When and How Should Cities Implement Inclusionary Housing Policies? Ann Hollingshead

When and How Should Cities Implement Inclusionary Housing Policies? Ann Hollingshead

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AUTHOR’S NOTE This report was prepared by Ann Hollingshead with funding from the Cornerstone Partnership, a program of the Community Solutions Group, LLC, which is a subsidiary of Capital Impact Partners. The author prepared this report as part of the program of professional education at the Goldman School of Public Policy, University of California, Berkeley. This report is submitted in partial fulfillment of the course requirements for the Master of Public Policy degree. The judgments and conclusions are solely those of the author, and are not necessarily endorsed by the Cornerstone Partnership, the Goldman School of Public Policy, the University of California, or by any other agency. Academic Advisor: Jack Glaser, Associate Professor, Associate Dean, Goldman School of Public Policy, University of California, Berkeley Client Advisor: Sasha Hauswald, Senior Program Officer for Inclusionary Housing Policy, Cornerstone Partnership

Acknowledgements I first and foremost would like to thank Sasha Hauswald for her guidance from start to finish. Thank you for giving me this opportunity, your interminable support, and your willingness to take the time to impart your depth of knowledge. I am grateful to Jack Glaser for his guidance and helpful feedback along the way; Emily Thaden for her assistance and insights; Anna Scodel for the thoughtful edits of a seasoned editor-in-chief; Lindsay Cattell for quantitative feedback and advice; and Alex Marqusee for cartographical contributions and indiscriminate assortments of housing knowledge and connections. On a personal note, I am thankful for the support and friendship of Sarah Marks who believes in me more than I deserve; Sarah Chevallier for comic, yogic, and Thai reprieves; Patti Hollingshead, my lifelong cheerleader; and, of course, Cameron Stone Adams for living up to his middle name. Finally, I am grateful to all of the interviewees who lent me their time and expertise. Your insights were invaluable and without them this report would not have been possible.

prepared for

PURPOSE AND AUDIENCE This report aims to inform the policy debate for municipalities in the United States pursuing or modifying inclusionary housing policies in the rental market. The primary audience of this report is advocates, policymakers, and researchers looking to design, modify, adopt, or eliminate existing inclusionary housing policies. For those municipalities that already know they would like to implement an inclusionary housing policy, this report can provide guidance on the choice between policies that focus on the provision of units or the provision of fees. While this analysis focuses on the rental market, many of the lessons and recommendations would also apply to an inclusionary housing policy applied to an ownership market.

CONTENTS Background ......................................................................................................................................................... 1 Report Overview ................................................................................................................................................ 4 Policy Alternatives ............................................................................................................................................. 7 Policy Design and Legal Considerations ........................................................................................................ 9 Criteria ...............................................................................................................................................................15 Do Inclusionary Housing Policies Have Unintended Market Consequences? .......................................18 Do Inclusionary Housing Policies Promote Housing Affordability? .......................................................37 Do Inclusionary Housing Policies Promote Socioeconomic Integration? ..............................................47 Analysis of Alternatives...................................................................................................................................53 Summary of Recommendations.....................................................................................................................58 Case Study Interviewees and Key Informants .............................................................................................60 Works Cited ......................................................................................................................................................62

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When and How Should Cities Implement Inclusionary Housing Policies?

EXECUTIVE SUMMARY Over the past decades, and in particular since the Great Recession, housing has become less affordable. Today, renters in the bottom fifth of the income distribution spend nearly two-thirds of their income on housing. In dollar terms, this means that if a two-earner household makes $1,800 per month in after-tax income, it spends, on average, $1,190 on rent, leaving $600 per month for utilities, transportation, food, clothing, childcare, and any other expenses. This share has grown over time: as incomes for most Americans have stagnated, rental prices have increased. Public policy at the state and federal level has failed to keep pace. In fact, federal funding for lowincome households has declined and state programs fall short of filling the gap. This situation has prompted localities to take action, with many turning to inclusionary housing policies. Under these policies, municipalities require developers building new market-rate development to set aside a certain percentage of the development’s units as affordable or pay a fee. While there are a range of design elements associated with these policies, most fall into three main categories: (1) fee-focused policies, or those that emphasize the collection of fees from developers, (2) units-focused policies, or those that emphasize the production of affordable units by developers, and (3) blended policies, or that make significant use of both fees and units. As of 2014, there were nearly 500 municipalities in the United States that had pursued one of these types of inclusionary housing policies. Despite this prevalence, many cities face a dearth of information about when and how to implement an inclusionary housing policy. Specifically, cities face competing and contradictory information about whether these policies promote or restrain overall affordability. When a city decides to implement an inclusionary policy, there is still debate over which policy type—a fee- or unitsfocused policy—is in the best interest of its residents. Finally, there is no formal, objective guidance that cities may use to inform this decision. This report aims to fill this gap. It provides formal and objective guidance for advocates, policymakers, and researchers looking to design, adopt, modify, or eliminate existing inclusionary housing policies that target low-income renters. Should a city decide to implement an inclusionary housing policy in the rental market, this report outlines the most efficient and effective designs of those policies, emphasizing the conditions under which a city might choose one type over another. To support these recommendations, this report relies on a mixed-methods approach that blends evidence from quantitative, qualitative, and theoretical perspectives. The four major analytic components are: (1) a detailed review of the existing literature, (2) interviews with experts in the field of inclusionary housing and housing economics, (3) a quantitative analysis of inclusionary housing policies in California, and (4) qualitative case studies of eight cities with experience in a variety of policy types.

On the debate of the effects of inclusionary housing on rental markets and overall affordability, this report makes three key contributions to the existing literature. These are: 1. Inclusionary housing policies contribute to overall housing affordability in the rental market. This report examines whether weakening a rental inclusionary housing policy has an effect on housing affordability. I find that weakening an inclusionary housing policy is associated with a 2 percent increase in median rental prices and a 3 percent increase in the price of low-cost units. 2. Developers did not lower rental prices among after cities eliminated or weakened their rental inclusionary housing policies. This report fails to find evidence that weakening a rental inclusionary housing policy is associated with a reduction in the price of high-cost units. This evidence may suggest that rental inclusionary policies are not systematically or aggressively associated with higher prices among high-cost units. 3. Fees associated with inclusionary housing policy are often set below their efficient level. An analysis of several case studies and interviews with experts reveal that cities would be able to produce more affordable housing, with few additional costs to developers and the public, by raising their fee levels. There is no “one-size-fits-all” inclusionary housing policy for all municipalities. However, this analysis provides some guidance on when and how municipalities should implement various forms of inclusionary housing policies. This report makes the following three key recommendations: 1. The ideal policy design is a blended policy that makes significant use of both units and fees. If properly structured, a blended policy can be the most effective for minimizing unintended market consequences and generating affordable housing. However, these policies only achieve these outcomes when the implementing city sets the fee schedule at the appropriate level. As noted earlier, however, cities commonly set these fees too low. As a result, cities should only pursue this alternative when they have the administrative capacity and political will to set fees appropriately. 2. In general, a units-focused policy is the most reliable alternative. This alternative may provide a good default option. The likelihood of a city achieving its desired outcomes under this alternative is highest. Cities that are not able to set the fee level appropriately for political or administrative reasons should prefer a units-focused policy. 3. In general, cities should not pursue a fee-focused policy. With few exceptions, from both an economic and a policy perspective, these policies do not have any advantages unitsfocused policies or blended policies. While I cannot conclude that every municipality should pursue an inclusionary housing policy, in general this analysis shows that these policies are flexible, effective tools for cities to achieve better housing affordability. Moreover, it is unlikely that these policies have significant or systematic costs in terms of housing prices and production. As such, any city currently facing, or expecting to face, challenges related to housing affordability may want to consider adopting an inclusionary housing policy to help meet its housing affordability needs.

When and How Should Cities Implement Inclusionary Housing Policies?

BACKGROUND Housing Has Become Less Affordable The combination of falling wages for middle income Americans and rising home prices have raised concerns about housing affordability. Rising rental prices are of particular concern for low-income and minority Americans, about half of whom are renters (Joint Center for Housing Studies of Harvard University 2013b). Compared to incomes, housing costs have increased in real terms. In 1960, the median renter spent about 18 percent of her income on housing. Today, she spends about 30 percent. For renters in the bottom fifth of the income distribution, the share of income spent on rent has increased from 47 percent in 1960 to 63 percent today (Collinson, Ellen, and Ludwig 2015). In dollar terms, this means that if a two-earner household makes $1,800 per month in after-tax income, they spend, on average, $1,190 on rent, leaving $600 per month for utilities, transportation, food, clothing, childcare, and any other expenses. Meanwhile, the population of very low-income renters has nearly doubled from 10.7 million in 1978 to 19.3 million in 2011 (Joint Center for Housing Studies of Harvard University 2013a), outpacing total population growth by a factor of two. In addition to its financial importance, housing is an important component of family well-being. Housing that costs more than a family can afford threatens its stability, exposing the family to the threat of eviction or foreclosure. Access to good-quality housing is of fundamental importance to other aspects of a family’s life, including employment, education, nutrition, and health. When facing housing affordability challenges, many families must settle for low-quality or geographically remote housing so that they can afford other basic necessities. This places additional stress on the family as housing that is isolated, overcrowded, or in substandard condition presents health and well-being concerns.

