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» Annual Privatization Report 2005

Housing and Land Use

•  Supreme Court Unleashes Eminent Domain in Cities
•  Affordable Housing
•  Inclusionary Zoning

Supreme Court Unleashes Eminent Domain in Cities

On June 23^rd, the U.S. Supreme Court gave a rubber stamp to government efforts to seize private property for economic development purposes. In Kelo v. New London, a small band of property owners challenged the city of New London, Connecticut's authority to seize their homes and businesses for the sole purpose of redeveloping the land to generate higher tax revenues.

The Supreme Court sided with the city in a split decision. "Promoting economic development is a traditional and long accepted function of government," wrote Associate Justice Stevens for the majority. "There is…no principled way of distinguishing economic development from the other public purposes that we have recognized." The decision effectively makes private property rights non-issues for local governments as long as they follow proper legal procedures.

Eminent domain is the government power to forcibly confiscate, or "take," private property as long as it is for a legitimate "public use" and property owners receive "just compensation." Traditionally, public use has meant activities for public use such as roads, schools, municipal buildings, canals, or parks. Cities offer these services and programs for the use of the public at large with equal access. The power was reserved for government use, under specific circumstances, and was not intended as a tool for private individuals and businesses to dispense with private markets and compel others to sell their land to them.

Yet, a recent analysis of takings cases for redevelopment purposes by Reason Foundation suggests this distinction in fuzzy at best.

A Green Light for Eminent Domain

The New London case is a direct descendant of the judiciary's "hands off" approach to eminent domain, and the Supreme Court effectively said as much in Kelo. Case law, including the groundbreaking decision in the mid-1980s by the Michigan Supreme Court in Poletown v. the City of Detroit, broadened the power of local governments and gave them license to effectively void individual property rights at their discretion as long as they say it is for a public benefit. The Poletown case, in particular, was important because the Michigan Supreme Court allowed a city to raze an entire neighborhood to accommodate a new General Motors plant in order to meet an explicit economic development goal.

While Poletown was a state court decision, the decision had nationwide impact. Building on federal law that granted increasingly broad scope to state and local governments, cities and states across the nation used eminent domain to seize private property and hand it over to other private property owners using economic development as a justification.

The result, perhaps inevitably, was Kelo. Local government officials targeted a 90-acre section of the city for redevelopment, condemning 115 properties in the Fort Trumbull neighborhood to clear the way for new offices and luxury apartments to complement a recently completed research facility developed by Pfizer, Inc.

The Michigan Supreme Court overturned Poletown in July 2004 when it ruled against a county's use of eminent domain for a private business and office park in County of Wayne v. Edward Hathcock. The effects of this reversal are likely to be limited given the U.S. Supreme Court's decision in Kelo (although the Court explicitly noted the ability of states to adopt more strict guidelines than in federal law).

The Institute for Justice, a Washington D.C.-based public interest law firm that defends property owners in eminent domain cases, estimates that eminent domain was used to threaten or "take" more than 10,200 properties nationwide between 1998 and 2002 where the primary beneficiary would be another private property owner.

The change in attitudes toward property rights among urban policymakers has corresponded with changing the legal definition of public use and the scope of activities that could fall under eminent domain. Even though governments are still responsible for paying "just" compensation when private property is seized, they often don't. Local officials often attempt to minimize payment for the property. Many of these and other abuses were chronicled in a recent book by Steven Greenhut, Abuse of Power. Cities will:

• hire appraisers to low-ball property valuations;

• use the threat of eminent domain to intimidate property owners to sell at below-market rates;

• compensate property owners at assessed valuation even though market values are significantly higher;

• avoid paying relocation costs for businesses and homeowners;

• ignore the value of "good will" and other intangible value implicit in a business's reputation or location; and/or

• underestimate start-up and marketing costs involved after a business moves.

Whether the courts will scrutinize compensation decisions more rigorously in the wake of Kelo has yet to be seen.

