Understanding Inclusionary Housing

Anyone who reads CPHA newsletters or follows development news in Baltimore has probably heard the term “inclusionary housing.” But not everyone understands what it is, what it’s supposed to accomplish, or why Baltimore’s law isn’t working.

We published an opinion piece in the Baltimore Sun last year on the need for a better law. But inclusionary housing is a complicated subject that an op-ed can’t fully capture. This is a technical article to supplement our previous writing on this topic.

This is a work in progress. As always, we are open to your comments and suggestions.

What is inclusionary housing?

Inclusionary housing is the practice of mandating that newly constructed market-rate residential developments rent or sell a certain percentage of units (usually from 5% to 20% depending on the market) at a below market value.

In determining how much a unit costs, laws use a calculation based on Area Median Income (AMI). For example, in the Baltimore area, the AMI for a family of four is $91,100, making us among the wealthiest metropolitan areas in the nation. Were legislation passed mandating that three-bedroom units be rented at an affordable level (no more than 30% of their income) to a family of four earning 60% of AMI ($54,650), that family’s rent would be no more than $1,367 a month.  In general, inclusionary housing laws target incomes ranging from 50-120% of AMI.

These below market rate apartments are usually created with no cash contribution from the jurisdiction mandating them. However, developers may be allowed cost offsets that include constructing more units than would be permitted under the current zoning, reductions in parking requirements, express permitting, or tax abatements. Developers may also have the option of building their affordable units off-site or they may be able to pay a fee-in-lieu of building the affordable units. If developers do pay a fee instead of building the units, that money goes into providing affordable housing elsewhere in the jurisdiction.

The overall goal of inclusionary housing is to construct affordable housing that would not otherwise exist and to create economically integrated communities.

Where has inclusionary housing been implemented?

Inclusionary housing is most common in robust and high-cost markets like Washington, DC, Montgomery and Howard Counties, San Francisco, and Boston. But with the nation in an affordable housing crisis and most developments receiving some sort of subsidy, increasing numbers of cities not typically considered high-cost housing markets have passed inclusionary housing policies. Newark passed an inclusionary zoning bill last year, and Philadelphia is on the verge of passing one as well.

We have heard from some developers that Baltimore’s housing market is too weak for inclusionary zoning. The above examples illustrate that this is not the case.

Won’t this increase the cost of housing or reduce the number of housing units constructed?

This issue has been studied extensively and the answer is that properly implemented inclusionary housing laws do not stall construction of new housing units or increase housing prices.  Housing prices are already pre-determined by market conditions. This means that developers are already pricing residential units at as high a price as they can. When local governments pass well-designed inclusionary housing laws, the cost of land also goes down, reducing overall developer costs. Some cities allow developers to offset the cost of providing the affordable units by enabling them to build more units than would otherwise be permitted under current zoning.

In certain circumstances, developers will accept reduced profit margins, though as we’ll explain this is not always possible.

It’s possible that if inclusionary zoning requirements were set too high they could potentially increase the cost of housing through reducing the supply of new housing. One way to prevent this is through commissioning a detailed feasibility study that will determine what percentage of affordable housing units and what affordability levels Baltimore’s market can handle.

To be clear, building lots of market-rate housing will not solve our housing affordability issues. That’s why we’re advocating for inclusionary housing in the first place! But building enough market-rate housing, even if it is targeted towards the luxury market does play a role in ensuring things don’t get worse.

Why do we need another study and why should I care if developers can’t build new housing? 

To answer this question, we need to understand a little about how development is financed. Most of the financing for and profit from a development does not go to the developer. What happens is that the developer will put up a little bit of their own cash and then seek out funders for the rest of the cost. In addition to bank loans, potential funders include pension funds, insurance companies, and investment banks.

Real estate can be a risky investment. When an investor puts money into municipal bonds, they are almost guaranteed to be paid back the money. As a result, the interest rates and financial returns on such investments are relatively low. Since investors are not guaranteed a positive return on a real estate investment, they demand a certain profit margin to account for this risk. By and large, real estate targets a profit margin of 15-20% to get built.

Developers and some housing experts say that if the profit margin is smaller than that, the project is considered not feasible.