State and Federal Assistance for Affordable Housing Has Declined While incomes have declined relative to rental prices nationwide and the population of low-income renters has grown relative to the total population, federal housing assistance for these populations has waned. For instance, funding for public housing has declined (Turner and Kingsley 2008) and programs targeted toward very low-income renters—for example Section 8 project-based rental assistance and programs for the elderly and disabled—have faced budget cuts and uncertainty in recent years (Pelletiere et al. 2008). More recently, federal budgetary pressures have curtailed any further expansion of the federal housing voucher program, putting additional downward pressure on federal assistance. In a study of states’ efforts to fill the gap from federal programs, Pelletiere et al. (2008) found that state programs fall short. The authors note that “despite the declining commitment of the federal government to serving the lowest income Americans, states often direct resources away from rental programs serving the lowest income populations with the greatest need.”

Background | Page 1

When and How Should Cities Implement Inclusionary Housing Policies?

Cities Have Responded with Inclusionary Housing Policies Eroding housing affordability and declining federal and state assistance have together prompted many localities to take action. While there are several policy interventions that cities can pursue to fill this gap, many have turned to inclusionary housing policies. Under these policies, a municipality requires a developer building a new development to either set aside a certain percentage of the units as affordable or to pay a fee. Most of these policies therefore fall into three main categories: policies that emphasize the provision of fees, policies that emphasize the provision of units, and policies that make significant use of both fees and units. As of early 2014, there were nearly 500 municipalities across 27 states and Washington, D.C. that had pursued some type of inclusionary housing policy (Hickey, Sturtevant, and Thaden 2014).

The Great Recession Has Deepened Concerns about Housing Affordability The aim of inclusionary housing policies is to promote housing affordability, particularly among low- and moderate-income residents. Yet some have argued these policies create unintended market consequences that erode their ability to meet this objective. For example, to the extent that inclusionary housing policies act like a tax on development, they may stifle housing production and increase the price of market-rate units, reducing overall affordability in a housing market. The validity of this concern is open to debate, and indeed it is a topic of major discussion of this report.1 This debate has become increasingly salient in the wake of the Great Recession, which contributed to a slump in housing production, increasing rents, and falling incomes (Ellen and Dastrup 2012). FIGURE 1. RENTAL PRICES HAVE OUTPACED INCOMES

From: Collinson, Ellen, and Ludwig (2015), figure 3, page 63 Note: These prices are all expressed in real terms (i.e., they are adjusted for inflation)

1

See “Do Inclusionary Housing Policies Have Unintended Market Consequences?” beginning on page 37.

Background | Page 2

When and How Should Cities Implement Inclusionary Housing Policies? As Figure 1 above shows, the gap between incomes and housing prices has increased since the Great Recession. Specifically, real rental prices rebounded after a small dip in 2007, but real income growth has remained low since 2009. In response to these concerns, cities have become wary of implementing or having policies in place that restrain housing markets. Some cities with inclusionary policies have responded by weakening or eliminating them. Some states have responded by banning inclusionary policies at the municipal level. For example, Arizona recently passed a law that prohibits its cities and counties from passing land use regulations, plan provisions, or zoning conditions that establish the sales or lease price for any housing units (Arizona Daily Star 2015) – effectively prohibiting inclusionary housing policies. This report explores a variety of policy-relevant characteristics of inclusionary policies—from a program’s potential to promote well-being through socioeconomic integration to its administrative costs. However, the debate over markets lies at its core. In short: What are the economic effects of inclusionary housing policies? And do inclusionary policies promote or suppress housing affordability?

SUMMARY Housing has become increasingly unaffordable, in particular in the years since the Great Recession. Meanwhile, federal and state assistance for affordable housing has remained stagnant, or by some measures, declined. Cities have responded to these challenges with inclusionary housing policies. Under these policies, a municipality requires a developer building a new market-rate development to either set aside a certain percentage of the units as affordable or to pay a fee. Yet some have argued these policies create unintended market consequences that erode their ability to meet their objective of preserving housing affordability. This debate lies at the heart of this report.

Background | Page 3

When and How Should Cities Implement Inclusionary Housing Policies?

REPORT OVERVIEW This section describes the report’s objective and methodology. It concludes with a brief overview of the structure of the remainder of the report.

REPORT OBJECTIVE When grappling over the question of whether, and how, to implement an inclusionary housing policy, cities face competing and contradictory information about whether these policies promote or restrain overall affordability. Even when a city decides to implement an inclusionary policy, there is still debate over which policy type—fees or units—are the most efficient and effective. For example, some cities have pursued fee-focused policies, convinced by the argument that these policies grant flexibility to developers, reduce market impacts, and promote more affordability overall. Others cities have pursued units-focused requirements. Their proponents argue these policies result more affordable housing and more economic and racial integration by neighborhood. In part, this debate remains unresolved because of the limited available research. To date, there has been no comprehensive study on the market impacts or effectiveness of units- versus fees-focused policies. Existing evidence on inclusionary policies focuses on large metropolitan areas and bears few implications for small and mid-sized cities. There are also no academic studies that address whether a city that has an inclusionary policy will experience better market outcomes if they repeal or weaken that policy. Finally, there are no convincing studies that estimate the effect of inclusionary housing policies on housing affordability. As a result, municipalities adopting inclusionary housing policies sometimes make arbitrary or politically-driven decisions about the structure and design of those policies, which may limit their effectiveness. In short, despite many cities’ long history with inclusionary housing policies, municipalities lack formal and unbiased guidance on whether to implement an inclusionary policy and how that policy should be designed. This report aims to fill that gap.

REPORT METHODOLOGY Both quantitatively and qualitatively, this report exploits the variation in rental inclusionary housing policies observed in response to the decision by California’s Second District of Appeal in Palmer/Sixth Street Properties LP v. City of Los Angeles. I use this decision quantitatively to analyze the market effects of inclusionary housing policies and qualitatively to determine the appropriateness of a fee-focused policy versus a units-focused policy. In the 2009 decision by the Second District Court of Appeals in Palmer/Sixth Street Properties LP v. City of Los Angeles case, the court ruled that inclusionary housing requirements on rental developments without cost-offsets or city benefits violate the Costa Hawkins Rental Act of 1995. The Costa Hawkins Act (Civ. Code §1954.50 et seq.) allows developers to set initial rents on newly constructed and voluntarily vacated units in jurisdictions with rent control. Units-focused policies inhibit developers’ abilities to set those initial rates. Report Overview | Page 4

When and How Should Cities Implement Inclusionary Housing Policies? The Palmer ruling therefore called into question the legality of existing mandatory on-site performance requirements for rental projects in California. While the legal interpretation of the Palmer decision varies, in general cities interpreted the decision to mean that they could no longer maintain a units-focused policy that did not include a fee alternative.2 Some cities responded to this legal uncertainty by eliminating their entire inclusionary housing policy and some by replacing their existing policy with a fee-focused policy. As a result, fee-focused policies grew in popularity in California in response to the Palmer decision. Palmer presents a unique opportunity to compare the outcomes, successes, and challenges of unitsfocused policies against those of fee-focused policies. For the quantitative portion of my analysis, I use the variation resulting from the Palmer decision to examine the effects of inclusionary policies on unintended market consequences (like increased prices of market-rate housing) and housing affordability. For the qualitative portion of my analysis, I interviewed key informants in eight cities in the Bay Area, each of which had an inclusionary policy pre-Palmer, but had varying responses to the Palmer decision (see Table 1 below). TABLE 1. CASE STUDIES

Jurisdiction Cupertino Fremont Livermore Los Altos Palo Alto Pleasanton Santa Clara Santa Rosa

County Santa Clara Alameda Alameda Santa Clara Santa Clara Alameda Santa Clara Sonoma

Pre-Palmer Rental Policy Units Fees and Units Fees and Units Units Fees and Units Primarily Fee Units Fees

Post-Palmer Rental Policy Fees Fees and Units None Units None Primarily Fee None Fees

Case Study Page 41 Page 45 Page 43 Page 22 Page 51

Source: Author’s Analysis Note: Los Altos authorizes its inclusionary housing policies under the State Density Bonus Act and therefore was able to legally maintain a units-focused policy post-Palmer.

