What should cities do to tackle growing housing affordability problems? Is inclusionary zoning a good way to provide more affordable housing, or will it actually worsen the constrained housing supply that’s a big cause of higher rents?  

In the next few months, the city of Portland, Oregon will be considering the terms of a new inclusionary zoning (IZ) policy. Like similar policies in other cities, the Portland IZ proposal will likely require developers of new multi-family housing projects to set aside some portion of newly built units to be rented at a discount from market rates. Earlier this year, the Oregon Legislature repealed the state’s ban on inclusionary housing requirements. (Oregon and Texas were reportedly the only two states that explicitly prohibited mandatory inclusionary zoning).

On September 12, the Northwest Chapter of the Urban Land Institute held a forum to discuss inclusionary zoning.  I was one of the panelists speaking at this event:  here’s a quick synopsis of my remarks and some observations about the presentations and discussion.

First, despite the enthusiasm among legislators and housing advocates for inclusionary zoning, there’s precious little evidence that it’s had a meaningful impact on alleviating the shortage of affordable housing in major US cities.  As we’ve reported at City Observatory, at least to date, these programs have produced remarkably few units in some of the nation’s largest and strongest real estate markets.

The bigger concern about inclusionary zoning is that it tends to drive up the cost of building new housing, thereby restricting supply, and actually aggravating market-wide affordability problems.  While the comparative handful of new units set aside for low or moderate income households are visible, there is an invisible cost in the form of units not built, and consequently, higher market rents for everyone. Whether, and how much, inclusionary zoning drives up costs is a subject of intense debate.

Mike Wilkerson of ECONorthwest presented a summary of his firm’s recent analysis of inclusionary policies (commissioned by the Urban Land Institute). They constructed pro-forma financial assessments of several common housing types (three-story stacked flats, “four-over-one” podium apartments and concrete and steel apartment towers) and examined their financial feasibility under a range of assumptions about market rents, land costs, incentives (tax breaks and density bonuses), and set-aside levels. The full report is well worth a read–and we’ll explore it in detail in a future commentary.

In his remarks, Wilkerson used the ECONorthwest analysis to examine the likely impacts of the proposed inclusionary zoning in the Portland market.  Portland has experienced some of the fastest rental growth in the nation in the past year, especially in close-in urban neighborhoods.  A key takeaway from Wilkerson’s remarks:  inclusionary zoning requirements are likely to skew developer choices away from higher density construction (like apartment towers) and toward lower density development (stacked flats and podium development). The combination of higher construction costs and higher needed market rents for towers means meeting IZ requirements is disproportionately burdensome for  denser construction. This is especially important in Portland, and its downtown and central neighborhoods, where the city’s comprehensive plan envisions high rise density as key method for meeting expected population growth.  On its face, the ECONorthwest findings should give policymakers in Portland pause about moving forward with inclusionary zoning.

But there’s an additional wrinkle. As thoughtful and comprehensive as the ECONorthwest analysis is, it is still just one firm’s pro-forma model of development costs. And there’s a good deal of uncertainty about some key assumptions that necessarily drive this kind of analysis.  

The ECONorthwest study joins a growing body of research that attempts to model current development costs and the impacts of inclusionary (and other) requirements on the cost and likelihood of housing development. We profiled several of these at City Observatory in July. Each of these analyses represents a solid, fact-based effort, but they come to quite different conclusions about whether and under what circumstances inclusionary requirements are feasible. As a result, no one knows for sure what will happen when these policies are implemented.

Uncertainty is a big risk.

A big challenge with Portland’s proposed inclusionary zoning program is that no developer can know, with any certainty, how big a cost the inclusionary zoning requirements impose, or how easy or difficult will be the process to get development approved under the new rules. As experience with New York’s new mandatory inclusionary zoning has shown, the entire program can be tripped up in the project-level approval process. As a result, many developers are likely to take a wait-and-see attitude–to let others go first, and then make an investment decision when the costs and contours of the new system are better understood.  The effect is almost certain to be a fall off in housing investment. Moreover, this could happen even if the program itself is well-designed and has incentives and cost offsets that lower developer costs; until this is proven in practice, it’s likely to be a deterrent to investment. And paradoxically, because less new housing will be built, prices are likely to be higher than they otherwise would be–worsening the affordability problem (except for those fortunate enough to get reduced price apartment).

It may be that the city will decide that inclusionary zoning requirements are fundamentally at odds with its development objectives (higher density in the urban core) or judge them to be counterproductive to solving the affordability problem.  But if it does decide to go ahead with an inclusionary zoning ordinance, there are several design features that might minimize the risk of the potential negative effects of such a policy. First, it could consider a long phase-in of the inclusionary requirements, to give developers time to carefully study and fully understand the costs and implications of the policy, and the effects of its incentives. Second, the city could establish a simple and clear approval standards for inclusionary projects; discretionary approvals and complex review processes are likely to magnify uncertainty.  Third, at least initially, it should set a relatively low in lieu-fee for developers who want to opt-out of building inclusionary units on-site. The availability of the in-lieu fee gives developers financial certainty that they know the costs the ordinance imposes, and is therefore likely to lessen the chilling effect on investment associated with the uncertainty of a new program. The fee could escalate over time to increase the incentive to build housing on site, once the costs and effectiveness of the program are demonstrated.

As we’ve frequently said at City Observatory, the underlying problem of affordability in Portland (and around the country) stems from our shortage of cities.  Simply put, the demand for urban living is growing much faster that the supply of great urban spaces. This is a strong market signal that we need to be improving urban neighborhoods in more places, and building more housing in the places that are already in high demand. There’s growing evidence in many markets that the supply response–building more apartments–is beginning to blunt the rate of rent increases. The last thing any city concerned about affordability should do is get in the way of increasing housing supply.

A standard rule of medicine–which turns out to be good advice for public policy, as well–is “first, do no harm.” Portland’s City Council would be well advised as it considers an inclusionary zoning policy to design one that doesn’t, even inadvertently, sidetrack the current supply response in the housing market.