When it comes to real estate (and just about anything else) supply and demand matters, new market-rate (and usually luxury) residential construction is built because there is a demand for it. If developers were to stop building any new housing, that demand would not magically disappear. What would instead happen is those older apartment buildings now affordable to households with moderate incomes would rise in price in order to market to those with higher incomes. The result would be higher housing prices for the vast majority of us who live in market-rate housing.

However, there is a caveat to what we just wrote. Plenty of demand exists for housing for moderate and low-income households. But developers are unable or unwilling to construct new housing at those income levels without taxpayer subsidy.

Once again, market-rate housing alone will not solve the affordable housing crisis. But it does help.

The income levels mentioned for affordable housing seem kind of high? Do we even need more affordable housing for individuals and families earning those incomes? Can’t we mandate that developers provide housing for Baltimore’s poorest residents?

First and foremost there is a need for affordable housing for households earning these income levels. According to a 2016 report from the Abell Foundation, almost 30% of all households in Baltimore City earning between $40,000 and $70,000 are housing cost burdened. It gets even worse when you look at specific areas. An administrative assistant earning 50% of AMI ($31,900) won’t have much luck finding an apartment in neighborhoods like Downtown or Fells Point. This is despite the fact many of these newer developments received a public subsidy.

This being said, the target incomes for inclusionary housing do not represent the most significant need when it comes to affordable housing. Far and away the most housing cost-burdened households in Baltimore City and around the nation are those earning at or below 30% of AMI. However, it would be difficult for developers to build units affordable to households at that low an income level without even more subsidies than they already get.

Inclusionary housing policies can still serve households at these income levels. Local governments can use the in-lieu fees paid by developers to build units elsewhere for households not earning enough to afford inclusionary housing units. Cities can also require that all inclusionary housing units adhere to anti-source of income discrimination laws so that voucher holders can access them. Finally, in some jurisdictions, local housing authorities can gain access to these units at a discount and will place poorer households in them.

Then there is a broader reality that in the United States, the commitment to shelter for our most vulnerable residents remains elusive.

What’s this about in-lieu fees and allowing developers to build offsite? 

Many inclusionary housing laws allow developers to pay an in-lieu fee instead of building the affordable unit or will even allow them to fulfill their affordable housing requirements by constructing offsite units. Such flexibility is permitted in some laws because a development project may be infeasible otherwise. For example, if a developer is building a highrise, building codes require them to use steel or concrete materials instead of wood. This increases the price per unit and may make the costs of constructing the affordable units within the market-rate development infeasible.

There are also some additional benefits to offsite construction and in-lieu fees. For example, in-lieu fees can be used to provide housing for those who earn too little income to qualify for inclusionary housing units. In some cities, developers will partner with nonprofit developers and construct affordable units at a cheaper cost than if they were built within a market rate development.

Units created through offsite requirements may also be better suited for families than those in market-rate developments. For example, the Lincoln Institute of Land Policy’s guide to inclusionary housing tells the story of the Ramirez family in San Francisco. The Ramirez’s were previously homeless but now lived in an affordable unit located in a high priced condominium. However, they described their living situation as “awkward.” Though their building had a doggie spa, it did not have any other families. Meanwhile, another development built across the street by a nonprofit developer funded with in-lieu fees consists of mostly two and three bedroom apartments with many families living in it.

However, these alternatives come with significant caveats. If the in-lieu fees are too low, then developers will opt to pay the fee and not build any affordable housing. This is what happened in Chicago. Though the in-lieu fees did generate a lot of money for affordable housing, most of the housing built with those funds was constructed in Chicago’s impoverished southside neighborhoods strengthening economic and racial segregation within the city. Recent amendments to Chicago’s inclusionary housing law significantly raised in-lieu fees for most areas of the city and required that most residential projects provide at least 25% affordable housing units onsite in an attempt to solve this problem.

Offsite options can also be problematic. One of the primary goals of inclusionary housing is to create economically integrated communities. If developers are allowed to build units anywhere in a city, they may choose to build them in a less affluent area. The solution to this problem is to mandate that developers build offsite units near the location of their market-rate units and/or in an area with similar economic characteristics.

Most inclusionary housing policies should be designed with the intention that most units will be built within the development. However, in-lieu fees and offsite development options are useful tools that are sometimes necessary.

What’s the problem with Baltimore’s current inclusionary housing law and why are so few units being built?