Each of these case studies presents a unique opportunity to examine the tradeoffs cities may face when choosing whether to pursue a units-focused policy, a fee-focused policy, or a blended policy that makes significant use of both fees and units. While all of these case studies inform my analysis, I present five full case studies in this report. These case studies appear throughout the report as indicated in Table 1 above. In addition to the quantitative analysis and case study interviews, I conducted a thorough examination of the existing empirical and qualitative literature on inclusionary housing policies. A full list of my citations begins on page 62. Finally, I conducted a variety of key informant interviews with economists, policy experts, advocates, and planners. The findings from these expert interviews appear throughout the report. A list of the experts consulted for this report appears on pages 60-61. Some cities, however, have maintained a units-only requirement by authorizing that requirement under the State Density Bonus law. See, for example, the case study of Los Altos on page 43. 2

Report Overview | Page 5

When and How Should Cities Implement Inclusionary Housing Policies?

ORGANIZATION OF THIS REPORT In structure, form, and framing, this report relies on Eugene Bardach’s method for policy analysis known as the Eightfold Path (Bardach 2012). Using this method, I compare four alternative policies (pages 7-8) against a set of pre-defined criteria (pages 15-17) to make a recommendation about the preferred policy alternative. The remainder of the report is organized as follows. I first present the four policy alternatives under consideration in this report. I then present an overview of the design and structure of these policies and legal considerations for municipalities considering adopting one of these policies. The remaining sections of the report project the outcomes of each of the policy alternatives, organized around the three major criteria outlined in this report. Specifically, the first section in this part presents the five criteria I will use to evaluate the policy alternatives. The following three sections address the three key criteria in this analysis. They analyze each alternative’s effectiveness in minimizing unintended market consequences, promoting housing affordability, and promoting socioeconomic integration. These sections include the results of my quantitative and qualitative analyses described above. The following section summarizes the results of my analysis, systematically comparing each of the alternatives against each of the criteria. The last section of this report provides my recommendations.

Report Overview | Page 6

When and How Should Cities Implement Inclusionary Housing Policies?

POLICY ALTERNATIVES In this section, I present the four major alternative policies that cities may consider when deciding whether and how to implement a rental inclusionary housing policy. First, a city may choose to adopt no inclusionary housing policy or eliminate an existing policy, which in general is the baseline condition. Second, I classify three distinct types of inclusionary housing policies based on their emphasis on the production of units or payment of fees: fee-focused policies, units-focused policies, and blended policies that make significant use of both units and fees. Typically the term “inclusionary housing policy” refers to mandatory units requirements. This term is also generally interchangeable with others’ use of the term “inclusionary zoning.” In this report, for the sake of simplicity and parsimony, I use the term “inclusionary housing policy” or “inclusionary policy” to refer to units, fee, and blended policies. As discussed in more detail below, there is a distinction between a legal emphasis and a practical emphasis on units or fees. From a legal perspective, a municipality may make a units-focused policy its default, but through the program structure, emphasize the payment of fees. It may accomplish this, for example, by setting the fee level relatively low, which creates an incentive for developers to pay fees rather than build units. The classifications below reflect a policy focus, but need not also reflect a legal focus.

ALTERNATIVE 1: NO INCLUSIONARY HOUSING POLICY Under the first policy alternative, which in some cases serves as the baseline condition, a municipality may choose not to implement an inclusionary housing policy. Other municipalities that have inclusionary housing policies may choose to repeal these policies, in which case this alternative is not the baseline condition.

ALTERNATIVE 2: A UNITS-FOCUSED POLICY Under units-focused policy, developers must sell or rent a certain percentage of newly-developed housing at below-market-rate to lower-income households. The most straightforward example of a units-focused policy is one where the developer may only choose to build units and does not have the option to pay a fee. However, a units-focused policy may also include a legal alternative for the payment of fees. From a legal perspective, these may include fee-first policies, where the legal default is for the developer to pay fees, or units-first policies, where the legal default is for the developer to produce units. In either case, to qualify as a units-focused policy, the policy structure must encourage the production of units such that the majority of developers will choose to build units rather than pay a fee.

ALTERNATIVE 3: A FEE-FOCUSED POLICY Rather than asking a developer to build units, municipalities can charge a fee to developers and then use the revenue from that fee for the provision of affordable housing. The most straightforward Policy Alternatives | Page 7

When and How Should Cities Implement Inclusionary Housing Policies? example of a fee-focused policy is one where the city requires the developer only to pay a fee, usually called a housing development impact fee, and does not allow the developer to build units as an alternative. However, a fee-focused policy may also include a legal alternative for the provision of units. As discussed previously, these may include fee-first policies, where the legal default is for the developer to pay fees, or units-first policies, where the legal default is for the developer to produce units. In either case, however, to qualify as a fee-focused policy, the policy structure must encourage the payment of fees such that the majority of developers will choose to pay the fee, rather than build units.

ALTERNATIVE 4: A BLENDED POLICY Under a blended policy, the developer may choose to either pay a fee or build units. In its ideal form, the municipality structures the program so that the median developer faces a meaningful choice between paying a fee and building units. This design results in a significant provision of both units and fees for the city. From a legal perspective, the default option for a blended policy could be either the payment of fees or the production of units.

Policy Alternatives | Page 8

When and How Should Cities Implement Inclusionary Housing Policies?

POLICY DESIGN AND LEGAL CONSIDERATIONS This section provides the legal justification for inclusionary housing policies, which vary by policy type. These legal considerations are important for municipalities to consider when implementing any type of policy. Next, this section presents an overview of the design elements for units-focused, feefocused, and blended policies. Again, these design elements are important for the success of an inclusionary housing policy, although their details are not a focus of this report. Finally, while municipalities often apply inclusionary housing requirements to both rental and ownership developments both this section and this report focus on the rental market.

LEGAL JUSTIFICATION FOR INCLUSIONARY HOUSING POLICIES The legal justification and requirements are different for units-focused policies, fee-focused policies, and blended policies. In general, a city’s legal ability to impose a units-focused inclusionary housing policy falls under its authority to regulate land use under its police powers. This standard is widely-accepted and relatively robust under the Supreme Court ruling in Penn Central Transportation Co. v. New York City. Under Penn Central, inclusionary policies can vary significantly in terms of their impacts on developers as long as they leave property owners with some profitable use of their properties. Municipalities’ legal requirements and justifications for fee-focused policies are stricter. The most important legal justifications for these policies come from a pair of U.S. Supreme Court cases, Nollan v. California Coastal Commission and Dolan v. City of Tigard, together known as Nollan/Dolan. Under the Nollan/Dolan standard, municipalities imposing fee-focused policies must meet two requirements. First, there must be an “essential nexus” between the impact of the development and the required fee. Second, the fee must be “roughly proportional” to the impact of the development. Municipalities may address these requirements using a nexus study, which I discuss in greater detail on page 12. Municipalities’ legal requirements and justifications for implementing a blended policy or a unitsfocused policy with a fee option are less strict. According to the ruling in San Remo Hotel v. City and County of San Francisco, as long as the fee structure does not allow for much latitude in calculation and application, it is not subject to the heightened scrutiny requirements under Nollan / Dolan. Nonetheless, in Elrich v. City of Culver City, California courts determined that in-lieu fees must still bear a “reasonable relationship” to their impacts. This standard lies somewhere between Penn Central and Nollan / Dolan in terms of its deference to local authority (Jacobus and Beech 2015). While inclusionary housing is largely a local issue, these requirements and restrictions can also vary by state. Some states have expressly granted municipalities with the authority to, or in some cases prohibited municipalities from, implementing inclusionary housing policies (Hollister et al 2007). While it is outside of the scope of this report to discuss all of these differences, a few states bear

Policy Design and Legal Considerations | Page 9

When and How Should Cities Implement Inclusionary Housing Policies? mentioning. On the prohibition side, Oregon, Texas, and Arizona are the only three states that have banned inclusionary housing requirements.3 On the facilitation side, New Jersey is the state with the closest example of a statewide inclusionary housing requirement. In a series of two landmark decisions in New Jersey, the 1975 Mount Laurel decision and the 1983 Mount Laurel II decision, the Supreme Court interpreted the New Jersey State Constitution to mean that municipalities must use their zoning powers in an affirmative manner to provide realistic opportunity for the production of affordable housing. Since 1985, the state has imposed detailed state regulations that govern the scope, character, and features of inclusionary housing policies. As a result, while inclusionary housing is not explicitly mandatory in the state, the cost of alternative means of achieving the state’s legislative and judicial goals has led to circumstances where it “is at the heart of nearly every suburban fair-share plan” (Calavita, Grimes, and Mallach 1997).

