What is “Inclusionary Zoning”? The California YIMBY Explainer

What is “affordable housing?”

When most people hear the term “affordable housing,” they think “housing that I can afford based on my income and expenses,” not “housing that is subsidized and restricted to households that make less than a certain income.” 

However, in housing policy discussions, “affordable housing” is a technical term that specifically refers to rent-regulated, below-market-rate housing for people at specific income levels. This type of housing is also typically (but not always) subsidized, either by the government, or by other renters with higher incomes.

In the housing policy world, if your housing cost requires 30% or less of your income, that housing is considered affordable to you. If it’s over 30%, you’re considered “cost-burdened.” If it’s over 50%, you’re severely rent- or housing cost-burdened.

In addition, the income level that determines whether a resident can qualify for subsidized housing is measured regionally, or within an “area.” The logic is simple: Incomes vary widely across different geographies; so, while a household earning $125,000 a year in Houston, Texas, will find plenty of market-rate housing they can afford, that same salary in San Jose, California is insufficient – there is no market-rate housing affordable to a family at that income level. 

The metric that housing policy experts use to measure incomes and affordability in a given region, or area, is referred to as “area median income (AMI).” This is also the standard used to determine who qualifies for subsidized and income-restricted housing.If the difference between affordable housing and housing affordability sounds arcane, confusing, and technical, that’s because it is arcane, confusing, and technical.

How do market-rate homes contribute to affordable housing?

In the United States, most people – including most low-income people – live in what’s called “market-rate housing,” which is any housing that is not either income-restricted or subsidized affordable housing. This is because, in a functioning housing market, home builders continue to build homes as a region’s population and economy both grow; the abundant supply of new housing ensures that renters and home buyers both have a wide variety of housing options. As homes age and depreciate, less costly housing and older homes become available to households with lower incomes, through a process known as “filtering.” 

But in many regions of the U.S., especially California, homebuilding is severely restricted, or even prohibited, by local land use regulations and other ordinances that hinder the construction of new homes. These rules typically target multi-family homes like apartments and condos, which are generally the most affordable types of market-rate housing.

When local governments restrict the construction of new homes – of any type, whether subsidized, or market-rate – the result is housing shortages that drive up costs for everyone, creating the need for even more subsidized or income-restricted housing. If homebuilding is impeded for long enough, regions can fall so far behind on their housing need that they can’t provide sufficient subsidy to make up the difference; the cost would be too prohibitive, even for the government.

What is Inclusionary Zoning?

Governments and policy makers have come up with a suite of interventions to try to bridge the gap between housing people can afford, and the housing that is available in their jurisdictions. One such method is called “inclusionary zoning (IZ).” 

Inclusionary zoning is a regulatory framework imposed by local, county, or state governments that encourages — or, more often, requires — home builders to set aside some of the new homes they build for residents who could not afford them at the market price. These homes can be built into new market-rate housing projects, resulting in developments known as “mixed-income housing:” some homes will be market rate, and some will be subsidized and “deed-restricted” – that is, only residents whose incomes are below a certain AMI threshold are allowed to live there. 

But just as often, developers will pay a “fee in lieu” for the “inclusionary” homes required by the regulations. Those fees are then distributed by the government to developers who specialize in building affordable housing that is also deed-restricted by income.

Why do people need housing subsidies?

Due to a variety of factors, building new homes today is always more expensive than building new homes yesterday, or last year, or 20 years ago. This is why brand new homes, like brand new cars, are more expensive than older models. At the same time, the price of new housing can’t be infinitely high – wealthy people may have more money to spend on housing; but they have their limits.  

So when a home builder is planning their project, they have to make sure their construction budget for the housing is low enough that they can recoup all of their costs, along with their profit, when that housing is sold or rented at the going price.

This is where the subsidies for affordable housing become so important: Lower-income residents often can not afford to pay rents that would allow builders to cover their costs. While cities that build abundant housing help ensure there’s enough affordable housing for most low-income people – through “filtering” – many US cities do not do this. Instead, they have maintained a regulatory regime, through rules like zoning and height limits, that forces housing scarcity. 

In any case, people with very low incomes will almost always require some form of housing subsidy. But due to the scarcity of housing in many of our cities, a growing cohort of residents can only afford housing in their communities if they’re also offered rent at subsidized rates.

Who pays for these subsidies?

Housing subsidies are typically distributed in one of two ways: as vouchers for tenants or as subsidies for buildings.

The federally-funded Housing Choice Voucher program, often referred to as “Section 8” in reference to the law that created it, enables low income tenants to find housing on the open market by paying landlords the difference between market rate rents and 30% of the voucher-holder’s salary. Notably, these vouchers are held by tenants and not tied to any specific building.