Razing Arizona

The case of Bailey's Brake Service in Mesa, Arizona provides a case in point. Randall Bailey had been operating his family-owned and operated business on Site 24 for decades. He remained the principal tenant (and landowner) even after Redstone Property began purchasing the businesses and land around him on behalf of Lenhart's ACE Hardware. As other buildings were purchased by Redstone and left vacant, Bailey kept his business open and thriving at the location based on references, reputation, and an intergenerational client base.

Neither Lenhart nor Redstone Development approached Randall Bailey about purchasing his property. In fact, when Randall Bailey approached Redstone to discuss the possibility of incorporating his business into their redevelopment plan, representatives referred Bailey to the city of Mesa, which was acquiring property for the redevelopment project.

Further analysis of the case found:

• Eminent domain was a tool of first resort, not last resort in Mesa;

• Properties targeted for redevelopment were identified by potential private investors, and the city then proceeded to condemn the properties in order to sell them to the private developers;

• The city's redevelopment agreement with private developers would have amounted to effective subsidies ranging from $176,000 to $592,000 dollars.

• Existing small business owners and homeowners were effectively shut out of the negotiations and redevelopment decisions; and

• Many properties seized were viable and growing. Property values in the neighborhood increased by 19.3 percent between 2000 and 2002.

Mesa's case may be unique in that the city relied almost exclusively on eminent domain to achieve its redevelopment objectives. The mechanisms used, however, are common in the redevelopment community. In fact, the statutory requirements for using eminent domain—initiate a planning process, adopt a redevelopment plan, acquire the property, then transfer the property to a private developer—could serve as a template for other communities across the nation. As long as Mesa had an approved development plan, and had adhered to procedures for determining blight, the city could effectively seize one person's property and transfer it to someone else.

After several years of litigation, the Arizona Court of Appeals upheld Bailey's right to keep his business and property, but the decision was very limited and did not implicate the redevelopment techniques used by the city of Mesa. Eminent domain was struck down because the only significant beneficiary of the project was another private party (in this case Lenhart and the local developers). Moreover, the ruling stipulated that eminent domain cases needed to be reviewed on a case-by-case basis, and did not set new precedent for limiting the scope of eminent domain beyond the narrow circumstances surrounding Randall Bailey's case.

Grassroots Flood Control in Lakewood

The city of Lakewood, Ohio, a "first tier" suburb immediately adjacent to Cleveland, provides another telling example of how eminent domain has become a cornerstone of city redevelopment initiatives. Lakewood isn't one of the suburban communities mired in decline. On the contrary, the average home sells for $146,605, 15.9 percent higher than Cuyahoga County and almost on par with suburban Cleveland communities. The city's assessed valuation increased by 15 percent between 1994 and 2000 according to the Cuyahoga County auditor, significantly faster than the average for Cleveland's suburbs. Despite being boxed in by surrounding communities, the city managed to issue 1,645 residential building permits between 1999 and 2000 as well. By all significant indicators, Lakewood has a robust economy.

Nevertheless, like most cities, not all neighborhoods fare equally well. The West End is one neighborhood like that. The West End consists of 31 acres on the western edge of Lakewood. The area has substantial scenic value, looking over the Rocky River protected by the Cleveland park system. Almost 3,000 people lived in the neighborhood in 2000, occupying more than 1,700 housing units.

The West End neighborhood was developed primarily in the decades spanning the turn of the 20th century. Almost all the non-apartment residential and commercial buildings were built between 1897 and 1925 and the area exhibits the structural limitations common to older buildings and roads.

During the summer of 2002, planning consultant D.B. Hartt and architectural consultant Square One, Inc. conducted surveys of the buildings in the West End. Surveys of the buildings and city records led them to conclude that the West End neighborhood had "sufficient deficiencies…which together are detrimental to the public health, safety and welfare and which impeded the sound growth, planning and economic development of the City of Lakewood" and "that substantial portions of the" community development area met the definitions of blight as defined in the city's ordinances.