OVERVIEW OF POLICIES THAT INCLUDE A UNITS REQUIREMENT In this section, I provide an overview of policies that include a requirement for developers to build units, either through a units-focused policy, a blended policy, or a fee-focused policy that includes a units alternative. This section includes the legally required or recommended analyses municipalities must or should conduct before implementing such a policy and the general structure and design elements of these policies.

Relevant Analyses According to a forthcoming legal analysis by Jacobus and Beech (2015), jurisdictions should undertake economic feasibility studies for inclusionary housing policies with unit requirements. The goal of a feasibility study is to determine how a new inclusionary policy would affect market-rate housing development costs and profits. These studies also help policymakers ensure that new policies are economically sound, will not deter development, and will deliver the types of new affordable units the local community needs. These studies aim to satisfy the Penn Central test by showing that the proposed requirements leave property owners with some profitable uses of their properties.

Design Elements Inclusionary housing policies are diverse and often flexible. In this section I describe the various design elements that municipalities may consider when designing a units-focused policy. Compliance Type. Municipalities may make their inclusionary housing policies voluntary or mandatory. Under voluntary policies, municipalities offer developers incentives to build units onsite. Municipalities also use these incentives, or cost offsets, under mandatory policies. Under a mandatory policy, however, a developer does not have a choice about whether or not to build units, regardless of the cost offsets offered. For the purposes of this analysis, I focus primarily on mandatory inclusionary housing requirements. 3

Arizona recently passed its ban. The Oregon Legislature is currently considering repealing its state ban.

Policy Design and Legal Considerations | Page 10

When and How Should Cities Implement Inclusionary Housing Policies? Inclusionary Percentage Requirements. Municipalities vary the percentage requirements of their inclusionary housing policies—that is, the percentage of units that developers must build as affordable. These requirements usually range from 10 to 25 percent. Trigger Size. Some municipalities require developers to build units only when the development is above a certain size. For example, a developer may only be required to build affordable units in developments with 10 or more units. Other municipalities do not have a trigger size and the policy applies to all market-rate development. Area Median Income (AMI) Targeting. Municipalities require developers to build units so that they are affordable to families earning various income levels expressed as a percent of area median income (AMI). This calculation is based primarily TABLE 2. AREA MEDIAN INCOME TARGETING on the U.S. Department of Housing and Urban Development’s (HUD’s) estimates of the median Category Income Range family income for every county each year. HUD Extremely Low Income < 30% of AMI defines four income categories based on Very Low Income 31 - 50% of AMI Low Income 51 - 80% of AMI percentages of AMI shown in Table 2. Moderate Income

81 - 120% of AMI

Municipalities often require developers to build a certain percentage of units as affordable according to these classifications. For example, a city might require developers to build 50 percent of their affordable units at very low income and 50 percent at low income. However, these requirements can be set to any level of AMI. For example, the City of San Francisco requires developers to build at 55 percent of AMI in the rental market and 90 percent of AMI in the ownership market. Source: U.S. Department of Housing and Urban Development

Term of Affordability. Municipalities may set varying affordability control periods, which is the length of time that the units must remain affordable at the level prescribed. Affordability control periods can range from 10 years to 99 years (Hickey, Sturtevant, Thaden 2014). A subset of municipalities requires developers to keep affordable units affordable “in perpetuity” or as long as possible by law (Mulligan and Joyce 2010). Alternatives to Construction. Many municipalities allow developers to meet their affordable housing requirements with other alternatives to building units. Most notably, some communities allow developers to pay a fee, which is a focus of this report. Other options include allowing a developer to: (1) build or partner with a non-profit housing developer that agrees to build the units off-site; (2) convert or rehabilitate existing units and offer them as affordable; (3) dedicate land to the local government that will accommodate at least a comparable number of units; or (4) build more units than required in exchange for building fewer units in a future development. Cost Offsets. Municipalities offer a variety of cost offsets to either incentivize developers to build beyond their requirements or to offset the costs associated with building their required number of affordable housing units. These offsets include: (1) subsidies; (2) fee reductions, waivers, and Policy Design and Legal Considerations | Page 11

When and How Should Cities Implement Inclusionary Housing Policies? deferrals; (3) tax abatements; (4) growth control exemptions; (5) design flexibility; (5) fast track processing; (6) density bonuses; (6) reduced parking requirements; and others. Density bonuses are some of the most popular cost offsets. Under these allowances, developers are permitted to build a larger number of units on a given parcel than allowed under conventional zoning. Design flexibility is another example of a cost offset. Under this allowance, developers still must design affordable units to look identical or similar to the market-rate units, but are allowed to vary internal features to facilitate financial feasibility (California Coalition for Rural Housing and Non-Profit Housing Association of Northern California 2009). Geographic Tiering or Targeting. Some cities, especially geographically large or heavily populated cities, have a diverse range of neighborhoods that have different economic and local housing markets conditions. These cities occasionally use geographic tiering or targeting to add flexibility to their inclusionary housing policies, allowing them to address the individual needs of their neighborhoods. Under these policies, cities will either limit the geographic scope of their policies or adjust their requirements by neighborhood. For example, in Charlotte, NC and Tallahassee, FL, inclusionary housing policies apply only to specifically designated census tracts. In Austin, TX and Washington, D.C., inclusionary policies apply only to specific zoning or planning districts. In Chicago, IL and Denver, CO, inclusionary policies are calibrated by project type. For example, Denver’s policy only applies to developments with buildings that have more than three stories, elevators, and over 60 percent of the parking in a garage.

OVERVIEW OF POLICIES THAT INCLUDE A FEE REQUIREMENT In this section, I provide an overview of policies that include a requirement for developers to pay a fee, either through a fee-focused policy, a blended policy, or a units-focused policy that includes a fee requirement. This section includes the legally required or recommended analyses municipalities must or should conduct before implementing such a policy, the general approaches municipalities use when setting fees, and how municipalities usually use fee revenues.

Relevant Analyses Before implementing a fee-focused policy, jurisdictions often complete two types of studies: (1) a nexus study and (2) a feasibility study. To satisfy their legal requirements under Nollan/Dolan, a municipality considering imposing a feefocused or fee-first policy should commission a nexus study. These studies establish both the essential nexus and the rough proportionality required by the Court in those cases. A nexus study quantifies the new demand for affordable housing that is generated by new commercial or market-rate housing development. Specifically, using a hypothetical development of one or more market-rate development projects, the study analyzes how increased household spending on goods and services would lead to the creation of jobs for lower-income workers. It then

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When and How Should Cities Implement Inclusionary Housing Policies? estimates the associated demand for housing generated by these workers. The nexus study identifies the legal maximum supportable fee, or the upper bound, for the municipality when setting a fee. Jurisdictions should also undertake economic feasibility studies for a fee-focused policy. The goal of a feasibility study is to determine how a new inclusionary policy would affect market-rate housing development costs and profits. These studies also aim to satisfy the Penn Central test by showing that the proposed requirements leave property owners with some profitable uses of their properties.

Approaches for Setting Fees While the nexus study produces the maximum legal threshold for the fee, most municipalities do not usually set their fees at this level. Instead, there are three ways a municipality would usually determine its fee schedule. These are through: The funding gap or existing production cost. Municipalities use the proceeds from fees to build or fund affordable housing. Under this specification, the municipality sets the fee to be at least as much as the gap in funding it must provide to a developer to build affordable housing. That is, the amount that the public has historically invested to produce each affordable unit. Cities could calculate this funding gap either including or not including their potential to leverage fee revenue with state and federal funding sources. The affordability gap or developer’s opportunity cost. The opportunity cost of a units requirement is the present value discounted difference between the proceeds of the below-marketrate rent and the rent the developer would have earned at market-rate. Under this alternative, the fee is based on the typical difference in price between market-rate and affordable units. A percent of development costs. Finally, making assumptions about profitability and prices, municipalities can set fees as a fixed percentage of estimated development costs. All of these are uniform approaches, which use averages that do not vary by development type or cost. In practice, however, these approaches set an average rate and municipalities may use this average to construct a fee schedule that is adaptable to various development types and costs.

