What makes an effective program?

The experience in the US shows that to be fully effective IZ programs should incorporate a number of key aspects.  These aspects deal with how the rules in IZ programs should be framed and approached rather than with what specifically should be in them. (The latter is addressed in an introductory way in this website in A Guide to Developing Inclusionary Housing Programs.)

1)    Make the programs mandatory

First and foremost, the programs should be mandatory – that is, they should require the developers to provide affordable housing as a condition of obtaining a development approval.

Voluntary (otherwise called incentive-based or optional) programs have been proven to be far less effective in producing affordable housing. Developers have shown little interest in voluntarily providing that housing even in exchange for incentives. As a consequence, voluntary are no longer considered to be a credible option.

Municipalities also should be aware of a crucial difference between the two. In voluntary programs, the municipalities will be expected to provide sufficient compensation to make the developers “whole” again – that is, to cover the cost burden associated with the affordable housing. In well-designed mandatory programs, municipalities will not have that responsibility, for the cost burden can be passed back to the land.

2)    Apply the obligation as universally as possible

In order to achieve the greatest output, the affordable housing obligation should fall on as many developments as possible. These should include developments proceeding as-of-right, as well as those getting a rezoning. Also, they should include small developments because they typically represent a significant proportion of the total housing production.

Applying the obligation as widely as possible is also important for another reason: it is necessary if all developers are to be treated consistently and fairly.

3)    Use fixed and non-negotiable rules

The rules should be fixed, non-negotiable and set out in advance. This applies most particularly to those rules determining the cost of the affordable housing obligation, and also the value of any concessions (if any) provided by the municipality.

Fixed rules are fundamental to mandatory programs, as there can be no mandatory obligation if it can be negotiated away. They also are important for treating all developers consistently and fairly, and for facilitating the approval process.

Finally, fixed rules crucially affect the need for compensation in the programs. When developers know the cost burden of the affordable housing obligation with certainty and ahead of time, they will offer correspondingly less for purchasing the land for development. In effect, this will reduce or eliminate the need for other compensation by passing the cost of the affordable housing back to the land.

4)    Target “below-market” housing

The programs should be directed at extending the affordability range of the housing currently being made available. They will serve little or no public purpose if they are used to produce more of what private developers are doing already. So, the programs should clearly target “below-market” housing – meaning housing provided at a price or rent below what the market is providing for the equivalent housing

5)    Allow enhanced provision through negotiation

The programs should be capable of taking advantage of, and even encouraging, opportunities to secure enhanced provision. Most developments can be expected to meet the minimum provision with no negotiation, and with no change to the required obligation nor the concessions (if any) offered. But there will be others willing to provide an enhanced provision – possibly through a larger number of affordable units and/or the units at a deeper level of affordability. To achieve, the programs will need to be open to negotiating compensation specific to the added costs associated with that enhanced provision, and to fostering partnerships with non-profit providers.

6)    Maintain affordability “permanently”

The affordability of the affordable units should be protected for a long period of time, if not permanently. Those protections should ensure the housing remains available at an affordable rent or price, and only to income-eligible households.

During that period, the units should not be sold in the open market, even if the value of affordable housing is recaptured, because the inclusionary benefits of the housing will be lost.

7      Provide flexibility but within limits

The regulations should provide some flexibility in how the affordability housing obligation is met – particularly, by allowing the use of cash-in-lieu payments and off-site development. Both of these are important and useful ways of producing a wider range of affordable housing types and/or housing at deeper levels of affordability. They also potentially have the added benefit of engaging the non-profit sector in producing that housing.

There is a downside to allowing unlimited access to these options. Many developers will take advantage of them, with the consequence that the benefits of inclusionary developments will not be achieved.

So, the options should be available only at the discretion of the municipality, and only then where they can be demonstrably shown to produce a greater public benefit than the on-site obligation. There could be still other limits, such as requiring these options to be used only on developments in close proximity to the originating development.

8)    Recognize the importance of growth

These programs depend upon harnessing market activity to provide affordable housing. They take a share of what the developers are otherwise building. Where there is little or no such activity, IZ by itself is not capable of producing much affordable housing.

As a consequence, it should be recognized that the programs work most readily in communities or areas facing sustained and strong growth. They work well there because the growth leads to rising land values that can be tapped to support the provision of affordable housing.

What is not necessarily needed – compensation

Compensation for the affordable housing is not necessarily needed in mandatory programs in order for them to be productive. This is shown by the many productive programs that provide no or only limited compensation.

Mandatory (unlike voluntary) programs can be designed so that cost burden is passed back to the land – that is, reflected in the purchase price offered for the land. This can be achieved by setting reasonable affordable housing obligations, and using fixed rules that establish the cost burden with some certainty in advance.

