The underpinnings of inclusionary housing in California: current practice and emerging market and legal challenges
Inclusionary zoning, commonly known as inclusionary housing (IH), first originated in the United States in the early‐1970s in the wealthy suburbs of Washington, DC. Since then, the epicenter of IH practice in the U.S. has moved west to California. Today, more than 25 % (145) of the state’s local governments have adopted inclusionary policies. These policies vary greatly in detail, but share common characteristics. In contrast, IH in Europe is of newer vintage, emerging mostly in the 1990s as governments began to withdraw from direct provision of social housing and impose affordable housing requirements on private developers. And, unlike Europe, IH in the U.S. is not imposed via national, state, or regional government land use and planning laws, but is, generally, a voluntary election by individual localities. Since 2008, the implosion of the California real estate market and negative court cases have challenged the fundamental assumptions underlying IH and brought the virtual cessation of new IH programs. Some existing programs have been modified, suspended, or repealed. This research discusses the political and ideological debates that inform IH within the American context, profiles the origins and characteristics of these programs, and speculates about the future of IH in view of recent changes in the housing market and the legal environment.
KeywordsAffordable housing Inclusionary zoning Land values Mixed-income communities Social and economic integration
Inclusionary housing (IH), also known as inclusionary zoning, first originated in the United States in the early-1970s in the wealthy suburbs of Washington, DC., as local governments began to impose mandates on private residential developers requiring them to ensure new development included a mix of housing prices and types affordable to lower-income households.
Since then, the epicenter of IH practice has moved west to California. During the last three decades, high population growth and home prices, dwindling land supplies, and State mandates that cities and counties meet their fair share of the affordable housing need have prompted more than 25 % (145) of the state’s localities to adopt IH. These policies vary greatly in detail, but share common characteristics.
IH in European and other countries is of newer vintage, emerging mostly in the 1990s. Calavita and Mallach (2010) note the worldwide spread of IH, not only in Western Europe, but Canada, Australia, South Africa, and India. They locate this trend within a broader international movement towards privatization, deregulation, devolvement, and shrinkage of the national government role in direct public financing, ownership, and management of social-sector housing. Moreover, some countries have adopted IH not only to increase supplies of privately-provided affordable housing, but to offset rampant private speculation in the housing market that was creating artificial shortages and price increases.
Since 2007, however, the worldwide implosion of the housing market and economic recession have challenged the assumptions underlying inclusionary housing, causing governments to reconsider their policies. In addition, in California, two recent court cases have limited the power of localities to impose inclusionary rental restrictions, as well as fees in lieu of development.
Today, one can reasonably ask whether California is now in a post-inclusionary period in which the economic rationales and legal bases undergirding IH have been irretrievably altered. Absent greater judicial clarity or new state legislation, will local governments modify their existing IH policies to meet these new conditions, temporarily suspend them, or repeal them? Will they seek affordable housing by alternate means using other land use tools at their disposal?
In Sect. 2 of this article, we review the justifications that gave rise to IH in California and the ideological, political, and economic undercurrents that inform the IH debate in the U.S. Sect. 3 reveals the central characteristics of California’s IH programs. Section 4 discusses the implications for IH of the current economic and judicial environment in California. The article concludes in Sect. 5 with reflections on whether recent housing market and legal challenges to IH signals the emergence of a new post-inclusionary regime.
2 Inclusionary housing in California: 40 years of innovation
As the inclusionary housing (IH) tool has grown in California and elsewhere to address severe shortages of affordable housing it has become correspondingly important to draw upon its lessons. The relatively long history of IH and widespread application provide a rich body of experience for jurisdictions to consider when designing, operationalizing, and updating such programs. Furthermore, in the current period of uncertainty when legal, judicial, and market challenges are causing local governments to reconsider their programs, it is particularly important to understand current IH practice.
2.1 What is inclusionary housing in the U.S. context?
Since the first programs were adopted in Fairfax County, Virginia, Montgomery County, Maryland, and Palo Alto, California, in the early 1970s, IH has proven to be an effective tool for some local jurisdictions to ensure new housing development is balanced with affordable dwellings for lower-income households. IH encompasses a large variety of policies that share the common element of requiring or strongly encouraging private developers of housing to directly build or facilitate the building of affordable housing for purchase or rent in new single-family home subdivisions and apartment complexes. But, no two programs are identical.