How Municipalities Use Fees The proceeds of inclusionary housing fees do not go to General Funds, but rather, often to Housing Trust Funds or Local Housing Funds for the provision of affordable housing. Municipalities can use proceeds from Housing Trust Funds in several ways. For example, they can use them for direct loans or grants to owners or developers of low-income housing; to underwrite bonds sold to support low-income housing; or for direct low-income rental assistance or homebuyer subsidies. Some municipalities will also combine fee revenue with a housing levy or voter-approved bonds in these funds. Municipalities often leverage these local funding sources with state or federal funding for affordable housing. The most notable federal funding sources are the Low Income Housing Tax Credit (LIHTC), which is a dollar-for-dollar tax credit for affordable housing investments; and two HUD

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When and How Should Cities Implement Inclusionary Housing Policies? programs: the HOME Investment Partnerships Program and the Community Development Block Grant Program. Many of these federal and state sources require the input of local funds to receive any funding. If the city has a high leveraging ratio it may more than triple its funding for affordable housing using fees as a local commitment to match or complement other funding sources (Jacobus 2015). If the fee revenue from the inclusionary housing policy is the community’s only source of funding for affordable housing, then this leveraging may result in a substantial increase in the amount of affordable housing the community has the capacity to build. Rather than building units, some cities use their funds to preserve or maintain existing affordable housing. This may include acquisition and rehabilitation of existing buildings, often done in partnership with non-profit organizations. Other cities will spend their funds directly to maintain public housing or other affordable housing projects. Finally, some cities restrict or target their funding to certain populations, socioeconomic groups, or neighborhoods. For example, cities can use fees specifically to support housing developments for a formerly homeless or veteran population. Often funding is not restricted to these uses, but rather city staff members are given the flexibility to pursue these types of policy priorities.

OVERSIGHT AND MONITORING Once the affordable units are built, municipalities must dedicate a level of ongoing administration and oversight to effectively preserve the affordable housing. According to Jacobus (2007) there are four major administrative tasks associated with overseeing a rental inclusionary housing policy. They are: Overseeing the production of new affordable housing units; Pricing (i.e., setting rents) so that these units are affordable initially and over time; Marketing of inclusionary housing opportunities and selection of eligible residents; and Monitoring the units to ensure appropriate occupancy and payment of taxes and insurance. As Jacobus (2007) notes, to deliver on their potential, “inclusionary housing programs must be well run.” While this report does discuss the administrative costs associated with various forms of inclusionary policies, it does not address these administrative challenges in great detail.

SUMMARY Cities implementing any type of inclusionary housing policy face a range of policy design options, which may each contribute to that policy’s effectiveness in promoting lasting housing affordability or achieving socioeconomic integration. While these design options are not a focus of this report, they are important to bear in mind for any municipal official who is designing or implementing an inclusionary housing policy. Policy Design and Legal Considerations | Page 14

When and How Should Cities Implement Inclusionary Housing Policies?

CRITERIA This section outlines the five criteria that I use to compare the four policy alternatives described above. Using Bardach’s (2012) methodology, I outline these criteria so that I can be explicit about the evaluative standards that I will use to judge the relative merits of each of the proposed policy alternatives. In short, these criteria define and operationalize the meaning of “success.” I present these criteria in the order in which they will appear in the remainder of the report, but this order does not necessarily indicate their relative importance.

Criterion 1: Effectiveness in Minimizing Unintended Market Consequences A policy is effective in minimizing unintended market consequences to the extent that it minimizes increases in the price of market-rate housing and decreases in the production of market-rate housing. The primary criticism levied against inclusionary housing policies is that they may have unintended market consequences. In particular, critics argue that if inclusionary policies are sufficiently restrictive they may impose additional costs on developers, restrain the production of housing, and possibly result in increased prices of market-rate units. These effects could have the added negative consequence of restraining housing affordability (see criterion below). In the context of still-stifled housing production from the Great Recession, many municipalities may be particularly concerned about the potential for an inclusionary policy to further dampen a still-weak housing market. The extent and magnitude of these relationships is under debate and is a primary focus of this report. This analysis begins on page 18.

Criterion 2: Effectiveness in Promoting Housing Affordability A policy effectively promotes housing affordability to the extent that it results in lower rental prices, particularly among low-cost rental units. Inclusionary housing policies may promote more housing affordability by: (1) promoting the production of affordable housing; (2) preserving existing affordable housing; and (3) putting downward pressure on market-rate units through competitive pressures. However, some have argued the unintended market consequences listed above erode the policy’s ability to meet this objective. As a result, it is critical to understand the net effect of an inclusionary housing policy’s impact on affordability. Cities seeking to maximize the well-being of their residents may care about housing affordability for many reasons. The amount that a family spends on housing directly affects its overall well-being. A dearth of affordable housing in a jurisdiction limits families’ access to employment and good schools. It requires low-wage workers to make long commutes and therefore inhibits their ability to participate in their community and household lives. It may also negatively impact businesses that are unable to meet their employment needs with local workers.

Criteria | Page 15

When and How Should Cities Implement Inclusionary Housing Policies? The analysis of the extent to which the various policy alternatives promote housing affordability begins on page 37.

Criterion 3: Effectiveness in Promoting Socioeconomic Integration A policy is effective in promoting socioeconomic integration to the extent that it provides opportunities for low-income residents to live in low-poverty neighborhoods. Municipalities may care about socioeconomic integration either for its own sake or to the extent it promotes better outcomes among low-income residents or has value to the entire community. Neighborhood conditions can play a powerful role in the quality of life for individuals in terms of educational, economic, and social opportunities. Neighborhoods vary in terms of peer influences, exposure to violence and environmental contaminants, amenities, and social networks and organization. Better educational and economic opportunities are more likely to be located where new market-rate housing is being produced or existing housing is high-cost. As a result, to be effective on this parameter, inclusionary housing policies must promote socioeconomic diversity in residential neighborhoods so that low-income households are better connected to better educational, economic, and social opportunities. Socioeconomic diversity may be the means to promote better outcomes for low-income families, but it may also be an end itself. On its own, socioeconomic integration may be important to a municipality that values diversity. As a result, the degree to which a municipality prioritizes this criterion over others may depend on its own values. The analysis of the extent to which the various policy alternatives promote socioeconomic integration begins on page 47.

Criterion 4: Minimizes Administrative Costs This criterion refers to the extent to which the alternative minimizes administrative costs for the jurisdiction that has implemented it. Inclusionary policies may vary in terms of their costs to city taxpayers. These expenses may vary in terms of the cost of implementation, monitoring, or oversight. Many localities are increasingly costconscious and as a result may want to minimize administrative costs of an inclusionary housing policy. While this report does not include a separate analysis of the administrative costs of each of the policy alternatives, a discussion of these costs appears in the Analysis of Alternatives, beginning on page 53.

Criterion 5: Likelihood of Achieving Intended Outcomes This criterion refers to the probability that the alternative will achieve its desired outcomes. All of the proposed alternatives vary not only in terms of their outcomes under an ideal design but also in terms of their probability of achieving those outcomes given the political and administrative

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When and How Should Cities Implement Inclusionary Housing Policies? challenges municipalities face when implementing an inclusionary policy. This criterion captures the relative certainty with which a policy will achieve its desired outcomes. While this report does not include a separate analysis of this criterion, a discussion of these uncertainties appears in the Analysis of Alternatives, beginning on page 53.

SUMMARY Five criteria, which define the “success” of an inclusionary housing policy, provide the backbone of the analysis in this report. They are: (1) Effectiveness in Minimizing Unintended Market Consequences; (2) Effectiveness in Promoting Housing Affordability; (3) Effectiveness in Promoting Socioeconomic Integration; (4) Minimizes Administrative Costs; and (5) Likelihood of Achieving Intended Outcomes. The reminder of the report is organized around the analysis of these criteria. Specifically, the remaining sections analyze the extent to which various policy alternatives: have unintended market consequences; promote housing affordability; and promote socioeconomic integration. While this report does not include a separate analysis of the administrative costs of each of the policy alternatives or their likelihood of their intended outcomes, a discussion of each of these criteria appears in the Analysis of Alternatives.

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When and How Should Cities Implement Inclusionary Housing Policies?

DO INCLUSIONARY HOUSING POLICIES HAVE UNINTENDED MARKET CONSEQUENCES? The primary criticism levied against inclusionary housing policies is that they may have unintended market consequences. In particular, effective in minimizing critics suggest that when inclusionary policies are restrictive they unintended market restrain the production of housing. Alternatively, if they impose consequences to the additional costs on developers, those developers may be able to pass extent that it along their increased costs to market-rate renters, resulting in minimizes increases in the price of market-rate increased prices of those units. These effects could have the added negative consequence of restraining housing affordability (see housing and decreases criterion 2, beginning on page 37). In response to this concern, many in the production of municipalities, uneasy about still-stifled housing production leftover market-rate housing. from the Great Recession, have either weakened their inclusionary housing policies or decided not to implement a new one. Yet there is debate over the extent and magnitude of these relationships. Criterion 1: A policy is

In this section, I examine whether inclusionary housing policies have unintended market consequences on housing production and prices. In support of this analysis, I review the literature, report findings from my case study interviews, and present the results of my quantitative analysis. I conclude this section by presenting my framework for analyzing whether a units- or fee-focused policy would have greater unintended market consequences.

