hardship application instructions.


                                            17
$201,062.02. Five percent of $100,000.00 equals $5,000.00. Three percent of the next
$100,000.00 equals $3,000.00. Two percent of the remaining $1,062.02 equals $21.24.
Thus, the amount that should be accepted for the projected year management fee expense
is $8,021.24.11

        Legal fees — The auditor accepted the figures submitted by the owners for both
the representative year ($10,354.90) and the projected year ($11,335.73). The
representative year figure was based on actual expenses in that year and the projected year
figure was based on a monthly average of legal fees incurred, by the past and current
owners, for the 30-month period immediately prior to the filing of the hardship
application. According to the application, legal activity in the relevant periods was
broken down into three categories: building purchase; landlord-tenant; and building
business. The owners stated in the application that they did not include in their
calculations fees relating to the purchase or sale of the building. In addition, they did not
include “overlapping” fees, i.e., the current owners did not include in their calculations
fees they paid relating to landlord-tenant litigation ($8,484.39) against the prior owner for
the period from November 1982 to May 1983 (although they did include the fees incurred
by the prior owner).

         At the hearing, Duffy testified on behalf of the tenants that he thought the
$11,335.73 figure was excessive and that he would simply budget $1,000.00 per year for
tax certiorari. On cross-examination, however, Duffy admitted that there was a greater
likelihood of litigation in a residential building than in a commercial one; he would
budget for litigation though only if he knew that it was going to occur. In addition, Duffy
testified that occasionally, in his role as a managing agent, he would represent an owner
in housing court.

        The owners argued that the projected year figure of $11,335.73 was reasonable
despite Duffy’s testimony. They noted that the figure they submitted was based on actual
experience — as contrasted with Duffy’s hypothetical testimony — and was consistent
with the costs listed in the 1984 edition of “The Economics of Loft Housing.” They also
argued that Mishaan, one of the respondents, was very litigious and was in fact
responsible for many of the legal fees actually incurred; the owners argued, therefore, that
it would be unfair to accept the tenants’ argument that the submitted legal fees were
unreasonable. In their memoranda, the tenants argued that only minimal landlord-tenant
costs should be allowed. They further argued that the owners’ projected cost was based
in large part on two lawsuits that had been completed subsequent to the 30-month period
used by the owners. The tenants concluded that “[s]uch a one-time charge should not be
permitted to be projected into the expense base.”

11
    Although this amount differs from the $4,007.63 argued for by the owners, it is clear
from their application that they thought they were seeking the maximum amount allowed
under the rules for management fees, and not seeking some lower level. To recommend
$8,021.24 for the projected year management fees is therefore not giving the owners more
than they were seeking.


                                             18
         It seems clear that, as a general matter, regularly occurring legal fees — such as
those arising from landlord-tenant litigation and from what the owners called “building
business” issues — should be included in the operating expenses of a building.
Furthermore, in Application of Hertzoff, Loft Board Order No. 1072, at 17, 19, 11 LBR
at 108, 109, the Board allowed legal fees for the filing of the hardship application at issue
to be counted in the representative year and used in the calculation of projected year legal
fee figure. However, analysis of the record does not clearly lead to figures the Board
should accept for the representative and projected year legal fee expenses. As noted by
the tenants, the actual expenses relied on by the owners in their analysis include fees
relating to a separate, completed lawsuit among several of the parties.12 Such fees can
hardly be considered “representative,” despite the owners’ argument that Mishaan was
very litigious (although proof of such litigiousness might justify higher than average
general landlord-tenant litigation fees). The problem, however, is that the documentation
submitted by the owners as to what the actual legal fees were for — consisting mostly of
periodic itemized legal bills — did not break down the cost by activity, but simply gave a
total figure for a list of activities. Therefore, it is impossible on this record to determine
the exact amount of the fees used by the owners in their calculation arising from the non-
representative lawsuit.

         In light of this defect in the record, the most equitable approach is to average the
parties’ positions in order to come to the accepted projected year figure for legal fees.
The owners argued for a figure of $11,335.73. The tenants’ expert stated that $1,000.00
per year would be required for tax certiorari. Furthermore, in his memorandum, tenants’
counsel argued that $300.00 per unit would be sufficient to cover typical landlord-tenant
litigation.13 Thus, the tenants’ position was that the projected year legal fees should be
$1,600.00. The average of the two positions is $6,467.87. This amount should thus be
the accepted projected year legal fee figure. I find this amount to be reasonable because,
although only an approximation, it should account for the legal fees categories of tax
certiorari, building business, landlord-tenant litigation, and the cost of the hardship
application, without counting nonrepresentative legal fees. As to the actual year figure:
The submitted actual year figure was apparently different from the projected year figure
because the owners based the projected year figure on a 30-month average rather than
solely on the representative year. As the tenants did not challenge this analysis, it may
stand as the basis for the accepted projected year figure of $6,467.87. However, as the

12
     The tenants have not rebutted the assertion by the owners in the application that the
owners did not include the costs of litigation that they incurred, as tenants, against the
former owner. Therefore, it appears, tenants’ counsel’s assertion notwithstanding, that
the “one-time” costs included by the owners in their analysis relate only to the lawsuit
filed by Mishaan against the current and former owners, and not also to the lawsuit filed
by the current owners against the former one.
13
     Although counsel stated that the appropriate total would therefore be $2,100.00, he
apparently was assuming seven residential units in opposition to the landlord, rather than
the two units at issue here.


                                             19
owners submitted a representative year figure lower than their projected year figure, the
representative year figure the Loft Board should accept should be correspondingly lower.
The Board should accept an representative year legal fee figure of $5,977.45, which is the
average of the owners’ submitted figure of $10,354.90 and the tenants’ figure of
$1,600.00.

        Administrative costs — In her audit, the Board’s auditor accepted the owners’
submission of $2,783.97 for representative year administrative costs and $3,400.00 for
projected year administrative costs. The owners explained in their application that the
projected year figure included a 10 percent increase over the representative year for
accounting fees and a $1,200.00 budget for advertising. The auditor commented in her
report that the projected year increase seemed “to be within reasonable limits.”

         At the hearing, Duffy testified on behalf of the tenants that a bookkeeper was not
necessary because the managing agent would keep the books and an accountant would do
the taxes. In their memoranda, the tenants argued that the projected year administrative
cost figure should be reduced, based on Duffy’s testimony, because the owners did not
rebut his testimony that the administrative costs would be supplied by the management
company at no additional expense. The owners argued that the $3,400.00 projected year
figure was reasonable and noted that it was only slightly more than the comparable figure
listed in the 1984 edition of “The Economics of Loft Housing.”

       The $3,400.00 projected year figure, as accepted by the Board’s auditor, should be
accepted for administrative costs. The projected year figure was based on actual
accounting fees incurred in the representative year and a budget for advertising. Duffy’s
testimony does not address the advertising issue. In addition, his testimony actually
appears to support the need to pay accounting fees, the tenants’ argument
notwithstanding. As it was based on costs actually incurred, the representative year figure
of $2,783.97 should also be accepted.

       Mortgage interest — This category consisted of two topics: the interest payable
by the owners on the mortgage they used to purchase the building and the interest on any
loan used to legalize the building.

        As shown by the application and the owners’ September 6, 1985, submission in
response to questions from the auditor, the owners financed their purchase of the building
with a purchase money mortgage given by them to the seller (Newboro Realty
Corporation) at the time of the closing. The purchase price was $725,000.00. The
principal on the loan was $425,000.00 and the term of the mortgage was 10 years. The
interest rate was 15 percent. While the closing occurred on May 26, 1983, interest did not
become payable until September 1, 1983. Under the terms of the mortgage, the interest
due for September and October 1983 (the last two months of the representative year)
totaled $10,625.00. The interest due for the projected year was $63,750.00.




                                            20
        In their September 6, 1985, submission, the owners explained why they had
purchased the building with a noninstitutional loan at a 15 percent interest rate.
According to that submission, interest rates were high (although dropping) during the
period — July 1982 through October 1982 — in which the owners negotiated the terms
for purchasing the building. In August 1982 the prime rate was 15 percent and on
October 11, 1982, it was 13 percent. The owners did not apply for an institutional loan
because, assuming a bank would have made a $425,000.00 loan to “individuals of limited
resources for the purchase of a residentially occupied loft building that had no residential
certificate of occupancy,” a loan at two points above prime would have resulted in an
interest rate no better than they got through the purchase money mortgage. Furthermore,
although the prime rate on October 26, 1982, the date the contract of sale was signed, was
only 11.5 percent, the owners believed they would have lost the contract had they started
seeking an institutional loan at that point. The owners noted that they had, in 1985,
unsuccessfully sought to refinance their mortgage with an institutional loan.

       In her audit, the auditor computed the construction loan interest at a rate of 13
percent, based on the owners’ September 6, 1985, submission. According to that
submission, the owners assumed a self-amortizing, 15-year institutional loan at a 13
percent interest rate for the full amount of the actual costs of code compliance. They
explained that they assumed the 13 percent interest rate “to eliminate the necessity of
making allowances for origination fees, application fees, commitment fees, points and
other miscellaneous fees and charges associated with such a loan.”

        At the hearing, Hegy testified on behalf of the owners on the loan issues.
According to Hegy, a trustee of the Manhattan Savings Bank who evaluated loans for the
bank, a preferential rate on the refinancing of the purchase money mortgage, in order to
include construction costs, would not be granted on a loan of less than $1,000,000.00. He
estimated that a loan of $750,000.00 to refinance the purchase money mortgage and for
code compliance costs would be at a rate between 10 and 11.5 percent. He also testified
that the costs in connection with such a refinancing would include an origination fee of
one to two percent of the loan, a broker’s fee of one to three percent, one to two percent
worth of costs for a title search and attorneys’ fees, and possibly additional costs
associated with the supervising of construction loans.

         Duffy testified on behalf of the tenants on the loan issues. Specifically, he
computed the cost of refinancing the purchase money mortgage with a loan that was also
intended to pay for code compliance and the installation of a new elevator.14 He assumed
that repayment of the loan would begin on May 1, 1986. On cross-examination, Duffy
testified that, in preparation for the hearing, he consulted with a mortgage broker, who
had a relationship with several institutional lenders, regarding his opinion on the
availability of financing for the building. Duffy told the broker that the building was a

14
    Duffy testified that the elevator replacement represented approximately 18.25 percent
of the total cost of the proposed loan and that elimination of the elevator replacement cost
would reduce the amount of the interest payment proportionately.


                                            21
five-story loft building, with two stores, that was located on lower Fifth Avenue. He also
told the broker the rents that were being paid for the various units in the building. He
then asked what the rate for a mortgage would be, assuming that the building qualified.
The broker stated that the rate would be 10 1/8 percent, with one point, for a 10-year
term. Duffy did not remember whether he told the broker that the building did not have a
certificate of occupancy or that it was to some extent subject to rent regulation. He stated
that he did not discuss with the broker the question of whether the building would qualify
for the mortgage; he only discussed what the rate for the mortgage would be. While the
broker was certain that a 10-year self-amortizing mortgage would be available for the
building, he told Duffy he might have been able to find other mortgages.

        Duffy’s opinion was that the building would have had to borrow $657,490.00 to
satisfy the existing first mortgage, which he computed to have a balance of $416,874.11
as of May 1, 1986, to pay for the necessary code compliance work, which he assumed
would cost $114,106.45 based on the figures submitted by the owners, to pay for a new
elevator, which he assumed would cost $120,000.00, and to pay the mortgage placement
fee.

        Duffy also stated that, if the building wanted to have the lowest monthly and
yearly payments possible on the mortgage, the owners could have obtained an
interest-only mortgage, for which the annual payment would have been $55,475.76. He
arrived at this number using the 10 1/8 percent interest rate, the total loan amount of
$657,490.00, and a “mortgage reduction table.” Duffy later acknowledged that 10 1/8
percent of $657,490.00 was approximately $66,570.00, and that he had therefore been
mistaken; the annual payment on an interest-only mortgage would have been this amount,
and not $55,475.76.

     Duffy was not certain whether the 10 1/8 percent financing was available in
November 1983 and stated that he would have to research the matter.

        On redirect examination, Duffy testified that it would be easier to obtain a
mortgage if the amount sought was reduced by removing financing for a new elevator. At
that reduced level, it was Duffy’s opinion, based on his experience, that a building like
the subject building could have obtained financing.

         In their memorandum, the owners argued that Duffy’s testimony concerning
interest rates in 1986, at the time of the hearing, was meaningless because he admitted
that he had not considered the different interest rates in effect at the time the owners
purchased the building. The owners made the same argument with respect to the 13
percent rate they assumed would apply in any construction loan. They also noted that
Duffy’s testimony failed to consider the costs associated with refinancing the mortgage
for construction purposes, such as attorneys’ fees and appraisal costs. The tenants argued,
on the other hand, that the testimony of both Hegy and Duffy supported the proposition
that, in the projected year, the owners could have refinanced their mortgage and financed
legalization costs in the same transaction at an interest rate of 11 percent with a one


                                            22
percent origination fee. Assuming the propriety of the size of the mortgage and the
legalization expenses alleged at the hearing by the owners of approximately $230,000.00,
the tenants argued that this testimony led to a total interest expense that was $21,722.57
less than the amount in the revised Loft Board audit.

        The interest rates submitted by the owners — 15 percent for the mortgage and 13
percent for the construction loan — should be accepted. The owners persuasively
explained why they took initially took out a 15 percent purchase money mortgage and, in
fact, the tenants do not appear to challenge this aspect of the interest question. Therefore,
the mortgage interest rate that the Board should accept for the representative year is 15
percent.

        The tenants focused on the projected year, arguing that the projected year interest
rates for both the mortgage and a construction loan should be 11 percent, with a one
percent origination fee. However, Duffy admitted that his testimony was not based on
financing available during the projected year. Therefore, his testimony cannot be said to
rebut the owners’ projected year submission, as accepted by the Board’s auditor.
Furthermore, the auditor adopted — and I find reasonable — the owners’ approach of
folding the various costs of taking out the construction loan into the assumed interest rate,
and the tenants have provided no basis for disturbing this approach. Therefore, for the
projected year, the Board should accept 15 percent as the rate for the mortgage interest
and 13 percent as the rate for the interest on the construction loan.

        The question remains, however, how these interest rates translate into projected
and representative year expenses. As to the projected year: Based on the analysis above,
the projected year mortgage interest expense, as accepted by the auditor, should be
$63,750.00. The projected year construction loan interest expense depends on the
accepted costs of legalization, which, as discussed below, equal $66,931.33. Based on a
15-year construction loan for this amount at 13 percent, the total amount of interest due
equals $85,501.85, for which the payment in the projected year would be $8,610.81. This
is the amount the Board should accept as the projected year construction loan interest
expense.

       The representative year mortgage interest expense presents a different problem.
Based on the 12-month period chosen by the owners to be the representative year
(November 1, 1982, to October 31, 1983) and the fact that the owners did not begin to
pay mortgage interest until September 1, 1983, the representative year submission by the
owners includes only two months’ worth of mortgage payments, which totaled
$10,625.00. While the owners’ choice of the 1982-1983 period to be the representative
year was in the abstract unremarkable, their choice of that year, turned out to be
problematic as to the issue of mortgage payments, for the following reasons.

        Under MDL §285(2)(ii), an economic hardship application may be granted on the
ground that “obtaining a legal residential certificate of occupancy would cause an
unjustifiable hardship . . . because . . . the cost of compliance renders legal residential


                                             23
conversion infeasible” (emphasis added). Cost infeasibility is then defined in terms of a
reasonable return on investment, which is further defined as a net annual return of five
percent or more. See MDL §285(2); 29 RCNY §2-03(b)(2)(ii). The need to isolate the
hardship resulting from code compliance explains the requirement in 29 RCNY
§2-03(b)(2)(ii) that an owner making a hardship claim submit evidence of both “the
current annual return for the building” based on a representative year, and the projected
net annual return following legalization.

        In the instant case, however, the owners have not submitted “representative,” i.e.,
typical, evidence of the cost of the mortgage payments, because they picked a year that
included only two months’ worth of payments. The result is that the difference between
the representative and projected year statements of net annual return represents a change
not in one variable, the inclusion of the costs of legalization, but a change in two
variables, the inclusion of the costs of legalization and the cost of 10 months’ worth of
mortgage payments. This is a crucial difference because, as audited, the figures
submitted by the owners appear to show that legalization would cause them to go from
making a 10 percent rate of return to making a negative 21 percent rate of return. In fact,
however, those figures mask the inclusion of an expense (10 months’ worth of mortgage
payments) that wrongly appears, on the surface, to be attributable to legalization. Had the
owners included a full year’s worth of mortgage payments in the representative year, the
change from representative year to projected year would have been smaller, because it
would have reflected only the costs of legalization.