Income ranges for IH-unit eligibility
Extremely low income
0–30 % of area median income
Very low income
31–50 % of area median income
51–80 % of area median income
80–120 % of area median income
Above 120 % of area median income
Oftentimes, IH programs offer private developers alternatives to building the below-market-rate homes on the same site as the market-rate homes. These include options to: (1) partner with a nonprofit organization that agrees to build the units; (2) build the units off-site or convert existing units under certain conditions; (3) dedicate land to the local government that will accommodate a comparable number of units; (4) pay an ‘in-lieu’ fee to the local government to be used for affordable housing; or (5) build more than the required units in exchange for reducing the requirement in another development.
Programs may also include financial offsets, such as direct subsidies, density bonuses, design and parking concessions, fee waivers, reductions, or deferrals, and expedited processing, that reduce developer costs of building the below-market-rate units. These incentives not only mitigate costs, but often make the adoption of IH programs more political palatable.
It is also important to call out what is not inclusionary housing. Conventionally, IH has been defined as a set of government-imposed mandates imposed on private developers.1 In California, however, State-mandated density bonus programs are sometimes confused with IH. Under Government Code Section 65915, cities and counties are required to grant residential developers a boost in the allowable density when developers voluntarily agree to include affordable housing. Since the mandate is on the local government, not the developer, and since production of the affordable units is a voluntary choice by the developer, labeling these programs inclusionary housing blurs the essential distinction between inclusionary requirements placed on developers versus local governments.
In addition, the conventional definition has included incentive-based programs with voluntary compliance by developers. However, when the incentives are weak and the negative consequences of non-compliance minimal to none, can it truly be said that a locality has an inclusionary policy? We take the position that only voluntary programs with ‘teeth’ should be considered true IH. And, as a general rule, voluntary programs are much less desirable for producing actual units in volume.2
An example of a voluntary program with teeth can be found in the City of Morgan Hill. The City has created a Residential Development Control System (RCDS), a competitive permitting scheme that limits the number of residential building permits awarded annually and strongly encourages homebuilders to include below-market-rate (BMR) units within their market-rate developments. Twenty percent of each year’s RDCS building allotment is for affordable housing. Maximum points are awarded to developments that commit 5 % of the units for low-income and 8 % for median-income households. While not mandated, in essence, the program can be characterized as ‘voluntary mandatory’ since developers are forced to include below-market units to ensure award of scarce permits.
2.2 Inclusionary housing and regional housing needs
In California, the adoption of inclusionary housing policies, with a few exceptions, is at the sole discretion of each local government exercising its police powers to control land uses within its jurisdiction. Efforts at the state legislative level to mandate IH in all cities and counties have failed in the face of strong opposition from the building industry. Local governments also typically resist efforts in the State Legislature to impose land use and housing requirements that impinge on powers they consider to be their prerogative, especially when such mandates are unfunded. Thus, where IH is adopted, it is usually voluntary and highly differentiated by local conditions and political considerations.
While IH is not mandated by the State, the State does mandate that every city and county plan for the housing needs of all of its citizens and accept its fair share of the regional housing need. Adopted in 1969, California Code Section 65583 requires that every unit of local government prepare a Housing Element to its General Plan every eight years in concert with regional transportation plans. Among other information, jurisdictions are required to state goals and actions to meet their fair share of the regional housing need, including identification of sites zoned or to be zoned for provision of housing affordable at all income levels. Regional housing needs are determined by the State of California Department of Housing and Community Development within each income range (see Table 1) and assigned to regional councils of government (COGs), where they exist. COGs then allocate each member city and county its fair share of the regional housing need.
The State’s Housing Element and Fair Share Housing Allocation laws have their share of critics, with advocates for the poor saying the laws do not have sufficient ‘teeth’ and local governments saying the laws are too onerous. The relevance for IH, however, is that legal services attorneys have successfully challenged non-compliant jurisdictions in the courts, resulting in local adoption of IH as a way to meet jurisdictions’ fair share. In the City of Folsom for example, the court issued a moratorium on development of all vacant sites until the City agreed to undertake specific steps to zone adequate sites for affordable housing, create a housing trust fund, and adopt a mixed-income housing law (Hallfeldt v. City of Folsom, 2002). The City’s IH ordinance requires that at least 10 % of new housing be affordable. Several other jurisdictions have also created IH programs in response to court edicts.
2.3 California inclusionary programs in international perspective
As noted earlier, the worldwide movement of national, regional, and local governments to adopt inclusionary housing is perhaps one of the most important housing policy trends of the last few decades. The factors that have combined to catalyze international interest in IH are many-faceted, but share the thread of declining supplies of affordable housing for increasing numbers of residents. Program variations reflect the unique political, legal, financial, and economic conditions within each country and within distinct regions of countries.