Most of these programs do offer compensation, but only mainly through concessions available through the regulatory process – such as, relaxed development standards (notably, increased density), fee waivers and fast-tracked approvals. These typically do not include cash subsidies, property tax abatement, nor state or federal assistance of any kind.

Density increases are the most effective and widely used of these regulatory concessions. They are particularly valuable because the economic benefit generated by additional density will be by itself sufficient to cover the cost burden of the affordable units.

In most cases, however, that compensation can be best described as being no more than notional or token. The amounts are arbitrarily set and not related to the cost burden. They are based on what the municipalities can readily provide, and not what they need to provide. Once set, the compensation is seldom adjusted, although the cost burden changes over time and project-by-project.

There is certainly no evidence – whether in their ordinances or actions – that the municipalities in mandatory programs have ever assumed any obligation to make the developer “whole” again, or even to cover the cost burden in any calibrated or substantial way.

Compensation is provided the most in particular circumstances – namely, where the developments provide an enhanced provision beyond the minimum obligation. To do this, these developments need to be offered incentives covering the added costs specifically due to that enhanced provision. Because they are often negotiated on a one-off basis, this leads to much wider range of compensation being used than normally associated with these programs.

Density Bonusing

Density Bonusing

Density bonusing has been long identified with inclusionary zoning, but it is time for this association to be severed.  Simply put, density bonusing represents an ineffective and generally inappropriate approach to inclusionary zoning, and so should be no longer used in this context.

Density bonusing refers to the practice of giving developers the right to build additional density in exchange for providing affordable housing.  The increased density is given to offset the cost burden of providing the units.

Density bonuses are one of various possible regulatory concessions that are often offered in inclusionary zoning.   Others include fee waivers, fast-tracked approvals, and reduced standards for parking, setbacks and other zoning requirements.  But density bonuses are probably the single most rewarding of these concessions.

It is a fundamental characteristic of all inclusionary zoning programs that the key rules are fixed.   These rules are set ahead of time and kept non-negotiable, so that all developers are treated fairly and equitably. This applies particularly to the affordable housing obligation of the developer, and also to any regulatory concessions offered by the municipality.  As a consequence, when density bonuses are offered, they are given automatically (or as-of-right) according to some pre-set formula.

(There is another practice – typically called “incentive zoning” or “bonus zoning” that offers density bonuses negotiated ad hoc on a project-by-project basis.  This approach has generally been unproductive, and in any case, should not be confused with inclusionary zoning.)

The problem is that density bonuses provided in this way can lead to bad planning, particularly when provided over and above the appropriate permitted density.  The approved density should be based solely on what is physically suitable for a particular site in terms of the capacity of the supportive infrastructure, impact on neighbouring development, consistency with strategic planning decisions and similar other objective criteria.   As important as affordable housing is, developments with affordable housing should not be automatically granted additional density rights exceeding  what is appropriate as compensation for the housing.  (Nor should the permitted density be kept deliberately low so that it can be raised to a reasonable level to pay for the affordable housing.)

It is relevant to note that the City of Toronto intentionally – and quite rightly – does not use the term ‘density bonus’ when administering s37.  The reason is that the city determines the permitted density based on what is appropriate for any site according to planning grounds.  It does not base the permitted density on what is necessary to achieve community benefits like affordable housing.

The persistence of density bonusing as a relevant concept can be ascribed to its association specifically with voluntary inclusionary zoning programs.  In voluntary programs, density bonuses are essential because the developers will be seeking incentives to cover the cost burden of providing the affordable housing.  In the absence of sufficient incentives, of which increased density is probably the key one,  they are unlikely to agree to provide the affordable housing.

The empirical record, however, clearly shows that voluntary programs have been ineffective in providing affordable housing (see Mandatory vs Voluntary).  While there were once many voluntary programs, their relative number has steadily declined over the years.  So, while density bonuses could be essential in voluntary programs, these programs themselves have been dismissed as a viable option.

On the other hand, density bonuses are not needed in mandatory programs.  There is no imperative in these programs to make the developers whole through any regulatory concessions .  In these programs, the cost burden can and should be passed back to the land – that is, it should go toward reducing the price being paid for the land (see Who Pays?).

Passing the cost back to the land is entirely reasonable.  The landowners have benefitted greatly from rising land values while doing nothing to create them.  Inclusionary zoning is a way of capturing some part of that enhanced land value for the public benefit, particularly when the municipalities have had a significant role in creating those values through public investments and planning decisions.

In summary, density bonusing represents the wrong way to think about inclusionary zoning.  The provision of affordable housing should be seen as a reasonable obligation by all residential developments, and not just an exceptional contribution for which some reward (like a density bonus) is due.

25 April 2016

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.

Issues

In this section, various contentious issues related to inclusionary zoning are addressed.  These include the following: