Over the last few years, there has been a growing understanding that the cost of the affordable housing in inclusionary zoning (IZ) programs can be and is “passed back to the land”. In other words, it is being recognized that the cost burden (measured by difference between the market price or rent of these units and the reduced price or rent at which they must be provided) is substantially or entirely taken out of the price developers are willing to pay for land.

Developers typically determine the land value 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, municipal fees and so on) as well as their anticipated profit (or return on investment). In this process, the affordable housing obligation is treated as another cost. The price that can be paid for the land is residual value left after the total costs are deducted from the revenue.

Predictability is critical for this to happen. The affordable housing obligation must be fixed in advance so that all developers are able to compete on a “level playing field” when bidding for the land. (Notably this does not happen in the case of s37 where the value of community benefits is determined by the negotiations over the development agreement, and so well after the land has been purchased.)

This process, it is recognized, raises a short-term problem. Developers already owning the land when these IZ provisions are passed will not be able to pass these costs back (unless they were able to anticipate the changes). As a consequence, these developers would be hit by the costs of the inclusionary obligation.

This problem can be addressed by exempting those projects already in the approval pipeline, and delaying – or, better yet, phasing in the affordable housing obligation – for some reasonable period (say, 3-5 years) after passing the inclusionary zoning by-law.

Burdening landowners in this way should not be seen as unwarranted or unfair. Landowners in high growth areas especially have benefitted enormously from rising “unearned” land values that they have done nothing to create. The municipalities, on the other hand, typically have a major hand in creating those land values through their investments in infrastructure and decisions over land-use and planning. So, IZ represents a way for municipalities to recover some part of that value that they helped to create but that otherwise would fall into private hands.

What the literature says

The literature on IZ frequently refers to this process. It is recognized by these leading authorities in the US:

• 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.”

Even the Urban Land Institute, in a recent report (2016) that has been endorsed by the development industry, acknowledges the possibility of this process. It notes that “IZ may reduce what a developer can pay for land”. And “(when) IZ policies remain in place over a sustained period of time, land prices may adjust and the IZ requirements absorbed as a ‘cost of doing business’ in the jurisdiction”.

Who else could pay?

Other candidates for bearing the cost burden of the affordable units have been identified. These include the municipalities, developers and other homebuyers. But
the current evidence supports that none of these pay in any substantial way for the housing. So, this also indirectly bolsters the case for the cost burden falling back on the landowners.

Much of the key evidence comes from two studies (Furman 2007 and Smart Growth 2008) undertaken by non-partisan and university-based organizations. They independently collected and statistically analysed empirical data from a large sample of jurisdictions over a long period. Both came to the same basic conclusion: namely, that IZ has had little or no impact on the overall production or price of housing in the communities where it is used.

Homebuyers

Developers often take the position that they will simply pass on the cost burden associated with IZ to the other market buyers in the particular development. In turn, this will drive up the price of housing more generally. So, as a consequence, these programs essentially will require the other homebuyers to subsidize the affordable homebuyers.

The two authoritative studies refute this. They found that IZ had little or no impact on housing prices. The overall house prices in municipalities with inclusionary requirements were virtually the same those in municipalities without. And, if there was any increase attributable to IZ, it was insignificant when compared with the overall increase in market prices.

The reason for this is not difficult to understand. The price of housing is determined by the market as a whole – in a sort of tug-of-war between all developers and all buyers – and not by any individual developer on their own. Furthermore, it can be reasonably assumed that developers are already charging what they would consider to be the full market value for their product, and the homebuyers (especially, at the low-end-of-the-market) have already maxed out the price they can payit So, any cost burden imposed by IZ cannot be simply recovered from the other homebuyers through higher prices.

Developers sometimes also express this position by saying that homebuyers ultimately pay for everything – including not only the house itself, but also all of the government impositions like development charges, planning fees and inclusionary requirements. While true, there is a limit to what the homebuyer will bear and that is expressed through the market price. The job of the developers, if they want to stay in business, is to ensure that all of costs of development (along with their profits) somehow stay within that market price.

Developers

IZ programs are not, and cannot be, designed with the expectation that the developers will do so. Although the municipalities under IZ can require the provision of affordable housing as a condition of getting a development approval, they have no power to compel developers to build.

The developers have never expressed any willingness to absorb the cost burden. If the inclusionary obligation generates an unacceptable burden, developers will stop building, or at least delay building until the prices have risen sufficiently to make their profit.

But the empirical evidence shows that IZ does not impact overall housing production. While some developers might be adversely affected, municipalities with IZ programs produce housing more or less at the same volume as comparable municipalities without programs.

These findings indicate that developers are able to accommodate the affordable housing obligation, and to continue to build without significant damage to their viability. This is done by passing the cost burden back to the landowners

Municipalities

The role of the municipalities in assisting the provision of affordable housing in IZ programs is complicated. Most mandatory programs – but certainly by no means all – offer some form of compensation or other assistance. But that assistance is typically very limited in value and scope, or highly targeted when used more extensively.

Most offer a fixed and standard set of regulatory concessions in exchange for the affordable housing. These typically include relaxed regulations (for density, height, setbacks, parking, and others), waived fees and charges, and/or fast-tracked approvals.

But it is important to note there are also many successful programs that offer no assistance whatsoever. This is a clear indication that the provision of affordable housing under IZ is not dependent upon this help.

Also, in none of these programs do the concessions fully cover the cost burden. These concessions are best seen as token payments. They are given in the main because the municipalities consider unfair to impose costs and restrictions when the developers are being required to deliver housing at a lower price or rent. They are never calibrated to fit the needs of any particular development, nor provide a pre-determined level of assistance.

More extensive concessions are used in two particular and narrow circumstances:

• In voluntary (or incentive-based) programs, where unlike in mandatory programs, municipalities must fully re-imburse developers for the affordable housing provision in order to gain their participation. But once widely used, these programs have declined to a small minority because they have been proven to be unproductive.

• In negotiated and one-off agreements, where municipalities used additional forms of assistance to secure from selected developments (often non-profit) to reach greater affordability than possible under the standard and fixed provisions.

In both cases, municipalities have offered a wider range of assistance – like financial subsidies and property tax relief – that are rarely or never given to developers providing housing under the standard and fixed provisions. But the developments benefitting from this additional assistance represent a relatively portion of the total IZ developments. By not making the above distinctions, surveys tend to distort and inflate how the assistance is used in most common programs.

What does this mean for compensation?

If the cost burden can be passed back to land, it raises this question: why do municipalities need to provide concessions or any other assistance. It is not essential for effective programs. Unless done with care, this assistance will just sustain inflationary and values, and support the large unearned profits of the landowners.

Municipalities, after all, do have limited resources to provide for this assistance. Requiring them to provide significant assistance will actually undermine the productivity of these programs. This is because the lack of resources will limit the number of units and/or depth of affordability that can be supported by them.

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

Municipalities should design programs in which developments providing the standard and fixed obligation receive no or little concessions. Their limited resources, instead, should be focussed on selected developments where they can effectively negotiate for deeper affordability in the form of additional affordable units and/or units serving lower incomes.

References

Vicki Been, et al.: “The Effects of Inclusionary Zoning on Local Housing Markets: Lessons from the San Francisco, Washington DC and Suburban Boston Areas”; Furman Center for Real Estate & Urban Policy, Working Paper 07-05, November 2007.

Gerrit-Jan Knaap, et al: “Housing Impacts of Inclusionary Zoning”; National Center for Smart Growth Research and Education; February 2008.

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.

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

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
27 Mar 2019