It is helpful to understand the particular brand of inclusionary housing practiced in California and the United States, which, in general, reflects the peculiarly American federal system of governance and reverence for local control and private property rights. In the U.S., land use decisions are highly decentralized, with the national government deferring most decision-making on non-federal lands to states and local governments. Decisions pertaining to the locations, types, and quantity of affordable housing are the province of state and local governments, with many powers reserved at the local level.
At the state level, governments have also taken a ‘hands-off’ approach when it comes to requiring private developers to produce affordable homes they would not otherwise choose to produce on their own. State governments often incentivize affordable housing via scoring preferences in competitive funding programs, rather than mandating when, where, and how such housing will be produced. Some states, like California, require units of local government to plan for affordable housing, but no state imposes a mandate directly on private developers. Regional governments, where they exist, serve at the pleasure of member local governments and do not have independent authority to dictate pro-affordable housing land use decisions or override decisions that create barriers to affordable housing.
The absence of strong interventions at the national, state, and regional levels reflects the extreme ambivalence, if not hostility, many Americans have towards government, especially the highest levels of government. It is inconceivable, therefore, that anything close to the mandatory inclusionary housing policies adopted by some national or regional governments could ever be achieved in the U.S. Even local governments, which are considered the ‘closest’ to the people, are hesitant to directly intervene in the housing market when opposed by powerful and well-funded private property and development interests. Consequently, IH in California is a patchwork of uniquely customized policies that offer a smorgasbord of different programmatic permutations of highly variable effectiveness.
Furthermore, as discussed later, the concept of land value recapture, also known as community betterment or value-plus, which has been used as a justification for inclusionary policies in some countries, is virtually non-existent in the U.S. context. In countries like England and Spain, private financial gains from increased private property values generated by public actions are to be shared for the public good (Calavita and Mallach 2009). Within the American context, value-enhancing actions by local governments that confer collateral financial windfalls on private land owners, such as up-zoning from agricultural to residential uses or construction of nearby infrastructure improvements, are ‘banked’ by the owner and rarely shared with the public sector.
2.4 Goals and limitations of inclusionary housing
Most proponents of inclusionary housing hold that IH is an appropriate tool for government intervention. They cite at least the following three goals.
2.4.1 Increased production
Production of affordable housing in California, as in many other parts of the U.S., is very expensive due to the high costs of labor, materials, local fees, financing and, above all, land. IH increases affordable housing supplies by mitigating two of these costs. It shifts some public costs of financing to private developers and it ensures that scarce land slated for development in new-growth areas or in-fill sites in old-growth areas includes affordable housing. Moreover, the existence of an IH requirement, described later, may actually reduce the value of land in a community. Given deep cuts in government housing subsidies, these cost reductions are critical in expensive localities.
2.4.2 Social and economic integration
A singular element of IH that distinguishes it from other affordable housing strategies is its potential to achieve social and economic integration. Where programs are working to maximum advantage they are providing real opportunities for lower-income households to live in new-growth areas, including urban infill sites undergoing regeneration, with high-quality schools, shopping, parks, infrastructure, and services. In many cases, the affordable units are contiguous to and indistinguishable from market-rate units. These households live side-by-side with middle-income households, instead of concentrating them in distressed areas.
When the affordable units are built generally at the same time as the market-rate units, concurrent development can mitigate one of the major obstacles to affordable housing production—opposition from existing neighbors. Organized neighborhood opposition adds additional, costly delays and can kill projects. Simultaneity can preempt local resistance.
However, even the most effective inclusionary housing programs have important limitations and these are readily conceded by program proponents. IH is not a panacea. First, it only works in jurisdictions that are growing and is subject to the vicissitudes and volatility of the residential construction industry.
Housing development is a slow process, and even with a relatively good 2 % annual growth rate, adding 20 % to the housing stock over 10 years, a typical inclusionary requirement of 10 % will increase the supply of affordable housing by less than 2 % of the total housing stock over that 10-year period. In the current economic environment with permitting of new home-building at all-time lows, few affordable units are being produced via IH.
Second, there are great variations in the quality and productivity of programs. The most successful jurisdictions create mandatory programs accompanied by meaningful incentives that result in actual units, whether by direct production, land dedications, or fees. Jurisdictions with voluntary programs that rely only on ‘carrots’ with no ‘sticks’, mandatory programs with weak compliance alternatives, or mandatory programs that impose onerous conditions with few, if any, financial or regulatory offsets typically fail to achieve the purported goals of the program.