Yet, the consultants' report does not provide evidence that the majority, or even most, of structures in the West End neighborhood meet the criteria for blight. The conclusions rest on inferences from small samples of buildings and a fundamental belief that older buildings are inherently inferior to new, comprehensive development. In fact, there was virtually no evidence presented regarding ill health, transmission of disease, infant mortality, and juvenile delinquency, or moral hazard in the West End. Almost all the evidence presented highlighted features of buildings and sites typical of neighborhoods 80 years old outside the primary growth path of a region.

While significant differences appear to exist in different areas of the West End, these differences would be expected when some areas are characterized by very high densities and others by lower densities.

Moreover, this kind of diversity is part of the natural evolution of neighborhoods. This diversity should be expected in a neighborhood more than 80 years old. In short, homes and buildings built in the early 20th century did not conform to the city of Lakewood zoning code in 2002, and these discrepancies became evidence that the homes and businesses should be razed and redeveloped according to plans created by the city. An analysis of trends in the neighborhood found:

• Property values in some parts of the West End were increasing faster than for the city as a whole, suggesting a strong real estate market;

• Residential vacancy rates for homeowners were falling faster in the West End neighborhood than for the city as a whole;

• Homeownership rates had increased in the West End neighborhood between 1990 and 2000; and

• The West End neighborhood was healthy, growing, and stable using standard criteria of neighborhood development.

The city's primary motivation for redeveloping the site, it appeared, was the potential for substantially increasing its tax base. The city's redevelopment plan for the area estimated that the total value of real estate in the West End could increase from $31.3 million to $131.1 million by transforming the area from an older, affordable residential neighborhood to a mixed-use "lifestyle center" with offices, high-end restaurants, luxury apartments, and movies theaters. Significantly expanding the commercial mix of the land and replacing the existing affordable homes with upscale housing would increase the total value of real estate to between $79.8 million and $131.1 million dollars. Real estate taxes would triple and income taxes would double. Redevelopment could boost city tax revenues from just $638,694 to as much as $1,657,733.

In razing the affordable housing and the small businesses that serve that neighborhood (generally convenience stores, fast food, and discount establishments), the city of Lakewood sought to fundamentally change the character of the neighborhood,shifting it from an affordable residential neighborhood to an upscale commercial mixed-use area.

In the end, the West End was saved at the ballot box. Grassroots opposition rose to ward off local politicians and planners despite heavy financial and political support from Lakewood's political and business establishment. Unfortunately, a political solution is as permanent as the next election cycle, and no judicial precedent was set in Ohio. The majority decision in Kelo makes it clear, however, that Lakewood's efforts to oust its residents from the growing West End would be legal and legally legitimate.

Is There an Alternative?

Eminent domain destabilizes the investment climate for everyone except those negotiating directly with the city for a piece of the development project. Even in these cases, investors cannot be certain their investments and property are safe. If the neighborhood or commercial area continues to decline, or fails to achieve the investment objectives established by the redevelopment plan, their property rights will be at risk as well. In fact, based on the conventional wisdom in the economic development community, cities would be obligated to reinitiate the redevelopment process, putting each property at risk again. Few people will invest in homes or small businesses if they are unsure if they will be in the home or neighborhood for long. Yet, this is the climate the broad-based use of eminent domain for redevelopment purposes creates.

Cities increasingly think of redevelopment as large-scale, comprehensive projects. An incremental approach to redevelopment is discouraged even when a project's timetable for completion (build out) may be 10 or 15 years.

An alternate approach is to look for more incremental and property-rights-friendly approaches to redevelopment. Dozens of less draconian tools exist, however, including:

• Upgrading roads, sewers, public transit and other infrastructure;

• Implementing zoning regulations that restrict land uses to certain types and densities;

• Employing tax rates, tax abatements, and tax incentives to promote certain types of development;

• Reforming zoning codes to allow faster and streamlined project approvals;

• Incentive zoning to encourage private-sector development of specific types of projects;

• Landscaping and streetscaping;

• Offering loans, grants, and direct subsidies to developers and builders; and/or

• Voluntarily purchasing land.

