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Mayor's Board Room
Monday, July 25, 2011, 10:14 AM
Book: 65, Page: 1

Special Meeting

Called To Order The meeting was called to order by Committee Chair Jack Weiss

Roll Call
    Jack Weiss, Council Member, First Ward
    Gene Knutson, Council Member, Second Ward
    Michael Lilliquist, Council Member, Sixth Ward

    Seth Fleetwood
    Council Member
    At Large


Presentation of Economic Analysis of Draft Incentive Zoning Ordinance

Staff: Jeff Thomas, David Stalheim, Mark Gardner
Participants: David Easton, Perry Eskridge, Linda Twitchell

David Stalheim reviewed history of the issue in the context of affordable housing. There is a high percentage of people locally without access to affordable housing, including a number of people paying more than 50 percent of their income for housing. Council requested a draft incentive zoning ordinance to encourage greater affordable housing production in rezones and annexation areas, as well as an economic analysis of the resulting ordinance. The results of the analysis will be presented today. Some recommendations to the Council are that alternatives should be considered. The economic analysis shows the program does not pencil out, especially for rental housing. The City could reduce the program requirements or increase the incentives in response. An in-lieu fee option, along with a rental conversion ordinance that would require relocation assistance when apartments are converted to condominiums, could be considered as alternatives.

Greg Easton reviewed the rationale for a program. The program trades more density and corresponding added value as an incentive for public benefits. Affordable housing is one benefit. If the total return from building a project with the affordable units is less than a market rate project, there is a cost to a program. The question is whether the program provides sufficient incentive. The study looks at various scenarios, including both rental and ownership, and various density changes. It looks at how economic conditions affect the program and how changes in program design would affect viability of a program. The program would require affordable units for 10+ unit projects under annexation and density scenarios. Ten percent of units are required to be affordable at 80 percent of area median income for ownership housing, and 50 percent of median income for rental units. An affordable rental unit counts as 1.5 units as an added incentive. Across both, there is one bonus unit allowed for each affordable unit up to a 15 percent increase in total density. The study costs out projects looking at existing zoning, at a new base after a rezone, and at the new base including the affordable units. The median income standards are adjusted for household size, and households should not spend more than 30 percent of income, including utilities, on shelter.

Michael Lilliquist. What is the cost of building an affordable rental unit so that the unit pencils out for a developer?

Greg Easton. The study looked at overall rate of return. The cost of construction is part of that analysis. Looking at an affordable versus market rent is also important. For ownership, a down payment is figured in. The feasibility model looks at entrepreneurial return as a percent of development costs. Return of a rental unit is measured as the capitalized value of the monthly or annual rental income. With for-sale housing, you subtract total costs of construction from the sale price to get net proceeds. A project is feasible if it falls between 10 percent and 20 percent. The study assumes a minimum 10 percent return for a feasible project.

Michael Lilliquist. Ten percent received immediately is different from a ten percent return only realized after a number of years.

Greg Easton. Returns are measured across the development cycle which may cover 3-5 years between planning and design and final lease-out or sale. Carrying costs or soft costs are figured into the analysis.

The analysis includes 6 separate scenarios: 2 for annexation and 4 for rezones. Annexation scenarios are based on actual projects. We look at project performance before the rezone or annexation, at base zoning after a rezone or annexation, and a base+affordable unit scenario. For rental cases we look at market rent per month. For single family housing at 2000 sq. feet, market rent is about $1600 per month, while affordable rent is about $858 dollars. You have a huge gap. Developers do not usually build 3 bedroom single family homes for the rental market. For a more dense multifamily development of 800 square feet market rent is about $967 dollars, significantly greater than the $670 dollar affordable unit.

With ownership units there is the smallest difference in return between market and the affordable units. For large houses on large lots there is a large gap. For smaller units the market price is the same as the affordable price. With a slightly larger multifamily unit the performance is about the same.

Land prices are high for one unit on a ten acre lot but smaller on a per unit basis as density increases. Land price is based on prior zoning under the assumption that a developer buys at the low price and then develops at a higher density.

Michael Lilliquist. How do we get total costs for development for each type of unit. Can I add up the cost elements in the table to get market price?

Greg Easton. This would leave some soft costs out of the equation. We see some negative numbers for development under prior zoning. You have to pay so much for a 10 acre lot so the numbers do not work out, particularly in the rental scenario. With some annexations the return comes close to penciling out. There is value created. With an affordability requirement, the return drops from 8 percent to 4 percent.

