The Need for Compensation

Issue

The need for compensation in inclusionary zoning (IZ) remains a critical issue still to be resolved in Ontario. The basic question is this: does the success of IZ depend upon municipalities providing compensation – also known variously as contributions, concessions, incentives and cost offsets – to developers in return for the affordable housing.

Developers in Ontario have consistently and persistently called for ”municipal contributions” for the affordable units. For example, last August in the Toronto Star, the head of BILD wrote that the province’s IZ regulations were “all take and no give” by the municipalities. He then called again for a ‘partnership’, which is their coded way of referring to municipalities having to provide compensation. (Using this term in this way is peculiar to Ontario; there are no corresponding references to it anywhere in US.) (Wilkens 2018)

The draft Ontario regulations called for the municipalities to contribute towards 40% of the cost burden associated with the affordable housing. The municipalities were able to make these contributions only from certain regulatory concessions: namely, a waiver or reduction of planning application fees, parking requirements, parkland cash-in-lieu payments and/or development charges.

After pushback from the municipalities and affordable housing sector, this obligation was removed, but a new troubling one added. That regulation requires the municipalities to undertake a financial assessment of the “potential impacts on the housing market and on the financial viability of development”.

While this might sound reasonable and straightforward, the concern is that these assessments will be done in a narrow and conventional way, and particularly to determine what compensation is needed to make the developers “whole” again when providing affordable housing.

The key problem is this: because municipalities have only limited resources, requiring them to pay compensation is very likely to restrict the productivity of their IZ programs.
In other words, they will have to seriously reduce the number of units provided and/or the depth of affordability achieved in order to work within their resources.

The remainder of this paper addresses this issue by explaining that IZ programs can and should be designed in a way that they are not dependent upon compensation, and in any case, that compensation is not needed because the cost burden associated with affordable housing is not borne by the developers.

Experience in the US

The experience in the US clearly shows that compensation is not essential for having effective IZ programs. In other words, under the appropriate conditions, these programs can be productive without compensating the developers for the affordable housing.

This conclusion is recognized by a recent ULI report that has been touted by the development industry. That report states that “in very strong development environments (substantial amounts of new construction and rehabilitation, steady rent and price growth, low vacancy rates), IZ policies can yield development new workforce housing units without subsidy or other development incentives from the local jurisdiction”(Williams 2016).  Needless to say, all of above conditions apply in the City of Toronto.

The evidence in support of this conclusion is convincing, but needs some explaining.  In summary, it is based on these key points:

1)  While it is true that compensation is widely provided, it is not used in all mandatory programs. There are many of these programs that produce affordable housing without compensation. This, by itself, is clear evidence that compensation is not always needed.

2)   In most mandatory programs where compensation is offered, it is most typically provided through a fixed and limited set of regulatory concessions. These might include relaxed development regulations (for density, height, setbacks, parking, and others), waived fees and charges, and/or fast-tracked approvals.

These concessions are best seen as token payments. They are offered not as compensation, but mainly in recognition that municipalities should not be adding to the costs of providing affordable housing at same time as asking developers to deliver housing at a lower price.

In any case, the value of this relief is relatively small. It does not fully cover the cost burden of the affordable housing. As they are given on the same basis to all developments, they certainly are not calibrated to meet the needs of any particular development, nor any prescribed standard (like a 40% contribution).

There also is a downside to many of the most common concessions, and this in turn raises the question of how appropriate they are. For example, the waiving of fees could reduce service levels, or add the fees paid by others. The use of density bonuses could result in bad planning by approving higher density where not appropriate. The fast-track approvals for some applicants could cause delays for others.

3)  While some of these programs offer other forms of compensation, these are provided almost entirely in these two limited and targeted ways:

•   In all voluntary (or incentive-based) programs where, unlike in mandatory programs, municipalities must fully compensate developers for the affordable housing in order to secure their participation. But, while once widely used, these programs are used less and less because they are not productive.

•  In negotiated one-off deals where municipalities offer supplementary assistance in selected (often to non-profit developments) to secure greater affordability than provided under the standard and fixed rules. But, this practice occurs in a relatively small portion of the total IZ developments.

Among the additional forms of compensation provided in these cases are financial assistance like cash subsidies, property tax relief, and below-market loans. But it is important to note that these are rarely (if ever) provided under the standard and fixed provisions in the mandatory programs.

“Passing back to the land”

If the municipalities pay for none or only some of the cost burden associated with the inclusionary units, the question remains about who pays.

Over the last few years, there has been a growing understanding and recognition that the cost of the affordable housing under the appropriate conditions in IZ programs is “passed back to the land”. In other words, that cost will be substantially or entirely reflected in the lower price the developers are willing to pay for land.