Citizens and local policymakers must take a fresh look at how the economy repositions itself in an information-driven, globally competitive world market and what, if anything, public policy can do to influence these shifts. The following key observations and principles may help redefine how public officials approach redevelopment in urban areas.

• Focus on the Achievable. Vision is not enough. A practical key to successful economic development policy is the ability of local leaders to be realistic in their expectations and in the programs they create to achieve them.

• Provide Core Services Efficiently for Long-Term Success. Government investment does not create long-term job growth. Certain types of investments, such as road and sewer infrastructure, help lay a broad-based foundation for private investment.

• Create Sustainable Economies Through Private Investment. The vast majority of jobs come from local small businesses starting up, expanding and diversifying over time. These are the businesses hurt the most by eminent domain proceedings and large-scale redevelopment plans catering to the wants of large developers.

• Lead with Focus, Drive and Simplicity. A more effective strategy has been for local leaders to identify two or three key areas and goals, and then develop a timed, phased action plan to achieve them. The results are easier to measure, and implementation is clearly and more likely to succeed.

• Respect the Rights of All Citizens. Government should focus on providing core services that serve the broad-based citizenry and avoid the trap of believing the biggest or wealthiest citizen has more rights or more to offer than the hundreds of homeowners and businessmen that make up the city's foundation.

• Encourage Voluntary Investment and Redevelopment. Cities should work with developers to accommodate property rights protections to create a business climate more supportive of property rights, greater investment certainty, and a more cohesive community. Most redevelopment projects are implemented in phases, and few projects depend on all properties being acquired in order for them to be successful.

• Evaluate the Process Rigorously. A more rigorous definition of "blight" or "deteriorating" would provide guidance regarding which neighborhoods do in fact degrade community welfare. Public officials should also be required to consider the feasibility of accomplishing the project's goals by less aggressive means.

Commentary: Making Way for the Government Bulldozer

You may think your home is your castle, but the Supreme Court decided it isn't. It's just on loan from your friendly local government who can bulldoze it anytime it wants as long as a majority agrees, they held the right number of public hearings, and they have a plan.

That's what any reasonable person reviewing the Court's decision in Kelo v. New London might think. Hundreds of local governments already do it. The Supreme Court just gave them the rubber stamp they needed.

Kelo v. New London involves a hardy band of home and business owners in the historic neighborhood of Fort Trumbell in New London, Connecticut. The city, acting through its redevelopment agency, condemned the homes and businesses to make way for professional office buildings, swanky retail shops, and luxury condos and apartments.

The city's "vision" for the neighborhood, local officials thought, would generate more tax revenue. The newer buildings, bigger tax base, and more tax revenue constituted a "public use" and the Supreme Court agreed.

Of course, eminent domain is not a new government power. It's been around for centuries and enshrined in the Fifth Amendment to the U.S. Constitution.

What's new is the brazenness in which governments use it. Eminent domain is supposed to help governments when they need to provide a "public use". In the past, public use was considered as something open to the public or something necessary but could be provided by the private sector. Building roads, canals, acquiring land for public buildings, or providing parks qualified.

In the mid-1980s, that changed with the Michigan Supreme Court allowed the city of Detroit to demolish a close-knit, working-class neighborhood called Poletown to make way for a factory. The city condemned the properties, bulldozed the homes, and handed the land over to General Motors to build its plant.

The Michigan Supreme Court reversed itself in 2004, but the damage was done. The decision unleashed a wave of condemnations like New London's that shoved long-time residents and businesses aside in the name of economic development.

"Promoting economic development is a traditional and long accepted function of government," Justice Stevens wrote in the majority opinion. Apparently, public use can now be interpreted as any function of government, and private property can be seized as long as the former owners are compensated.

Indeed, this is exactly what Justice Sandra Day O'Connor fears. In her stinging dissent, she validated the danger inherent in upholding the New London case: "The specter of condemnation hangs over all property. Nothing is to prevent the state from replacing any Motel 6 with a Ritz-Carleton, any home with a shopping mall, or any farm with a factory."