REVIEW OF THE LITERATURE AND THEORY Theory and Evidence on Housing Prices Based on economic theory, the simple hypothesis of the market effects of inclusionary housing polices is that they are tax on market-rate development. If an inclusionary policy operates like a tax, and consumers are not perfectly mobile, the developer would be able to pass along some its costs to consumers in the form of higher rental prices on new market-rate units. This can only occur if consumers are willing to pay a premium to live in the location with the inclusionary housing policy or willing to accept price increases (Padilla 1995). Figure 2 below illustrates this theory, showing that a tax on housing production will increase equilibrium housing prices from P* to PIH. In the interest of dispelling a common misunderstanding, it is important to note that these market effects are aggregate, not individual. That is, a single developer cannot pass along or increase his prices above the market equilibrium. He would not be able to do this because, seeing his excess profits, another developer would enter the market, charge the equilibrium price, and draw the customers away from the more profitable developer. However, if costs increase for all developers (e.g., a tax or an increase in the price of land or construction costs) then the supply curve will shift to the left and prices may increase.

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When and How Should Cities Implement Inclusionary Housing Policies? FIGURE 2. SUPPLY AND DEMAND EFFECTS OF A TAX ON DEVELOPMENT

Consumers may not be willing to accept price increases in new market-rate development in the relevant market because they are able to move to another market or because there are plenty of housing substitutes in the relevant market. In short, these reactions describe the slope of the demand curve, which may either be steep and inelastic (i.e., consumers are not price sensitive and will accept price increases) or shallow and elastic (i.e., consumers are price sensitive and will not accept price increases). If consumers are price sensitive, developers have three other possible responses. First, if the developer does not own land at the time the policy is enacted, it could bargain with landowners for a lower land price (Calavita and Grimes 1998). Second, some developers may accept that they cannot raise prices and be able to reduce their profits (Calavita and Grimes 1998, Padilla 1995). Third, developers may shift housing production to another type, exit the market, or reduce the number of homes they build (Been 1991, Clapp 1981, and Ellickson 1981). The third response would cause a reduction in the supply of housing, including market-rate housing, in the market impacted by the inclusionary housing policy. This unintended effect is discussed further below. The existing empirical literature on the effects of inclusionary housing policy on prices has generally found these policies will lead to an increase in the price of market value homes of up to 3 percent. In a study of California between 1988 and 2005, Bento, Lowe, Knaap, and Chakraborty (2009) found that inclusionary housing policies had a positive effect on the price of single-family houses, increasing prices by about 2 to 3 percent. Similarly, and again using evidence from California, Knaap, Bento, and Lowe (2008) replicated their findings, estimating that in jurisdictions with inclusionary housing policies, housing prices increase, on average, by 2.2 percent. In a study of San Francisco and Boston, Schuetz et al. (2009) examined the impact of inclusionary housing policies on prices and production of market-rate housing production. In Boston, Schuetz et Do Inclusionary Housing Policies Have Unintended Market Consequences? | Page 19

When and How Should Cities Implement Inclusionary Housing Policies? al. (2009) found that a 1 percent increase in years the program was in place leads to a 1.4 percent increase in the prices of single family homes. In San Francisco, they fail to find an effect of inclusionary housing policies on prices.

Theory and Evidence on Land Values The discussion of the effects of inclusionary housing policies on land values is highly related to the question of home prices. This is the other side of the same coin: when levying a tax on development, a developer may choose to shift the cost of the tax forward to consumers, through higher housing prices, or backward to landowners, through lower land values. In fact, on the whole, many economists believe that, in the long run, the cost burden of an inclusionary housing policy is capitalized into decreased values of residential land (Calavita and Grimes 1998, Mallach 1984). As such, in the long-run, it is likely that landowners, and not homebuyers, bear the costs of inclusionary housing (Calavita and Grimes 1998). It is important to note that this relationship is theoretical and, to date, there have been no empirical studies of the association between inclusionary housing policies and land values.

Theory and Evidence on Housing Production If mandatory inclusionary housing policies are a tax on new residential development, they would reduce the production of residential properties (Been 1991, Clapp 1981, Ellickson 1981). A reduction in supply could occur either because the same developers are willing to build fewer units or because only certain types of developers are willing to build at all (Clapp 1981). Powell and Stringham (2005) add that many national firms have a choice in setting up or closing shop in any given state or city and, in the long run, the number of firms will adjust. Figure 2 in the previous section illustrates this theory, showing that if developers are mobile, a tax on housing production will reduce equilibrium housing production from Q* to QIH. Not all inclusionary policies operate as a pure tax on development, however. In some cities, cost offsets offered to developers may fully offset, or possibly more than offset, the costs of building the affordable units. In those places, inclusionary policies may even promote more market-rate development. For example, in cities with very constrained housing markets (e.g., strict density requirements and other forms of exclusionary zoning) a flexible inclusionary policy that gives density bonuses and subsidies create opportunities for developers to build more. While this assessment is theoretical, the implication is that it is not necessarily the case that inclusionary policies would result in a decrease in the production of market-rate housing. While the literature is not robust, the available empirical evidence has failed to find credible evidence of negative relationship between inclusionary housing policies and housing production. Several studies find no evidence of an effect. Schuetz et al. (2009), for example, found a minor effect of inclusionary housing on housing production in Boston and no evidence in the Bay Area. Using data from Los Angeles and Orange Counties, Mukhija et al. (2010) found no statistically significant evidence of inclusionary zoning’s adverse effect on housing supply in cities with inclusionary

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When and How Should Cities Implement Inclusionary Housing Policies? mandates. The authors conclude that critics of inclusionary housing policy “overestimate its adverse effects on housing supply.” In a study of 28 Californian cities over a 20-year period, Rosen (2004) examined building permit data to test the effect of inclusionary housing policies on the pace of development. He found no negative effect on overall production. In some cases, housing production increased. The California Coalition for Rural Housing and the Non-Profit Housing Association of Northern California (2004) examined 107 inclusionary zoning policies in California and did not find any evidence that the policies slowed development. Neither of these studies, however, used a methodology that establishes credible causality and their results should be interpreted as descriptive only. Other studies have mixed results. In the study of Californian cities, Knaap, Bento, and Lowe (2008) found that inclusionary housing policies have no significant effect on the number of permits for single-family housing units. However, they do find that single-family permits as a share of total permits are lower in jurisdictions with inclusionary housing policies. Bento et al. (2009) found that cities with inclusionary housing policies did not experience a significant reduction in the rate of single-family housing starts; however, they did experience a marginally significant increase in multifamily housing starts. Powell and Stringham (2004) offer the most robust findings that associate inclusionary housing policies with negative effects on housing production. On average, they found that in cities with inclusionary housing policies permits declined 10 to 30 percent in the seven years after the policies were adopted. However, critics have raised concerns about several questionable assumptions and technical limitations of this study (see Basolo and Calavita 2004). These critics have noted that this study should be interpreted only as descriptive, not as evidence of a causal relationship between inclusionary housing policies and housing market outcomes.

Limitations of the Existing Literature The extant literature suffers from a number of weaknesses. First and foremost, none of the studies adequately addresses the issue of reverse causality. There is no doubt that cities enact inclusionary policies in response to eroding affordability (i.e., when prices are increasing). These studies use difference-in-difference models, controlling for year and city fixed effects, which would not account for this fact. If, for example, cities adopt inclusionary housing policies when their rates of rental price growth are higher than typical or higher than their peers that do not adopt these policies, then the coefficient would be biased upward. The current literature also fails to address two additional questions: first, it does not address what would happen to market outcomes if a city removed its existing inclusionary housing policy. Second, most studies do not address the effects of inclusionary housing policies on mid-sized and small cities, but rather focus on large cities with hot housing markets, such as Boston and San Francisco. This analysis aims to respond to these limitations.

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When and How Should Cities Implement Inclusionary Housing Policies?