Third, IH is only one tool, and perhaps a modest one at that, among the many land use and financing strategies that can be deployed by local governments. Some jurisdictions impose IH requirements on market-rate developers but deny or obstruct housing production by affordable housing developers, using a weak inclusionary requirement as a ‘fig leaf’ to mask exclusionary policies. Relying solely upon inclusionary mandates on private developers defeats the purpose of an IH program, which is to supplement not replace other production methods.
Finally, administering these programs and ensuring compliance with affordability covenants can be labor-intensive and requires systematic and long-term monitoring. In smaller, lower-capacity jurisdictions, lack of professional staff and oversight can undermine a well-intentioned program.
2.5 Economic impacts of IH on land values, unit production, and home prices
Arguably, the question of who pays for inclusionary housing is still an open issue that has not been proven with absolute certitude by either proponents or opponents. To determine conclusively whether market-rate consumers ultimately bear some or all of the cost, close inspection of developer pro formas for actual developments would be needed to fully understand how the production of below-market rate units factors into developer profitability and choices. Nonetheless, we have both theory and research to draw on to help resolve the arguments over the economic impacts of IH.
A key concept that is often overlooked in this analysis is land value. Typical market critiques of IH fail to recognize that housing has two distinct components—the building and the land—and that land value or land rent has a very different character than the value of most commodities sold on the market. Urban or urbanizing locations gain their value from a combination of value-enhancing externalities resulting from government services, such as highways and streets, fire and police protection, and schools, as well as the economic activity and status of the population around those locations. This value is created by the public as a whole, not by the land owner, and the public can fairly lay claim to a share of that value, especially when development approvals will generate windfall profits for the land owner. The role of the public in creating land value is widely recognized in Europe, but little understood in the U.S.
The challenge for inclusionary ordinances, then, is whether they can be designed so the costs fall on the land rather than the building. For this reason, Calavita and Mallach (2009, pp. 15–21) recommend that new inclusionary ordinances have a phase-in period during which developers and landowners can adjust their expectations about land values. As long as the developer can offset the cost of the inclusionary units via purchase of land at reduced prices, the requirement should have little effect on the overall profitability of the housing. In addition, they argue that the ordinances will be most effective when accompanied by changes in zoning that allow greater densities and other developer incentives that will enhance profit-taking. This is because, if the IH requirement only reduces land values, some owner-developers will simply hold onto the land waiting for a higher price and not develop it. Speculative land-holding is peculiarly a problem in California, where a constitutional limitation on increases in the property tax until sale makes it inexpensive for owners to hold underutilized land.
The actual experience of California’s IH ordinances shows that they have had little effect on overall housing production. Bento et al. (2009) found that inclusionary programs tended to make single-family housing more costly, but also increased the production of multifamily housing. This finding is worth considering in more detail. In the U.S., most local governments have long been dominated by local owners of single-family detached homes who associate density with crime and reduced property values (Perrin 1977). The result is a persistent bias in land use regulations against construction of multifamily housing.
Longitudinal studies of permitting activity in California jurisdictions with inclusionary policies indicate that construction activity does not decrease as a direct result of the adoption of an IH program (Rosen 2004; Schuetz et al. 2009a, b). Some jurisdictions, in fact, experienced increases in permitting activity after adoption. Where construction activity has decreased, the change is much better explained by national downturns in the construction economy caused by such extra-local factors as higher interest rates or by such local conditions as dwindling supplies of land or anti-growth movements. An analysis by Rosen of 28 cities in California with and without IH found that production decreases correlated much more closely with locally high unemployment rates than they did with adoption of an IH program. Claims to the contrary are based on industry-sponsored research with major methodological flaws (Basolo and Calavita 2004; Rusk 2005).
Furthermore, claims that the costs of inclusionary housing are shifted to market-rate renters and buyers are counter-intuitive. Developers and landowners are business people who strive to maximize their returns on investment. If they thought buyers were willing and able to pay higher prices, they would charge higher prices. It also likely that if developer costs were to decrease, for example, due to elimination or reduction of an inclusionary requirement, home prices would remain at the same levels, although land values and land prices might increase.
The weight of opinion in the academic and professional literature is that home prices will only rise in the aggregate if IH programs result in reduced or skewed housing production. As we have seen, there is little evidence for this in California, although some evidence in the Boston area (Schuetz et al. 2009a, b, 2011). The critical factor is whether the inclusionary program is well-designed and flexible to meet local conditions. Overall, the economic case for inclusionary ordinances is strong in areas with high land values, such as coastal California.
