The Precedent of NYC’s Broker Fee Commission Structure: Lessons for Boston

The recent debates and court rulings around who should bear the burden of broker fees in New York City have sparked considerable discussion about the broader implications for apartment rental markets across the country. The 2020 mandate issued by New York state that landlords should pay these fees was met with significant resistance and eventually was overturned in court.  However earlier this year, NYC's City Council reintroduced the controversial bill, dubbed the Fariness in Apartment Rentals Act (FARE), which shifts the cost of broker fees to landlords.  That bill passed on November 13, 2024 with a veto-proof majority of 42-8 and will go into effect in 180 days.

This initial bill put forth by New York state that was eventually overturned provides valuable insights into the potential impacts of similar policies in other cities, such as Boston. Understanding the negative consequences of forcing landlords to pay broker commissions and the benefits of a free-market approach can help guide effective housing policies. Many economists, business leaders, and developers have clearly expressed their real concerns that overly restrictive policies have had devastating effects of limiting housing stock supply. It has been clear that the greatest way to bring affordable housing is to massively increase production and give the consumer the most choices– this is what brings down prices and encourages landlords to participate more in paying broker fees (and other concessions).

Constitutionality of Broker Fee Liability

It is clear that the government was never intended to interfere with private negotiations in the marketplace. Commissions are generated through the individual efforts of a real estate agent and their ability to close transactions through all the hurdles, impediments, and nuances of each transaction.  The constitutionality of banning the practice of tenants paying broker fees would likely hinge on the following legal principles and precedents:

1. Contract Clause (Article I, Section 10 of the U.S. Constitution)

• The Contract Clause prohibits states from enacting laws that retroactively impair the obligations of contracts.
• Key Case: Allied Structural Steel Co. v. Spannaus (1978): The Supreme Court held that state laws interfering with private contracts must meet a high standard of justification, including serving a significant public purpose and being reasonable and necessary.
• Application: If a government law retroactively invalidates agreements where tenants agree to pay broker fees, this could potentially violate the Contract Clause. However, forward-looking laws that ban the practice may be more permissible.

2. Commerce Clause (Article I, Section 8)

• The Commerce Clause allows the federal government to regulate interstate commerce but limits states from enacting laws that unduly burden private businesses.
• Key Case: Granholm v. Heald (2005): Struck down state laws that discriminated against out-of-state businesses under the Commerce Clause.
• Application: A ban on tenants paying broker fees might be challenged if it is found to impose an undue burden on the real estate market, especially if it affects interstate transactions or discourages brokers from entering the market.

3. Substantive Due Process (Fourteenth Amendment)

• The Fourteenth Amendment asserts that laws regulating private businesses must be rational and not arbitrary. They must serve a legitimate public interest without violating fundamental rights.
• Key Case: Lochner v. New York (1905): Though largely discredited, this case dealt with government overreach in labor regulations. Modern courts apply a rational basis review to most economic regulations.
• Application: A law banning tenants from paying broker fees could be challenged if it were seen as arbitrary, capricious, or lacking a legitimate government interest. The government would need to show that the ban reasonably serves a public purpose (e.g., addressing housing affordability).

4. Takings Clause (Fifth Amendment)

• According to the Fifth Amendment of the US Constitution, if a law effectively deprives brokers of a legitimate stream of income (such as tenant-paid fees) without just compensation, it could be argued as a regulatory taking.
• Key Case: Penn Central Transportation Co. v. New York City (1978): Established a balancing test for regulatory takings, considering the economic impact and interference with investment-backed expectations.
• Application: Brokers might argue that banning tenant-paid fees constitutes a government taking of their right to earn income.

5. Preemption Doctrine

• According to the Law of Preemption, if federal housing laws or regulations permit tenants to agree to pay broker fees, state or local laws banning the practice might be preempted.
• Key Case: Pacific Gas & Electric Co. v. State Energy Resources Conservation & Development Commission (1983): Federal laws preempt state laws if the state laws conflict or interfere with federal purposes.
• Application: If broker fee arrangements are protected under federal law or HUD regulations, a state ban could be challenged.