At CPHA’s 2016 forum on inclusionary housing, a Baltimore based national expert referred to Baltimore’s law as a “parody” of how inclusionary housing is supposed to work. This is because the law states that:

This subtitle is not intended to impose additional financial burdens on a developer or a residential project. Rather the intent of this subtitle is that the cost offsets and other incentives authorized under it will fully offset any financial impact resulting from the inclusionary requirements imposed.”

It then goes on to read:

“If cost offsets and other incentives are not made available to a residential project in accordance with this subtitle, the residential project is not subject to this subtitle.”

The city has taken this to mean that it must pay cash for any inclusionary housing units built. While there is an inclusionary housing fund, it rarely has any money in it, and therefore most projects receive a waiver. Even when units are built, they have been for households earning around 80% of AMI. For a one-person household that is equivalent to $47,600 a year and for a family of four it’s $68,000. Units affordable for these income ranges would rent as high as $1,190 and $1,700 respectively. Given that rental units are found in areas across the city at these prices, this may not be the best use of scarce affordable housing dollars.

How did Baltimore end up with such a failed inclusionary housing law?

A task force on affordable housing was established and headed by CPHA. It came up with recommendations for what the city should do to make housing affordable for everyone, and an inclusionary housing law was introduced that did not require cash contributions from the City. However, a total of 93 amendments were placed into the bill that effectively gutted it.

What is being done to fix the law?

The City Council passed a resolution this past December establishing a new task force for affordable housing. This was several months behind the originally scheduled date. Not only will the task force look at the City’s inclusionary housing law it will also focus on developing an overall affordable housing strategy for the City. In addition to inclusionary housing, the task force will look at ways to fund the city’s newly established affordable housing trust fund and may also take a look at community land trusts.

However, The Council has not yet publically announced the makeup of this task force nor will it be providing any funding to the task force for additional research or consultants that may be needed. However, there may be some funds available from the foundation community. We are deeply concerned about the City’s commitment towards inclusionary housing and affordable housing in general.

What needs to be done to fix the law?

Any change to Baltimore’s law will require leadership from both the Council and the Mayor’s office. We urge the city to show leadership through funding a feasibility study that will determine what levels of affordability and what percentages of affordable units are feasible for the Baltimore market. These studies are considered a standard best practice when it comes to inclusionary housing and there are experienced consultants across the country Baltimore City can turn to for this work. With the city and nation at large in the midst of an unprecedented affordable housing crisis, the time for excuses is over.

15% profit margins, feasibility studies, building lots of luxury housing? This way of development stinks!  Are there any alternatives?

It’s important to recognize that inclusionary housing is just one tool in an overall affordable housing strategy. Other ways to fund affordable housing include Housing Choice Vouchers (Section 8), Low Income Housing Tax Credits, and the Baltimore City’s newly created affordable housing trust fund.

But there’s a more significant issue at play here. Everything we’ve described is the result of relying on the free market to provide most of our housing supply. At a time of reduced federal government funding for both community development and affordable housing, cities feel they have little other choice than to bend over backward to accommodate developers. But grassroots community organizations are working on alternative development models.

Here in Baltimore, a promising model is that of a Community Land Trust (CLT). At its core, CLTs are about giving communities full control over the land in their neighborhoods with the creation of “development without displacement.” One of the most prominent CLTs is the Dudley Street Neighborhood Initiative in Boston. At the local level, our friends at the Public Justice Center, Baltimore Housing Roundtable, and United Workers are leading this effort.

Other resources on inclusionary housing

Lincoln Institute of Land Policy report on inclusionary housing:

http://www.lincolninst.edu/publications/policy-focus-reports/inclusionary-housing

Grounded Solutions website on inclusionary housing:

https://www.inclusionaryhousing.org/

Urban Land Institute, Terwilliger Center for Housing Report on the Economics of Inclusionary Zoning

http://americas.uli.org/wp-content/uploads/sites/125/ULI-Documents/Economics-of-Inclusionary-Zoning.pdf

Rand Corporation, Is Inclusionary Zoning Inclusionary? A Guide for Practitioners

https://www.rand.org/pubs/technical_reports/TR1231.html

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Gregory Friedman

Gregory Friedman

This article was written by Gregory Friedman. Click here to meet our writing team.

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