3 Key characteristics of IH programs in California
In this section, we profile the major characteristics of IH programs in California and evaluate what lessons can be learned from current practice and experience.
Since the first program was adopted in 1973, IH in California has increased enormously. In a 2006 survey, 170 jurisdictions self-reported they had inclusionary requirements.3 From 2007 to 2008, the California Coalition for Rural Housing (CCRH) assembled electronic and hard copies of the ordinances and policies of nearly all of these jurisdictions. Through closer examination and contacts with key local government staff, 25 programs did not meet the study’s definition of IH, arriving at the current number of 145 programs in more than a quarter (26.9 %) of the state’s 540 jurisdictions. Over 30 key characteristics of these programs were input into a searchable database at www.calruralhousing.org. This paper draws from these earlier studies, information in the CCRH database, and field work to profile the characteristics of all IH programs extant in California.
3.1 IH production has resulted in more than 29,000 units
Perhaps the most important question concerning IH, and the most difficult one to answer, is how many affordable units have resulted. One estimate in 2003 is that these programs had resulted in the addition of at least 34,000 affordable units to the state’s housing stock.4 Another study estimated that from 1999 to 2006 these programs had produced over 29,300 new affordable homes.5
There are multiple challenges to determination of the number of IH units produced. First, these programs span more than four decades and earlier units, especially for purchase, were not systematically inventoried and monitored. Moreover, staff initially responsible for administering these programs may have long since departed, leaving no records for successor staff. Second, program implementation is often the province of more than one local government department and there may be no single person responsible for compliance monitoring once units are put into service. Third, since these programs are not mandated by the state, there is no centralized reporting and documentation system. Data collection is wholly dependent on the cooperation and records of local staff located in over 140 jurisdictions scattered throughout the state.
3.2 Most programs were adopted within the last 20 years
3.3 The majority of programs are located in expensive coastal communities
In recent decades, the fastest-growing areas of IH adoption have been in outer ring suburbs and rural parts of the state that have experienced increased pressures on home prices from ‘spill-over’ growth from urban dwellers. These include interior cities and counties that are still affordable to and within commuting distance of city wage-earners, as well as tourist, resort, and retirement destinations that have become new magnets of population growth. Lower-cost communities away from major metropolitan cities and from the coast are much less likely to have IH programs.
3.4 Most IH programs are in small towns
3.5 Inclusionary requirements triggered by unit-number threshold of 5 units or less
3.6 Typical inclusionary programs target 10 or 15 % affordability
Within these percentages, jurisdictions typically differentiate among different income bands. For example, a city mandating 15 % affordability might require that 8 % of units be affordable to low-income households at 51–80 % of area median income (AMI) and 7 % affordable to very low-income households at 31–50 % of AMI. Some jurisdictions establish minimum and maximum percentages depending on the size of the development. For example, the City of Davis requires developers of multi-family rental developments containing 20 or more units to ensure that at least 25 % of the units are affordable to low-income households and at least 10 % are affordable to very low-income households. A developer of multi-family rental developments containing between five and 19 units, however, need only ensure that 15 % of the units are affordable to low-income households and 10 % to very low-income households.
In order to incentivize developers to produce homes affordable to very low- and extremely low-income households, some jurisdictions further allow that percentage minimums may be reduced the deeper the targeting. For example, a program requiring no less than 10 % of total units be available for very low-income households might reduce the requirement to 5 % if the developer agrees to dedicate units with rents affordable to extremely low-income households at 0-30 % of AMI. The theory is that units targeted to the lowest-income populations are scarce and require developers to more deeply subsidize rents. Therefore, it is good public policy to exchange fewer units for deeper income-targeting.
3.7 Rental units target lower-income households than owner units
3.8 Programs require units stay affordable from 30 to 55 years
Additionally, there has been an ongoing tension in housing policy as to whether production of homes for lower-income homebuyers should be mostly about creating wealth or increasing supply. One view is that these households should have mostly unfettered access to the equity in their homes in order to graduate to better housing and achieve economic independence. Some earlier owner inclusionary programs did not impose deed restrictions on the first occupants of the homes and allowed them to sell whenever and to whomever they chose at whatever price.
Most jurisdictions now take the view that units should remain affordable for a specified number of years and control equity access through a deed restriction recorded against the property, although terms vary greatly from jurisdiction to jurisdiction. Some allow owners to sell units on the open market at market price, but share a portion of the equity proceeds upon sale depending on the number of years the unit was owned—known as subsidy recapture. Others limit the sales price to an amount that is affordable to the targeted income group—known as subsidy retention. However, monitoring units is very difficult as many jurisdictions do not have dedicated staff and systems to track affordability over time.
