In desirable housing markets across the country, the rent, as one former New York gubernatorial candidate once said, “is too damn high.”
While high rents in hot markets are what many investors and developers want, there’s no guarantee those markets stay hot forever. When the economy cools, eventually those units need to be filled to sustain cash flow.
Municipal governments face similar balancing acts. They might want their constituents to afford their homes, but are hesitant to invest more public funds to meet those needs.
Inclusionary zoning is a compromise. It leverages the private market instead of public funding to increase the supply of affordable housing.
What Is Inclusionary Zoning?
Inclusionary zoning is a policy tool that requires or encourages private developers to include a number of units that are below market rate in desirable neighborhoods close to school, employment, public transportation and entertainment. In exchange for providing a certain percentage of affordable units in a given project, developers get incentives. These include density bonuses that allow them to build more units than would otherwise be allowed, faster permitting and/or reduced permitting fees for zoning permits for their projects, greater height allowances, reduced parking requirements, tax breaks and exemptions from other regulatory requirements.
IZ is used in large cities like New York and Chicago, suburban areas such as in Montgomery County, resort towns like Telluride, Colorado, and rural areas like North Elba, New York.
Types of Inclusionary Zoning
Inclusionary zoning policies vary widely in their rules and implementation depending on multiple factors, including:
- Mandatory versus voluntary: According to the National Housing Conference, 80% of the approximately 886 jurisdictions that have IZ institute a mandatory program.
- Percentage of units required to be below market rate: The most common is 10-30% of units in a particular development
- Definition of affordability: The prices of the below market rate units are usually determined by the Area Median Income (AMI). As Bloomberg explained, some developers end up producing more middle-income units, (for people earning 80 to 120 percent of the AMI), and fewer low-income units (for people earning less than 50 percent of the AMI). Affordable is often defined as at or less than 30% of the AMI.
- Minimum size of developments that are subject to the ordinance
- Whether the affordable units must be on site or located nearby: Some developments have separate entrances for the affordable units, often referred to as a poor door, which many affordable housing advocates criticize for promoting segregation between market and non-market rate tenants.
- Length of price restrictions, how long the units will stay affordable
- Types of incentives for developers: i.e. density bonuses, waived fees, tax breaks, etc.
Pros and Cons of Inclusionary Zoning
While IZ continues to grow across the country, with 886 programs in 25 states, there are concerns, especially from investors and developers. This anxiety includes the impact of IZ on developer profits and overall housing production, and whether enough affordable units are produced to meet demand.
Kathryn Howell, Associate Professor of Urban Planning in the Wilder School of Government and Public Affairs at Virginia Commonwealth University and co-director of the Richmond Virginia Eviction Lab, told Leverage that while IZ can be an important policy for increasing affordable housing — particularly in high-demand, high-price markets — it is only one piece of a larger puzzle of increasing affordable housing.
Pros of Inclusionary Zoning
- Incentives: For developers, there are opportunities to skip fees, take advantage of expedited permitting processes and — with significant density bonuses — the opportunity to build bigger projects in areas that might otherwise be zoned for smaller-scale developments.
- Multiple ways to meet the affordability target: As Local Housing Solutions pointed out, “some communities require a lower set-aside if the affordable units provide ‘deeper’ affordability… they may require 20 percent of units to be set aside if they will be affordable to households earning up to 60 percent of the area median income, or 10 percent of units to be set aside if they will be affordable to households earning up to 30 percent of the area median income.”
- More income diversity in a given neighborhood: The policy provides low and moderate income residents access to housing in prime locations. For example, in one 31-unit Washington, DC . building, the average monthly rent for a two-bedroom was $2,400 to $2,745 when it opened in 2020. The three units created under IZ were $1,636.
- Less direct government spending to produce the affordable units: Note that governments still might have to give up tax revenue if they offer tax breaks in their IZ policies, or permitting or other fees, again, depending on how their policies are structured
Cons of Inclusionary Zoning
- Costs are passed on to the developers and without significant incentives, negatively impacts investor and developer profits. Opponents argue IZ decreases housing production overall and raises market rate rents.
