The high cost of housing is one of the most challenging planning issues of our time. The meager supply of affordable housing is a major contributor to the problem, yet the policy tools to address the shortfall often seem to worsen the problem. But this is because they ignore the underlying infrastructure and financing to support growth.
Housing affordability is really about two things: income and cost. The building industry is doing very little about the former, oftentimes opposing prevailing wages for construction workers. On the latter, the key question (being debated in California now) is whether deregulation of market rate housing projects will somehow “trickle down” to households, enabling them to afford rising rents and mortgages.
The supply-side perspective, espoused by the state’s Legislative Analyst Office (LAO) suggests that the solution to containing housing costs is building 100,000 additional units annually. Given the LAO’s skepticism of affordability restrictions, the theory is that the housing bought by wealthier people will filter down to poorer people as the wealthy move up to more expensive housing.
This trickle-down theory is very leaky. It depends on upward mobility in the middle class, and assumes that there are no foreign investors swooping in with hard cash and clogging up the filtration system. And even if it did occur, research by the Urban Displacement Project shows that the filtering process can take generations, whilst the properties deteriorate. The steeper the price increases, the slower the rate of filtration. Also, if wealthy buyers are willing to pay exorbitant sums for an old house in order to give it a pricey makeover, the theory is turned downside up. I’d call it "trickle-up."
There are several limitations of the supply-side perspective:
- Due to its focus on new construction, this theory is narrowly limited in policy prescriptions to less than 1 percent of the total housing stock. To put this in perspective, California has a built stock of 13 million housing units, of which 6 million are rentals. Roughly 41 percent of owners with a mortgage and 57 percent of renters in the state cannot afford to meet their housing costs. The supply-side perspective assumes that any rent or price controls on 99 percent of the housing stock will impact the production of the 1 percent.
- The supply-side perspective conflates different housing markets and diverse clientele into one uniform package of building permits. The basic rule taught in Real Estate 101 is being violated by these sweeping theories of a uniform housing market in California, when the reality is that each metro has its own market and submarkets, and product types segmented by their unique customer-class (for example, McMansions, luxury condos, single-family detached, luxury apartments, hotel apartments, single-room occupancy housing, senior living, etc.) Each market has its own sensitivity to price changes, and the demand within each segment also differs. To illustrate, a luxury condo purchased as a second-home by a millionaire in San Francisco makes no difference to a middle-income renter in Fresno; and the relative impact of a 10 percent increase in housing costs for each is not comparable.
- The supply-siders assume builders will respond to the demand in an egalitarian manner. They don’t. Builders respond to profits, and the reluctance of the building industry to build entry-level homes reflects a fundamental flaw in the “let them eat cake” argument that the increased supply of luxury goods will somehow make staple goods more affordable.
Unfortunately, Governor Jerry Brown has proposed the (supply-side) idea, vociferously promoted by the building industry, that the evil-doers are the local regulators that condition project approvals on community benefits, anti-displacement and relocation provisions, better jobs, environmental quality and higher levels of affordable housing.
The High Cost of Cheap Sprawl
It's become so common and customary to blame NIMBYism for the housing mess that it has sparked a counter-YIMBY movement among market urbanists. No doubt, there are individual projects that have been derailed by neighbors concerned about protecting their home equity; but to vilify public participation in the approval of projects belies the fundamental principle of democratic planning in serving the public interest.
We may disagree about what the “public interest” is, but to eliminate public participation at a project-specific level is undemocratic.
I do think that it is in the public interest to address the crisis of high rents. Since low vacancy rates are a primary driver of rent increases, I examined the rental vacancy rates in California since 1986, and compared them to the national level to provide a baseline for economic conditions. The data show that rental vacancy rates in California spiked during the 1990s, even higher than the national rates. So what was going on in the 1990s to account for this surplus supply?
In one word, sprawl.
According to research commissioned by the California Senate Office of Research, the metropolitan areas of Fresno, Los Angeles, Riverside, Merced, Sacramento, Oakland, San Francisco, San Luis Obispo, and Stockton all experienced the state’s greatest increases in urban sprawl during the 1990s. Average metropolitan growth in urban fringes between 1980 and 1990 were twice as great as growth in the urban population. And between 1987 and 1997, the average percentage of a California metropolitan area’s land devoted to farming fell by about 9.4 percent.
New subdivisions were being built by developers—often consuming greenfields and clogging freeways. Pro-sprawlers argued that infill opportunities were limited, and that a majority of sprawl was really attached multi-family housing. Sprawl was cheap and profitable, but cost municipalities twice as much to serve. In hindsight, this was an economically inefficient and environmentally destructive form of growth. By the late 1990s, California started running out of land to keep the growth machine chugging along.
