California and many urban areas nationwide face a housing affordability crisis. New housing production has chronically failed to meet housing needs, causing housing prices to escalate. Faced with demands to “do something” about the housing affordability crisis, many local governments have turned to “inclusionary zoning” ordinances in which they mandate that developers sell a certain percentage of the homes they build at below-market prices to make them affordable for people with lower incomes.
The number of cities with affordable housing mandates has grown rapidly, to about 10 percent of cities over 100,000 population as of the mid-90s, and many advocacy groups predict the trend will accelerate in the next five years. California was an early leader in the adoption of inclusionary zoning, and its use there has grown rapidly. Between 1990 and 2003, the number of California communities with inclusionary zoning more than tripled—from 29 to 107 communities—meaning about 20 percent of California communities now have inclusionary zoning.
Inclusionary zoning attempts to deal with high housing costs by imposing price controls on a percentage of new homes. During the past 20 years, a number of publications have debated the merits of inclusionary zoning programs. Nevertheless, as a recent report observed, “These debates, though fierce, remain largely theoretical due to the lack of empirical research.”
This study attempts to fill the research void. In this paper we use data from communities in the San Francisco Bay Area region to evaluate the effects of inclusionary zoning and examine whether it is an effective public policy response to high housing prices. We chose the Bay Area because inclusionary zoning is particularly prevalent there; today more than 50 jurisdictions in the region have inclusionary zoning. These communities have various sizes and densities with different income levels and demographics, so they provide a good sample to tell us how inclusionary zoning is probably working nationwide.
These are our findings:
Inclusionary Zoning Produces Few Units
Since its inception, inclusionary zoning has resulted in few affordable units. The 50 Bay Area cities with inclusionary zoning have produced fewer than 7,000 affordable units. The average since 1973 is only 228 units per year. After passing an ordinance, the average city produces fewer than 15 affordable units per year.
Inclusionary zoning cannot meet the area’s affordable housing needs. At current rates, inclusionary zoning will only produce 4 percent of the Association of Bay Area Governments’ estimated affordable housing need. This means inclusionary zoning will require 100 years to meet the current five-year housing need.
Inclusionary Zoning Has High Costs
Inclusionary zoning imposes large burdens on the housing market. For example, if a home could be sold for $500,000 dollars but must be sold for $200,000, the revenue from the sale is $300,000 less. In half the Bay Area jurisdictions this cost associated with selling each inclusionary unit exceeds $346,000. In one fourth of the jurisdictions the cost is greater than $500,000 per unit, and the cost of inclusionary zoning in the average jurisdiction is $45 million, bringing the total cost for all inclusionary units in the Bay Area to date to $2.2 billion.
Inclusionary Zoning Makes Market-priced Homes More Expensive
Who bears the costs of inclusionary zoning? The effective tax of inclusionary zoning will be borne by some combination of market-rate homebuyers, landowners, and builders. How much of the burden is borne by market-rate buyers versus landowners and builders is determined by each group’s relative responsiveness to price changes.
We estimate that inclusionary zoning causes the price of new homes in the median1 city to increase by $22,000 to $44,000. In high market-rate cities such as Cupertino, Los Altos, Palo Alto, Portola Valley, and Tiburon we estimate that inclusionary zoning adds more than $100,000 to the price of each new home.
Inclusionary Zoning Restricts the Supply of New Homes
Inclusionary zoning drives away builders, makes landowners supply less land for residential use, and leads to less housing for homebuyers—the very problem it was instituted to address.
In the 45 cities where data is available, we find that new housing production drastically decreases the year after cities adopt inclusionary zoning. The average city produced 214 units the year before inclusionary zoning but only 147 units the year after. Thus, new construction decreases by 31 percent the year following the adoption of inclusionary zoning.
In the 33 cities with data for seven years prior and seven years following inclusionary zoning, 10,662 fewer homes were produced during the seven years after the adoption of inclusionary zoning. By artificially lowering the value of homes in those 33 cities, $6.5 billion worth of housing was essentially destroyed.
Considering that over 30 years inclusionary zoning has only yielded 6,836 affordable units, one must question whether those units are worth the cost in terms of fewer and higher-priced homes.
Inclusionary Zoning Costs Government Revenue
Price controls on new development lower assessed values, thereby costing state and local governments lost tax revenue each year. Because inclusionary zoning restricts resale values for a number of years, the loss in annual tax revenue can become substantial. The total present value of lost government revenue due to Bay Area inclusionary zoning ordinances is upwards of $553 million.
Price Controls Do Not Address the Cause of the Affordability Problem
Price controls fail to get to the root of the affordable housing problem. Indeed by causing fewer homes to be built they actually make things worse. The real problem is government restrictions on supply. From 1990 through 2000, the Bay Area added nearly 550,000 jobs but only about 200,000 new homes. The California Department of Finance recommends 1.5 new jobs per new home—the Bay Area produced only 55 percent of the suggested amount of housing.
Supply has not kept up with demand due to artificial restrictions. One recent study found that 90 percent of the difference between physical construction costs and the market price of new homes can be attributed to land use regulation.
The solution is to allow more construction. When the supply of homes increases, existing homeowners often upgrade to the newly constructed homes. This frees up their prior homes for other families with lower income. Inclusionary zoning restricts this upgrade process by slowing or eliminating new construction. With fewer new homes available, middle- and upper-income families bid up the price of the existing stock of homes, thus making housing less affordable for everyone.
Inclusionary zoning has failed to produce a significant number of affordable homes due to the incentives created by the price controls. Even the few inclusionary zoning units produced have cost builders, homeowners, and governments greatly. By restricting the supply of new homes and driving up the price of both newly constructed market-rate homes and the existing stock of homes, inclusionary zoning makes housing less affordable.
Inclusionary ordinances will continue to make housing less affordable by restricting the supply of new homes. If more affordable housing is the goal, governments should pursue policies that encourage the production of new housing. Ending the price controls of inclusionary zoning would be a good start.