3.9 Jurisdictions offer a range of compliance alternatives
Jurisdictions vary greatly on how they implement each of these compliance alternatives. In-lieu fees typically are formula-based and are linked to 100 % or less of the construction cost or purchase price of a comparable unit. Off-site construction allows the inclusionary units to be built simultaneously on another site owned by the developer, provided the site has acceptable zoning, carrying capacity, and other locational attributes. Land dedications permit developers to contribute land to the local government, which may be deeded to an affordable housing developer, to build an equal or greater number of IH units. And, conversions enable developers to meet the IH requirement by converting an existing residential or non-residential property into affordable housing.
Each alternative involves trade-offs. For example, a jurisdiction may conclude that it is better public policy to favor a land dedication than on-site construction if a greater number of affordable units with deeper affordability will be produced by a nonprofit organization on the site. The trade-off may be more units but less inclusion if the dedicated site is not integrated into an area with higher incomes than the target population. A jurisdiction may also decide that the in-lieu fee is preferable to on-site construction because the funds can be used flexibly to meet pressing needs off site, such as operating funds for a homeless shelter, capital funds to rehabilitate an existing affordable housing complex, or down payment assistance for first-time homebuyers.
Generally, larger jurisdictions are more likely to have more sophisticated and complex programs than smaller jurisdictions and offer a greater range of alternatives. Smaller jurisdictions may seek to limit alternatives in order to simplify administration and avoid alternatives, such as land dedications, that will place them in the de facto role of housing developer.
3.10 Jurisdictions offer a range of developer incentives
On the other hand, flexible design, fee deferrals, fee waivers, and fee reductions, which are offered by 59, 50, 44, and 40 % of jurisdictions, respectively, are concessions that local governments can often grant on a discretionary basis without public approval. Design concessions, in particular, can greatly reduce developer costs by allowing developers to produce smaller units with fewer amenities using more economical materials, provided that the outward appearance of the units is compatible with the market-rate homes and physical quality and functionality are not compromised.
Design- and building-approval concessions, such as fee deferrals, waivers, and reduction, may be less controversial than increased density. Flexible design, in particular, can greatly reduce developer costs by allowing developers to produce smaller units with fewer amenities using more economical materials, provided that the outward appearance of the units is compatible with nearby market-rate homes.
Subsidies are an incentive in one-half of jurisdictions’ policies. This is perhaps the most critical incentive to offset developer costs and mollify developer opposition, especially for the production of units targeted to the lowest-income groups. However, in an environment of limited and highly competitive credit and capital at the national, state, and local levels, the inability of local governments and developers to mobilize sufficient subsidy can greatly inhibit IH program effectiveness.
4 Current economic and legal factors affecting inclusionary housing in California
Perhaps at no time since adoption of the first inclusionary housing programs in the 1970s have the underpinnings of IH been so challenged as they are now. Unprecedented home price increases during the first half of the 2000s, followed by steep price declines and the worst economic downturn since the Great Depression, have jolted IH implementation as never before. Older IH programs have weathered periodic cycles of reduced construction and declining prices in the past. The question ahead is whether current changes in the housing market are just another cycle—a temporary correction—or reflect a long-term transformation to a new post-inclusionary period.
The changing economics of IH in California: In California, home prices grew at an historic pace from the beginning of 2000 through the end of 2006, increasing 133 % or an average of 22.1 % per annum and over 30 % per annum in some markets.8 Affordability reached an historic low in the 2nd quarter of 2007 when only 11 % of first-time homebuyers could afford an entry-level home in the area where they lived.9 Meanwhile, production of new homes rose to a peak of 207,400 units in 2004,10 but not nearly enough to meet the cumulative aggregate demand over many years.
Today, the prices of new and existing homes for purchase have dropped by more than half in some of the most over-heated markets. High concentrations of foreclosed properties in many markets have had a depressive effect on home prices. According to the California Association of Realtors, the median price of a single-family home declined by 51.3 % from the peak of $597,64011 in April 2007 to $291,080 in March 2012.12 Over half (55 %) of first-time homebuyers could afford the median-priced entry-level home at the end of 2011, quintuple the low point in 2007.13 Only 45,200 residential permits were pulled in 2011, up from a record low of 33,000 in 2009, but far below the volume needed.14 In 2013, home prices have begun to rebound, but the continuing presence of significant numbers of vacant and foreclosed properties in some areas has created a popular perception that there is no longer an affordable housing problem and that IH is unnecessary because low-cost homes can already be found in the private market.