        The question then becomes how the Board should correct this problem. The only
logical approach is to extrapolate backward from the two mortgage payments made at the
end of the representative year in order to attribute an entire year’s worth of payments to
the owners. The owners’ mortgage payments for the representative (and projected) year
were $5,312.50 per month. At that rate, the mortgage interest expense for the 12 months
of the representative year should be $63,750.00, or the same amount as was submitted by
the owners for the projected year. This is the amount that the Board should accept for the
representative year expense, because the approach by which it was arrived at isolates the
costs of legalization as the only difference between the representative and projected years,
and thus allows the Board to determine whether the costs of legalization, as opposed to
the cost of purchasing the building, create an economic hardship.

         I note that the owners’ representative year mortgage interest submission was the
only expense item for which they did not make 12 months’ worth of submissions. They
submitted a full year’s worth of data for virtually every other expense (except for fees and
permits), even though they did not own the building for the entire representative year. It
is difficult to imagine a principled reason for analyzing the mortgage interest expense in a
manner different from the manner in which the other expenses were analyzed, i.e., by
computing a full year’s worth of expense. While, instead of extrapolating from the
owners’ actual mortgage payments to determine the representative year figure, the Board
could instead look at the mortgage payments made by the previous owner in the first part
of the representative year, it seems fairer to do the extrapolation described above, because


                                            24
the prior owner’s mortgage payments would seem to bear no relationship to the expenses
of the current owners.

       For these reasons, I recommend that the Board accept $63,750.00 as the
representative year mortgage interest expense.

       D. Commercial Unit Income

        First floor commercial units — During both the representative and projected
years, the first floor south unit, unit 1S, was occupied by 1-2-3 Copy Center Inc. pursuant
to a written lease that had commenced on February 1, 1980. The annual rent in effect for
the first three months of the representative year (November 1982 through January 1983)
was $14,400.00, or $1,200.00 per month. Beginning in February 1983, the annual rent
was $16,800.00, or $1,400.00 per month; this rent level continued through January 1986.
Based on these lease provisions, the owners submitted, and the auditor accepted,
$16,200.00 as the representative year income for unit 1S ($1,200.00 for three months,
plus $1,400.00 for nine months) and $16,800.00 as the projected year income for the unit.
The tenants do not dispute these amounts and they should be accepted by the Board.

        As to unit 1N: During both the representative and projected years, the first floor
north unit, unit 1N, was occupied by China Books and Periodicals, Inc. Beginning on
December 1, 1975, China Books occupied the space pursuant to a written lease that was
for a term of three years with the possibility that it could extend the lease for an additional
five years. China Books evidently exercised that option; the rent under the extension, for
the period from December 1, 1978, through November 30, 1983, was $16,800.00 per
year, or $1,400.00 per month. As this period included the representative year (November
1, 1982, through October 31, 1983), the owner submitted, and the auditor accepted,
$16,800.00 as the representative year income for unit 1N (12 months at $1,400.00 per
month). The tenants do not dispute this amount and it should be accepted by the Board.

        However, the tenants dispute the projected year income for unit 1N. On
November 29, 1983, one day before the lease extension was to expire (and one month
after the owners perfected their hardship application), the owners and China Books
entered into another lease extension. This extension was for one year, to November 30,
1984, at an annual rent of $33,600.00, or $2,800.00 per month. Based on the lease
extensions, the auditor accepted $32,200.00 as the income from unit 1N for the projected
year (November 1, 1983, through October 31, 1984). This amount was computed as
follows: $1,400.00 for November 1983 (under the terms of the first extension), plus
$30,800.00 for December 1983 through October 1984.

        At the hearing, however, Duffy testified on behalf of the tenants that the minimum
rent for unit 1N in December 1983 should have been $18.00 per square foot, rather than
the $15.52 to which the China Books lease extension was equivalent. He also stated that
the one-year lease in question was not typical, and that a lower rent level would have been
set to compensate the tenant for the shortness of the lease term. Duffy testified that a 10-


                                              25
year lease was standard and that “upscale” tenants would have paid between $30.00 and
$40.00 per square foot. On cross-examination, Duffy testified that the $15.52 per square
foot rent level might have been reasonable if the owner wanted possessory control of the
space. On redirect examination, Duffy stated his (revised) opinion that the yearly rent for
the one-year period starting in November 1983 should have been $41,000.00, based on
his belief that fair market value for the space was $20.00 to $25.00 per square foot and
his understanding that the store was 2,050 square feet in size. He also characterized his
estimate of $20.00 to $25.00 per square foot fair market value as very conservative.

        In their memorandum, the tenants relied on Duffy’s testimony to argue that the
projected year income for unit 1N should be increased to fair market value and to argue
that the owners’ decision to enter into a lease extension with China Books that was for
below fair market value, while the hardship application was pending, was evidence that
any alleged hardship on the owners was self-created. In response, the owners argued that
it was reasonable to base the projected year rent for the unit on the lease in effect during
the projected year, which represented a doubling of the prior annual rent. The owners
noted that on cross-examination Duffy conceded that a short-term lease might be entered
into with a long-time commercial tenant if there were the possibility that there might be a
need for substantial renovations or vacatur in the near future. The owners further argued
that Duffy had insufficient experience to express an opinion as to market commercial
rents relevant to the building.

       It is unnecessary to determine the projected year fair market rent for unit 1N, for
the purposes of determining the income for that unit for that year, because the income
issue must be determined pursuant to the lease actually in effect for the unit. Under 29
RCNY §2-03(b)(2)(ii)(B), the Board may impute fair market rental values only for vacant
units or units “occupied either residentially or non-residentially by the landlord, any
member of the landlord’s family or an employee of the landlord.” China Books’s
occupancy of unit 1N does not fit into these categories. Therefore, the income for unit
1N, for the purposes of determining the owners’ projected year rate of return, must be
deemed to be the rent contained in the lease in effect in that year. The Board should thus
accept $32,200.00 as the projected year income for unit 1N.15




15
    The evidence that the China Books lease extension in the projected year might have
been for below fair market value arguably would be relevant to the issue of self-created
hardship, as argued by the tenants. However, as discussed below, the owners have not
proven that the costs of legalization have created a hardship under MDL §285(2)(ii).
Therefore, the issue of whether the owners’ lease extension with China Books was for
below fair market value need not be addressed.


                                            26
        Second floor commercial units — In order to determine the income for the
second floor commercial units, it is first necessary to resolve the conflicting evidence as
to the commercial fair market value for those units.16

        On behalf of the owners, Hegy stated his opinion that the units on the second
through fifth floors, assuming all had been rented for commercial purposes, would have
had an average fair market value of $8.00 per square foot on November 1, 1983, the start
of the projected year. He based his opinion on rents in several other buildings. Hegy
further testified that the second floor might rent for 10 percent more than the upper floors
(assuming commercial use on those floors) because the possibility for “display” gave it a
greater commercial value. In addition, Hegy had determined the second floor’s
commercial value based on the assumption that the floor contained two units. When
informed that the second floor was, at the time of the hearing in 1986, divided into five
spaces, Hegy stated that the value of the second floor might be another 20 percent higher.
Hegy testified that the value of the second floor at the time of the hearing was $12.00 to
$13.00 per square foot and that rent levels had increased by 25 percent since November
1983.

        Hegy’s testimony leads to the conclusion that the fair market value for the second
floor units would have been $8.00 to $8.67 per square foot in the projected year. I reach
this conclusion as follows: Adjusting the $12.00 to $13.00 per square foot for the 25
percent increase in the market rents by the time of the hearing results in a range of $9.60
to $10.40 per square foot during the projected year. Further adjusting for the 20 percent
increase in value because of the second floor subdivision that had occurred by the time of
the hearing results in the range of $8.00 to $8.67. This range is consistent with Hegy’s
testimony that he believed the average commercial fair market value for the building to be
$8.00 per square foot but that the second floor might rent for an additional 10 percent.17

        Duffy testified on behalf of the tenants that the commercial fair market value of
the second floor units, as subdivided by the time of the hearing, was $12.00 to $18.00 per
square foot. He further testified that the market had risen about five percent over the five
years prior to the hearing (1981-1986). His opinion as to the projected year (November 1,
1983 through October 31, 1984) was that the second floor, containing the two units that
existed at that time, would have brought a minimum of $10.00 per square foot; he was

16
    As described in greater detail below, unit 2S was owner-occupied for portions of the
representative and projected years. Therefore, it will be necessary to also consider
residential fair market value for that unit.
17
     In her memorandum, owners’ counsel interpreted Hegy’s testimony to mean that he
believed the value of the second floor units was approximately $9.50 per square foot.
However, she apparently included the value of subdivision in arriving at that figure.
Because the second floor was not subdivided in the projected year, that added value
should not be considered in determining the projected income for that year. In fact,
counsel elsewhere in her memorandum analyzed the income issue as though there were
only two second floor units.


                                            27
reluctant to state an opinion as to the maximum the units might have rented for, which he
stated would have depended on the nature of the tenancies. However, in light of his
testimony about the values at the time of the hearing — in which the maximum fair
market value was 50 percent greater than the minimum — it is reasonable to assign to
Duffy’s testimony a maximum value for the projected year of $15.00 per square foot.

       In their memorandum, the owners argued that Hegy’s expert testimony should be
accepted over that of Duffy because of certain deficiencies in Duffy’s analysis. The
owners noted that Duffy assumed the building would continue to have an elevator
following legalization, an assumption that was unwarranted in light of the legalization
testimony. They also argued that Duffy had seemed to confuse use of the units for strictly
commercial use with use for joint living and working purposes. In addition, the owners
noted that Duffy’s straight-line projection backward from the hearing to the projected
year was skewed by the fact that commercial prices had risen very rapidly in the
neighborhood in the years immediately before the hearing, meaning that the projected
year values should have been lower.

        The tenants argued in their memoranda that Duffy’s testimony should be accepted
over Hegy’s because Duffy based his opinion on his own experiences while Hegy had
relied on the opinions of other persons in forming his opinion. In addition, the tenants
responded to the owners’ claim that Duffy’s method of computing the projected year rents
was defective by noting that both Hegy and Duffy had testified to the same level of
increase.

        I do not accept the tenants’ argument that Duffy’s testimony is inherently more
reliable than that of Hegy. While Hegy did testify that he discussed commercial fair
market value with other persons, so did Duffy. Furthermore, Hegy testified to having
personal experience with the renting of commercial spaces. The question remains though
whether there were specific problematic aspects of the testimony of either Hegy and
Duffy.

       While Duffy did discuss, in other areas of his testimony, the relative effects of
commercial and mixed use on fair market value, he did not do so with regard to the
second floor commercial spaces. It appears that the confusion, if any, alluded to by the
owners arose in the context of the owner-occupied units, for which Duffy was asked to
assign a commercial fair market value. Therefore, I find that Duffy’s testimony should
not be discounted for this reason as to the second floor commercial units. Furthermore,
the owners’ complaint about Duffy’s use of a “straight-line projection” back from the
hearing to compute market values in the projected year simply does not seem to be
supported by Duffy’s testimony. While Duffy did testify that the market had risen by five
percent per year, adjustment of his testimony about values at the time of the hearing
($12.00 to $18.00 per square foot) by that percentage would result in projected year




                                           28
values of $10.62 to $15.93 per square foot.18 As Duffy in fact testified to lower projected
year values — $10.00 to $15.00 per square foot — it appears that he did take into account
the rapid rise in values shortly before the hearing, as the owners argued he should have.

        However, the owners did correctly note that Duffy’s general testimony assumed
the existence of an elevator in the building following legalization, which the legalization
experts for both sides testified would not be possible. As it appears reasonable to assume
that the presence of an elevator would add value to second floor commercial lofts,
Duffy’s values must be reduced to some extent to account for the projected year absence
of an elevator. I find that a 10 percent reduction would be reasonable, based on Duffy’s
own testimony. Duffy testified that the installation of a self-service elevator (to replace
the manual elevator) would increase market rents by at least 10 percent in the building.
While he did not indicate by what percentage the rents would decrease in the absence of
any elevator, it is reasonable to assume that it would be by at least the same percentage as
that by which the rents would increase if a self-service elevator were installed. Thus,
reducing Duffy’s projected year values — $10.00 to $15.00 per square foot — by 10
percent results in a range of $9.00 to $13.50 per square foot.

        The result of this analysis is as follows: Hegy’s testimony results in a range of
projected year fair market values for the second floor commercial units of $8.00 to $8.67
per square foot. As just stated, Duffy’s testimony leads to a range of $9.00 to $13.50 per
square foot. As the parties have provided no basis other than the ones discussed to
choose between these ranges, a reasonable approach is to average them. The result is a
range of $8.50 to $11.09 per square foot. Based on the evidence, I find this result to be
reasonable. Furthermore, for the purpose of computing projected year income for the
second floor units, it also seems reasonable to average the range of values. This results in
a figure of $9.80. Again, based on the evidence, I find this result to be reasonable.

        Thus, the projected year rent for the second floor commercial units should be
$9.80 per square foot. As the second floor has 4,050 square feet and as the owners
conceded in their memorandum that gross dimensions should be used for computing
commercial rents, the yearly rents for units 2S and 2N would have been 19,845.00 each
($9.80 times 2,025 square feet), or $1,653.75 per month.19


18
      Duffy testified approximately 2 1/2 years after the start of the projected year.
Adjusting the $12.00 to $18.00 per square foot range to account for 2 1/2 years of a five
percent per year increase results in the $10.62 to $15.93 per square foot range. For
example, $12.00 was multiplied by 20/21 (to account for one year’s worth of five percent
increase). The result was again multiplied by 20/21 (to account for a second year’s worth
of five percent increase). The result was then multiplied by 40/41 (to account for a half
year’s worth of increase at five percent per year). The result is $10.62.
19
     Although the owners state in their memorandum that the second floor units were
assumed to be 2,000 gross square feet (as opposed to 2,025), this statement appears
inconsistent with their concession that gross area was to be used for commercial spaces.


                                            29
        With this conclusion, it is possible to compute the representative and projected
year income for units 2N and 2S. As to unit 2N: The tenants have not disputed the
representation made on page 13 of the owners’ September 6, 1985, submission that the
unit was occupied by Lira and Sutil (two of the applicants) until June 1, 1983, when they
moved to unit 4S. In addition, the tenants have not disputed the representation in the
supporting documentation to the owners’ application that Lira and Sutil were paying
$450.00 per month in rent for unit 2N until they moved. Therefore, as Lira and Sutil paid
rent as tenants for unit 2N through May 1983 (they became two of the owners of the
building on May 26, 1983), the $450.00 per month they paid for the period from
November 1982 (the beginning of the representative year) through May 1983 should be
considered the income from that unit for those months. This amount equals $3,150.00.
For the remainder of the representative year, fair market commercial rental value must be
imputed for the unit, because it was vacant. See 29 RCNY §2-03(b)((2)(ii)(B). Using the
figure of $1,653.75 per month that was previously computed, the income for the months
of June through October 1983 (the remainder of the representative year) equals
$8,268.75.20 Thus, the total income for unit 2N for the representative year should be
$11,418.75 ($8,268.75 plus $3,150.00). For the projected year, the total income for unit
2N should be $19,845.00, which is one year’s worth of imputed commercial fair market
rent for the vacant unit.21



In addition, in their September 6, 1985, submission (Exhibit O), the owners listed these
units as having 2,025 square feet.
20
     Although the $1,653.75 figure was computed based on testimony as to what market
rates would have been in the projected year, which did not begin until November 1983,
the parties did not submit evidence as to the commercial fair market value for the second
floor units in the representative year. While Hegy and Duffy did testify as to the change
in market rent levels, their testimony was not entirely consistent and does not provide a
basis for determining how much lower market rent levels would have been in the last five
months of the representative year as compared to the projected year. In any event, in light
of the testimony of Hegy and Duffy, the difference in rent levels would be minor.
21
    In the supporting documentation to their application, the owners represented that unit
2N was vacant throughout the projected year (November 1, 1983 to October 31, 1984).
In addition, the owners’ analysis throughout their various submissions as to this unit
treats the unit as though it was empty. I note, however, that on page 14 of their
September 6, 1985, submission, the owners state that “[i]t was not until March of 1984
that the second floor was rented up in its entirety,” a comment inconsistent with unit 2N
being vacant throughout the projected year. However, in light of the fact that (1) the
owners submitted no documentation as to what the actual rent level for the unit was at
any time in the projected year; (2) the owners otherwise analyzed the projected year
income issue as though the unit had been vacant in the projected year; and (3) Exhibit O
to the September 6, 1985, submission itself treated unit 2N as though it was vacant, I
believe it is appropriate to impute a fair market rent level to the unit for the entire
projected year.