Sound extreme? Read the words of New London's lead attorney during oral arguments on page 30, lines 3-9:

Justice Sandra Day O'Connor: For example, Motel 6, and the city thinks, well, if we had a Ritz-Carlton, we would have higher taxes. Now, is that okay?

New London's Attorney: Yes, Your Honor. That would be okay.

At least he showed respect to Justice O'Connor.

Sad as it may be, many people ignored eminent domain in the past because it seemed to apply mainly to the poor—removing so-called "urban blight." The poor have always been at a disadvantage because they were renters or couldn't afford attorneys to fight city hall. Now, eminent domain is removing the middle class. Only the rich may be safe from the government bulldozers.

Private property rights were once a hedge against government corruption and abuse. This protection was so essential the Founding Fathers explicitly limited its use to special circumstances—public uses and as long as "just compensation" was provided to homeowners.

Now, there appears to be little "right" left in private property rights. Columbia University law professor may be correct when he told the Associate Press "The message of the case to cities is yes, you can use eminent domain, but you better be careful and conduct hearings."

As long as the city holds the requisite number of public hearings, and a majority of the city council agrees, private property no longer serves as a check against government abuse. The U.S. Supreme Court just told every city, county, and state government that. They even put it in writing.

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Affordable Housing

Housing has long been one of the staples of American society and the United States' economic prowess has afforded its citizens an abundance of safe and decent housing. The national homeownership rate as of Q1, 2004 is 68.6 percent, according to the National Association of Realtors. But this success is tempered by the fact that some Americans are finding it increasingly difficult to afford housing in their communities. Housing prices are growing faster than incomes in some areas, in severe cases, pricing low-income buyers out of the market. The real estate boom of the last few years has caused housing prices to skyrocket, making it difficult for low- and middle-income families in many areas to purchase a home. Unfortunately, most of the political remedies aimed at making housing more affordable to these families don't consider the real world functioning of housing markets and wind up making the problem worse. "Affordable housing" is now in the lexicon of seemingly every state, city, and housing advocacy group.

Housing affordability is largely a function of income. One of the best available measures for determining affordability is the Housing Opportunity Index (HOI). This index simply states the percentage of homes sold in a given area that would have been affordable to a household with the area's median income. Affordability is defined as a house payment no greater than 28 percent of gross household income. Housing advocates have further defined affordability to include rental affordability (rent payment not exceeding 30 percent of household income). The nationwide HOI as of Q1, 2002 is 64.8 (the most recent data) implying that households earning the national median income can afford nearly two-thirds of all houses sold. HOIs in the 1990s hovered in the 50s and mostly 60s implying that there has been no dramatic shift in the last decade. However, aggregate HOI data do not tell the whole story. HOIs in selected markets are extremely low, particularly the West Coast and parts of the Northeast. Many of the California markets are below 30, for example. The data indicate that the perception of widespread housing unaffordability is largely exaggerated, but that selected markets are experiencing unacceptably wide gaps in housing prices and income.

Housing policy is in dire need of a paradigm shift. "Affordable" has become the buzzword of choice as a euphemism for "subsidized." Furthermore, the debate has centered on the housing unit as a measure of affordability, when in fact the hard construction cost of a housing unit is not necessarily an indication of its value. Given the shortcomings of current housing policy and the overall perspective of the housing issue, a new approach to housing policy is needed. Several options that address the concerns of both low-income renters and low-moderate renters and homebuyers include:

1. Stop policies that reduce the supply of housing and drive up prices. Land use controls are a significant contributor to high house prices, especially urban growth boundaries, growth moratoria, tangled and lengthy entitlement processes, and excessively high impact fees. Loosening such restrictions will increase "for sale" housing construction and the additional supply would almost certainly relieve some pricing pressures.

2. Encourage the use of market innovations such as location-efficient mortgages. Location-efficient mortgages (LEM) allow borrowers to increase their gross monthly income-to-mortgage payment ratio higher than the conventional loan standard of 28 percent (36 percent total debt). In order to qualify, the borrower must live in a location the lender deems efficient in terms of auto commuting. The premise is that by lowering a household's automobile transportation costs, the family will have more money to allocate to their mortgage payment.

