Lower Fees Lead to More Homes and More Revenues
One of the many levers that California cities control that directly influence housing production is the one-time fee they charge builders to help cover roads, parks, and other public infrastructure. A new RAND Corporation study by Lizhong Liu and Jason M. Ward, Understanding How Impact Fees Shape Housing Development Feasibility and Local Fiscal Revenue, finds that modest cuts to these fees could spur thousands of additional homes in the state’s priciest cities – and the lost revenue would be recovered within a few years, thanks to the higher revenues that result from housing growth.
Key Takeaways:
- Legal, yet Unprofitable to Build. Los Angeles, San Diego, San Francisco, and Palo Alto have nearly 133,000 parcels zoned for denser housing than currently exists on those parcels. Yet, building homes only makes financial sense on a fraction of those parcels: 10% of LA’s parcels make financial sense to build homes on versus 35% in SF and San Diego, 45% in Palo Alto.
- LA and San Diego Gain Most. According to the study, a 25% fee cut would spur developers to build 277 projects in LA and 55 in San Diego, but just 20 in San Francisco and 1 in Palo Alto. Those latter two cities have fewer large parcels that would benefit from fee cuts.
- Revenue Recovery Time Varies. A 25% fee cut pays back fastest in San Diego (4 years) and slowest in Palo Alto (7), because San Diego’s cut creates more feasible homes that can bring in new tax revenue.
The researchers mapped “underbuilt” parcels: lots zoned for more homes than exist today. For each one, they modeled a building and its return on cost, i.e yearly rent minus operating costs and property taxes, divided by total building costs (construction, land, soft costs, and fees). A project counted as feasible only above 6 percent. They reran this under fee cuts of 25-100 percent, then compared each city’s lost fee revenue against future property and sales taxes, tracked up to 30 years.
This is what they found:
Zoned capacity far outpaces what’s actually profitable. LA has room to add 870,000 units under current zoning, but zoned capacity isn’t the same as profitable capacity. Only 10 percent of LA’s eligible projects actually clear the bar, compared to 35 percent for San Diego and 45 percent for Palo Alto. Fees aren’t the main reason: LA’s average fee ($513K) is lower than San Diego’s ($550K). It’s because LA’s average project costs $13 million to build against San Diego’s $9 million, while rents don’t rise to match. Palo Alto’s high 45 percent rate comes with a caveat: its sample of large projects is too small to draw firm conclusions.
Fee cuts help each city differently. A 25 percent fee cut unlocks 5,647 new homes in Los Angeles and 2,726 in San Diego, but just 706 and 26 in San Francisco and Palo Alto, respectively. LA’s gains cluster in mid-size buildings, 11 to 50 homes; in San Francisco and San Diego, it’s the largest buildings, 100-plus homes, that become viable. Palo Alto barely moves until cuts reach 35 to 40 percent. Both Palo Alto and San Francisco have fewer large, higher-density parcels among their underbuilt sites, the ones most likely to be unlocked when fees drop.
Cities recover forgone fees at different speeds. San Diego and LA pay back a 25 percent fee cut fastest, in 4 and 5 years, mainly because those cuts create far more newly feasible homes, bringing a bigger property and sales tax base online sooner. San Francisco hits the same five-year mark despite unlocking far fewer homes. That’s because it keeps roughly 75 percent of property tax revenue, versus 55 to 57 percent in LA and San Diego, since it’s both a city and county in one. Palo Alto, with neither advantage, takes 7 years. Cutting fees to zero stretches every city’s timeline from 22 to 30 years.
The study suggests a 25 percent fee cut pays back fastest, in 4 to 7 years; a 50 percent cut still pays back in 8 to 13 years, slower but still reasonable. San Francisco should also consider removing its planning-area fees alone, which delivers roughly as many newly feasible projects as a citywide 50 percent cut.
Fee cuts do not guarantee a single home gets built. Financing, permitting, and developer capacity may also impact development. However, California cities have less control over those latter parameters, but they can control fees. And cutting them modestly could mean more housing without a lasting hit to their budgets.
Photo Attribution: Dietmar Rabich / Wikimedia Commons / “San Francisco (CA, USA), Twin Peaks, Blick auf Downtown — 2022 — 3050” / CC BY-SA 4.0