                                            30
        As to unit 2S: The tenants have not disputed the representation made on page 13
of the owners’ September 6, 1985, submission that the unit was occupied by Wollen (one
of the applicants) until December 1, 1983, when she moved to unit 4S. In addition, the
tenants have not disputed the representation in the supporting documentation to the
owners’ application that Wollen was paying $500.00 per month in rent for unit 2S for the
period from November 1982 through January 1983 and then $550.00 per month from
February 1983 until she moved. As Wollen paid rent as a tenant for unit 2S through May
1983 (she became an owner of the building on May 26, 1983), the rent paid for the period
from November 1982 (the beginning of the representative year) through May 1983 should
be considered the income from that unit for those months. This amount equals $3,700.00
($500.00 times 3, plus $550.00 times 4). For the remainder of the representative year,
fair market residential rental value must be imputed for the unit, because it was owner
occupied. See 29 RCNY §2-03(b)(2)(ii)(B). As discussed in the next section of this
report, that amount, for the south units, equals $1,554.02 per month. Therefore, the
income for the months of June through October 1983 (the remainder of the representative
year) equals $7,770.10. Thus, the total income for unit 2S for the representative year
should be $11,470.10. For the first month of the projected year (November 1983), the
fair market residential rental value of $1,554.02 must be imputed because Wollen was
occupying the unit as an owner. For the remainder of the projected year, fair market
commercial rental value must be imputed for the unit, because it was vacant. See 29
RCNY §2-03(b)((2)(ii)(B). Using the figure of $1,653.75 per month that was previously
computed, the income for the months of December 1983 through October 1984 equals
$18,191.25. Thus, for the projected year, the total income for unit 2S should be
$19,745.27, which equals $18,191.25 plus $1,554.02.22

       E. Owner-Occupied Unit Income

        I have already recommended, in the section on preliminary issues, that the owner-
occupied units be analyzed in terms of residential use, consistent with the alteration
application that the owners filed at DOB. I have also already recommended that fair
market rents must be imputed to the owner-occupied units pursuant to 29 RCNY
§2-03(b)(2)(ii)(B). Therefore, in order to determine the income to be imputed to the
owner-occupied units (units 3N, 3S, 4N, 4S, and 5NR), it is necessary to resolve the
conflicting expert testimony regarding residential fair market value.

         Hegy testified on behalf of the owners that the fair market value for residential use
on November 1, 1983 (the start of the projected year), would have been $10.00 per square
foot per year. He based his opinion on information from other brokers, on the rents for
residential tenants in lofts he owned, and on his opinion of the market in general. He
testified that the market for residential lofts at the time of his testimony was $12.00 to
$12.50 per square foot and that it had improved by 25 percent over the approximately two


22
    See footnote 20 as to the unit’s vacancy in the projected year. The analysis in that
footnote also applies to unit 2S.


                                             31
years since November 1, 1983. Hegy’s recollection was that units 3N, 3S, 4N, and 4S
were each 2000 square feet and that 5NR was 1000 square feet.

        On cross-examination, Hegy testified that he had not brokered any leases for
residential lofts in the second half of 1983 or through the time of the hearing. He stated
that, while he preferred to rely on his own knowledge, he felt that the information he had
received from other brokers could not be bettered. He conceded that his method was
subject to error, but that a $1.00 per square foot, or 10 percent, error for the residential
rate would be high. He also stated that he had personal knowledge of the current market,
which he considered to have steadily increased, since November 1983, by 25 percent.
Hegy testified that the $10.00 per square foot figure for residential use applied generally
to all the units; he conceded that conditions in the units varied and that, because it was
smaller, unit 5NR might bring an extra $0.50 per square foot.

         Gordon Riesner, a real estate broker, testified on behalf of the tenants as to the
market value of residential lofts. Riesner testified that, in general, he determined the
rental value of lofts by comparing them to lofts he had previously rented and for which he
thus knew the rent level. In his experience, the factors that contributed to the market
rental value of a loft included the condition of the building, the condition of the loft, the
quality of the outside lighting, the number of fixture and appliances that were in the loft,
and whether there was elevator service (and of what type). Other important factors
included whether there was roof or balcony space available, the location of the building,
and, if a fixture sale was involved, the length of the lease.

        After describing his generally favorable opinion of the building itself and its
location (between 19th and 20th Street in the Flatiron District), Riesner gave his opinion
of the market value of the owner-occupied units at the time of the hearing, based on their
individual attributes, the quality of the outside light in each loft, the presence of an
elevator, and the nature of and demand for the neighborhood in which the building was
located. In sum, his testimony as to the monthly residential fair market values at the time
of the hearing was as follows: unit 3N — $2,800.00; unit 3S — $2,200.00; unit 4N —
$2,400.00; unit 4S — $2,200.00; and unit 5NR — $2,800.00.

        Riesner also gave his opinion of the rental fair market values for the units for the
projected year (November 1983 through October 1984), which he arrived at using the
following technique: Riesner took one of his old advertisements — each containing
descriptions of four to 12 different lofts — at random from the three he ran during each
month of the projected year. He then analyzed each loft listed in the advertisements that
was between 900 and 2,000 square feet, which he testified was a range similar to that in
the subject building, to determine what had been the price per square foot.

        Riesner’s analysis led to his opinion that lofts had been renting for approximately
11 percent less during the projected year than they were at the time of the hearing. This
was a figure that applied to all of the lofts. Thus, for example, Riesner’s opinion was that
Unit 4N, which he believed would rent for $2,400.00 per month at the time of the


                                             32
hearing, would have rented for $264.00 less, or $2,136.00 during the projected year.
Riesner explained the change in the market by his belief that, at the time of the hearing,
there was a heightened public awareness that lofts were available to live in, and by the
fact that many people had chosen to work in the area of the subject building since the
projected year, a factor he believed also increased the desirability of the lofts.

        Riesner’s opinion was that Hegy’s estimate of $12.00 to $12.50 per square foot
for the residential fair market rent for the units in question, at the time of the hearing, was
very low. Riesner stated that, based on his testimony, he believed the average figure
should have been $16.77 per square foot. For the projected year, Riesner thought a figure
of $10.00 per square foot was also low. His opinion was that the figure would have been
approximately $15.00.

         On cross-examination, Riesner explained that he arrived at the 11 percent
difference in market value between the projected year and the time of the hearing by
comparing his projected year calculations to calculations for a 15-month period ending at
the time of his testimony. After averaging the rent per square foot for those two periods,
he compared the two averages and arrived at the 11 percent figure. In response to the
effort of owners’ counsel to show that the 11 percent differential was not supported by the
projected year advertising on which Riesner relied, Riesner admitted that he made the
comparison between the two time periods without regard to the size of the comparison
lofts, i.e., the 11 percent figure was an average of the values for all of the comparison
lofts. Riesner also admitted that his analysis had not been broken down geographically,
although he did not believe that how “established” a neighborhood was affected demand
for a loft in that area.

         On redirect examination, Riesner stated that there was a “unique demand” for the
location of the subject building, because of its proximity to the “photography district.” It
was thus more attractive to photographers and businesses that used photographic services
than areas such as Tribeca, SoHo, NoHo, or Greenwich Village. Riesner said this
uniqueness had a substantial effect on the values he computed for the building’s lofts,
considering their nature, as compared to the values he would have given the lofts had they
been located in other neighborhoods; the subject lofts would have been much easier to
rent at the levels he gave them than they would have been in other neighborhoods. He
stated that the neighborhood would have been attractive to photographers, graphic
designers, and visual arts businesses during the projected year. Riesner further testified
that the relatively low number of lofts available in the neighborhood had a substantial
effect on their market value, making it substantially easier to get a higher rent for them.
As to comparison lofts he testified about on cross-examination that were located in other
neighborhoods, the rental values for some of them — if they had been located instead in
the neighborhood of the subject building — would not have changed from the amount
listed in the advertisements because they had been overpriced. Others of them, however,
would have rented more easily if they had been located near the building and would have
brought higher rents.




                                              33
       Riesner estimated that lofts in the area of the building would have rented at an
average level 10 to 20 percent higher than lofts in other areas. He thought that lofts
amenable to activities related to photography might rent for an even higher rate, while
lofts not so amenable would rent for a higher rate than in other neighborhoods but
possibly for less than 10 percent more.

       On recross-examination, Riesner admitted he included in his market analysis
some advertisements that contained “overpriced” rent levels. He stated, however, that the
vast majority of the advertisements were not “overpriced.”

       In their memorandum, the owners argued that the residential fair market value of
the owner-occupied units during the projected year should be deemed to be no more than
$11.00 per square foot, based on Hegy’s testimony that the value should be $10.00 per
square foot and that his estimate had a $1.00 per square foot margin of error.

        The owners first pointed to Hegy’s experience and “independence in his
judgment” as reasons for accepting his testimony. They contrasted Hegy with Riesner,
whom they claimed had a “personal axe to grind” because of ties to the loft tenant
community. According to the owners, Riesner was biased for several reasons, including
(1) his acting as broker for residential loft rentals, after the passage of the Loft Law, in
buildings that did not have a residential certificate of occupancy; (2) his referring
prospective loft tenants to a list of attorneys that included counsel for one of the tenants in
this case; and (3) his testimony before the Loft Board at the request of LMLT on the issue
of fixture fees. The owners further argued that Riesner’s alleged bias manifested itself in
the relatively short amount of time he spent examining the units in the building, his
inability to remember appliances that were in the lofts, and his inconsistent testimony as
to the effect of “a unit’s level of finish.”

        Furthermore, the owners argued that Riesner’s analysis of fair market values in
the projected year was flawed. They noted that the figures in the document Riesner
prepared for comparison purposes were only offers (i.e., advertisements) and not
consummated deals. In addition, they noted that the sample advertisements from the
projected year relied on by Riesner were weighted toward the end of that period, a fact the
owners found significant in light of his testimony that rents began to rise in the middle of
the period. The owners also pointed to a number of alleged errors that Riesner made in
doing his calculations based on the advertisements. Finally, the owners simply disagreed
with certain of Riesner’s comparisons, alleging that he wrongly ignored advertisements
that were relevant because of the size or features of the lofts described there. As an
example of their claim that Riesner testimony was “affected by . . . malice,” the owners
pointed to his valuation of unit 5NR, for which he gave a very high value. They noted
that he gave it a value (allegedly over $29.00 per square foot) that was higher than any
other unit his company advertised, even though he testified that the unit would not have
commanded the highest rent. The owners also noted that Riesner’s valuation of unit 5NR
did not take into account testimony regarding how the unit would have been changed by
legalization.


                                              34
        The owners argued that all of the defects in Riesner’s testimony meant that, at
best, only the low end of his estimate of the range of values during the projected year
($12.00 per square foot) should be considered. The owners thus argued that $11.00 per
square foot was “a reasonable compromise” between this value and Hegy’s value of
$10.00 per square foot.

         In their memorandum, the tenants argued that Hegy had the least experience of all
the expert witnesses with fair market values of lofts in buildings such as the subject one.
In addition, they argued that Hegy did not take the varying conditions of the residential
lofts into account, thereby underestimating their value.

        In their reply memorandum, the tenants argued that their experts, including
Riesner, should not be found biased because of their ties to the tenant community. The
tenants’ first argument was that it would be arbitrary to devalue expert testimony that
was, on its own terms, credible and supported by independent indicia of reliability, simply
because of abstract statements of possible bias. For example, the tenants noted that
Riesner’s testimony before the Loft Board — that fair market value should be defined as
what a willing seller and buyer would agree to as a price — was consistent with the
definition of fair market value implicit in Hegy’s testimony. Furthermore, the tenants
argued that each of the sources of bias alleged by the owners was equally applicable to
their own witnesses. For example, the tenants argued that, based on his background,
Hegy brought as much of an owner perspective to his testimony as Riesner brought a
tenant perspective. The tenants argued that this reason should not disqualify either one of
them from presenting evidence.

        However, the tenants did argue that Riesner’s fair market value testimony should
be given greater weight than Hegy’s because: (1) Riesner had much more experience
than Hegy with residential loft rental; Hegy’s testimony was based mainly on
second-hand information rather than first-hand experience. (2) While Hegy testified that
fair market value took into account specific conditions such as the availability of light and
air and a unit’s placement in a building, he (inconsistently) assigned a uniform value to
each of the residential units; Riesner, on the other hand, evaluated the particular attributes
of each unit.

        In order to resolve the conflicting expert testimony on residential fair market
value, it is first necessary to decide how much weight, in general, to give to the opinions
of Hegy and Riesner. Based on the record, I believe that both witnesses were sufficiently
experienced with the topic in question to give valid expert opinions. Hegy testified that
he was a senior vice president of Brown Harris Stevens (“BHS”), a full service real estate
organization whose activities included managing buildings, acting as selling agent in
residential conversions, leasing commercial space, doing appraisals, and obtaining
financing. At the time of his testimony, Hegy had been employed by BHS for about 10
years. He had been involved in the real estate field since 1945, had been licensed as a




                                             35
broker in 1948, and had, prior to joining BHS, owned (with other persons) the firm of
Brett, Wykoff, et al.

        Hegy also testified that he was an appraiser and had done hundreds of appraisals,
generally for banks in connection with mortgage applications. Of those appraisals,
dozens involved loft buildings in the area of the subject building, although only two or
three buildings contained residential space and only three spaces in those buildings were
vacant. Hegy testified that he referred to a variety of sources — such as the opinions of
other brokers, BHS records, and newspaper listings — in order to impute fair market
value to vacant spaces. Hegy stated that he had appraised three loft buildings in the year
prior to his testimony — one in Tribeca and two in SoHo.

        Riesner, the tenants’ expert, was a real estate broker affiliated with Court
International Realty, Inc. (“CIR”). He was in charge of all residential leasing for CIR.
He had been with CIR since 1976 and had become the head of residential leasing about
four or five years before the hearing. Before that time, he had also been involved with
residential leasing, primarily concerning lofts. In fact, he had focused almost entirely on
the residential leasing of lofts for the entire time he had been with CIR. At the time of the
hearing, Riesner had been involved in at least 1,500 potential rentals, of which
approximately 300 had actually resulted in a rental. He estimated that he had been
involved with approximately 20 to 30 successful rentals in 1984 and had been involved in
five times as many transactions.

        Based on these credentials, I have no reason to discount the general ability of
either expert to give a valid opinion on residential fair market value. While Riesner
appears to have had more personal experience with residential leasing, Hegy had some
relevant personal experience and appeared qualified to base his opinion on that
experience and the research he described. Furthermore, there was nothing in the
backgrounds of either Hegy or Riesner indicating that either one was inherently biased
and therefore unworthy of belief.

        However, the owners also claim that Riesner was specifically biased in favor of
tenants, i.e., that he had a “personal axe to grind” because of ties to the loft tenant
community. I do not believe, however, that the bases for the owners’ allegation support
their claim. The owners argue that Riesner was biased because he had testified before the
Loft Board, on behalf of the Lower Manhattan Loft Tenants, on the issue of how to
evaluate the fair market value of improvements. Riesner had also previously testified on
behalf of a tenant in a coverage case and had testified in court on behalf of both tenants
and co-op owners regarding residential fair market value. These facts simply do not show
bias. By its very nature, the loft community is divided into owners and tenants. In light
of this situation, an expert cannot be deemed biased, based merely on the fact that he or
she testified on behalf of one group or another, because the expert really has no choice
but to be hired by one side or another. Furthermore, a rule that would disqualify an
expert from testifying at a hearing on an individual application simply because the expert
had previously testified before the Board in its rulemaking capacity would wrongly


                                             36
deprive both the Board and litigants of expert testimony in what is an extremely
specialized field.

        The owners’ other grounds for arguing that Riesner was biased were based on a
portion of his testimony relating to his activities as a broker. Riesner testified that he
advertised under the heading, “Living Lofts for Rent,” some units that were illegal for
residential purposes in the sense that they were not protected under Article 7-C, were not
sublets, co-ops, or condominiums, and were not in buildings that had a residential
certificate of occupancy. Riesner stated that when he showed potential renters lofts that
were not covered by Article 7-C and where residential occupancy was not otherwise
allowed, he would inform them of that fact, discuss the issue with them, and advise them
to seek the advice of an attorney. Riesner explained that he had compiled a list of
attorneys to which he would refer people who were considering renting lofts. The list
consisted of attorneys on a list he had obtained from LMLT and other attorneys that he
knew himself. Riesner stated that Jeffrey Ween, one of the tenants’ attorneys, was on the
list. Riesner stated that he sometimes simply gave customers the list of attorneys and
sometimes discussed with them whom he would not recommend.

        I do not believe this testimony shows that Riesner was biased. The implication of
the owners’ argument regarding the presence of Ween’s name on the list of attorneys used
by Riesner is that the two of them had some sort of business relationship that would lead
Riesner to testify untruthfully on behalf of Ween’s client. However, an expert hired by a
party in litigation always, by definition, has a business relationship with the party and
possibly with counsel. While that relationship may be explored by opposing counsel, it
does not, by itself, provide grounds for disqualifying the expert. Furthermore, in this
case, it is hard to see exactly how the presence of Ween’s name on Riesner’s list would
affect Riesner’s testimony. While Ween might in theory be beholden to Riesner for
Riesner’s referrals to him, the reverse would not seem to be true, i.e., Riesner would not
become beholden to Ween by referring business to him. On this record, these facts do not
provide a basis for discounting Riesner’s testimony.