IDENTIFICATION STRATEGY Before 2009, many jurisdictions in California had mandatory units-focused policies for both ownership and rental developments. Some, but not all, of these policies allowed developers to use a fee in place of the units requirement. In 2009, the California’s Second District of Appeal made a ruling in Palmer/Sixth Street Properties LP v. City of Los Angeles that called the legality of units-focused policies into question. In the Palmer case, the court ruled that inclusionary housing requirements on rental developments violate the CostaHawkins Rental Act of 1995. As an alternative that would likely stand up to legal scrutiny, jurisdictions were able to assess fees on new rental developments rather than require units.

CASE STUDY: SANTA CLARA In response to the Palmer decision, Santa Clara eliminated its units-focused policy and now has no rental inclusionary housing requirement. The City of Santa Clara is located about 45 miles southeast of San Francisco and in the heart of Silicon Valley. With a population of about 116,000, Santa Clara is one of the ten largest cities in the San Francisco Bay Area. It is home to the San Francisco 49ers stadium and the headquarters of several tech companies including Applied Materials, Intel, and Texas Instruments, which are the city’s largest employers. Median household income in Santa Clara is about $91,000, above the state median of $61,000. Median rental prices are $1,609, also above the median state price of $1,224. According to the most recent estimates from the American Community Survey, Santa Clara’s rental vacancy rate is low, at about 4 percent, and 55 percent of Santa Clara’s occupied housing units are renteroccupied. Pre-Palmer. In 2009, Santa Clara had a mandatory, units-focused inclusionary housing policy established in the city’s housing element. The policy applied to developments with ten or more units and required developers to build 10 percent of units on-site as affordable. It distributed affordability levels based on the city’s Regional Housing Needs Allocation (RHNA) requirements. In general, these resulted in a required distribution of 60 percent of units at 50 percent AMI (very low income) and 40 percent of units at 80 percent AMI (low income). The program had no fee option. Post-Palmer. In response to the Palmer decision, Santa Clara suspended its entire inclusionary housing rental policy. As a result, Santa Clara no longer has an inclusionary housing program that applies to rental development, although it does have a policy for ownership development. In the immediate aftermath of Palmer, most jurisdictions with inclusionary policies did one of two things. First, some jurisdictions stopped enforcing their inclusionary housing rental policies entirely. For example, before the Palmer decision, both the City of Palo Alto and the City of Livermore had Do Inclusionary Housing Policies Have Unintended Market Consequences? | Page 22

When and How Should Cities Implement Inclusionary Housing Policies? mandatory inclusionary housing policies for rental development that allowed developers to pay a fee as an alternative to the construction of units. In reaction to the Palmer decision, both cities stopped enforcing their entire inclusionary housing policy. Similarly, the City of Santa Clara had an inclusionary housing policy without a fee option. In response to the decision, Santa Clara suspended its entire rental inclusionary housing policy (for more information about Santa Clara’s policy changes after Palmer, see the case study description on page 22). Second, many jurisdictions that had policies that included a fee option stopped enforcing their unit requirements and converted to a fee-focused policy. For example, before the Palmer decision, the City of Cupertino had a mandatory units-requirement for developers building seven or more units and a fee option for developments with six or fewer units. After the Palmer decision, Cupertino transitioned to a fee-focused policy, requiring all developers to pay a fee (for more information about Cupertino’s policy changes after Palmer, see the case study description on page 41). Another subset of jurisdictions continued enforcing both aspects of their policies, although they maintained the units requirement as an option for developers in conjunction with a fee. Jurisdictions that had no inclusionary policy, or already had a fee-focused policy, did nothing. There are two possible ways to interpret this policy change. First, we may interpret this as a transition from largely units-focused policies to largely fee-focused policies. Second, we may interpret this policy change as an overall weakening of inclusionary requirements. However, because fee levels are relatively low in many places, it is reasonable to assume that on average, it was easier for developers to meet inclusionary housing policy requirements post-Palmer. Palmer was a state-level ruling, so at the local level the decision to suspend inclusionary requirements is plausibly exogenous. Exploiting this exogenous shock, I compare outcomes post-Palmer among those cities that had inclusionary housing policies to those that did not. Unfortunately, my data do not allow me to systematically identify which cities continued to enforce a fee-focused policy postPalmer. However, the Palmer decision on average weakened inclusionary housing policies statewide, which means this method allows me to compare market outcomes on average for municipalities with no inclusionary requirements to those that weakened their policy. The treatment period begins in 2010. While the Palmer decision occurred in July 2009, it took at least a few months for cities and developers to react. In one of the quickest reactions, the City of Cupertino stopped enforcing its unit requirements for rental developments within a few months. Other cities took longer. For example, the City of Pleasanton did not finish analyzing the legal implications of Palmer for its inclusionary policy until May of 2010. As a result, 2010 is the first year that we might expect to see market effects from Palmer.

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When and How Should Cities Implement Inclusionary Housing Policies?

EMPIRICAL DESIGN For the technical reader, I present my two primary model specifications in this section.

Basic Model Equation 1 below shows the general specification that I estimate for prices and production. (1) log⁡(𝑦𝑐𝑡 ) = ⁡𝛼 + ⁡𝜏𝐷𝑐𝑡 + ⁡𝛿𝟏(𝑡 = 1) + ⁡𝛾𝟏(𝑐 = 1) + 𝑋𝑐𝑡 𝛽⁡ + ⁡ 𝜀𝑐𝑡 where log(yct) is the natural log of the outcome variable: either rental prices or housing units produced. D is a dummy variable that equals 1 if the city had a rental inclusionary housing policy before Palmer and for the treatment period, and 0 otherwise. This variable identifies the model’s main treatment effect (i.e., treated cities in the treated period). The interpretation of 𝜏 is therefore the average effect, by city, of the Palmer decision, which on average resulted in a weakening of inclusionary housing policies. The model includes year and city fixed effects: t is a vector of dummy variables for years and c is vector of dummy variables for cities. These fixed effects control for city-specific characteristics that do not vary over time (e.g., geography) and time-specific characteristics that do not vary by city (e.g., statewide economic conditions). X is a vector of time-variant individual city characteristics, including population size, racial composition, and rates of educational attainment. These variables control for additional attributes that vary both by time and city. Standard errors are clustered at the county level because housing market outcomes between cities that are geographically close to each other are likely correlated with one another.

Event Study Model Equation 2 below shows the event study specification that I estimate for prices and production. (2) log⁡(𝑦𝑐𝑡 ) = ⁡𝛼 + ∑𝑇𝑗=𝑡 0 𝜏𝑗 [𝟏(𝑡 = 𝑗)𝑥⁡𝐷)] ⁡ + ⁡𝛿𝟏(𝑡 = 1) + ⁡𝛾𝟏(𝑐 = 1) + 𝑋𝑐𝑡 𝛽⁡ + ⁡ 𝜀𝑐𝑡 Rather than a estimating a single treatment effect, this model allows me to specify a vector of treatment effects by year, 𝜏𝑗 . This specification gives me the flexibility to examine differences in treatment and control, year by year. In short, it “unpacks” the pre- and post-period trends into yearby-year estimates. The event study specification has two advantages over the basic model. First, it allows me to examine pre-trends in the period before Palmer (i.e., 2007 to 2009). Given that the parallel trends assumption is a key identifying assumption for the difference-in-differences model, if I find no statistically significant differences in the pre-treatment coefficients it will strengthen the validity of the estimate. Second, it allows me to examine the time path of the effect of treatment. Standard errors are again clustered at the county level.

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When and How Should Cities Implement Inclusionary Housing Policies?

DESCRIPTION OF THE DATA My analysis covers 120 cities in California, which are those cities for which I have 1-year ACS estimates.4 This section describes the sources for the dependent and independent variables included in the model.

Dependent Variables: Price I measure rental prices using annual median rental prices, by city, from the U.S. Census’ one year American Community Survey (ACS). These one year data are available from 2007 to 2013. To test whether there is a difference in this outcome for high-cost versus low-cost properties, I run the same model using two additional outcome variables from the 1-year ACS data: upper quartile rental prices and lower quartile rental prices. I adjust all rental prices for inflation using the Consumer Price Index (All Urban Consumers, Current Series).

Dependent Variables: Production Ideally, to measure the impact of the Palmer decision on housing production, I would use a measure of the production of rental FIGURE 3. INCLUSIONARY CITIES IN CALIFORNIA, BY COUNTY, 2009 units. No such data are available, however, so I measure housing production of rental units with a proxy from the RAND California Residential Construction Statistics. RAND reports monthly permits for various types of new privately-owned residential construction, by city, in California. RAND imputes some the data from the U.S. Census. These data are available from 2006 through the end of 2012. They include permits by single-family homes, duplexes, buildings with three to four units, and building with five or more Source: Author’s analysis with data from California Coalition for Rural Housing. units. Image credit: Alex Marqusee.