3. Take advantage of non-profit efforts. Community groups can help provide affordable housing in many ways. For example, local affiliates of Habitat for Humanity (HFH) have built 50,000 safe, affordable, decent homes for U. S. households alone. HFH builds simple, small homes and keeps them affordable by using community volunteers and the new owners themselves to build the house and offering qualified households interest-free mortgages.

4. Focus on the people, not the housing. Most state and local government plans to tackle affordable housing issues focus on how to build subsidized supplies of new housing. A better approach is to identify folks who need help affording housing and provide them assistance to buy or rent housing in the market. The concept of traditional HUD voucher programs like Section 8 is sound, though the execution has been problematic. Local governments, through cooperative agreements or through their Metropolitan Planning Organizations (MPOs) could offer flexible housing vouchers to earned-income tax credit qualified households tailored to local conditions. Vouchers could be offered on a sliding scale to those in need and could be used for rental or mortgage payments.

5. Deal with civil service compensation issue directly. In some communities the affordable housing dilemma hinges on local government workers like police officers and teachers being able to afford to live in the community. Creating subsidized housing for civil servants or teachers does not solve the problem. Instead, the problem is usually supply, discussed in point number 1 above, and that the local government organizations are not paying salaries commensurate with the cost of living in the community and should confront that problem directly.

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Inclusionary Zoning

As housing prices rise around the nation, there is great pressure on state and local governments to "do something" about the housing affordability crisis. One of the most popular responses has been "inclusionary zoning" ordinances that mandate developers sell a certain percentage of the homes they build at below-market prices to make them affordable for people with lower incomes. A report in the mid-90s estimated that about 10 percent of cities over 100,000 in population had inclusionary zoning requirements, and many advocacy groups predict the trend will accelerate in this decade.

The way inclusionary zoning tries to tackle the affordable housing problem is by mandating that developers sell a certain percentage of new homes at a cut rate. But inclusionary zoning tends to lead to less housing and higher prices. If developers are required to sell some houses at prices below market rates, they will have to make up the difference by raising the prices of the other homes in the development. And if that does not work, they can simply shift development to other communities where there are no inclusionary zoning mandates. Either way you get higher prices or less housing.

More important, inclusionary zoning tries to make the wrong end of the housing market affordable. Affordable housing is not new homes, it is older homes. The housing market is akin to a ladder, a natural economic process [see Repairing the Ladder: Towards a New Housing Paradigm.]. Typically, people rent when they are young. As incomes rise and family situations change, people tend to move up the housing ladder. Maybe they first seek a better apartment, then a starter home, then a bigger home, etc. Along the way, they make trade-offs regarding a number of factors—location, home size, community amenities, school districts, pricing, discretionary spending, etc. Subsidizing rents or houses in all communities breaks the housing ladder because it allows households to avoid these tradeoffs. For example, a lower-income family may find that it can live in a less expensive city within the same metropolitan area, share a car or own an older one, rent or buy a smaller residence, or lower discretionary spending. Trying to force entry-level buyers into the new housing market turns the natural market on its head and ensures we won't get the most efficient outcomes.

In some instances, "density bonuses," or rewards given for constructing housing with a higher density, are granted to developers to make up for lost revenue, but there are problems with this approach to compensating developers for providing low-income housing. First, the initial allowable density was likely artificially restricted through zoning and the land purchase price may have a density bonus factored into the price. In this way, density bonuses try to solve a problem created by regulation with more or "counter"-regulation. Second, the developer may believe that the project is not suited to higher density and therefore, chooses not to "capitalize" on the additional allowable density.

Empirical research published by Reason on the effects of inclusionary zoning in cities in California confirms that the hopes for inclusionary zoning are false. In most communities the number of affordable homes being built declines after inclusionary zoning is put into practice, and home prices go up.

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