Affordable housing, on the other hand, works at the building level: individual homes are designated as affordable and rent restrictions are written into the deed for the property (this is why affordable housing is sometimes referred to as “deed restricted affordable housing,” as opposed to other forms). 

There are a few different ways of funding subsidized housing at the building level. Most 100% affordable housing projects are built by nonprofit developers that get tax credit funding from the government to build subsidized housing. 

In some places, local and state governments give developers property tax breaks to offset the cost of providing below-cost housing in mixed-income projects. They also will pass affordable housing bonds and special tax assessment districts, and set up housing trust funds, to provide subsidies to specific housing projects within their jurisdictions.

In California, while local, state, and the Federal government provide the lion’s share of subsidies for affordable housing, inclusionary zoning generally does not come with any kind of public funding or tax breaks. Instead, the subsidies are paid for by the other residents of the building who live in the market-rate units.

This setup, where residents who don’t qualify for housing subsidies are charged higher rent to cover the cost of the subsidies for the residents who need them, is called a “cross subsidy.”

How does this impact the cost of housing?

The dilemma of a cross subsidy like inclusionary zoning is that it only works when the market price of housing is very high. That is, the market price of new homes must be so high that the residents are willing to pay the base cost (construction cost plus builder profit) plus the amount needed to subsidize lower-income residents. 

In essence, inclusionary zoning works best in places that have engineered a housing shortage so profound, that housing costs are extremely high for everyone. In cases where market rents aren’t high enough to allow for cross-subsidies, new homes don’t “pencil”—revenues will not cover costs—and landowners either decide not to build multi-family homes, or they default to building the most expensive form of housing available: Single-unit homes. 

Of note: No jurisdiction in the United States requires inclusionary zoning for single-unit developments – even though single-unit homes are the most expensive form of housing on the market.

Why don’t these developers just take lower profits?

Like most businesses, home builders usually borrow money from lenders to finance their housing projects. And like most lenders, the people who finance housing only provide the funds when builders commit to a certain rate of return. This means builders have to deliver competitive investment returns to get funding from lenders. If they accept a lower profit, they won’t be able to finance and build any homes at all.

Perversely, this means IZ can actually exacerbate an area’s housing shortage and lead to more displacement. By forcing market-rate rents to go up to cover the cost of the cross-subsidy, and thereby making some new home construction financially infeasible, inclusionary zoning often inadvertently kills new home construction. 

When this happens, it unleashes a vicious cycle of housing unaffordability: Prices for existing homes increase, canceling out the affordability gains from the few affordable units that do get built, creating a deeper housing shortage, forcing the need for more subsidies, which then can’t be generated by IZ because the projects are no longer feasible.

A recent UCLA analysis of Los Angeles’ Transit Oriented Communities program found exactly this effect. Transit Oriented Communities (TOC) is an optional “density bonus” program that gives developers permission to build taller, denser buildings in exchange for setting aside some of them as affordable. The UCLA analysis found a steep tradeoff: for each low-income affordable housing unit built under the program, between 4.5 and 9 market-rate units were not built because they were financially infeasible.By placing the entire burden of funding subsidized housing on the market-rate renters who live in the project, inclusionary zoning results in fewer homes, and those homes that are built are only affordable to high-income residents.

What’s wrong with having wealthier people subsidize low-income housing?

Taxing rich people’s housing wealth to fund housing subsidies for poor people is a great idea; but IZ doesn’t actually do that. This is because IZ generates its cross subsidies within individual developments, not at a city- or statewide level. The people who live in market-rate, multifamily housing mostly aren’t rich. 

The wealthiest residents in most metropolitan areas overwhelmingly live in single-family homes that they own, not apartments; and because IZ is never applied to single-unit housing, these wealthy residents don’t pay a penny for subsidies under IZ. As such, the financial burden for subsidizing low-income housing falls on middle-class renters.

How do we maximize production of affordable housing without harming overall housing affordability?

There are a variety of ways to fund affordable housing without driving up the price of market rate housing. For starters, the state could make more efficient use of existing affordable housing funds by simplifying the funding application process, consolidating our many different programs into one to reduce development costs, and adopting other cost-savings measures.

The state could also get into the development business itself by creating a permanent social housing developer, or offering low-cost financing for European-style limited-profit housing cooperatives. More radically, California could move away from IZ and other forms of “value capture,” which function as a tax on new housing, and instead repeal Proposition 13 and tax property at market value—or implement a land value tax—and spend the revenue on subsidized housing for poor people.

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