Relaxing affordability targets for above-moderate or middle-income units which are now affordable in the market.
Recalibrating formulas for computing prices of new homes for purchase because current formulae are yielding prices equal to or exceeding current market prices.
Reducing lengths of affordability of new homes for purchase to make deed-restricted, below-market units more desirable than non-restricted, market-rate homes.
Reducing the dollar amounts of in-lieu fees.
Adverse court decisions: In addition to economic challenges, two recent court decisions in California have created a chill in IH adoption and implementation which decades of builder opposition could not achieve. The long-term implications are still unknown, but in the short-term many cities and counties are revisiting their policies and exploring modifications and work-arounds to limit legal exposure.
In the first of the cases, Building Industry of Central California v. City of Patterson (March 2009), the Fifth Appellate District Court found that the City had imposed an unreasonable and unsupported in-lieu fee on a residential developer (Rawson 2010). In other words, the City had failed to demonstrate the linkage between the production of market-rate homes and increased need for affordable housing and this need justified imposition of a fee of nearly $21,000 per unit. Having not proven an appropriate nexus, the in-lieu fee component of the City’s IH program was invalidated.
The upshot is that some jurisdictions have concluded that they must now conduct a nexus study to: (1) make the link between new market-rate housing development and increased demand for affordable housing; and (2) determine an appropriate fee in lieu of development. Previously, jurisdictions imposed fees as an alternative compliance method typically tied to the replacement cost or purchase price of a comparable unit affordable unit rather than the supposed cost that market-rate housing production has on housing affordability. The justification was that jurisdictions have the authority via their land use and zoning powers to dictate what kinds of private development may occur within their borders.
A nexus justification for exaction of an in-lieu fee creates not only an additional burden of proof and legal jeopardy, but bureaucratic and financial demands. For some jurisdictions, especially jurisdictions with low staff capacity and financial resources, such a reading of Patterson may cause them to reduce the fee, eliminate the in-lieu fee option altogether or, in exceptional cases, repeal their ordinances. Ironically, the City of San Francisco commissioned a sophisticated nexus study which yielded significantly higher in-lieu fees per unit than existed in their programs prior to Patterson. Some developers, thus, may conclude that challenges in higher-capacity localities are too risky and that the production option may be preferable. Moreover, in two subsequent suits brought by the building industry against the Cities of Sunnyvale and Palo Alto, trial courts have opined that IH serves a legitimate public purpose and need not be based on the demand for affordable housing created by new market-rate housing.
The second case, Palmer/Sixth Street Properties v. City of Los Angeles (July 2009), poses perhaps even more daunting challenges to IH. Here, the Second District Appellate Court concluded that the City had violated the state’s rent control law, the Costa-Hawkins Rental Housing Act of 1995, which allows landlords to set initial rent levels at the commencement of a tenancy. IH proponents have argued that the court misread the legislative history of Costa-Hawkins, which was intended to apply only to market-rate rental housing, not affordable rental housing built with public involvement. Nevertheless, the effect of the ruling is that mandatory rental inclusionary housing programs have momentarily come to a virtual standstill. Owner inclusionary housing programs were not affected by Palmer.
Legislation in 2011–2012 (Senate Bill 184) to clarify that local governments have the police powers under the State Planning and Zoning Law to adopt an ordinance establishing, as a condition of development, inclusionary housing requirements was defeated in the California Senate due to builder opposition. Consequently, jurisdictions are currently left with few options. These include:
Nexus fees on new rental housing: While Palmer currently prevents local governments from requiring private developers to set initial rents below market rates, except when they voluntarily agree to rent restrictions in exchange for financial or regulatory incentives, it does not prevent imposition of nexus fees on new rental development. As previously mentioned, some justifications have responded to Patterson by conducting nexus studies as a way to justify fees on new market-rate rental housing and generate funds for affordable housing developers to build low-rent housing.
In-lieu fees on new owner housing: Likewise, jurisdictions may still collect fees in lieu of production of price-restricted ownership units, which are not precluded by Palmer. These fees do not need to be used to build affordable homes for purchase and can, instead, be deployed to subsidize production of affordable rental housing.
Affordable housing overlay zones: As an alternative to IH, an increasing number of jurisdictions are designing and adopting affordable housing overlay zones. These are incentive-rich areas overlaying multi-family zones that are intended to entice private developers to build affordable housing voluntarily and avoid running afoul of Palmer and Costa-Hawkins. Incentives may include financing and regulatory concessions. A ‘super’ density bonus ordinance could be adopted in such zones to reward developers agreeing to build additional affordable units above and beyond what is specified in State law. This voluntary approach, however, is less desirable than a traditional rental inclusionary program that mandates actual production of below-market-rate units.