The Contract Clause and Substantive Due Process are the most likely grounds for challenging a law banning tenant-paid broker fees as unconstitutional. However, courts often defer to legislatures when evaluating economic regulations, applying a rational basis test. For a successful challenge, the plaintiff would need to demonstrate that the law either violates preexisting contracts, imposes an undue burden on commerce, or lacks a legitimate public purpose.

Negative Impact of Forcing Landlords to Pay Broker Fees

Using NYC as a case study, mandating landlords to pay broker fees can lead to several adverse effects:

Increased Rents

• Pass-Through Costs: Landlords are likely to offset the additional costs by raising rents. This practice can make rental units more expensive over time, negating the immediate financial relief tenants might experience from not paying the broker fee upfront.
• Reduced Affordability: Higher rents exacerbate the housing affordability crisis, making it increasingly difficult for low and middle-income tenants to find affordable housing options. This could drive residents further away from urban centers, leading to longer commutes and increased transportation costs.

Decreased Incentive to List Properties

• Limited Listings: When landlords are forced to pay the brokers fees; they will raise rents to cover this added expense and as a result there would be less apartment turnover. Tenants would stay in apartments longer, leading to less availability and vacancies and higher rent prices. This all points back to simple supply and demand. People move around less when prices go higher. This reduction in available rental units can decrease accessibility for those that need it most.
• Market Inefficiencies: With fewer properties available through brokers, tenants may experience longer search times and have to settle for less ideal living situations, leading to increased frustration and decreased satisfaction. This will create a more cumbersome and less dynamic rental market, where tenants struggle to find suitable housing options quickly.

Reduced Investment in Property Maintenance

• Budget Constraints: Landlords facing higher costs will reduce spending on property maintenance and improvements to be able to cover soaring insurance, labor and material costs. This can result in a decline in the quality of rental housing over time. Tenants may find themselves living in properties that are not adequately maintained, impacting their overall quality of life. Innovations and technology improvements to our housing stock could be stunted resulting in the loss of jobs for other people that participate in the real estate industry.
• Deferred Maintenance: Essential repairs and upgrades will be postponed due to lack of available funds, negatively impacting tenants' living conditions and overall property values. Over time, this could lead to a deterioration of the housing stock, making it less attractive to prospective tenants and investors.

Positive Aspects of a Free Market System for Broker Fees

When the market determines who pays broker fees, several benefits emerge,:

Increased Market Transparency and Choice

• Negotiation Flexibility: Tenants and landlords can negotiate who pays the broker fee, allowing for more customized agreements that reflect the specific circumstances and preferences of both parties. This flexibility can lead to more equitable arrangements, fostering a more cooperative relationship between tenants and landlords. Professional real estate agents focused on leasing apartments with access to real time data can be instrumental in providing the best deal for both parties through specificity of local knowledge.
• Competitive Advantage: Landlords willing to absorb the broker fee might attract more tenants, creating a competitive market environment that can lead to better deals and improved tenant satisfaction. This competition can drive innovation and improvement in the quality of rental services offered. The main theme of transparency is to provide as many choices as possible to consummate deals so that everyone wins. Legislation mandating only one party must pay limits freedoms and creativity to create opportunities through compromise.

Encourages Investment in Rental Properties

• Property Improvements: With the financial burden of broker fees removed, landlords are more likely to invest in property maintenance and improvements, enhancing the overall quality of rental housing. Tenants benefit from better-maintained properties and a higher standard of living.
• Market Attractiveness: A free-market system where tenants typically pay broker fees can make the rental market more attractive to investors, ensuring a steady supply of rental units and contributing to market stability. This increased investment can lead to the development of new rental properties, expanding housing options for tenants. The mere mention of additional non-sensical and potentially damaging legislation can cause numerous developers and builders to seek other states or areas where they believe they will be treated with respect and dignity. Legislators that scapegoat the real estate community in exchange for votes is not a viable business model. Education of legislators on fundamental market principles such as supply and demand is needed.

