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

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

The affordable units provided by IZ are subject to various controls to protect the long-term affordability of the units. The following addresses one of the key aspects of those controls: how the maximum price and income limits are set for the resale of the affordable ownership units.

The principal purpose of these particular controls is to ensure that the public stake in this housing is never lost. This refers to the value of the price reduction that has been engineered by these programs – or more specifically, the current difference between the initial market value of the unit and the initial permitted affordable selling price but as adjusted to the time of the resale.

In effect, under these controls, when an affordable unit is resold within the control period (now typically 30 or more years), it can be resold only at or below the permitted price and to a corresponding income-eligible household of the same size. Units sold after the control period can be sold on the open market, but the home seller only receives the current value of the permitted sales price, while the remainder of the value goes to the municipality for re-investment in affordable housing.

These controls are also affected by another consideration. All of the affordable ownership programs attempt to provide the owners with some reasonable share of the equity gain whenever the units are resold. This equity sharing is considered necessary to promote the proper upkeep of the unit, and also to help the owners to sell and move on when they want.

These two considerations are somewhat in conflict, and this leads to two different equity-sharing approaches that will be noted shortly.

Some of the programs set the limits in terms of price and others in terms of income. But they come to the same thing because one can be readily converted to the other using the current loan-to-income ratios determined by the prevailing mortgage interest rates and related factors. This is important because the programs in a sense must operate in two languages: the developers are most concerned about price and not income, and policymakers about income and not price.

(Note: the PPS definition does not treat them as interchangeable, and that is just one of the many unnecessary complications raised by this flawed definition.)

The resale price and/or income limits are set according to an index or formula registered in the title of the affordable unit when first sold, and then passed from owner to owner whenever resold. This same index or formula is used for the resales within and after the control period. As already noted, the only difference is where the public stake goes; it is either locked into the price of the unit, or it goes to the municipality.

There might be as many as a dozen indices or formulas that have been used to set the permitted resale price in affordable ownership programs in the US and Canada. For example, these include the CPI, a fixed percentage, and a fixed percentage with a cap. Many have been found wanting because of the skewed results that can occur when used over a long term.

Two of these make the most sense, and have used in the great majority of the affordable ownership programs. One is price-based and the other income-based.

The income-based approach uses the local median income as the index. So, for example, if the developers were required to sell the unit initially at a price affordable to a household at 80% of local median income, that unit can be resold to another household of a corresponding size at 80% of the median income as adjusted over time. The US government facilitates this approach by annually providing the median income for each household size for every jurisdiction in the country.

(Note: the income data needed to use this approach is not available. To be more specific, what is lacking is median income data for every jurisdiction that is updated annually and broken down by household size.)

The price-based approach uses average market price as the index. So, for example, if the unit was initially sold at 75% of the average market price, the homeowner can resell it only at 75% of the new market price current at the time of resale.

Two approaches lead to different equity-sharing arrangements, which serve two different policy objectives. The homeowners share in the price-based approach are likely to be much lower than the income-based because incomes generally have risen at a much lower rate than prices. Nevertheless, nearly all IZ programs use this approach because their objective is to provide and maintain affordable housing over the long term. Strictly speaking, this can only be done by ensuring the housing continues to go to households at the same income level.

The price-based approach, on the other hand, is used in programs where the emphasis is on using homeownership as a way of building household wealth and financial security. Notably, Habitat for Humanity takes this approach. Under this approach, the affordability of the units from an income viewpoint will steadily erode at each resale, but the price will always remain below the full market price.

The duration of home ownership is not relevant in these controls. For example, homeowners are not required to own the unit for (say) five or more years as a protection against windfall gains. Under these controls, the unit could be flipped the day after purchase because no special or unearned benefit will go to the seller.

The programs do not guarantee the permitted sales price; they only put a cap on it. If there is a downturn in the housing market, or if the housing is not maintained, the affordable homeowner will suffer the consequences like any conventional homeowner.

RD  22Feb2018