For ownership, returns do not pencil out under prior zoning. In reality, though, a developer might build a larger house to get to the required total return. At higher densities the return starts to approach the 10 percent. With for-sale housing there is a small difference in return between base costs and costs with affordable requirements. For rental the difference is large.

Michael Lilliquist. Why does a change to a more dense zoning result in a lower rate of return (Scenario 1).

Greg Easton. The study assumes the same market price for each type of house in order to be consistent. This may not be realistic in this case. We assume a $400,000 three bedroom unit at the higher density. The price may be too high.

The study also contains a sensitivity analysis. We look at higher prices or rents; lower development costs; lower affordability requirements, etc. One variation is that people build at 84% of allowed density, which is the average across many recent projects in Bellingham. Price and development costs were the most important variables. Changes in required number of affordable units does not make much difference, at least in the ownership cases.

Conclusions: value is created with higher density, and larger increases in density result in larger increases in value. The affordability requirement reduces the rate of return. If developers build to lower density, the effective affordability requirement goes up. Market factors are the most important in determining feasibility. Density bonuses make little difference especially in relationship to higher value created by an upzone. Ownership with the affordable housing requirement is closest to feasibility because the gap between the market and affordable price is less. Administering rentals requires less than administering ownership units. With ownership you need continued review of all sales transactions.

Michael Lilliquist. Why is there a higher administrative burden with ownership? The developer would record a covenant with the land so there wouldn’t be any additional administrative burden for the developer.

Greg Easton. Some entity needs to monitor the transactions. A covenant is not enough to ensure requirements are met.

Jack Weiss. At previous meetings we talked about having the developer contract with some organization such as a land trust to oversee the ownership part of a program.

Greg Easton. One question is whether developers would want to create units on-site or whether they would prefer alternatives. They want the greatest return and the least uncertainty. In-lieu fees would be most attractive, especially given long term monitoring obligations.

Michael Lilliquist. Some differences in return are relatively small. We are giving a lot and not asking for a lot back. Providing affordable units results in an opportunity cost of a reduced rate of return which is not the same as saying something is not profitable.

Greg Easton. We’ve estimated the true developer cost. If the bar showing rate of return dips slightly there is not much of a difference in lost income. But the total rate of return may be less than the 10 percent threshold and then projects may not be built.

Michael Lilliquist. It looks like we’re taking something away, when really it is just that we are not giving as big a gift.

David Stalheim. I think that what Greg was trying to get to was that people may not take that risk.

Michael Lilliquist. Can we reduce developer costs to get the bar above 10 percent, such as by changing our impact fee formulas? The program as outlined may only be successful in up markets. Additional incentives may be needed in a down market.

Jack Weiss. Does this report answer the policy questions? The community creates profits through upzones. Impact fees only cover part of the cost of development. An upzone in the Cordata area was from industrial to mixed use. There was no return of value to the community. Some developers just sell the land parcels and take the profits. This provides no value to the community. What is the dollar value of a rezone from industrial to residential? If we had a 10 percent affordability requirement the developer probably still would have been interested although he wouldn’t have been happy about it. More than 130 communities have IZ programs. I would think they would be faltering if things were as bleak as presented in this study, and some requirements are higher than 10 percent.

Greg Easton. I am familiar with projects elsewhere and conditions vary from market to market and community to community. You asked what was the value of land before and after an upzone. We do calculate that explicitly. If we assume a parcel zoned for one unit per acre that would be $125,000. If we compare to 2.2 units per acre the land price if roughly 5 times as great on a per-acre basis. That is the value created.

Jack Weiss. When we look at the additional value created then we can look at what reasonable claw back of value the community would like to have.

Greg Easton. For each of the scenarios we did pro-formas on, we have a base case that has a particular density so we assume an appropriate land price for that prior zoning. If the prior zoning was 10 units per acre we assumed they purchased their land at $12,500 per acre. When we look at the impact of additional density we are assuming they’re still buying that land at the lower price but they are building more units, reflecting increased value. The concept you are talking about is embedded in the analysis. For each change in density we can calculate the value of land created by the change in density. We are going beyond that to see if there is adequate return to attract investment. If someone buys a property and then flips it after rezoning those numbers would apply.

Jack Weiss. A lot of them just flip the lots. If a developer flipped a parcel with requirements for affordable housing the sale price would be lower.

Gene Knutson. We don’t do annexations and rezones at the same time. We annex and then rezone later.

Jeff Thomas. When we annex we move to a zoning that was similar to that in the County.

Jack Weiss. The county had already upzoned the properties but it is access to utilities that creates profit margins.