- Per the Furman Center for Real Estate and Urban Policy at NYU, “the amount of revenue a developer can gain by selling or renting a unit required to be affordable by a mandatory IZ policy is generally lower than the costs of developing that unit, so unless developers can offset these losses, IZ programs may cause developers to earn lower profits.”
- Below market rate does not always mean affordable to everyone who needs housing. A unit that is affordable to someone making 50% of the AMI might not be affordable to another person making 30%.
- The units might not meet the needs of the communities they’re being marketed to. As Howell explained, “when you’re developing a bunch of studios or one bedrooms that hits a particular population, that may not be [right for] families with children who really need affordable housing.”
Why Is Inclusionary Zoning Controversial?
Governments favor IZ because it requires little or no public subsidies.
Developers against IZ argue that the programs are an indirect tax on their projects. Local Housing Solutions explained this is “based on the argument that affordability requirements function as a ‘tax’ on developers, who pass any added costs on to market-rate consumers.”
Affordable housing advocates argue that IZ policies don’t produce enough units to meet resident demand in areas with rising rents, and production varies widely by area. In a study of programs in San Francisco, suburban Boston, and Washington, D.C., the Furman Center for Real Estate found that in 2008, “While nearly all IZ programs in the San Francisco area have produced some affordable units, some 43% of the jurisdictions in suburban Boston with an IZ program on the books have not produced any units, and over one-third are unable to report how many units have been produced.” Washington, D.C.’s IZ program got off to a slow start, but produced 191 units in 2016, for a total of 402 units in nine years.
5 Factors When Developing or Investing in an Inclusionary Zone
Your success depends on whether you’re developing in a strong or weak market, land control/acquisition costs, what incentives the municipality is offering in exchange for affordable units, and your access to capital (cost and availability). Below are potential questions and factors to consider before developing or investing in IZ. If you have numbers in mind already, try using the Grounded Solutions Network’s Inclusionary Housing Calculator to test potential revenues, profitability, and the impact of local policy incentives on both.
1. Will the market-rate units “cross subsidize” the below market-rate units?
The Urban Land Institute cautions that this is a rare occurrence, but it’s worth running the numbers to see if it’s possible, especially if you’re developing in an extremely high-demand area with high-income residents and limited supply.
2. What is the set-aside percentage of affordable units?
Determine how many units out of the total need to be below market rate, and what the losses per unit will be. According to the Urban Land Institute, the higher the set-aside percentage, the lower the revenue per unit in a given development, and “the revenue loss associated with increasing the set-aside percent.”
3. What are the affordability requirements?
This factor includes the percentage of AMI required for rents, whether the units will be targeting low or middle-income residents, and how long the units must remain affordable. Most IZ policies for rental housing target households at 60 to 80% of AMI. Under Chicago’s Affordable Requirements Ordinance , rental units remain affordable (60% of AMI) for 30 years. For-sale units are placed in the Chicago Community Land Trust (CCLT) for 90 years. Other programs have shorter time periods or different AMI requirements.
4. What incentives are being offered, and how will those incentives offset the revenue loss associated with set-aside percentages and affordability requirements?
Maybe the density bonuses are large enough that you’ll be able to build enough units in total to make up for revenue lost by developing below market-rate units. Maybe the jurisdiction you’re developing in offers tax abatements that will benefit your bottom line in the long term.
5. Developing IZ Units Versus Paying In Lieu Fees
Some IZ programs allow developers to pay a fee to the city in lieu of developing new IZ units, which the city can use to subsidize construction for low-income housing.
Investors and Inclusionary Zoning Don’t Have to be Enemies
Make sure you understand the overall picture of incentives, how those incentives will impact the overall cost of your project, the current demand in the area you’re planning to develop in, and whether you have (or want to have) experience developing and investing in affordable housing. While investors and developers have been opponents of IZ, in the right markets there are opportunities to build bigger in areas you might not expect.