        Similarly, it is difficult to see how Riesner’s apparent willingness to broker the
unlawful residential occupancy of certain lofts shows that he was biased in this case. The
owners’ argument was that “[o]bviously Riesner [was] prepared to . . . participate in
illegal activity if he [would] be rewarded financially for it.” However, even assuming
Riesner’s brokering activity in this regard might result in unlawful occupancy, it was
activity that was equally beneficial to both owners and tenants, and therefore did not
show that he was inherently biased in favor of tenants. Furthermore, without other
evidence, it is simply too speculative to conclude that Riesner was lying in this case
because of the likelihood that he was paid for his testimony. On this record, I believe it is
appropriate to let the testimony of Riesner rise or fall on its own merits.

       As to those merits: The owners point to several alleged defects in Riesner’s
testimony that, they argue, should cause the Board to consider only the low end of the
range of fair market values to which he testified. The owners first point to the allegedly


                                             37
short time he spent examining the units prior to forming his opinions and his inability, at
the hearing, to remember certain details about the units. Riesner testified that he spent
approximately 1 1/2 hours inspecting the seven residential units in the building. He also
testified that when he inspected a loft for the purpose of placing an advertisement, he
would spend about an hour in the unit. Riesner explained that this discrepancy arose
from the fact that a substantial amount of the time he would spend in a loft before placing
an advertisement was devoted to issues such as determining whether the owner really
wanted to rent the loft and the length of the lease the owner was willing to offer, and in
gaining the owner’s trust. Of the average hour spent at such a loft, Riesner stated that he
spent approximately 15 minutes examining the loft and the rest talking to the owner. In
light of the time he usually spent examining a given loft, Riesner thought that the amount
of time he spent inspecting the lofts in question was adequate.

        Based on this explanation, which appears credible, I do not find that Riesner’s
testimony was weakened by the amount of time he spent examining the units in the
subject building. In addition, considering the number of units to which he was testifying,
I do not believe that he inability to remember certain details of the units weakened his
testimony.

        However, I do find there were certain weaknesses in Riesner’s analysis, although
not all of the ones alleged by the owners. Riesner testified that, in general, the presence
of an elevator added to the residential fair market value of a unit. He further testified that
the elevator present in the building at the time of the hearing added value to the units. As
discussed below, both legalization experts testified that the elevator would need to be
removed. Therefore, at least for the projected year, Riesner’s estimates need to be
reduced.

        Furthermore, as argued by the owners, Riesner’s analysis was weakened by the
fact that he used advertisements, rather than data from consummated deals, to calculate
fair market value, a weakness that clearly undercuts the theoretical basis of fair market
value. Even Riesner admitted that certain of the advertisements he used contained
“overpriced” rent levels, although he testified that most of them did not. In light of this
weakness, Riesner’s estimates must be further reduced.

        Other of the owners’ criticisms, however, do not warrant reducing Riesner’s
estimates. For example, the owners complain that the comparison advertisements chosen
by Riesner were weighted toward the end of the projected year, allegedly to take
advantage of the rising market at that time. However, this argument seems largely based
on the fact that Riesner chose the advertisements based on their “office” date, rather than
the date they actually ran. Holding aside the problem of using advertisements, I believe
that Riesner’s choice of dates was actually an advantage, because it more accurately
reflected the potential lessors’ positions; the delay involved in publication was irrelevant
to what these persons were seeking in rent.




                                             38
         Also on the issue of the dates of the projected year advertisements chosen by
Riesner: The owners argue that, as the start of the projected year was the significant date
for setting the fair market values, Riesner wrongly chose comparison advertisements from
throughout the projected year. They argue that he should have instead chosen
comparisons from the months immediately surrounding the start of the projected year.
Again, the owners argue that Riesner’s method wrongly reflected the increase in market
values that occurred during the projected year. The problem with the owners’ argument
is that there is no basis for their position that fair market values must have been fixed at
the start of the projected year. Neither the Board’s rule on the test for infeasible costs, 29
RCNY §2-03(b)(2)(ii), the instructions for completing hardship applications, nor the
August 19, 1985, letter from a prior hearing officer requesting that the owners supply
estimated fair market values for the owner-occupied units contained such a requirement.
Furthermore, there is no apparent reason that fair market values for owner-occupied units
should be frozen as of the first date of the projected year, particularly as those values are
not set pursuant to contract. Thus, I do not believe that Riesner’s approach, to the extent
it reflected a rising market, is flawed. His opinion as to projected year fair market values
may properly be seen as an average value for that period.

        Finally, I reject the owners’ arguments regarding errors in Riesner’s calculations
and how his analysis resulted in inconsistent values for comparable units. Correcting the
alleged computational errors would have, at best, a de minimis effect on Riesner’s
calculations. Furthermore, the owners’ effort to prove that certain similar units in other
buildings were advertised at lower levels than those set by Riesner in the subject building
was both inconsistent with Riesner’s stated approach of choosing a random sample of
advertisements to use for comparison and, significantly, was extremely speculative in
light of the large number of variables that affect fair market value.

        As to Hegy’s analysis: As with Riesner, Hegy presumably considered the
presence of the elevator to be a positive factor, despite the testimony by the legalization
experts that the elevator would need to be removed. Therefore, his estimated fair market
value needs to be reduced. In addition, I find that his failure to consider the differences
between the units and assign separate values to them was a defect in his approach.
However, there is no reason to doubt his testimony that the $10.00 per square foot figure
he arrived at for the projected year was an average for all of the units. As the ultimate
issue in this section is the income derivable from all of the owner-occupied units, Hegy’s
testimony may be used as is, with the understanding that the figure for a given unit under
his approach might vary from his opinion about that unit had he not averaged it with the
other units.

        In sum, Hegy’s opinion as to the residential fair market values for the
owner-occupied units requires adjustment to account for the absence of an elevator after
legalization. Riesner’s estimates must also be reduced for this reason, and because of his
reliance on advertisements. I believe it is appropriate to reduce Hegy’s estimate of
projected year residential fair market value by five percent, to account for the absence of
the elevator, and to reduce Riesner’s estimates by 10 percent, to account for both the


                                             39
elevator and advertisement defects.23 As calculated below, I find the result of these
reductions to be reasonable.

        As with the issue of the fair market value for the second floor commercial units, it
is reasonable to average the experts’ opinions, as modified, to compute income for the
units. However, in order to average the modified opinions of Hegy and Riesner, it is
necessary to convert Hegy’s opinion, given in price per square foot, into a monthly rent
level, which is how Riesner testified and which is necessary to compute income. In their
memorandum, the owners argued that net useable square footage should be considered,
consistent with Riesner’s testimony on behalf of the tenants. Also consistent with
Riesner’s testimony, the owners argued that the north units had 1,900 square feet and that
the south units had 1,700 square feet. Therefore, it is reasonable to conclude that these
were the correct figures for units 3N, 3S, 4N, and 4S.24 The owners argued that unit 5NR
had 1,000 square feet, consistent with Hegy’s testimony. Although Riesner testified that
he believed that unit 5NR had 1,200 square feet, he was unable to explain how he arrived
at that figure, considering that it was greater than the gross square footage listed for the
unit on the floor plan he used as the starting point in his computation. Therefore, the
figure of 1,000 square feet should be used for unit 5NR.25

        Using these figures, Hegy’s testimony can be converted to monthly rent levels.
Hegy’s opinion was that the owner-occupied units would have rented for $10.00 per
square foot in the projected year. Thus, at 1,900 square feet, units 3N and 4N would have
provided $19,000 income per year, or $1,583.33 per month. At 1,700 square feet, units
3S and 4S would have provided $17,000 income per year, or $1,416.67 per month. At
$1,000 square feet, unit 5NR would have provided $10,000 income per year, or $833.33
per month. Reducing Hegy’s figure by five percent, as discussed above, results in the
following projected year residential monthly fair market values: unit 3N — $1,504.16;
unit 3S — $1,345.84; unit 4N — $1,504.16; unit 4S — $1,345.84; unit 5NR — $791.66.


23
     I also find it reasonable to reduce the residential values, in light of the projected year
absence of an elevator, by less than I reduced the commercial values, because Riesner, the
tenants’ expert on residential fair market value, testified to many more variables relevant
to residential market rents than Duffy did about those relevant to commercial rents. On
this record, it is reasonable to therefore assume that the absence of an elevator would
have a smaller relative effect on residential rents.
24
    Although Hegy testified that these units were all 2,000 square feet, the record does not
indicate that he did as careful an analysis of the issue as did Riesner. In light of the
owners’ use of Riesner’s testimony, I am not using Hegy’s testimony on this issue.
25
     At the hearing, tenants’ counsel correctly argued that no foundation had been laid as
to the accuracy of the floor plan’s floor area figures. However, tenants’ counsel was not
arguing that Riesner’s complete testimony regarding square footage should be
disregarded. The point is that Riesner’s testimony about the size of unit 5NR was
inconsistent with the approach he used for every other unit — i.e., using the floor plan as
a starting point — and was therefore possibly inaccurate.


                                              40
        As discussed above, Riesner’s figure as to the projected year residential monthly
fair market values for these units must also be reduced. Making this reduction results in
the following figures, each of which is the result of reducing Riesner’s calculation of the
fair market value at the time of the hearing by the 11 percent he believed the market had
risen since the projected year, and further reducing that amount by 10 percent in light of
the deficiencies in his analysis: unit 3N — $2,242.80; unit 3S — $1,762.20; unit 4N —
$1,922.40; unit 4S — $1,762.20; unit 5NR — $2,242.80.

        Averaging Hegy’s and Riesner’s modified opinions as to the projected year
residential monthly fair market values for the owner-occupied units results in the
following figures: unit 3N — $1,873.48; unit 3S — $1,554.02; unit 4N — $1,713.28;
unit 4S — $1,554.02; unit 5NR — $1,517.23.

        With these figures, the income for the projected and representative years from the
owner-occupied units may be calculated. According to the owners’ September 6, 1985,
submission, unit 3N was occupied by the Bottomleys, owners, throughout the projected
year. Therefore, the projected year income for unit 3N should be $22,481.76 ($1,873.48
times 12). Similarly, unit 3S was occupied by Lira and Sutil, owners, throughout the
projected year; the projected year income for unit 3S should be $18,648.24. Unit 4N was
occupied by Varon, an owner, throughout the projected year; thus, the projected year
income for unit 4N should be $20,559.36. Unit 4S was vacant for the month of
November 1983 (the start of the projected year) and was then occupied by Wollen, an
owner. Under 29 RCNY §2-03(b)(2)(ii)(B), fair market value must be imputed to both
vacant and owner-occupied units. Therefore, the projected year income for unit 4S
should be $18,648.24 ($1,554.02 times 12). Unit 5NR was occupied by Vaccarella and
Hruby, owners, throughout the projected year; thus, the projected year income for unit
5NR should be $18,206.76.

       Computation of the representative year income is more complicated because the
applicants herein were not owners for the entire period; they purchased the building on
May 26, 1983. Unit 3N was occupied by the Bottomleys throughout the representative
year. According to the supporting documentation to the owners’ application, their rent
from November 1982 (the start of the representative year) through June 1983 was
$505.00 per month. However, commencing June 1983, the first full month the
Bottomleys were owners, fair market value must be imputed to the unit. Thus, the
representative year income for unit 3N should be $12,902.40 ($505.00 per month times 7,
plus $1,873.48 per month times 5).26

       According to the owners’ submissions, unit 3S was commercially occupied
through August 1983 at a rent of $450.00 per month, and was vacant for the last two

26
    I am applying the projected year residential fair market value for this (and the other
owner-occupied) units to months in the representative year for basically the same reasons
I applied projected year commercial fair market value to the computation of income for
unit 2N in the representative year. See footnote 20.


                                            41
months of the representative year. The tenants have not disputed these representations.
Therefore, the representative year income for November 1982 through August 1983
should be $4,500.00 ($450.00 per month times 10). The representative year income for
September and October 1983 should be $3,108.04 ($1,554.02 per month times 2). Thus,
the total representative year income for unit 3S should be $7,608.04 ($4,500.00 plus
$3,108.04).

       Unit 4N was occupied by Varon throughout the representative year. According to
the supporting documentation to the owners’ application, his rent for November and
December 1982 was $500.00 per month and his rent for the remainder of the
representative year was $550.00 per month. However, commencing June 1983, the first
full month Varon was an owner, fair market value must be imputed to the unit. Thus, the
representative year income for unit 4N should be $12,316.40 ($500.00 per month times 2,
plus $550.00 per month times 5, plus $1,713.28 per month times 5).

        According to the owners’ submissions, unchallenged by the tenants, unit 4S was
residentially occupied by one Frank Siciliano until June 1, 1983, at a monthly rent of
$550.00. On that same day, Lira and Sutil (who had just become two of the owners of the
building) moved into the unit, which they occupied until they moved to unit 3S on
November 1, 1983 (the start of the projected year). Thus, the representative year income
for unit 4S should be $11,620.10 ($550.00 per month times 7, plus $1,554.02 per month
times 5).

       Unit 5NR was occupied by Vaccarella throughout the representative year.
According to the supporting documentation to the owners’ application, her rent
throughout the representative year was $300.00 per month. However, commencing June
1983, the first full month she was an owner, fair market value must be imputed to the
unit. Thus, the representative year income for unit 5NR should be $9,686.15 ($300.00
per month times 7, plus $1,517.23 times 5).

       F. The Cost of Legalization

        In order to compute the projected year income from the two tenant-occupied units,
it is necessary to first determine the allowable cost of legalizing the building, in order to
be able to compute the amount of the code compliance rent increase attributable to those
units.

        Atlas’s alleged bias — Before addressing the details of the expert testimony on
legalization costs, I must address the owners’ argument that the testimony of Arthur
Atlas, the tenants’ expert, “should be radically discounted or entirely ignored on account
of his personal bias.” Specifically, the owners argued that Atlas had “a personal ax to
grind” and that he was “politically” biased.

       The owners first pointed out that Atlas lived in an interim multiple dwelling, had
been a member of LMLT’s steering committee and the head of its housing clinic, and had


                                             42
counseled Mishaan, one of the respondents, at the clinic regarding the subject building.
The owners argued that Atlas was thus biased and that the record demonstrated his bias.

        The first aspect of the record the owners pointed to as proof of Atlas’s bias
involved the circumstances surrounding the preparation of Caine’s and Atlas’s reports.
The owners argued that they had not realized, until four months before the hearing began,
that the costs of legalization would be an important issue at the hearing, partially because
the Loft Board had not promulgated its code compliance and rent adjustment rules until
shortly before that time. The owners did not hire Caine until after that time. They
contrasted their difficult situation with that of Atlas, who was allowed to prepare new
reports in response to Caine’s report (his first reports were prepared before Caine’s
testimony). The owners argued that the substantial differences between Atlas’s earlier
and later reports cast doubt on his credibility because “his conclusions regarding the cost
of legalization should not have been a function merely of what he thought he was
responding to, but a function of his independent evaluation as an expert in the field.”

         The owners next argued that Atlas’s personal bias was shown by his testimony
concerning his conversations with Vaccarella and Hruby, two of the owners. Atlas had
testified that he first became familiar with the building in 1981 and 1982 because the
occupants had been interested in purchasing the building; as a result, he had a number of
discussions with Vaccarella about legalization of the building. In addition, Atlas testified
that he spoke to Vaccarella and Hruby on a number of occasions in late 1982 and early
1983 about how the hardship rules might apply to the building. Atlas stated that
Vaccarella and Hruby were interested in the hardship rules both as tenants (as they were
at the time) in the event they could not buy the building, and as owners, in the event they
purchased the building and wanted to “remove some of the occupants.” Atlas told them
they were “playing a dangerous game,” because the elevator needed an expensive
replacement; legalization, therefore, would be “tenuous,” regardless of whether they were
tenants or owners. Atlas testified that, in response to his advice, Vaccarella stated that
she was going to meet with the occupants of the building and suggest that they purchase.
According to Atlas, she believed that a hardship would be found and that they would
therefore not have to legalize the building.

        Atlas recalled that he “warn[ed] her on a number of occasions that what she was
doing was very dangerous in terms of walking a very fine line between the legalization of
the property in real terms and the legalization of the property as a punitive measure
against some of the occupants of the building.” In addition, Atlas stated that Vaccarella
told him it was her intention to get rid of the occupants of unit 5NF. Furthermore,
Vaccarella said that Nalla Wollen (another applicant) wanted to move to unit 5S and “that
was her interest in the hardship regulation and how it might apply to her eventual
purchase of the property.”

        Atlas elaborated on the discussions with Vaccarella and Hruby about how the
hardship rules related to the purchase and occupancy of the building as follows: He
stated that they discussed keeping the building residentially occupied, selling it as a


                                            43
vacant commercial building, and converting substantial portions of it to commercial use.
According to Atlas, the provisions of the hardship rules, which were about to be voted on
by the Loft Board, were discussed in relation to these options in great detail. Atlas stated
that he was very aware at that time of the basics of the proposed rules; he stated that
“certainly the major concepts were in place, the major concepts, for the most part, being
mandated by Article 7-C.” Atlas further stated that a major topic of discussion was the
requirement that an owner who successfully brought a hardship application had to record
a covenant that, for 15 years from the date of recording, the building could not be
reconverted to residential use. Atlas stated that Vaccarella and Hruby discussed the
possibility of “vacating the building temporarily and reoccupying as residential tenants on
the sly.” Atlas testified that Vaccarella asked him how the covenant would be enforced.
He told her that the Department of Buildings did not have the staff “to enforce much of
anything on a regular basis” and that she “possibly could get away with it.”