In general, single-family homes and duplexes are associated with ownership development and buildings with three or more The U.S. Census Bureau publishes 1-year estimates for all cities with populations sized 65,000 or more. The fact that my sample only includes these larger cities may mean that these results are not generalizable to smaller cities. 4

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When and How Should Cities Implement Inclusionary Housing Policies? units are associated with rental development. As a result, I use the permits for single-family homes and duplexes to proxy for ownership production and permits for multifamily buildings to proxy for rental production. I also report my findings using total building permits.

Key Independent Variable I measure the presence of a mandatory rental inclusionary housing policy with survey data from the California Coalition for Rural Housing (CCRH), the Non-Profit Housing Association of Northern California, the Sacramento Housing Alliance and the San Diego Housing Federation. Led by CCRH, these organizations conducted a survey of inclusionary housing policies between 2008 and 2009. The data are not time-series, but rather only give a snapshot of what existed in the beginning of 2009. As a result, I assume that if a city had an inclusionary housing policy in this dataset, it also had that policy in 2007. I also assume that no city passed a rental inclusionary housing policy between the survey date (January 2009) and the Palmer decision (July 2009). The qualitative evidence from my case studies supports these assumptions. Figure 3 shows the geographic concentration of inclusionary cities, by county, in 2009. It shows the percent of cities in each county with an inclusionary housing policy. In general, cities with inclusionary housing policies in 2009 were in coastal counties. The map also shows that few cities in the Central Valley or Sierra Nevada regions had inclusionary policies.

Control Variables Table 3 below shows the covariates included in all of the model specifications. This list of variables follows from those used in Schuetz et al. (2009). TABLE 3. OTHER INDEPENDENT VARIABLES

Variable Log of total population Percent of 19 year-olds and over who are employed Percent of population that is white Percent of population that is black Percent of population that is Hispanic Percent of population with a BA degree or above

Source American Community Survey, U.S. Census American Community Survey, U.S. Census American Community Survey, U.S. Census American Community Survey, U.S. Census American Community Survey, U.S. Census American Community Survey, U.S. Census

The dataset from CCRH also includes a number of descriptive dimensions of program characteristics, such as information on set-aside requirement; income targeting; and the presence of various alternatives to construction; trigger size for requirements; and cost offsets for developers. These variables are not pre-determined, so it would not be appropriate to include them as covariates. To test whether the strength of the inclusionary housing policy has an effect on prices or production, I also ran stratified samples using the models above. I do not report the results from the stratified samples for two reasons, however. First, I do not find a substantial difference in the effects of a “strong” policy (defined in various ways) from the effects of an average policy. Second, my qualitative interviews revealed the policy attribute data are unreliable and subject to excessive measurement error. Given these facts, I concluded it was inappropriate to report these results. Do Inclusionary Housing Policies Have Unintended Market Consequences? | Page 26

When and How Should Cities Implement Inclusionary Housing Policies?

DESCRIPTIVE STATISTICS In 2009, there were 125 cities in California that had inclusionary housing policies in the rental market, which I will refer to as “treatment” or “inclusionary cities.” I refer to cities without an inclusionary housing policy in 2009 as “control” or “non-inclusionary cities.” As Figure 3 in the previous section showed, in 2009 inclusionary cities were largely clustered in the coastal counties, particularly in the Bay Area and in southern California. Table 4 shows that, on average, inclusionary and non-inclusionary cities are similar on a variety of metrics. However, in general, inclusionary cities are more educated and less Hispanic than their noninclusionary counterparts. Cities with inclusionary housing policies also tend to be slightly larger, although not strikingly so. Excluding San Francisco and Los Angeles, the mean population of inclusionary cities is 171,977 and the mean population of non-inclusionary cities is 143,598. TABLE 4. MEAN OF KEY VARIABLES FOR TREATMENT AND CONTROL CITIES IN 2009

Population Mean Mean Median Rental Price Mean Percent Employed Mean Percent White Mean Percent Black Mean Percent Hispanic Mean Percent with BA or above

Treatment Cities 194,136 $1,319 59.9% 65.3% 6.4% 26.9% 39.1%

Control Cities 188,035 $1,241 58.4% 61.7% 8.4% 40.5% 24.8%

Source: Author’s analysis with data from the U.S. Census

The Palmer decision occurred at very unusual time for housing market in California. Residential permits plunged in 2009, down to 35,000 statewide, about half their rate in 2008, before picking back up in 2010. Overall housing production continued to lag between 2010 and 2012, however, housing production in the multi-family market rebounded much quicker (Department of Housing and Community Development 2012). Figure 4 below displays the unconditional means of annual multifamily housing construction permits for inclusionary and non-inclusionary cities.

Do Inclusionary Housing Policies Have Unintended Market Consequences? | Page 27

When and How Should Cities Implement Inclusionary Housing Policies? FIGURE 4. MEAN ANNUAL RENTAL HOUSING PRODUCTION OF CITIES WITH AND WITHOUT I NCLUSIONARY HOUSING POLICIES , 2001-2012

Source: Author’s analysis with data from RAND

As Figure 4 above shows, 2009 was the inflection point of rental housing production in California. While the trends are similar in inclusionary and non-inclusionary cities before and after 2009, it is clear that inclusionary cities rebounded from the crisis much faster and likely for reasons separate from the Palmer decision. Given that I cannot completely control for these differences with a reasonable set of covariates, any estimate for the effect of Palmer on housing production is likely invalid. In short, the cross-currents in the housing market were just too strong in 2009 to reasonably isolate an effect of the Palmer decision on housing production. The basic analysis above shows that these estimates are likely to fail the assumption of parallel trends. As a result, I do not present results from a production model in this report. While this period was also a relatively unusual time for housing prices, a basic analysis of median rental prices reveals that they were much more stable over this period. Rental prices also stagnated between 2008 and 2010, although generally followed the same trends before 2008 and after 2010. Figure 5 below shows the unconditional means of median rental prices among inclusionary and noninclusionary cities over the period for which I have data: 2007 – 2013.

Do Inclusionary Housing Policies Have Unintended Market Consequences? | Page 28

When and How Should Cities Implement Inclusionary Housing Policies? FIGURE 5. MEAN ANNUAL RENTAL HOUSING PRICES OF CITIES WITH AND WITHOUT INCLUSIONARY HOUSING POLICIES, 2001-2012

Source: Author’s analysis with data from the U.S. Census

According to this basic analysis of pre-trends, a price model is less likely to fail the parallel trends assumption, which is the key identifying assumption for the analysis below.

RESULTS In this section I present the results of my analysis for median housing prices, upper quartile housing prices, and mean residential valuation of multi-family units.

Effects of Palmer on Median Housing Prices Table 5 below displays the results of my analysis from Equations (1) and (2) on median rental housing prices. The results in 1a and 2a show the results without the inclusion of covariates. Specifications 1b and 2b include all covariates listed. Keeping with the convention in the economics literature, I designate statistically significant coefficients using astrices on the standard errors.

Do Inclusionary Housing Policies Have Unintended Market Consequences? | Page 29

When and How Should Cities Implement Inclusionary Housing Policies? TABLE 5. EFFECTS OF PALMER DECISION ON MEDIAN RENTAL PRICES

Dependent Variable

Log(Median Rental Prices)

Variable

(1a)

Treatment

0.025 (0.008)**

0.019 (0.008)*

7.041 (0.006)** 0.70 790

0.001 (0.001) 0.002 (0.001)* 0.177 (0.071)* -0.001 (0.000)** -0.002 (0.001) -0.001 (0.001) 0.001 (0.001) 4.878 (0.847)** 0.71 753

2007 Treatment Effect

(1b)

2008 Treatment Effect 2010 Treatment Effect 2011 Treatment Effect 2012 Treatment Effect 2013 Treatment Effect Percent with BA Degree Percent Employed Log of Total Population Percent White Percent Black Percent Hispanic Percent Under 19 Constant R2 Observations

(2a)

0.013 (0.012) -0.010 (0.009) 0.011 (0.009) 0.014 (0.013) 0.035 (0.014)* 0.044 (0.015)**

7.037 (0.007)** 0.70 790

(2b)

0.015 (0.012) -0.006 (0.009) 0.011 (0.009) 0.014 (0.012) 0.030 (0.013)* 0.035 (0.013)* 0.001 (0.001) 0.002 (0.001)* 0.171 (0.073)* -0.001 (0.000)** -0.002 (0.001)* -0.001 (0.001) 0.001 (0.001) 4.957 (0.871)** 0.71 753

Robust standard errors clustered by county. Table excludes year and city/town fixed effects. * p