Who Pays?

Who pays for the affordable housing provided under inclusionary zoning is a key question.  The provision does not come free. The requirement for developers to provide housing at less than its full market value creates a cost burden that must be absorbed somehow in the development process.

Knowing who pays this cost burden is fundamental to understanding how IZ works, and also how to create programs that are both effective and as fair as possible to the developers.

The following examination is based upon what has happened with IZ programs in the US. It applies only to mandatory IZ programs, as voluntary (or incentive-based) programs set-up a different dynamic about who shoulders the burden.

The following deals in turn with each of the potential candidates for bearing the cost:
∙   the municipalities;
∙   the developers;
∙   the other homebuyers; and
∙   the landowners.

Municipalities

IZ is not reliant on funding either from the municipalities, or any other level of government, to provide the affordable housing. IZ can and does successfully operate without the use of any financial subsidies.

Having said that, it must be noted funding is used in particular circumstances, and this clearly represents the exception rather than the rule. To be more specific, the funding is always applied on top of what is required by the inclusionary regulations. In this way, the funding is used to reach an even lower level of affordability not possible by IZ alone.

What many municipalities – but no means all – do offer are regulatory concessions in exchange for the affordable housing. These typically allow for relaxing certain regulations (such as, those setting density and height limits, parking standards, and others), waiving fees and charges and using fast-tracked approvals. All of these concessions have an economic benefit, but they do not involve actual cash transfers.

In none of these programs, however, do these concessions make the developers “whole” again. In other words, they are not designed or calibrated to cover the full cost of providing the affordable housing. These concessions might be better seen as political cover, rather than anything close to financial remuneration.

Also, it is important to note there are also successful programs that offer no such concessions whatsoever. This indicates that the provision of the affordable housing under IZ is not dependent upon having these concessions, and so they are really not necessary at all.

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.

Finally, municipalities also typically offer cost savings through regulatory concessions of another type. Many allow for the affordable units to be smaller in size, and/or to be built with a lower standard of finish, fixtures or amenity generally. In other words, while the affordable units must still meet an acceptable minimum standard of construction, they need not match the market units in all of their costly aspects. These savings are most unlikely to cover the cost burden, but they do serve to soften that burden.

Developers

IZ programs do not expect nor rely upon the developers absorbing this cost burden. They are particularly not expected to take a loss to their profits. This is an assumption held by many, but one that is wrong.

It is unreasonable to expect developers to take the hit. Although the municipalities under IZ can mandate the provision of affordable housing as a condition of building, they have no power to compel developers to actually build anything. Developers can and will stop building when suffering an undue financial loss caused by the inclusionary requirements.

That the developers are not hit unreasonably by IZ is supported by clear empirical evidence showing that they do not stop production in municipalities with IZ. Two studies, done by non-partisan and university-based organizations (see  Furman and Smart Growth), both independently came to the same conclusion: namely, that IZ has had little or no impact on the overall production of housing in communities where it is used. Where IZ did have an impact – and this should be of no surprise – was on the size and type of housing being produced. In other words, IZ caused the production of smaller units and more multiple housing, but not a cut in the overall housing output.

From these findings, it can be reasonably inferred that developers are able to accommodate to the affordable housing requirements, and to continue to build without significant damage to their bottom lines, at least once these programs are fully established (see FOOTNOTE).

Homebuyers

Developers take the position that under IZ programs they will simply pass on the cost burden to the other buyers in any particular development. In turn, this will inevitably drive up the price of housing generally. As a consequence, these programs are asking the other homebuyers to subsidize the buyers of the affordable units.

The available empirical evidence does not support this position. Specifically, the authoritative studies noted above also examined the impact of IZ on housing prices and came to the same conclusion – namely, that IZ had little or no impact on housing prices. The house prices in municipalities with inclusionary requirements were virtually the same those in municipalities without. And, if there was any rice increase attributable to IZ, it was insignificant when compared with the overall increase in market prices felt in those places.

The reason for this is easy 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 the individual developers on their own. Furthermore, developers can be reasonably expected already to be charging what they consider to be the full market value for their product. So, any cost burden imposed by IZ, or any of the myriad other potential cost increases, cannot be simply passed on to the other homebuyers in the form of higher prices.

(Developers sometimes express this position by saying that the homebuyer ultimately pays for everything – including not only the house itself, but also all of the government impositions like development charges, planning fees and inclusionary requirements. This is true but only to a point, because there also 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 (plus their profits) somehow stay within that market price.)

Landowners

Economists that have examined IZ generally conclude the cost burden of these programs is mainly “passed back to the land” (see FOOTNOTE). By this they mean that any additional cost associated with IZ – or at least that not recovered in other ways like the regulatory concessions – results in the developers offering and paying less for the land. This outcome is not specific to IZ; it applies to all cost increases that cannot be included in the overall purchase price.

Before buying any piece of land for development, developers typically do some sort of financial analysis that involves comparing projected revenues with projected costs in one or more potential schemes. The inclusionary requirement is just another one of the many costs that needs to be quantified and considered in this analysis. Ultimately, it is the difference between the revenues and the costs (plus profits) that sets the ceiling for the price they can offer for the land.

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

Summary

The provision of affordable housing under IZ does impose a cost burden that must be absorbed somehow in the development process. That cost burden hits various players in this process in the following ways:

∙ The other homebuyers are not affected by these programs in any substantial way. Specifically, they do not see any significant increase to the house price they pay. While developers will certainly try to pass these costs on to the other homebuyers, their scope for doing this is very limited.

∙ The developers do not, nor are they expected to, absorb this cost. In particular, they do not typically take a profit loss under these programs.

∙ The municipalities generally offer regulatory concessions in these programs, but these concessions only provide limited and partial recompense. They do not offer financial subsidies for meeting the basic inclusionary requirement, but can use subsidies for meeting still deeper levels of affordability.

∙ The landowners must absorb most of the cost burden associated with these programs. Developers typically pass these costs back to the landowners by offering to pay less for the land.

FOOTNOTE

The foregoing analysis describes what happens in mature programs that have been in operation for some reasonable time. In these programs, the market dynamic will have adjusted so that the developers will have learned to limit what they offer for the land. So, in this way the cost burden will be passed back to the purchase price of the land.

There will be a different dynamic when these programs are first introduced. Developers already owning the land, and particularly those that have developments in the approval pipeline, will not be able to pass these costs back to the land. As a consequence, these developers could be hit by the costs of the inclusionary requirements.

To be fair to these developers, this problem will have to be addressed in some way – possibly, by phasing-in the provisions and/or delaying compliance until the adversely effected projects can be flushed through the approval pipeline.

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