Developers typically assess the value of the land before making a purchase. To do so, they determine the potential revenue that can be obtained by one or more development schemes. From that they deduct the projected costs of development (for construction, loans, fees and so on) as well as their anticipated profit (or return on investment). In this process, the affordable housing obligation is treated as just another cost. The price that then can be paid for the land is the residual value left after the total costs are deducted from the revenue.

Mandatory programs, unlike voluntary ones, enable this process by fixing the affordable housing obligation ahead of time, so it is known by all potential purchasers when bidding for the land. This stands in contrast with the s37 provisions, through which the value the land cannot be reliably determined because the community benefits are negotiated during the approval process and well after purchase.

The current literature contains many references confirming this process from acknowledged IZ authorities:

• David Rosen (2016): “Regulation and development impact fees or residential development that increase the costs of development, including housing standards, will ultimately be passed through to the land owner in the form of reduced land prices.”

• Rick Jacobus (2015): “When a city imposes inclusionary housing requirements, … land prices will fall to absorb the costs of the inclusionary housing requirements.”

• Nico Calavita and Alan Mallach (2009): “There is little doubt that there are costs associated with complying with a municipality’s inclusionary requirement. … There seems to be agreement in the literature that in the long run … most of these costs will be passed backward to the owners of land.”

• Douglas Porter (2004): “Economists tend to argue that, in the long run, developers of projects subject to special development costs (such as impact fees and inclusionary requirements) will lower prices for developable land, since housing must be produced at competitive prices and rents the market will bear.”

• Nicholas Brunick (2003): “Basic economic theory suggests that an inclusionary set-aside, without providing cost offsets or incentives to cover the incremental cost of producing the affordable units, would cause developers to … pay less for land. … most of the economic literature indicates … that developers will most likely … bargain for a lower land price in order to profitably develop the housing. Thus, the theoretical incidence of an inclusionary zoning program (without sufficient cost offsets or incentives) over time, would be born by owners of land … (who) might see a reduced rate of appreciation in the values of their land over time. However, this moderate reduction in a rising real estate market is not likely to deprive these owners of earning a still, very healthy return on their investment.”

• Alan Mallach (1984): “There seems to be agreement in the literature that in the long run … most of the costs [of the affordable housing] will be passed backward to the owners of land.”

This process should be considered fair and reasonable. Landowners obtain windfall gains – often enormous – due to rapidly rising land values that they have done nothing to create. On the other hand, municipalities do have a major role in creating those values through infrastructure investments and planning decisions. So, municipalities should be able to capture some of that gain, at least to the extent they have had a hand in creating it.

What this means for compensation

If the developers pass the cost burden back to landowners in this way, then it means they do not absorb the cost of providing the affordable housing. And so, municipalities should not be obliged to provide compensation to the developers. Providing compensation in these circumstances does not assist the provision of affordable housing, but rather mainly serves to sustain high land prices and add to the windfall gains of the landowners.

It bears repeating that municipalities have limited resources to provide for this assistance. If required, it would seriously hamper the output of these programs.

Municipalities should be looking to design their basic programs in a way that most developments would be required to provide a standard and fixed obligation while receiving no or little compensation. At most, out of fairness, municipalities should only consider offering regulatory relief to these developments.

Their limited resources, rather than being spread thinly over many developments, should be focussed on where they can have the greatest impact. That means they should be offered to selected developments where deeper affordability can be negotiated in exchange for the compensation.

In this context, the financial assessments of these programs should be devoted to determining, not what compensation is needed to make the developers “whole” again, but what are the limits to driving the costs back to the land and capturing inflated land values for a public purpose.

References

Dave Wilkes: “Inclusionary zoning plans are all take and no give”; Toronto Star; 18 August 2018.

Stockton Williams, et al: “The Economics of Inclusionary Development”, The Urban Land Institute and Terwillinger Center for Housing, 2016.

Nicholas Brunick: “The Impact of Inclusionary Zoning on Development”; Business and Professional People for the Public Interest; 2003.

Nico Calavita and Alan Mallach: “Inclusionary Housing, Incentives, and Land Value Recapture”; Land Lines, Lincoln Institute of Land Policy; January 2009.

David Paul Rosen & Associates: “Inclusionary Housing Study for the City of Portand”; November 2016.

Rick Jacobus: “ Inclusionary Housing – Creating and Maintaining Equitable Communities”; National Community Land Trust Network, Cornerstone Partnership and Lincoln Institute of Land Policy; 2015.

Douglas R. Porter: “Inclusionary Zoning for Affordable Housing”; Urban Land Institute, 2004.

Alan Mallach: “Inclusionary Housing Programs: Policies and Practices”; Center for Urban Policy Research, Rutgers University, 1984.

Richard Drdla
18 March 2019