       Atlas testified that did not know what approach Vaccarella and Hruby ultimately
decided to take, although he did see plans for placing a shopping mall in the building,
because Vaccarella resigned from the LMLT steering committee; he had only limited
contact with her after that time.

        In their memorandum, the owners argued that Atlas’s testimony was
“preposterous” because: (1) at the time Vaccarella resigned from LMLT, in February
1983, the owners were under contract to buy the building, and not merely in negotiations;
(2) Hruby’s time sheets for his architectural services to the owners show that he did not
start making “schematic” drawings until June 1983, well after Atlas claimed to have seen
some; (3) the Loft Board staff did not submit its initial memorandum on possible
hardship rules to the Board until May 10, 1983, again well after Atlas claimed to have
discussed them. According to the owners, these facts proved that Atlas was lying about
the conversations with Vaccarella and Hruby, possibly because of loyalty to Mishaan,
loyalty to the loft tenant community, or animus against Vaccarella and Hruby for
becoming property owners. The owners concluded therefore that, having been proven to
be untruthful, none of Atlas’s testimony — including that relating to legalization costs —
could be believed.

        In their reply memorandum, the tenants argued that, as with the owners’ claim
about Riesner, Atlas should not be discredited simply because of his ties to the tenant
community. After arguing that it would be arbitrary to devalue expert testimony that was,
on its own terms, credible and supported by independent indicia of reliability, the tenants
argued that each of the owners’ alleged sources of bias was equally applicable to their
own witnesses. For example, the tenants noted that while Atlas represented mainly
tenants, Caine represented only owners and developers. In addition, according to the
tenants, both Atlas and Caine had testified before the Loft Board on many occasions on
behalf of their respective constituencies, and both had been retained as consultants by the
Board itself. The tenants argued that the Board could nonetheless evaluate their
testimony.




                                            44
       Furthermore, the tenants argued that the timing of the promulgation of the Board’s
hardship rules did not undercut Atlas’s testimony about his conversations with Vaccarella
and Hruby. According to the tenants, Vaccarella did not resign from LMLT until the
spring of 1983. While the hardship rules may not have been officially promulgated until
the summer of 1983, the tenants argued that “[i]t is a fact that in the first half of 1983 the
inchoate Loft Board regulations were sufficiently developed for people to discuss them
and speculate upon their application.”

        I reject the owners’ arguments that Atlas was biased and that his testimony should
therefore be discounted. I do not find Atlas to be biased simply because he lived in an
interim multiple dwelling, or had been a member of LMLT’s steering committee and the
head of its housing clinic, because, for reasons similar to those I stated in relation to
Riesner’s alleged bias, the Loft Board and litigants should not be deprived of expert
testimony regarding an extremely specialized field that is inherently divided simply
because an expert witness may have a connection to either the loft tenant or owner
community. As the Legislature saw fit to include both tenant (and owner) representatives
on the Loft Board, see MDL §282, I do not believe that expert witnesses in Loft Board
cases should be in effect disqualified merely because they have “partisan” connections to
one or another community no different from those of particular Board members.

         The question remains, of course, whether Atlas had a specific bias in this case that
should result in his testimony being discounted. I do not believe that the owners have
proven such a bias. First, the fact that Atlas may have counseled Mishaan at LMLT’s
housing clinic does not prove bias because it adds nothing to what was already obvious,
i.e., that Atlas testified in a way that benefited Mishaan, just as Caine testified in a way
that benefited the owners. The fact of the counseling does not show specific bias. More
substantially, the owners argued that Atlas’s specific bias was shown by the differences
between the reports he prepared before Caine’s testimony and those he prepared after.
The owners’ point was that the reports should not have been significantly different if
Atlas’s conclusions had been a “function of his independent evaluation as an expert in the
field.” However, Atlas testified that he believed his assignment, when he prepared his
initial reports, was simply to critique the legalization proposal presented by the owner; his
subsequent reports were clearly written to respond to Caine’s testimony. In light of the
fact that the owners have the burden of proof in this case, Atlas’s approach seems
reasonable. I do not think the fact that he chose to critique Caine’s report, rather than
come to an abstract conclusion about the cost of legalizing the building, indicates bias.

       Furthermore, I do not believe that the alleged defects in Atlas’s testimony about
his conversations with Vaccarella and Hruby prove that Atlas had a specific bias against
the applicants. The applicants note that they were under contract to buy the building, and
were not merely in negotiations, by the time the conversations allegedly ended (in
February 1983 according to the owners). Their point, evidently, is that they had already
made the decision to buy the building by the time they were allegedly discussing whether
the proposed hardship rules would make it worthwhile to buy. However, Atlas’s
testimony was that his conversations with Vaccarella and Hruby about the hardship rules


                                             45
began in late 1982. Thus, the exact timing of the relevant events is not clear on the
record. Furthermore, it appears to me that the owners could have decided to buy the
building and then continued to explore different options for its use. Therefore, I do not
believe that this timing argument proves Atlas was lying. Similarly, I do not believe that
Hruby’s timesheets, from when he was acting as architect for the owners, prove that Atlas
was lying. While, according to his timesheets, Hruby did not start preparing schematic
drawings until June 1983 (see Exhibit D to the owners’ September 6, 1985, submission),
he prepared other drawings as early as December 1982, consistent with Atlas’s testimony.
Hruby’s timesheets simply do not clearly impeach Atlas’s testimony. Finally, I do not
find that Atlas’s testimony was impeached by the fact that the Loft Board staff submitted
an apparently initial memorandum on possible hardship rules to the Board on May 10,
1983, after the time when Atlas claimed to have discussed them with Hruby and
Vaccarella. Atlas testified that he was aware of the major concepts of the proposed
hardship rules because those concepts were mandated by MDL Article 7-C. The 15-year
covenant against conversion to residential use following a successful hardship
application, described by Atlas as one of the major topics he discussed with Vaccarella
and Hruby, is in fact contained in MDL §285(2). Thus, Atlas could have had the
discussions to which he testified.

        In sum, I do not believe the owners have proven that Atlas was specifically biased
in this case. Thus, I believe it is appropriate to evaluate his testimony (and Caine’s
testimony) on the merits.

        Overview of legalization cost testimony — Caine’s opinion, on behalf of the
owners, was that the total allowable cost of legalization equaled $238,455.37. His report,
detailing how he arrived at this amount, contained over 200 items of work to be done.
The position of the tenants, as reflected in cross-examination of Caine and in Atlas’s
report and testimony, was that many of these items were not of the type, for one reason or
another, for which the owners could receive a code compliance rent adjustment under
MDL Article 7-C; under Atlas’s report, the total allowable cost of legalization equaled
$57,816.09. The tenants’ objections fell into several broad categories, which covered
many of the contested items. Therefore, their objections will be analyzed in terms of
these categories. Based on the following analysis, I find that the total allowable code
compliance costs equal $66,931.33.

        Second means of egress — One of Caine’s legalization proposals involved
providing sprinklers throughout the entire building; at the time of the hearing, the
building had sprinklers only in the cellar. While full sprinklering of the building is
apparently required for MDL Article 7-B compliance because the building is
non-fireproof, under six stories tall, and has a maximum floor area of between 3,000 and
5,000 square feet, see MDL §277(2)(b), the dispute at the hearing was whether full
sprinklering was necessary to comply with the egress requirements of Article 7-B. Under
MDL §277(9)(a), a non-fireproof building must have either (i) one independently
enclosed stairway and a fire escape from each dwelling unit; or (ii) where the building is
fully wet sprinklered, not over 75 feet tall, and not over 5000 square feet in area, one


                                           46
independently enclosed stairway from each dwelling and an independently enclosed,
one-hour fire rated hallway where there are two or more tenants on a floor; or (iii) a
sprinklered enclosed hallway with access to two independently enclosed stairs. At the
time of the hearing, the building had one stairway and a fire escape at the back of the
building. Caine’s proposal, however, was to follow the second option — full wet
sprinklering and one stairway — rather than use the existing fire escape with the stairway,
because, according to Caine, the fire escape did not provide a legitimate second means of
egress. Caine noted that the fire escape did not lead to an area that led directly to a public
street; it was therefore illegal. Caine explained that he did not think the fire escape could
easily be legalized because it led to the roof of the “first floor setback,” and that extensive
construction and Department of Buildings approval would be required to get it to lead to
the street.

        Atlas agreed that, as constructed, the fire escape did not provide a legal second
means of egress, because it ended at the second floor at the rear of the building. He
believed, however, that it could be legalized for less cost than was involved in
sprinklering the entire building. Atlas’s proposal was to upgrade an existing corridor on
the second floor so that it could serve as a fire corridor leading from the fire escape to the
front of the building, where a platform and drop ladder to the street could be installed. As
part of Atlas’s proposal, a fire corridor would have to also be constructed on the fifth
floor, to connect unit 5NF to the fire escape. It was Atlas’s opinion that, as his proposal
was less expensive than Caine’s proposal for full sprinklering, Caine’s proposal was not
“necessary” for legalization and therefore its costs should be disallowed (and the costs
associated with his plan considered instead).27

        Atlas’s position regarding Caine’s sprinklering proposal must be rejected, because
it became clear at the hearing that Atlas’s proposal was problematic. Atlas testified that
using the corridor on the second floor as part of the second means of egress might result
in an objection by the Department of Buildings, because the corridor would cross the
primary means of egress, i.e., the stairwell, a situation that Atlas described as
“imperfect.”28 He testified, however, that he had been involved in a number of situations

27
      Atlas was also of the opinion that the costs associated with Caine’s sprinklering
proposal should be disallowed because a second means of egress had been required for
the subject building by Labor Law §274, which, according to Atlas, applied to the
existing certificate of occupancy. However, Atlas admitted on cross-examination that it
was reasonable to assume that the second means of egress must have been sufficient
under the then-existing Building Code and Labor Law in 1930, when the existing
certificate of occupancy was issued. Therefore, the current Article 7-B provisions must
represent new requirements that must be complied with in order to obtain a residential
certificate of occupancy. As such, the costs of providing a “second means of egress” —
whether by sprinklering or by Atlas’s plan — may be passed on to the tenants. The
question is simply which plan, and the concomitant costs, should be accepted.
28
    Atlas had also testified that, instead of using the second floor corridor, the fire escape
could be legalized by extending it to the ground floor and building a fire corridor there


                                              47
where initial objections to imperfect second means of egress were withdrawn, because of
the “excellent” nature of the primary means of egress. On cross-examination, Atlas stated
that there had been one prior occasion in which he had received approval for a second
means of egress crossing the primary means of egress.

        Even accepting as true Atlas’s testimony that he had once obtained approval for a
technically defective second means of egress, I do not believe that his proposal proves
that Caine’s sprinklering proposal was not reasonable and necessary for obtaining a
residential certificate of occupancy. MDL §286(5). Atlas’s main point was not that
Caine’s proposal was unnecessary or otherwise inappropriate, but only that Atlas’s own
alternate proposal was less expensive. However, even he conceded that his proposal
might result in an objection by DOB because it was “imperfect.” In light of this
concession, I find that the tenants did not rebut Caine’s testimony. The mere articulation
by Atlas of a less expensive means of legalization that might be approved by DOB is not
sufficient rebuttal. Therefore, I accept the costs associated with sprinklering the building
as ones that may be passed on to the tenants; these costs total $34,235.20.29 In addition,
$320.00 in costs associated with the fifth floor common hall, which Atlas objected to only
on the grounds that they were superseded by his own proposal, should be included as
acceptable legalization costs.30

        Work necessary regardless of residential conversion — Under MDL §286(5),
an owner may receive rent adjustments based on the “costs necessarily and reasonably
incurred” in complying with the legalization requirements of the Loft Law. Thus, under
29 RCNY §2-01(i)(2), an owner “may apply for rent adjustments based on the necessary
and reasonable costs of obtaining a residential certificate of occupancy.” The Loft
Board’s rules, in 29 RCNY §2-01(j), go on to define certain work that will not be
considered “necessary and reasonable code compliance cost items” despite their inclusion
in the Board’s schedule of costs. One of these exceptions involves “preexisting
violations.” According to the applicable version of section 2-01(j), rent adjustments are
not to be given for “the costs of curing preexisting violations that would have to be cured
even if the building did not have to be made code compliant pursuant to Article 7-C.”31


from the rear to the front of the building. However, Atlas clearly chose creation of the
second floor fire corridor as his preferred method of legalizing the fire escape (see
Respondents’ Exhibit 12) and tenants’ counsel described the second floor corridor as
Atlas’s choice (post-hearing memorandum, page 39).
29
    Using the numbering system contained in Caine’s report, the items I find acceptable in
relation to the sprinklering are numbers 1.02 (sprinklering of public stairs and lobby),
1.18 (new water main and risers), 2.1.2 and 2.2.1.1 (commercial area sprinklering), and
3.1.9.2, 3.2.9.2, 3.3.8.2, 3.4.9.2, 3.5.9.1, 3.6.5.2, and 3.7.6.1 (sprinklering of residential
units).
30
   These are items 3.6.1.1 and 3.7.1.1 in Caine’s proposal.
31
    Effective September 19, 1994, this language was amended to disallow the cost of
curing only those preexisting violations that that were evidenced by municipal notices of
violation. That amendment, however, does not apply retroactively to the instant


                                             48
        Consistent with these rules, the tenants challenged the passing along to them of
the cost of a large number of the items in Caine’s report. Their challenge was on one of
three related grounds: (a) that the work was necessary under the Building Code
regardless of the use of the building (i.e., commercial or residential) and therefore was
needed to be done regardless of residential conversion; (b) that the work was needed to
cure preexisting violations; or (c) that the work was necessary under the existing
certificate of occupancy and therefore was not necessitated by the Article 7-C conversion.

        In their post-hearing memorandum, the owners made several arguments against
the tenants’ challenge. First, they argued that the tenants’ approach was premised on
speculation about what the Department of Buildings “deemed acceptable” in 1930, how
DOB would have interpreted the Building Code at that time, and how the building had
changed since that time. Furthermore, the owners argued that the tenants’ position
willfully disregarded reality: “if the work has to be done as a consequence of the
legalization of the conversion to residential use, its cost must be recognized as a ‘cost of
obtaining a legal residential certificate of occupancy,’ whether or not a building inspector
in 1930 should not have approved the condition . . . at that time.”

        The owners argued that the appropriate approach was one in which any costs
necessarily incurred to obtain a residential certificate of occupancy would be counted as
compliance costs for the purposes of a hardship analysis. The owners based their
argument on a 1979 Department of Buildings memorandum and section 27-221 of the
Administrative Code, both of which imply that a residential certificate of occupancy
would not be issued by DOB unless all conditions that existed in violation of any
applicable law were repaired. The owners also relied on the language of MDL §286(5),
which authorizes two rent adjustments, one for the cost of Article 7-B work and another
for additional costs associated with obtaining a residential certificate of occupancy.

        I believe that a proper interpretation of the Loft Law and the Loft Board’s rules
requires the tenants’ position on this topic to be accepted. Specifically, assuming that a
particular item of work was required regardless of residential conversion or was required
to cure a preexisting violation, the cost of doing that work cannot be accepted as an
allowable cost of legalization that may be passed on to the tenants. The key issue is
whether the costs of work not specifically related to residential conversion under Article
7-C may be “counted” for the purposes of a hardship application if that work must be
done before DOB will issue a new certificate of occupancy. The owners argue that the
“costs of obtaining a residential certificate of occupancy,” 29 RCNY §2-01(i)(2), must
include the costs of addressing any violations of any applicable law, because DOB will
not issue a residential certificate of occupancy unless those violations are corrected. The


application, which was filed and tried many years before the amendment became
effective. Cf. Application of Kasner, Loft Board Order No. 2017, at page 2, footnote 1
(amendment to section 2-01(k) not applicable to that case because effective after filing of
application).


                                            49
tenants do not seriously dispute the owners’ description of DOB’s policy; in the
discussion in their reply memorandum relating to deferred maintenance (see below), the
tenants concede that DOB’s 1979 memorandum states that a new certificate of occupancy
will not be issued where a violation had been issued and was outstanding.

        However, the owners’ position must be rejected because it conflates the
requirements of Article 7-C with DOB’s policy of using an owner’s request for a new
certificate of occupancy as an opportunity to have the owner correct outstanding
violations. While Article 7-C requires the owner of an IMD to seek a residential
certificate of occupancy, the fact that the owner may have to cure preexisting violations
unrelated to residential use in order to get the new certificate of occupancy does not mean
that the cost of curing those violations arises out of Article 7-C. Rather, the root cause of
the need to bear that cost is the owner’s failure to cure violations having nothing to do
with the Loft Law. Thus, there is no valid argument for counting the cost of curing such
violations for the purpose of determining allowable code compliance costs. To hold
otherwise seems to me to be clearly wrong, because it would result in the tenants of a
building bearing the cost, in the form of a rent adjustment, of curing preexisting
violations (or doing deferred maintenance). Such a result is explicitly barred by 29
RCNY §2-01(j) and, as that section may be fairly read as interpreting MDL §286(5), it is
barred by the Loft Law as well.