Michael Lilliquist. Did you assume that market rate and affordable housing costs the same to build? We were talking about rough comparability but not identical units. For example, affordable units may have cheaper finishes.

Greg Easton. The study assumes the same cost of construction.

Michael Lilliquist. What if the costs go down 5 percent because of finishes?

Greg Easton. These reductions in costs only apply to the affordable units, e.g. 10 percent, so they only impact a portion of the construction costs. We could assume a different cost for the affordable units and run the numbers.

Jack Weiss. Rents are driven by vacancy rates. What do we assume for rent increases?

Greg Easton. I’ve assumed a 10 percent increase from current levels.

Michael Lilliquist. Is the condominium market turning favorable? I know that the rental market is improving.

Greg Easton. The multifamily scenarios assume condominiums. It is supply v. demand. With condos many units are available. Financing is not readily available. Homeownership is less likely to be seen as a vehicle for wealth creation.

Michael Lilliquist. About 1/3 of our development in the waterfront and in Urban Villages is assumed to be condominiums.

Perry Eskridge. Condominiums are not a desirable form of housing for everyone. The market is split between large lot single family development and condos. There is nothing in between. There are legal liability risks for condos and law firms are soliciting condominium associations to sue developers. Banks are unwilling to loan. Developers are unwilling to build. Sometimes the cost of defense is higher than the cost to settle.

Mark Gardner. I know the state legislature has attempted to pass laws to weed out frivolous lawsuits – have any of those efforts been successful?

Perry Eskridge. How do you define frivolous? If it goes in front of a jury the jury may find it is not frivolous.

Jack Weiss. For in—lieu fees we do not want these to be easy outs for developers to exclude affordable housing. We want as a community to have a diverse economic neighborhood. A developer could set aside a parcel as part of an in-lieu program. In lieu fees would only be allowed as exceptions.

David Stalheim. Industrial to residential rezoning has not been looked at. The program only looked at projects with 10 or more units. Locating affordable units on the periphery may not always be the best policy. Affordable housing may be better placed on transit lines or near jobs. We could also use the in-lieu fees to leverage other programs including working with various non-profits such as the land trust etc. In-lieu fees could be used to leverage a lot of housing issues. Units could still be built near market rate units.

Jack Weiss. With a prior annexation we tried to tie it to affordability requirements. This was our most important Council priority in 2009.

Michael Lilliquist. It was brought in at the 11th hour. Can we discuss the staff recommendations? It appears that adding density bonuses is not a good pathway. Density bonuses do not have that huge an effect. If you go too far neighborhoods may react negatively.

Jack Weiss. I’ve never been a big fan of this approach. Some of our base densities are too high in Urban Villages.

Perry Eskridge. Realtors have contracted for a housing capacity analysis. I was hoping this program would be considered as part of the comprehensive plan update. You need to look at where building will be taking place. How many potential units are possible? How many affordable units are needed? We need prior analysis before creating a program. Right now single family units are going in multifamily zoning. Where can we put the 11,000 new units identified in the CHAT proposal?

Michael Lilliquist. We know the affordability needs are great and so we need to keep moving forward to meet them. We are taking an opportunistic approach with annexations even if these may not always be in the best location.

Jack Weiss. I agree that the annexation areas may not be best for affordable housing. We have a rezoning proposal coming up in October that may be an appropriate place.

Linda Twitchell. Some studies of incentive zoning show a price increase for market-rate housing with affordability requirements.

Mark Gardner. I looked at 30 or so different studies and most show that it does depend on the market, if you have a really up-market with high demand people will up-price a little bit or people may change the unit mix. Programs in New England are not working so well because they have huge program affordability targets, while in California targets tend to range between 10 and 20%. That was in the prior boom market but what is happening now may be different. 10-25% is the usual range and studies show that as long as program design is right overall housing production does not get affected that much. A study by homebuilders did not show much effect.

Michael Lilliquist. There is also a confounding because where these programs get put in place, prices are already rising fast so that is a prior condition. The question is whether adding an affordable housing requirement makes the prices go up. These are put in place where prices are already rising. In an up market these things are not a drag on the market but in a flat market things may be different.

Jack Weiss. We should discuss this issue further in an afternoon Council meeting.

Mark Gardner. Is it in the scope of study to vary construction costs between affordable and market units? The cost differential can be rather large.

Greg Easton. That can be added as another case in the sensitivity analysis.

There being no further business, the meeting adjourned at 12:01 PM.

Jack Weiss, Planning Committee Chair

ATTEST: Mark Gardner Policy Analyst

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