At the turn of the millennium, housing vacancies fell 3 percentage points below the national average, and have remained consistently low—we’ve experienced a lost decade in terms of apartment construction. However, there is no evidence that there was widespread adoption of NIMBY regulations by cities. So one could reasonably attribute this loss to Wall Street, initially on redirecting investment to the housing bubble, and then retrenching from financing any kind of development during the recession.
As we emerged from the recession, cities started focusing on infill, higher density development, but it is precisely this type of housing in these locations that is more expensive to build. The cost of construction increases as much as fivefold from low-rise wooden frame to high-rise steel and concrete. Residential land values in coastal California are over seven times the average in the U.S. And the site constraints are compounded with little room to adjust the building envelope. This is why permit processing in urban areas is under the microscope. The rationale for streamlining is that public input creates uncertainty for the developer and thus results in expensive delays, modifications, or rejections. Some of the rationale is justified, especially for smaller projects that cannot afford the time and cost of permitting.
But the regulatory hurdles are a bogeyman for the housing crunch. For example, in downtown San Diego, there is virtually no NIMBYism, and development permitting is mostly by right. Yet a majority of residential market-rate developers chose to utilize a significantly lesser share of their entitled floor area ratios and pay inclusionary fees in lieu of providing restricted units on-site, leaving the state-mandated density bonus on the table. In other words, private developers are building fewer units than the zoning allows, and avoiding building affordable housing altogether, despite a tower of regulatory incentives being offered to them. Building affordable housing is simply not profitable. This results in wasted land capacity in transit-accessible areas.
For large-scale projects, it's this same laissez faire approach to development that has created California’s buildable land shortage. It was building for short-term gains to maximize developer profits that created unsustainable growth patterns, which are now taxing California’s highways, roads, and water infrastructure.
Studies on the impacts of land-use regulations on housing are mostly one sided. They evaluate the cost of the regulation to the developer, but ignore the benefits of the regulation to the public. For example, the Wharton Residential Land-Use Regulation Index, one of the most commonly used indicators by laissez faire advocates, has eleven sub-indices that capture everything from rulings by state courts to the number of local planning board hearings. But it has no measurement of changes in project outcomes. In my opinion, process uncertainty is a necessary cost that the larger developer pays in order to procure outcome certainty for people working, living, and experiencing the project on a daily basis. Public input at a project-specific level is critical in maximizing outcome certainty for sustainable development:
The defining characteristic of sustainable development is that it is development plus other societal goals, particularly with respect to the environment, economy, and equity. It is therefore critical to include process uncertainty within the planning process to encourage deliberation in reconciling these tenuous goals at a project-specific level. When a project encounters a sufficient quantum of process uncertainty, it merits appropriate political interest and resources for deliberation. On the other hand, if a public agency offers a streamlined development approval process without accurate assessment and liability of the socioeconomic impacts of new development, it is shifting that outcome uncertainty from the developer to the community. From the developer’s perspective, there is no incentive to deliberate.
As planners strive toward greater certainty in terms of sustainable outcomes from development, process uncertainty needs to be managed, not eliminated. Project-level discretion is precisely the way that cities can avoid a planning paralysis that would occur if every development scenario was analyzed at a programmatic level.
The Housing Problem is An Infrastructure Problem
Developers often complain about regulatory fees. One developer-funded study in San Diego shows that they add 40 percent to the cost of housing. But a deeper analysis reveals that most of the so-called regulatory costs are related to capital improvements. According to a survey of local development fees by the state’s department of Housing and Community Development, capital facilities fees accounted for 80 percent of subdivision and infill fees, and 86 percent of apartment fees.
Since Proposition 13 of 1978, property taxes in California have been historically insufficient to pay for local infrastructure to meet the needs of a growing population. Counties in Texas, by comparison, have some of the highest property rates in the nation (average 1.81 percent), and can afford to give out permits without much planning, knowing that the project owners will pay for the municipal capital costs over their lifetime. But in California, cities looking to even keep up with their infrastructure needs have “one-bite” at the apple:
In other words, local governments could no longer rely on spreading the cost of new infrastructure across an entire tax base, they now had to focus the cost solely on new development which constitutes a much smaller number of units. It also means that a local government only gets one bite at the proverbial apple via impact fees rather than a recurring income stream that can be assessed upwards as need dictates.—Landmark Capital Advisors)
Furthermore, homeowners stay longer in their existing homes to avoid paying a higher property tax if they move, since they are assessed at 1 percent of the sale price (with a 2 percent annual increase). This “Prop 13 subsidy” further reduces the for-sale housing inventory. According to research published by the National Bureau of Economic Research, homeowners living in coastal California cities receive Prop 13 subsidies averaging in the thousands of dollars, and their average tenure length increased by 2 to 3 years. This longer tenure for homeowners forces younger households to delay their transition from renting to owning.