       The fact that this argument has arisen in the context of a hardship application does
not change the result. While it may very well be true that the owners herein will have to
bear costs in order to obtain a residential certificate of occupancy that are not allowable
code compliance costs, and are therefore neither reimbursable nor includible for the
purposes of determining the size of the acceptable legalization loan, the question, under
MDL §285(2), is whether “the cost of compliance [with Article 7-C] renders legal
residential conversion infeasible.” Based on the analysis above, the cost of curing
preexisting violations or other items unrelated to residential conversion may simply not
be considered part of the cost of complying with Article 7-C.

        The owners’ other arguments relating to this issue are also unavailing. Under
MDL §286(5), an owner may obtain a code compliance rent adjustment once upon
complying with MDL Article 7-B and once upon obtaining a residential certificate of
occupancy. The owners argue that, therefore, allowable code compliance costs must
include something other than the costs of work required by Article 7-B. The implication
of this argument is that all other costs needed to obtain a residential certificate of
occupancy, above those incurred in achieving Article 7-B compliance, may also be passed
to the tenants. However, this implication is wrong. While the owners are correct that
code compliance costs may be passed to the tenants for work not required by Article 7-B,
that work must be “necessary and reasonable” to comply with the legalization
requirements of the Loft Law; it may not be work that was needed anyway, such as
deferred maintenance or the correction of preexisting violations. To give one example of
work that is not required by Article 7-B (and is not deferred maintenance or the correction
of a preexisting violation) but is required to get a residential certificate of occupancy:


                                             50
Section 27-2048 of the Housing Maintenance Code requires owners of multiple dwelling
more than two stories in height to maintain signs, in the public halls and the stairways,
that state “the number of the floor.” Caine provided for such floor signs in his report
(item 1.24) and Atlas did not dispute that the cost of these signs could be passed along to
the tenants. I believe this was the type of work contemplated by the distinction in MDL
§286(5) between Article 7-B compliance and obtaining the residential certificate of
occupancy; I do not believe the Legislature intended by this distinction to erase the
requirement that costs passed on to the tenants be those that were “necessarily and
reasonably incurred” in complying with the Loft Law.

        Finally, I do not accept the owners’ argument that examining whether certain
work was arguably required under the existing certificate of occupancy because it was
required by the Building Code in 1930 necessarily involves improper speculation about
what the Department of Buildings “deemed acceptable” in 1930, how DOB would have
interpreted the Building Code at that time, and how the building had changed since that
time. While the tenants’ position as to any particular item of work may involve
speculation, and may thus mean that the tenants did not adequately rebut Caine’s
testimony as to the need for that work, the vast majority of this analysis does not require
speculation. As will be discussed below, Caine in fact agreed with Atlas that a number of
the items listed in his report were required under the existing certificate of occupancy.

       In sum, I agree with the tenants that certain costs included in Caine’s report may
not be accepted as allowable costs of legalization if they were required regardless of
residential conversion or use. The question remains, however, whether the items
challenged by the tenants were in fact so required.

         On cross-examination, Caine admitted that many of the work items listed in his
report and challenged by Atlas as not related to residential conversion were in fact legally
required by applicable codes regardless of whether the use of the building or unit was
residential or commercial. He made this admission as to specific work items throughout
the building. As to the common areas, Caine admitted that the following work was
required regardless of use: installing new windows on the second through fifth floors on
the front facade of the building; repairing certain of the building’s masonry walls;
installing an engineer’s hatch in the cellar; and installing a new boiler room door.32
While there was testimony by both Atlas and Caine as to whether the poor condition of
the front facade windows was the result of prior neglect, Caine also testified that the
existing windows, even in new condition, would have failed to meet Building Code
requirements, and that those requirements governed regardless of whether occupancy was
commercial or residential. Based on this testimony, it is unnecessary to decide whether
repair of the windows would constitute deferred maintenance; the cost of providing the


32
   Using the numbering system contained in Caine’s report, these items are 1.06 (front
facade windows), 1.08, 1.09, 1.10 (building masonry walls), 1.11 (engineer’s hatch), and
1.15 (boiler room door).


                                            51
new windows must be disallowed because Caine admitted that the need for adequate
windows was unrelated to residential use.33

        As to the second floor commercial units, Caine admitted that the following work
was required regardless of use: installing fire-rated doors for each of the units; raising the
public hall ceiling; filling lot line windows with concrete blocks; taping and painting
walls throughout the second floor; providing mechanical ventilation in certain units;
repairing certain wiring problems; doing certain work on toilet floors and walls; repairing
the walls in unit 203; and installing a new window in unit 204.34 As Caine admitted that
the provisions of the Administrative Code relevant to the lot line windows applied to both
commercial as well as residential buildings, it is unnecessary to address the issue, raised
by Atlas, of whether the Building Code in effect at the time the existing certificate of
occupancy was issued also required work to be done to the lot line windows, thus making
the state of the windows a preexisting violation.

        As to the residential units, Caine admitted that the following work was required
regardless of use: filling lot line windows with concrete blocks; repairing certain wiring
problems; replacing plastic plumbing piping; and finishing the edges of the walls and
ceilings in unit 5NF.35

        The total cost of the items listed in Caine’s report that Caine admitted were
required regardless of residential use is $53,975.00. This amount may not be included in
the total allowable legalization costs.

33
    In his report, Caine noted, under his provision for the installation of new windows on
the front facade of the building, that the building was located in a “newly proposed
‘Ladies Mile’ Historic District.” He then testified that if the historic district legislation
were enacted, the specifications for the new windows would change and the cost of
installing them would increase. Tenants’ counsel objected to Caine’s testimony about the
proposed historic district and the hearing officer reserved decision. By letter dated July 3,
1986, the hearing officer ruled that he would “hear testimony (if the parties wish to
provide it) concerning the present effect of the proposal having been made, but not as to
its future effect if approved. To the extent that such speculation has been included in the
record to date, it is deemed stricken.” As the cost of installing the new windows may not
be included in the total allowable legalization costs, I do not need to consider the possible
effect of the historic district on the cost of installing the windows.
34
    In Caine’s report, these are items 2.2.1.3 (unit doors), 2.2.1.4 (raising ceiling), 2.2.1.7,
2.2.1.8 (lot line windows), 2.2.1.9 (taping and painting), 2.2.3.1, 2.2.3.2, 2.2.6.3
(mechanical ventilation), 2.2.3.3, 2.2.3.5, 2.2.6.1 (wiring), 2.2.3.4, 2.2.3.6, 2.2.6.2 (toilet
floors and walls), 2.2.4.1 (unit 203 walls), and 2.2.5.1 (unit 204 window).
35
    In Caine’s report, these are items 3.1.9.3, 3.2.9.3, 3.3.8.4, 3.4.9.4, 3.5.9.3, 3.7.6.3 (lot
line windows), 3.2.5.2, 3.2.6.3, 3.3.2.3, 3.3.3.3, 3.3.3.4, 3.3.4.1, 3.3.5.3, 3.3.6.2, 3.4.2.4,
3.4.2.5, 3.4.3.4, 3.4.3.9, 3.4.4.1, 3.4.5.1, 3.4.6.2, 3.4.7.3, 3.4.8.4, 3.6.2.4, 3.6.3.3, 3.6.4.2
(wiring), 3.2.2.2, 3.2.3.1, 3.4.2.2, 3.4.3.1, 3.4.3.7, 3.7.2.2, 3.7.3.1 (plastic plumbing
piping), and 3.6.5.8 (finish edges in unit 5NF).


                                               52
         In addition, there were certain items that the tenants challenged as unrelated to
residential conversion or use that Caine did not admit was required regardless of use but
whose costs were, based on his testimony, clearly not allowable as legalization costs. In
his report, Caine proposed that a two-hour fire rated wall be placed around existing shafts
running to the bathrooms for the residential units. At the hearing, Atlas testified that this
work had already been required under the Building Code in effect in 1930, when the
existing certificate of occupancy was issued. On cross-examination, Caine testified that
he proposed this work because, although the shaftwalls had originally been two-hour fire
rated, they had become broken at various points so that plumbing connections could be
made and the breaks were never repaired. Based on this testimony, it is clear that, at best,
the work proposed by Caine is deferred maintenance, whose cost is not be allowed under
29 RCNY §2-01(j)(clause (z)). Thus, the total cost of the residential unit shaftwalls listed
in Caine’s report, $3,366.00, may not be included in the total allowable legalization
costs.36

        Atlas also stated that Caine’s proposal to legalize the existing public toilet on the
second floor and provide a second public toilet was unrelated to residential use. Caine
admitted that there were no Multiple Dwelling Law provisions requiring this work and
that the Administrative Code provision he cited related to commercial space. Therefore,
Caine in effect conceded that the work was not related to residential occupancy; the costs
associated with this work, $3,010.00, may not be included in the total allowable
legalization costs.37 Similarly, Atlas stated in his report that the ventilation requirement
for the boiler room was not related to residential use; on cross-examination, Caine
admitted that Article 7-B did not incorporate MDL §65, cited by Caine in his report as
support for the requirement. Thus, the cost, $1,000.00, of doing this work may not be
included in the total allowable legalization costs.38 In addition, in response to Caine’s
proposal that a gas meter room be built in the cellar, Atlas stated that neither the old
Building Code nor the Multiple Dwelling Law required the placement of the gas meters
there. Caine argued that Con Edison did not allow residential gas meters to be located in
residential units. However, he admitted that Article 7-B did not incorporate MDL §64,
which he had relied upon, and that the work was required, in any event, under the existing
certificate of occupancy. Therefore, the cost of building the gas meter room, $1,530.00,
may not be included in the total allowable legalization costs.39


36
    In Caine’s report, these are items 3.1.9.6, 3.2.9.7, 3.3.8.7, 3.4.9.6, 3.5.9.6, 3.6.5.7, and
3.7.6.6.
37
   In Caine’s report, these are items 2.2.1.5 and 2.2.1.6.
38
   This is item 1.14 in Caine’s report.
39
     This is item 1.16 in Caine’s report. I note that 29 RCNY §2-01(j) states that the
necessary and reasonable cost of constructing a meter room may be acceptable as a
legalization cost. However, in light of Caine’s admission that the work was required
under the existing certificate of occupancy, it appears that the need for the meter room in
this case did not arise from residential use.


                                              53
        Furthermore, the costs associated with Caine’s proposal to seal the elevator shaft
and remove the elevator equipment may not be included. While much of the testimony
on this item concerned whether the costs listed by Caine were excessive, Atlas also
argued, in his report and his testimony, that the problem with the elevator — that its doors
opened onto the fire stairwell, thus compromising the fire safety of the stairs — was a
violation regardless of residential use. Atlas cited section C26-604.8 (now 27-375) of the
Building Code in support of his argument. Although he did not cite a specific portion of
that section, subdivision (j) does state, without regard to the type of building, that “[n]o
openings of any kind, other than windows, fire department access panels, exit doors and
openings specifically authorized in reference standard RS 5-18 [concerning pressurization
of stairways] shall be permitted within a stair enclosure.” Caine’s testimony appears to
support Atlas’s argument; although he cited MDL Article 7-B as one source of the
requirement that the fire integrity of fire stairs not be breached, he also referred to the
Administrative Code. Thus, it appears that Atlas was correct that the elevator door
openings onto the fire stairwell were violations regardless of residential use. For this
reason, the costs associated with sealing the elevator shaft and removing the elevator
equipment listed in Caine’s report, equaling $27,800.00 may not be included in the total
allowable legalization costs.40 However, in light of Atlas’s position, conceded by Caine,
that the elevator shaft could be used as a mechanical ventilation shaft (see below), a total
of $1,041.25 should be included as the cost of making the elevator shaft useable for
mechanical ventilation.

        Caine included a number of mechanical ventilation proposals in his report for
which the costs may not be included. First, Caine provided for mechanical ventilation in
the unit 4N darkroom. While Caine is correct that the darkroom had to be ventilated, he
admitted on cross-examination that the ventilation was required whether use of the unit
was residential or commercial; this admission was supported by the language of section
C26-1206.1 of the old Building Code, which Caine cited as the basis for his proposal.
Thus, the $400.00 cost of this ventilation may not be included in the total allowable
legalization costs.41 Similarly, the $450.00 cost of the mechanical ventilation for the
office in unit 5NR may not be included.42 Atlas correctly noted that ventilation was
already required under the Building Code in effect in 1930 (section 131). In addition,
Caine provided for mechanical ventilation of the toilets in units 5NF and 5NR. However,
Atlas noted that these toilets had skylights and therefore already met the requirements for
ventilation. See MDL §277(7)(f) (toilets may be ventilated by natural means) and old
Building Code §C26-1205.5 (natural ventilation source may include skylight).
Furthermore, Caine admitted that the ventilation requirement was unrelated to residential
use. Therefore, the $100.00 cost of mechanically ventilating the unit 5NF and 5NR
toilets may not be included in the total allowable legalization costs.43


40
     This is item 1.26 in Caine’s report.
41
     This is item 3.4.5.4 in Caine’s report.
42
     This is item 3.7.5.1 in Caine’s report.
43
     These are items 3.6.3.2 and 3.7.3.3 in Caine’s report.


                                              54
        The costs of a number of items challenged by the tenants as unrelated to
residential conversion or use should be included as allowable legalization costs. In his
report, Caine included a number of items relating to the residential toilets that mostly
involved ventilation and the provision of a waterproof floor. Atlas testified that these
items would have been required to obtain a residential certificate of occupancy but that,
as the toilets — based on their nature and location — were original, the work was
required under the existing certificate of occupancy because of the provisions of the
Building Code and Labor Law in effect in 1930. Atlas further testified that the work
would not have been required had the building been maintained in accordance with those
laws. While Caine did not testify about when the toilets were built, the owners’ counsel,
in her post-hearing memorandum, stated that they had been built within the decade prior
to the writing of the memorandum. While counsel’s statement is not evidence, Atlas did
not provide a sufficient basis for his conclusion that the toilets existed in 1930. As both
experts agreed that the work was related to residential use, and as there was insufficient
evidence that the toilets had existed in 1930 — and were therefore subject to the legal
requirements in effect at that time — the cost of this work, $1,226.00, is properly allowed
as legalization costs.44

        Furthermore, the cost of installing kitchen sink traps of the proper size should be
allowed. While Atlas stated that two-inch sink traps, as proposed by Caine, were required
by the rules in effect in 1930, he conceded that the 1930 Plumbing Code required only a 1
1/2 inch trap for “general” sinks and that, therefore, the traps in the kitchen sinks could
have been legally sufficient when they were installed. Therefore, the tenants have not
proven that the cost of installing the two-inch traps — $600.00 — was not related to
residential use; it should thus be allowed.45

        Caine provided, throughout his report, for the “taping and painting” of various
existing walls. Atlas stated that the work was not required for existing walls that had at
one time been taped and painted, regardless of their current state, and appeared to argue
that the work was at least to some extent not related to residential use. Caine cited the
February 1, 1979, Department of Buildings memorandum, previously referred to, as the
basis for the requirement. That memorandum related to the issuance of temporary
certificates of occupancy for joint living-work quarters for artists or general residential
occupancy of loft buildings. As such, its requirements were clearly related to residential
use. However, examination of the memorandum does not reveal whether its requirements
for painting and finishing walls applied only to new walls or to all walls. As Caine and
Atlas disagreed on the applicability of the memorandum to the work proposed by Caine,
and as the memorandum is not self-explanatory, the tenants have not successfully




44
    In Caine’s report, these are items 3.1.3.1, 3.1.3.3, 3.2.3.2, 3.2.3.3, 3.3.3.1, 3.3.3.2,
3.4.3.2, 3.6.3.1, and 3.7.3.2.
45
   In Caine’s report, these are items 3.3.2.2, 3.4.2.3, 3.6.2.3, and 3.7.2.3.


                                            55
rebutted Caine’s position on this matter. Therefore, the costs associated with taping and
painting — $3,438.00 — are properly allowed as legalization costs.46

        In addition, the cost of installing certain windows should be allowed. Caine
provided for the installation of a window in the rear living area of unit 3S. Apparently,
the existing window had been replaced with glass blocks. Caine testified that this
situation did not allow the ventilation required by the Multiple Dwelling Law, and Atlas
agreed that natural ventilation was currently required. However, Atlas also testified that
natural ventilation had been required under the existing certificate of occupancy,
meaning, therefore, that substitution of the glass blocks for the window had created a
violation. It is not factually clear on the record, however, whether natural ventilation was
required by the Building Code in effect in 1930. While a window would apparently have
been required for a “residence building” under section 130, the existing certificate of
occupancy was commercial. Under section 131, relating to “business buildings,” the
room could have been ventilated by a window or by transom or other means; if a transom
was used, it had to open “into rooms ventilated directly to the outer air.” As I cannot tell,
on the record before me, whether the room in question could have been ventilated by
means other than a window, I cannot tell whether installation of the glass bricks created a
violation under the existing certificate of occupancy. Therefore, I must reject Atlas’s
position and accept Caine’s position that installation of the window was required for
residential conversion. The cost of installing this window — $1,100.00 — must therefore
be allowed.47 Similarly, the cost of installing two windows in the unit 3N bedroom —
$500.00 — must be allowed.48 While glass blocks were apparently not involved in that
unit, Atlas’s analysis was the same, and it must be rejected for the same reason; it is not
factually clear, on the record, whether natural ventilation was required under the Building
Code in effect in 1930.