The full impacts of Patterson and Palmer may not be known for years until subsequent courts weigh in and the revival of the construction sector forces jurisdictions to reconsider their programs to avoid legal challenge. In the meantime, implementation is uncertain and jurisdictions are struggling to fit their programs to the new economic and legal realities.
For 40 years, inclusionary housing has been a tool for local governments in California to manage the character of residential growth and create inclusive communities. Analysis of recent surveys, distillation of information from ordinances and policies, and case studies in California reveal that IH is working, albeit with great variation from jurisdiction to jurisdiction. Not only has IH been a strategy for larger cities, suburbs, and metropolitan counties, but increasingly a strategy of choice for smaller towns, resort, and retirement destinations with severe shortages of affordable homes for local residents. The popularity of IH coincides with a sustained period of rapidly growing population, decreasing housing affordability, and shrinking federal involvement in the financing of new affordable housing, especially for rent. Without IH, at least 29,000 affordable units would not have been produced in California.
The absence of mandatory inclusionary housing at the national and state levels has created the space for each jurisdiction in California, acting on its own, to design and adopt programs that best meet local conditions, while attempting to satisfy the State requirement that communities plan for and meet their fair share of the regional housing need. However, it also means that about three-quarters (73 %) of jurisdictions do not have IH requirements and the quality of these programs varies greatly.
California’s IH programs reflect the highly decentralized land use planning and regulation regime in the United States, which cedes most authority for zoning and development approvals, including housing, to local jurisdictions rather than federal, state, or regional bodies. In contrast, IH in European and other countries is reflective of the more central role played by the national and regional governments in local land use and housing policy. The imposition of strenuous IH requirements by the national government would be unthinkable in the American context.
Inclusionary housing only works when private builders are building. In today’s environment, characterized by declining home prices, high unemployment, scarcity in the capital and credit markets, budget deficits at all levels of government, and greatly reduced construction activity, the future of IH is uncertain. Moreover, in California, recent court decisions have favored private property and development rights over the discretionary authority of local governments to impose certain IH requirements. The practicality and durability of IH in the coming years will be largely determined by how nimbly these programs, adopted under very different economic conditions, can be recalibrated to assimilate current realities and counter-cyclical trends in housing.
The answer, then, to the question whether California has entered a post-inclusionary period is ‘too early to tell’. Most economists agree that the housing sector will eventually rebound, hopefully not repeating the excesses of the boom years of the mid-2000s, but to a new normal with more sustainable levels of production and consumption. And, there will always be a segment of the population unable to satisfy its shelter needs through the market and a need for more affordable housing for rent and purchase. Less certain is how the current legal challenges to inclusionary housing in California will play out and if IH will ever be able to return to its pre-Patterson and -Palmer prominence. And, more broadly, without strong inclusionary requirements, how will California’s local communities increase their supplies of low-cost housing and achieve economic and social integration.
Nonprofit Housing Association of Northern California, California Coalition for Rural Housing, San Diego Housing Federation, and Sacramento Housing Alliance (2007).
Nonprofit Housing Association of Northern California, et al. pp. 26, 33.
Nonprofit Housing Association of Northern California, et al. p. 5.
California Coalition for Rural Housing and Nonprofit Housing Association of Northern California (2003).
Nonprofit Housing Association of Northern California, et al. p. 5.
The nine San Francisco Bay Area counties are San Francisco, Marin, Sonoma, Napa, Solano, Contra Costa, Alameda, Santa Clara, and San Mateo. The southern coastal counties are Los Angeles, Orange, and San Diego. The Sacramento metropolitan counties are Sacramento, Yolo, Sutter, Yuba, Placer, and El Dorado.
California Department of Finance. (2007). E-4 Population Estimates for Cities, Counties and State, 2001–2007. Sacramento, CA.
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California Association of Realtors. (2012). Housing Affordability Index—Traditional. Market Data. Sacramento, California. Retrieved on May 31, 2012 from http://www.car.org/marketdata/data/haitraditional.
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California Association of Realtors. (April 2012). March Home Sales and Price Report. Newstand. Los Angeles, California. Retrieved on May 31, 2012 from http://www.car.org/newsstand/news/march2012sales.
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Union Democrat. (October, 6, 2010). Sonora, CA. Retrieved on May 31, 2012 from http://www.uniondemocrat.com/News/Local-News/County-tweaks-housing-rules.
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