Research shows that at high levels of density, public sector spending on both capital and services increases with each added person. In addition, rapid population growth imposes fiscal burdens on established residents in the form of lower service levels. The capital needs problem becomes particularly acute in older urban areas with deteriorating infrastructure, and no way of supporting new projects without taxing existing ones. LAO acknowledges this constraint in their report:
Expanded development can strain existing infrastructure—such as streets and roads, schools, and parks—requiring residents to change the way they use these public goods.
Nevertheless, metros across California are striving toward a greater density balance. Table 1 shows the sprawl measure for select metros based on the difference between the proportion of the population living in higher density and lower density census tracts over four decades. The data shows that in California, particularly in the areas with the least amount of sprawl are in the greater San Francisco Bay Area and Southern California. Since the sprawling era of the 1990s, sprawl has decreased significantly across California metros, quite often due to adoption of anti-sprawl policies.
Tax increment financing, during the former redevelopment era, was intended to fill the infrastructure gap for older communities to absorb new growth. It also funded affordable housing. Now, absent redevelopment, the state has limited control over local land-use. Cities in California undergo a paper planning exercise in 5-to-8 year cycles in which they demonstrate to the state the land-use capacity for housing at different income levels. In terms of actual production, they exceed their market-rate housing allocation, but have difficulty meeting their low-income housing needs.
Since cities are absorbing the costs of supporting or subsidizing new housing, the Governor’s approach places too much burden on compliance with local housing elements. It forces cities to accept deteriorating levels of service as long as a residential project complies with the underlying land-use zone. It bestows constitutionally protected entitlements on developers without similarly guaranteeing the recovery of public service and capital costs. It reduces the bargaining power of communities to mitigate the externalized impacts of projects. And worse, it allows non-compliant cities to cheat without impacting their infrastructure funding.
Its only a matter of time before the camel’s back breaks. Over-stressed local infrastructure may cause political backlash in the form of growth control measures as cities become less generous in their planning and zoning entitlements. Growth control tools include permit caps, downzoning, growth boundaries, height limits, and there is no limit to innovative ways to exclusion. As the Wharton Index shows, the wealthier the city, the more sophisticated the regulatory scheme. Other cities, not to be left to absorb the negative impacts of growth, would then follow suit. Unfortunately, this kind of domino effect would completely undermine the intent of housing affordability.
Residential Projects Must Include Affordability
California needs to build enough housing to at least keep pace with its growing population. The underlying issue in the lagging supply is finance. The private sector is only building what makes Wall Street happy, however erratic that may be, and fails to address the burgeoning needs of the vast majority of middle-and low-income households. And the public sector supply does not have adequate financial tools to balance out the supply and keep building, even when lenders are nervous. A permanent source to fund affordable housing adequately must be created, so that sufficient housing units are either acquired or built to serve those with the greatest need, and the construction of affordable housing is buffered in the long-run from the boom-and-bust of economic cycles.
Market rate projects can address housing affordability by mandating that 20 percent of the new units be affordable to low and very-low income families, and there are 170 jurisdictions in California with varied forms of inclusionary housing, a strategy that has been validated by the state courts. Much to the chagrin of the building industry, the U.S. Supreme Court refused to step in.
Requiring affordable housing to be built on-site should be as standard as requiring setbacks, or design articulations. Governor Brown’s earlier administration in the early 1980s prepared a “Model Inclusionary Housing Ordinance” and promoted it energetically to cities, creating an expectation that the ordinance needed to be adopted in order to comply with California housing law. According to the National Housing Conference, jurisdictions that produced the most inclusionary units were those that experienced the most rapid expansion, harnessing their growth to stimulate affordable housing production.
It is time for a statewide requirement for affordable housing in all large residential projects. A state mandated program will produce more affordable housing units than a hodge-podge of voluntary local ones, eliminate “municipal tinkering” that research shows weakens its effect, discourage developers from “shopping around” for loopholes, and despite claims to the contrary, does not raise housing costs. To meet this mandate, compensatory benefits for developers, such as design flexibility and fast-track processing will encourage innovation and increase affordable housing production.