        Deferred maintenance — Under 29 RCNY §2-01(j), the costs of doing “deferred
maintenance” may not be allowed as legalization costs. Deferred maintenance is defined
as the repair or replacement of items with similar or comparable items because of their
deteriorated condition. Deferred maintenance costs are not allowable as legalization costs
for work done in the common or commercial areas of the building or to the building’s
exterior (section 2-01(j) (clause 1)) or for the repair or replacement of utility risers, other
building system components, or structural components (clause z), even if that work is
done in residential units.

       The costs of several of the items included in Caine’s report may not be included in
the total allowable legalization costs, because the work at issue involves deferred


46
    In Caine’s report, these are items 3.1.3.4, 3.3.2.6, 3.3.3.6, 3.3.4.2, 3.3.4.3, 3.3.5.6,
3.3.6.3, 3.3.7.2, 3.4.2.7, 3.4.3.6, 3.4.3.11, 3.4.4.2, 3.4.5.5, 3.4.6.3, 3.4.7.4, 3.4.8.5, 3.6.2.7,
3.6.3.5, and 3.6.4.3.
47
   This is item 3.1.5.1 in Caine’s report.
48
   This is item 3.2.4.1 in Caine’s report.


                                                56
maintenance.49 First, Caine proposed that a new cellar ceiling be installed, and that
related work (such as installation of new sprinklers) be done, in order to provide the
required one-hour fire rating. However, Caine admitted on cross-examination that the
problem with the existing ceiling was not the material with which it was constructed, but
rather that it had holes in it. Caine blamed the holes on “a series of overlays of
construction, where things were not properly repaired.” He also admitted that patching the
holes would remove the need or installing new sheetrock and sprinklers. Based on this
testimony, it is clear that the costs associated with repair of the cellar ceiling —
$11,250.00 — may not be included in the total allowable legalization costs, because they
involve deferred maintenance.50 In light of this conclusion, it is unnecessary to address
whether it would be less expensive to take Caine’s approach or to patch the holes; in
either event, the costs may not be passed to the tenants. Similarly, the $1,000.00 cost
listed in Caine’s report to install a new boiler room ceiling may not be included in the
total allowable legalization costs.51 While there was much debate at trial as to whether
the Building Code in effect in 1930 required a fire-rated cellar or boiler room ceiling, the
owners did not rebut Atlas’s testimony that the problem with the ceilings was the
existence of holes. Therefore, the work proposed involved deferred maintenance.

        For six of the seven residential units, Caine proposed installing new fire-rated
front doors to the units. According to Caine’s testimony, some of the doors had holes and
therefore did not provide sufficient fire protection even when they were closed, and some
were not self-closing — either because of defective hinges or misalignment — and thus
were inadequate for that reason. This testimony clearly shows that addressing the
condition of the doors would constitute deferred maintenance. Therefore, the cost of
replacing four of the six doors — $1,600.00 — may not be included in the total allowable
legalization costs.52 However, for units 5NF and 5NR, Atlas conceded at the hearing that
new doors were necessary, in connection with construction of a new common hall
between the units. Therefore, the $800.00 cost associated with those doors may be
allowed.53 Furthermore, even for the other four doors, Atlas conceded that $222.00 worth
of new security equipment, such as peepholes, was required for residential conversion.

        In his report, Caine provided for the installation in the building of an intercom and
buzzer system for access to the building through the front lobby doors. Caine testified
that he did not know whether the existing bell and buzzer system could be made operable.

49
    In their memorandum, the owners objected to the deferred maintenance analysis on
the ground that it did not credit the owners for the cost of doing the work involved either
as legalization costs or as operating costs for repairs and maintenance. However, as
discussed above, I have rejected the tenants’ argument on this point and have included in
the projected year repair and maintenance costs the cost of doing the deferred
maintenance.
50
   These are items 1.03, 1.04, and 1.05 in Caine’s report.
51
   This is item 1.13 in Caine’s report.
52
   In Caine’s report, these are items 3.1.1.1, 3.3.1.1, 3.4.1.1, 3.5.1.1.
53
   These are items 3.6.1.2 and 3.7.1.2 in Caine’s report.


                                             57
To this extent, Caine’s proposal was at best deferred maintenance. However, a further
question regarding this proposal was whether the upgrade to an intercom and buzzer
system was required by MDL Article 7-B. Caine cited MDL §50-a(2) as a basis for his
proposal. However, he admitted on cross-examination that section 50-a was not
incorporated into Article 7-B by reference in MDL §278, the general Article 7-B
cross-reference section, while section 57, which refers in part to bells located at the
entrance to a building, was so incorporated. While MDL §277 also contains cross-
references to other MDL provisions, section 50-a is not incorporated through that section
either. Therefore, it appears that the upgrade to an intercom system was not mandated by
the residential conversion,54 and the costs of providing that system — $2,840.00 — may
not be included in the total allowable legalization costs.55

        In his report, Caine provided for the installation of four new radiators in unit 4S.
Atlas testified that the $1,400.00 cost listed by Caine was excessive and that, in any
event, provision of the radiators was deferred maintenance. However, provision of new
radiators, as opposed to the risers, for example, may not be considered deferred
maintenance under 29 RCNY §2-01(j). Furthermore, I do not accept Atlas’s testimony
that acceptable radiators could be obtained for $100.00 each, as opposed to the $350.00
listed by Caine. Atlas’s report and his testimony were inconsistent about whether the
$100.00 cost was for new or used radiators; in addition, the $350.00 cost is consistent
with the cost listed in 29 RCNY §2-01(p)(10). Therefore, the full $1,400.00 should be
accepted as an allowable legalization cost.56

         Miscellaneous legalization items — In Caine’s report, he proposed the
installation of gas hot water heaters in the residential units. The cost of this work
included not only the cost of the heaters themselves, but also the cost of building
fire-rated enclosures and installing ventilation risers in each unit. Atlas proposed instead
that electric hot water heaters be installed, because this approach would be less
expensive. On cross-examination, Caine admitted that use of electric heaters would
eliminate the need for the enclosures and the ventilation risers. In light of this testimony,

54
    The other legal basis cited in Caine’s report for the provision of an intercom, section
C26-1207.5 of the old Building Code, refers to ventilation of corridors, not to anything to
do with the installation of the intercom system. I also note that the Loft Board’s schedule
of costs, 29 RCNY §2-01(p)(7), lists an intercom system, at least for buildings with eight
or more residential units, and that, pursuant to section 2-01(j), the schedule is intended to
include necessary and reasonable code compliance items. However, while the reference
to eight or more units appears to contemplate the applicability of MDL §50-a, I cannot
conclude that compliance with section 50-a is required for Article 7-B compliance, in the
absence of any incorporation by reference in that Article. In any event, as the subject
building has only seven residential units, the provisions of section 50-a would not be
mandated.
55
    In Caine’s report, these are items 1.07, 3.1.9.4, 3.2.9.4, 3.3.8.5, 3.4.9.5, 3.5.9.4,
3.6.5.5, and 3.7.6.4.
56
   This is item 3.3.5.5 in Caine’s report.


                                             58
the cost of all of the work associated with the installation of the gas heaters must be
disallowed, and the cost of installing the electric heaters included instead, because, under
29 RCNY §2-01(j), a work item must be reasonable and necessary to achieve “minimal
code compliance,” which is defined in part as the least expensive method of compliance.
Therefore, the total cost of the gas hot water heater installation included in Caine’s report
— $17,003.00 — may not be included in the total allowable legalization costs,57 and the
cost of the electric hot water heater installation included in Atlas’s report — $4,200.00 —
must be included instead. In addition, as Caine admitted that the existing gas riser might
be sufficient for the remaining gas needs (consistent with Atlas’s report), the $4,200.00
cost of installing a new gas riser may not be included in the total allowable legalization
costs.58 However, in light of the increased demand for electricity that would result from
Atlas’s proposal, the $1,400.00 cost of the provisions in Caine’s report for ensuring
adequate electrical power to units 5S and 5NR should be included.59

       Also on the topic of less expensive alternatives, Caine proposed in his report that
two new mechanical ventilation risers be installed in the building. As discussed above,
Atlas argued that the elevator shaft could be used for the risers. He therefore was of the
opinion that there was no need to create two new shaftways. On cross-examination,
Caine admitted that the elevator shaft could be used for the mechanical ventilation risers.
Therefore, the cost of creating the two new shaftways — $6,986.00 — may not be
included in the total allowable legalization costs.60

        Similarly, Caine admitted that the mechanical ventilation he proposed in the
existing bedroom (which would be converted to an office), office, and storage area in unit
4S would not be necessary if the partition separating those rooms from the windows was
simply removed and replaced with a lower partition that allowed natural ventilation.
Thus, the $1,350.00 cost listed in Caine’s report for this work may not be included in the
total allowable legalization costs;61 however, the $36.00 listed in Atlas’s report for his
alternative plan should be included. In addition, for the same reasons, the $900.00 cost of
mechanically ventilating the existing bedroom and office in unit 4N may not be included,
although, pursuant to Atlas’s report, $45.00 should be included for removing the
problematic partition.62 On the other hand, Atlas’s testimony was not persuasive that the
existing, inoperable skylight in unit 5NR could be modified for less money than it would
cost to replace it with a new one. Caine explained that the existing skylight was
prefabricated and that it would be more expensive to do custom work on a prefabricated
skylight than it would be to replace it with a new prefabricated one. In light of this




57
     In Caine’s report, these are items 3.1.9.5, 3.2.9.6, 3.3.8.6, 3.4.9.7, 3.6.5.6, and 3.7.6.5.
58
     This is item 1.17 in Caine’s report.
59
     These are items 3.5.9.7 and 3.7.6.7 in Caine’s report.
60
      In Caine’s report, these are items 1.19, 1.20, 1.21, and 1.22.
61
     In Caine’s report, these are items 3.3.5.2, 3.3.6.1, and 3.3.7.1.
62
     These are items 3.4.7.2 and 3.4.8.2 in Caine’s report.


                                                59
testimony, the $750.00 cost of installing the skylight should be included in the total
allowable legalization costs.63

        Caine’s proposal called for the installation of fire-rated ceilings above the first
through fourth floors of the buildings, to separate each of the tenancies, whether
commercial or residential. While Atlas did not challenge the installation of a fire-rated
ceiling between the second floor commercial units and the third floor residential units,
apparently because of the Building Code requirement that different occupancy groups be
so separated, see Building Code §27-234, et seq., he did claim that there was no
requirement of fire-rated ceilings between the two commercial floors and between the
residential floors. Caine cited MDL §277(5) and section C26-273 of the old Building
Code in support of his proposal. However, neither of those sections requires the proposed
work. Section 277(5) of the Multiple Dwelling Law requires vertical fire separations
between tenancies, and thus could not be construed as requiring fire-rated ceilings.
Section C26-273 concerns exits. Therefore, installation of the challenged first, third, and
fourth floor ceilings is not necessary, and the cost associated with the work —$15,730.00
— may not be included in the total allowable legalization costs.64 However, as conceded
by Atlas, the $4,680.00 cost of the ceiling separating the second floor commercial units
from the third floor residential units may be included.65

        In a similar vein, Caine proposed the installation of insulation to provide
“acoustical separation” between various of the residential units. Caine cited only the
new, current Building Code in support of the proposal and admitted that the only legal
basis for the soundproofing requirement was the new Building Code. However, while an
owner may convert a building to residential use pursuant to the provisions of the new
Building Code, compliance with the new Building Code is not mandatory. Section
27-120 of the new Building Code states that, “[a]t the option of the owner, regardless of
the cost of the alteration or conversion, an alteration may be made to a multiple dwelling
or a building may be converted to a multiple dwelling in accordance with all requirements
of this code [the new Code] or in accordance with all applicable laws in existence prior to
December 6, 1968, provided the general safety and public welfare are not endangered”
(emphasis added). Thus, as compliance with the provisions of the new Building Code is
optional in this case, the additional cost of soundproofing the residential units —
$2,150.00 — may not be considered “minimal code compliance” under 29 RCNY
§2-01(j), and may not be included in the total allowable legalization costs.66

63
   This is item 3.7.2.1 in Caine’s report.
64
   In Caine’s report, these are items 2.1.3, 3.1.9.1, 3.2.9.1, 3.3.8.1, and 3.4.9.1.
65
   This is item 2.2.1.2 in Caine’s report.
66
   In Caine’s report, these are items 3.3.8.3, 3.4.9.3, 3.5.9.2, 3.6.1.4, 3.6.5.3, 3.7.1.4 and
3.7.6.2. I note that, during Atlas’s testimony, there was much focus on whether MDL §84
required soundproofing for this building. While section 84 does involve soundproofing
of residential units, it applies only to “any construction of a multiple dwelling
commenced after January 1, 1970,” (emphasis added) and not to alteration of existing
buildings, as in this case. See MDL §4(24) (definition of alteration).


                                             60
        Caine proposed the construction of waterproof shower stalls in units 4N and 5NF.
Atlas testified that of the work Caine proposed to comply with MDL §76, all that was
necessary was the installation of a waterproof floor. On cross-examination, Caine
admitted that work he proposed was not legally required. Therefore, of the $1,672.00
worth of work proposed by Caine, only the $200.00 worth of work to waterproof the
floors may be included in the total allowable legalization costs.67 In addition, the $100.00
cost associated with Caine’s proposal to waterproof the darkroom floor in unit 4N may
not be included because MDL §76 applies to water closets and bath accommodations, not
darkrooms.68

         Caine proposed the removal of an air conditioner from unit 5NR because it was in
a lot line window. Atlas testified that the presence of the air conditioner was a violation,
regardless of residential use, because it blocked the fire escape. The cost of removing the
air conditioner should be included in the total allowable legalization costs for two
reasons. First, the basis for Caine’s proposal was not any problem in relation to the fire
escape, but the fire safety problem caused by a poorly protected lot line window; the
provision of the old Building Code relied on by Caine addresses the issue of protection of
openings in lot line walls. Furthermore, as discussed above, the rear fire escape is not
going to be used as a second means of egress. Therefore, the fact that the air conditioner
may block the fire escape is irrelevant. The $50.00 cost of this item should be included in
the total allowable legalization costs.69

        The inclusion of the costs of certain work items turns solely on assessing the
credibility of the two expert witnesses as to the existence of certain conditions. As I find
Caine to be credible, I hold that the mere statement of opposing alleged facts by Atlas,
although I also find him to be credible, to be insufficient to rebut Caine’s testimony.
These disputed items concern the amount of metal railing that needs to be installed on the
roof, whether the electrical panel in unit 3N is close enough to the water heater to present
a danger, whether new cooking facilities are needed in units 4S, 4N, and 5NF, and
whether a skylight should be provided for the bedroom in unit 5NR.70 Their total cost,
which should be included in the total allowable legalization costs, equals $3,000.00.

        Undisputed legalization items — There were a number of items in Caine’s
report, not discussed above, that Atlas did not dispute either in his report or at the
hearing. These items concerned work such as the installation of mail boxes and floor
signs, the installation of certain kitchen features, and the installation of smoke detectors.71

67
   These are items 3.4.4.3 and 3.6.2.6 in Caine’s report.
68
   This is item 3.4.5.3 in Caine’s report.
69
   This is item 3.7.5.3 in Caine’s report.
70
   In Caine’s report, these are items 1.01 (roof railing), 3.2.9.5 (electrical panel), 3.3.2.5,
3.4.2.6, 3.6.2.5 (cooking facilities), and 3.7.4.2 (skylight).
71
    In Caine’s report, these are items 1.23, 1.24, 2.1.1, 3.1.2.1, 3.1.2.2, 3.1.3.2, 3.1.4.1,
3.1.4.2, 3.1.9.7, 3.2.2.4, 3.2.3.4, 3.2.6.1, 3.3.2.1, 3.3.2.4, 3.3.3.5, 3.3.4.1(b), 3.3.5.4,


                                              61
The items had a total cost of $8,436.50 and should be included in the total allowable
legalization costs.

        Conclusion as to legalization costs — Based on the analysis above, the total
allowable hard costs of legalization, using Caine’s report as the starting point, is
$67,679.95. However, two additional, related issues were raised in the parties’ post-
hearing memoranda that must be addressed. First, in the owners’ memorandum, counsel
concluded her legalization cost discussion by stating (on page 86), without citation, that
“the $47,790.00 in relocation payments which must be made to obtain a building permit
for the compliance work” must be added to the costs in Caine’s report. The tenants
responded that the owners’ argument — which they stated was based on Zoning
Resolution §15.50 —had to be ignored because it was outside the record. On the
substance, the tenants argued that the basis for the relocation contribution argument was
the illegal conversion of unit 3S, because all of the other units qualified for BRAC
exemption under MDL §285(3). The tenants are correct that the relocation payment may
not be included in the total allowable legalization costs. Examination of Zoning
Resolution §15-50 et seq. supports the tenants’ contention that the basis for the owners’
claim was in fact the relocation payments required under the Relocation Incentive
Program, commonly known as BRAC (Business Relocation Assistance Corporation)
payments. Under 29 RCNY §2-01(j) (clause 3), BRAC payments are explicitly excluded
from consideration in determining code compliance rent adjustments. Therefore, the
additional amount claimed by the owners may not be included.

         In addition to rebutting the owners’ BRAC argument, the tenants went even
further and argued that the legalization costs for unit 3S may not be included at all in the
total allowable legalization costs, because the unit could not be considered an IMD unit
under the Loft Law. The tenants based their argument on the fact that the unit was not
used for residential purposes until after the effective date of the Loft Law. This argument
by the tenants is also correct. In their September 6, 1985, submission, the owners admit
(page 11-12) that “[a]t the time of Article 7-C’s passage,” unit 3S was occupied by a
“month-to-month manufacturing tenant in the building for 40 years.” This admission is
crucial because of MDL §281(3), which provides, in part, that “[n]on-residential space in
a building as of the effective date of [the Loft Law] shall be offered for residential use
only after the obtaining of a residential certificate of occupancy for such space, and such
space shall be exempt from [the Loft Law], even if a portion of such building may be an
interim multiple dwelling.” Thus, unit 3S may not be considered an IMD unit and, in
light of that exemption, it certainly cannot be considered in determining legalization
expenses that might be incurred as a result of the Loft Law. The total amount of
legalization costs attributable to unit 3S is $5,706.50. Subtracting this amount from the
total allowable hard legalization costs contained in Caine’s report, $67,679.95, leaves
$61,973.45. This sum is the total allowable hard legalization costs for the purposes of
this application.


3.4.2.1, 3.4.3.3, 3.4.3.5, 3.4.3.8, 3.4.3.10, 3.4.5.2, 3.4.6.1, 3.6.1.3, 3.6.2.1, 3.6.3.4, 3.6.4.1,
3.7.1.3, 3.7.2.4, 3.7.3.4, 3.7.4.1, and 3.7.5.2.


                                                62
        The total allowable legalization costs for the building equal the total hard costs,
plus architectural and legal fees, computed at four percent of the hard costs each.72 Four
percent of $61,973.45 equals $2,478.94. Thus, the total allowable legalization costs
equal $66,931.33.

       G. Tenant-Occupied Unit Income

       For the actual year, the income from the two tenant-occupied units (5NF and 5S),
pursuant to the undisputed figures contained in the owners’ application, was $3,600.00
and $6,850.00, respectively.

        With the figure for the total allowable legalization costs, it is possible to
determine the projected year income from the two tenant-occupied units. It is first
necessary to calculate the individual unit rent increases that would result from the
apportionment of the allowable legalization costs pursuant to 29 RCNY §2-01(l). Under
section 2-01(l)(3), the individual unit share of the code compliance costs for work in the
common and commercial areas of the building is represented by the formula

                                   S = (TC x RA/TA)/R

where S equals the share per residential unit, TC equals the total allowable code
compliance costs of work in the common and commercial areas, RA equals the sum of
the floor area of the residential units, TA equals the total floor area of the building, and R
equals the maximum number of residential units.73

        In this case, as discussed above, the allowable common and commercial area costs
(TC) total $30,181.25.74 The total floor area of the building (TA) equals 18,979 square
feet, and the sum of the residential unit floor areas (RA) equals 10,700 square feet.75 The

72
    These were the percentages in effect, under 29 RCNY §2-01(p), at the time of the
application and hearing.
73
    Under section 2-01(l)(3), this formula is not applied to work described under section
2-01(l)(2), i.e., systems work that only services and is only capable of servicing
residential units, and work performed in commercial units solely to comply with MDL
Article 7-C. For such work, the total allowable cost is allocated equally among the
residential units. In this case, however, the parties do not seem to have addressed
whether the systems and commercial unit work at issue should be considered under
section 2-01(l)(2) or 2-01(l)(3). Therefore, I am considering the section 2-01(l)(3)
formula to be applicable to all such work. See Application of Feierstein, Loft Board
Order No. 1945, at 71-72, 16 LBR at 187.
74
    This is the amount for work that was allowable under sections 1 and 2 of Caine’s
report.
75
    As stated earlier, the area for the second floor equals 4,050 square feet, the area for
units 3N and 4N equals 1,900 square feet each, the area for units 3S and 4S equals 1,700


                                             63
maximum number of residential units (R) equals seven. See 29 RCNY §2-01(l)(3).
Therefore, when these values are placed in the equation above, the share per residential
unit for the allowable common and commercial area costs equals $2,430.80.76

        The projected year code compliance income for each of the residential units (i.e.,
the respondents’ units) is computed as follows: First the unit’s share of the common and
commercial area costs is added to the allowable costs for that individual unit. See 29
RCNY §2-01(l). To this sum is added the unit’s proportionate share of the allowable
architectural and legal fees, and the unit’s proportionate share of the interest on the
construction loan. See 29 RCNY §2-01(l); see also 29 RCNY §§2-01(p)(12)
(architectural and legal fees) and 2-01(k)(2) (interest on the construction loan).77 The


square feet each, and the area for unit 5NR equals 1,000 square feet. As the area for the
south residential units on the third and fourth floors equals 1,700 square feet, it is
reasonable to assume that unit 5S is also 1,700 square feet, which is consistent with
Exhibit O to the owners’ September 6, 1985, submission. Also consistent with this
submission, and Riesner’s testimony on behalf of the tenants, unit 5NF appears to be 800
square feet. Pursuant to the owners’ submission, the first floor contains 4229 square feet.
Under 29 RCNY §2-01(l)(3), the sum of the residential areas includes unit 3S, even
though its costs, as discussed above, may not be included in the total allowable
legalization costs, because RA includes not only the maximum number of residential
units that qualified for coverage under Article 7-C, but also residential units on the final
certificate of occupancy that did not qualify for coverage. As the alteration application
indicates that unit 3S was to be converted to residential use, its floor area must be
included in RA.
76
    $2,430.80 = ($30,181.25 x 10,700/18,979)/7.
77
    To compute a unit’s proportionate share of allowable architectural and legal fees, the
sum of the unit’s individual costs and its share of the common and commercial area costs
are divided by the total construction cost. The resulting percentage is then multiplied by
the total allowable architectural and legal fees, which, as discussed above, each equal
$2,478.94. See Application of Feierstein, Loft Board Order No. 1945, at 72 n.9, 16 LBR
at 187 n.9. In this case, unit 5NF’s proportionate share of the fees equals $610.55:
$2,430.80 for the unit’s share of the common and commercial costs plus $5,201.10 for
work in the unit itself, is divided by the total construction hard costs of $61,973.45; the
resulting percentage is multiplied by the total fees of $4,957.88 to get the proportionate
share of the fees for unit 5NF, which equals $610.55. In equation form, unit 5NF’s
proportionate share of the fees is: $610.55 = (($2,430.80 + $5,201.10)/$61,973.45) x
$4,957.88. The equation for unit 5S is: $448.86 = (($2,430.80 + $3,180.00)/$61,973.45)
x $4,957.88.

        To compute a unit’s proportionate share of the interest on the construction loan,
the sum of the unit’s share of the common and commercial area cost and its individual
costs are divided by the total amount of the loan, which in this case would be $66,931.33.
The resulting percentage is then multiplied by the total interest on the loan in order to get
the unit’s proportionate share. See 29 RCNY §2-01(k)(2); Application of Feierstein, Loft


                                             64
total for each unit is then divided by 15 to obtain the income attributable to the “cost of
code compliance increase” for each unit for the projected year, because the total costs of
code compliance are amortized over a 15-year period when a loan is taken to pay for the
costs of code compliance and the owner seeks reimbursement for the interest on the loan.
See 29 RCNY §2-01(k)(2)(ii). In this case the income from units 5NF and 5S in the
projected year attributable to the cost of code compliance increase is thus: unit 5NF —
$1,199.46; unit 5S —$881.81. These numbers were calculated as follows:

                     A           B                   C           D                 E
   Unit            Unit      Unit Code           Unit Share Construction         Code
  Number         Common     Compliance            of Arch.     Loan            Compliance
                Area Share   Costs ($)           and Legal    Interest          Total ($)
                    ($)                           Fees ($)   Share ($)
    5NF            2,430.80    5,201.10               610.55    9,749.42            1,199.46
     5S            2,430.80    3,180.00               448.86    7,167.55              881.81

The Code Compliance Total set forth in column E is calculated by adding the figures in
columns A, B, C, and D, and dividing that sum by 15.

        With this calculation, the total projected year income for units 5NF and 5S can be
determined. For each unit, an increase pursuant to 29 RCNY §2-06 should be made to
the base rent at the time of the application. See Application of Feierstein, Loft Board
Order No. 1945, at 74, 16 LBR at 187. For unit 5NF, Loft Board records indicate that
Rudolph Mishaan rented all of the fifth floor space (not subdivided into front and rear) by
a lease dated September 1, 1979. Under that lease, for which Nalla Wollen was a
co-tenant, the last rental increase occurred on September 1, 1982, when the rent for the
entire space went to $7200.00 per year.78 The lease did not contain escalator provisions.
Under these facts, the section 2-06 increase for unit 5NF should be nine percent. See 29
RCNY §§2-06(c)(1)(i) and 2-06(c)(3). Similarly, the section 2-06 increase for unit 5S
should be nine percent. Furthermore, an RGB increase should be added to the base rent
for each unit. See MDL §286(4); 29 RCNY §2-01(i)(1); Application of Feierstein, Loft
Board Order No. 1945, at 74, 16 LBR at 187. In a similar circumstance, the Board
assumed that the tenants would have elected a one-year RGB increase. See Application
of Feierstein, Loft Board Order No. 1945, at 74, 16 LBR at 187. On November 1, 1983,

Board Order No. 1945, at 72-73 n.9, 16 LBR at 187 n.9. In this case, involving a loan for
$66,931.33 at a 13 percent interest rate, the total interest on the loan amortized over 15
years would be $85,501.85. Thus, the proportionate share of the interest on the
construction loan for unit 5NF is computed as follows: $9,749.42 = (($2,430.80 +
$5,201.10)/$66,931.33) x $85,501.85. The proportionate share of the interest on the
construction loan for unit 5S is computed as follows: $7,167.55 = (($2,430.80 +
$3,180.00)/$66,931.33) x $85,501.85.
78
    The fifth floor north space was evidently divided into units 5NF and 5NR subsequent
to the making of the lease in 1979. This apparently explains why the representative year
rent for unit 5NF was listed as only $3,600.00.


                                            65
the first day of the projected year, see id., the RGB one-year increase was four percent.
Finally, the code compliance total for each unit for the projected year should be added to
the base rent as modified. The total income for the projected year for the residential units
is thus: unit 5NF —$5,280.42; unit 5S — $8,646.97. These numbers were calculated as
follows:


    A               B                C                  D            E             F
   Unit         Base Rent      With LBO            With RGB        Code      Total Income
  Number           ($)         #1 (Col. B x        (Col. C x     Compliance (Cols. D + E)
                                 1.09) ($)          1.04) ($)     Cost ($)        ($)
    5NF             3,600.00        3924.00            4080.96      1,199.46      5,280.42
     5S             6,850.00       7,466.50           7,765.16        881.81      8,646.97

As described above, the total income set forth in column F is calculated by adding the
figures in columns D and E.

       H. Absence of Hardship

       Based on all of the above, the accepted expenses and income for the
representative year are as follows:


                   REPRESENTATIVE YEAR

           ITEM                                           AMOUNT

OPERATING EXPENSES
1. Fuel                                                        5016.78
2. Labor                                                      22420.33
3. Utilities                                                   6794.67
4. R/E taxes                                                  15917.38
5. Fees and permits                                             328.00
                                                               2478.94
6. Service contracts                                            135.31
7. Repairs and maintenance                                     3077.82
8. Insurance                                                  10648.77
9. Parts and supplies                                           324.00
10. Management fees                                            1225.00
11. Legal fees                                                 5977.45
12. Administrative costs                                       2783.97
13. Mortgage interest                                         63750.00
    Total Expenses                                           140878.42

INCOME


                                              66
   Store 1N                                                16800.00
   Store 1S                                                16200.00
   2nd Floor N                                             11418.75
   2nd Floor S                                             11470.10
   3rd Floor N                                             12902.40
   3rd Floor S                                              7608.04
   4th Floor N                                             12316.40
   4th Floor S                                             11620.10
   5th Floor NR                                             9686.15
   5th Floor NF                                             3600.00
   5th Floor S                                              6850.00
   Miscellaneous income                                        0.00
   Total Income                                           120471.94

       Pursuant to 29 RCNY §2-03(b)(2)(ii)(A), a “reasonable rate of return” is defined
in terms of the owners’ net annual return. “Net annual return” is defined in that rule as
“the percentage amount by which the annual earned income from the building exceeds the
annual operating expenses of the building.” Based on this definition, the figures above
show an annual return for the representative year of negative $20,406.48 ($120,471.94 -
$140,878.42), which equals a net annual rate of return for the representative year of
negative 14.5 percent (negative $20,406.48/$140,878.42).

        Based on all of the above, the accepted expenses and income for the projected
year are as follows:

                       PROJECTED YEAR

          ITEM                                        AMOUNT

OPERATING EXPENSES
1. Fuel                                                     8525.16
2. Labor                                                   18000.00
3. Utilities                                                5343.59
4. R/E taxes                                               21320.38
5. Fees and permits                                          344.40
                                                            2478.94
6. Service contracts                                        1050.00
7. Repairs and maintenance                                  7500.00
8. Insurance                                               20088.00
9. Parts and supplies                                        518.00
10. Management fees                                         8021.24
11. Legal fees                                              6467.87
12. Administrative costs                                    3400.00
13. Mortgage interest                                      63750.00
                                                            8610.81


                                           67
     Total Expenses                                         175418.39


INCOME
   Store 1N                                                  32200.00
   Store 1S                                                  16800.00
   2nd Floor N                                               19845.00
   2nd Floor S                                               19745.27
   3rd Floor N                                               22481.76
   3rd Floor S                                               18648.24
   4th Floor N                                               20559.36
   4th Floor S                                               18648.24
   5th Floor NR                                              18206.76
   5th Floor NF                                               5280.42
   5th Floor S                                                8646.97
   Miscellaneous income                                          0.00
   Total Income                                             201062.02

        Based on the definitions contained in 29 RCNY §2-03(b)(2)(ii)(A) of reasonable
rate of return and net annual return, the figures above show a net annual return for the
projected year of $25,643.63 ($201,062.02 - $175,418.39), equaling a rate of return for
the projected year of 14.6 percent ($25,643.63/$175,418.39).

        In light of these figures, the owners in this case have not proven a hardship under
the infeasible costs theory. Under 29 RCNY §2-03(b)(2)(ii), the owners needed to prove
that they could not receive a “reasonable rate of return” on their investment in order to
prove a hardship; under section 2-03(b)(2)(ii)(A), reasonable rate of return is defined as a
net annual return of five percent or more. An analysis of both the representative and
projected years shows that the owners have not proved that legalization pursuant to MDL
Article 7-C would cause a hardship under this definition. First, the accepted figures for
the projected year, itself, show that legalization would not cause a hardship, because the
owners would receive a return of greater than five percent. Of equal significance,
however, is the fact that the owners were losing money in the representative year, before
legalization. While it is true that the owners’ expenses would increase by over
$34,000.00 because of legalization, and that the positive projected year rate of return can
be attributed in large part to the imputation of residential fair market values to the
owner-occupied units, the fact that the owners had a negative rate of return before
legalization shows that it is not “compliance with [Article 7-C] in obtaining a legal
residential certificate of occupancy [that] would cause an unjustifiable hardship.” MDL
§285(2). The owners took an expensive mortgage to buy the building, and the building
needs a great deal of repair work — unrelated to Article 7-C legalization — to come up to
legal standards.79 On this record, these factors are largely responsible for the owners’

79
   This is not to ascribe any motivation, good or bad, to the owners’ decision to buy the
building. While the tenants devoted much effort to arguing that the owners’ actions


                                            68
problematic balance sheet. In sum, it is clear that obtaining a residential certificate of
occupancy would not cause the owners to fall below a five percent rate of return; the
circumstances of the building and of their ownership are what put them below that rate.

III. RECOMMENDATION

          Based on all of the above, I recommend that the instant hardship application be
denied.



                                                     Howard Friedman
                                                     Director of Hearings

Dated:     July 1, 1997




showed that any hardship was self-created, I need not reach that issue because I find that
there was no hardship as a result of Article 7-C in the first place.


                                            69

				
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