The FARES Act: Results and Market Impact

The new bill will undoubtedly have notable effects on the market:

• Increase in Rental Prices: With the burden of broker fees falling on the landlord, they will feel compelled to raise rents significantly to help offset the upfront cost of finding a tenant.  This will, in effect, raise average rent prices in an already expensive market. This will affect tenants in that they will likely be paying the same over the course of their lease, but will absorb that cost over a longer period of time.
• Disincentivized Investment: The new bill will discourage landlords from continuing to invest in their properties with ongoing maintenance and improvements that benefit tenants. Unfortunately, this will have a negative impact on the quality and appeal of the rental housing stock in NYC.
• Market Efficiency:   Increasing the costs for landlords will discourage them from entering the rental market, and instead they will sell off their existing units and avoid buying long-term rental properties in the future.  The inventory of apartments will decrease in NYC, or fail to keep up with demand, which will inevitably push rent prices even higher in the future.

Recommendations for Boston: Embracing a Free Market System

Boston should not follow NYC's lead on this legislation.  We are already dealing with record low housing inventory, and we can ill-afford to disincentivize landlords from adding much needed rental inventory.   By adopting a free-market approach to broker fees, Boston will bring forth long-term solutions in the market for renters, including:

Enhanced Affordability

• Maintaining Market Equilibrium: Allowing the market to determine who pays broker fees can help keep rental prices more stable and affordable over time. By avoiding government-imposed mandates, Boston can prevent the unintended consequences that often arise from such interventions.
• Avoiding Rent Increases: By not imposing additional costs on landlords, the risk of significant rent increases is minimized, helping to maintain the affordability of rental housing. This approach ensures that tenants are not burdened with higher living costs indirectly through increased rents.

Improved Property Quality

• Encouraging Maintenance and Upgrades: Freeing landlords from the financial burden of broker fees encourages them to invest more in property maintenance and improvements, benefiting tenants. Well-maintained properties enhance tenants' living experiences and contribute to community well-being.
• Promoting Investment: A market-driven approach can attract more investors to the Boston rental market, ensuring a steady supply of quality rental units. This influx of investment can lead to the development of new rental properties, expanding housing options and improving the overall housing market.

Market Attractiveness and Stability

• Attracting Investors: Maintaining the flexible approach to broker fees will make Boston's rental market more attractive to investors, contributing to market stability. Investors are far more likely to enter and remain in a market that is perceived as fair and balanced.
• Fostering a Dynamic Market: Allowing market forces to dictate the payment of broker fees fosters a more dynamic and responsive rental market. This adaptability benefits both tenants and landlords by creating an environment where both parties can thrive.

Conclusion

The disastrous legislative experiment in NYC underscores the importance of a balanced, market-driven approach to rental brokerage commissions. Politicians and legislative bodies should be placing their focus on eliminating barriers to creating supply. The greatest way to get more landlords to pay brokers commissions is to vastly increase the supply of apartments. Generating ample supply will no doubt lower rents and also increase landlords paying greater incentives to get their places rented. No business model on earth can escape the free market fundamentals of supply and demand. Government needs to streamline the permitting process; remove or reduce affordability requirements for new developments to unleash the building community into delivering more supply. Forcing landlords to bear more and more costs has unintended negative consequences, including higher rents and reduced property investment. In contrast, a free-market system offers flexibility, encourages investment, and helps maintain affordable housing options.

Boston should avoid implementing any laws that mandate landlords to pay broker fees and instead allow the market to determine the appropriate arrangements. This approach will help maintain rental affordability, encourage ongoing investment in property maintenance, and ensure a dynamic and efficient rental market. By embracing the lessons learned from NYC, Boston can foster a healthy rental market that benefits tenants, landlords, real estate agents, and the broader community.