The Planning Commission took the first crack at the City’s inclusionary housing ordinance. Honestly I thought they did a very good job overall, as the ordinance is much improved from the parameters discussed during the study sessions over the Summer.

Readers will be unsurprised to learn that I still had a bunch of thoughts, which I shared as public comments and I’ve also republished below. One question that came up at the Planning Commission last night was whether, due to my meetings with the Staff on this subject (which was really only one sit-down meeting and a short phone call), I was being considered a “stakeholder”. And I guess I am, only in the narrow sense that (1) anyone looking for a home in Costa Mesa, or might be looking for such a home in the future, is a stakeholder when it comes to housing policy, and (2) I do (through the grace of God) own my own home, though due to zoning restrictions and other issues there is zero chance it will be redeveloped any time soon.

Otherwise, I’m just a nerd with a bee in her bonnet about the #1 issue facing the City (housing affordability), just like the other “engaged residents” that frequently call in and comment on such things. And I wish I even had a professional interest, but sadly I do not. I’ve never represented real estate developers or anything close (I think I might have done a deal for a REIT back in the day, but that was during my Wall Street days and it the farther I am from that kind of work, the better). And I have no interest in pivoting to that area. Real estate, frankly, seems like a terrible grind.

Anyways, for the curious, here are my thoughts that I sent last night, some of which will sound familiar if you’ve been reading along in my inclusionary housing series.

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Dear Planning Commissioners, Director Le and Principal Planner Huynh: 

Thank you for providing a draft of the City’s inclusionary housing ordinance (IHO). I appreciate that the public will be involved in this process as it is one of the most important pieces of legislation in the City’s history. It has the potential to have long lasting effects on our housing market and, hopefully, it will make a meaningful difference in the lives of those struggling to afford their homes.

I have only a few significant comments as the IHO appears to be fairly reasonable and conservative as proposed. It is clear that the City’s Staff has done a good job including relevant stakeholders and taking advantage of the expertise available through the City’s consultant, Keyser Marston Associates (KMA). However, I think there are still a few areas that deserve a second (third?) look.

First, a couple high-level thoughts. It is my view that the top reasons that a housing policy is successful are (1) thoughtful tailoring to the jurisdiction’s specific context (economy, demographics, current land use, etc.) and (2) features that ensure that the jurisdiction is an attractive development site compared to neighboring cities sharing the same labor market. 

With respect to the first factor, I still do not think enough weight is being given to the blow that’s been dealt to Costa Mesa’s development pipeline by Measure Y. As I have noted in earlier letters, Measure Y has left few properties in the hands of those interested in redevelopment. Thus many infill projects will require the land to transact prior to building. This adds substantial capital costs to our projects, and those capital costs will be multiplied by persistently high interest rates. 

This issue is potentially further complicated by the possibility that cannabis retail sites may compete for housing sites within the Measure K area, which I haven’t seen analyzed. As we have seen, cannabis site competition is fierce and we still have many applicants. To the extent cannabis is successful in Costa Mesa, it presents a land use that requires comparably minimal improvements compared to housing production and potentially high long-term revenues. It would be unfortunate to find that some of our housing opportunity sites would be more profitable and easier to develop as cannabis sites. 

Additionally, I wonder if the second factor — the IHO’s competitiveness compared to other cities — has been adequately analyzed. Investors, and thus the developers they fund, do not have allegiance to any particular city. Rather, they are more interested in the labor markets reachable by any parcel, as such markets will justify the rents and provide steady access to new tenants. Provided a developer can select from parcels with comparable access to the labor market, they will choose to develop in the city with the best mix of regulatory certainty and incentives. 

This implies that less restrictive jurisdictions within the same labor market will experience better rates of development, and this seems supported by the inclusionary housing literature. For example, a often-cited paper by the NYU Furman Center for Real Estate and Urban Policy, The Effect of Inclusionary Zoning on Local Housing Markets, found that, when comparing the performance of inclusionary zoning in several jurisdictions in San Francisco, “…the number of units built increases with the presence of a density bonus and minimum project size that triggers [inclusionary zoning]. These results suggest that less stringent programs actually produce more affordable units, a plausible explanation if developers avoid jurisdictions with highly stringent programs” (emphasis mine). Another study from the Furman Center looked at “upzoning with strings” in Seattle, WA, an approach similar to what we are attempting here, also found that inclusionary zoning encouraged developers to relocate projects to nearby parcels that did not require inclusionary zoning, even if those parcels were not upzoned: “Our quasi-experimental border design finds strong evidence of developers strategically siting projects away from MHA-zoned plots—despite their upzoning—and instead to nearby blocks and parcels not subject to the program’s affordability requirements” (emphasis mine). 

So in other words: although counterintuitive, lower inclusionary housing requirements can produce more inclusionary units overall, provided that the inclusionary housing requirements are light enough to maintain economic competitiveness for redevelopment compared to parcels in the same area. Thus, in general, more development with a relatively low inclusionary requirement will produce more units than little development with a high inclusionary requirement, especially if that high inclusionary requirement is more stringent than neighboring cities. 

With that context in mind, I have the following suggestions regarding the draft IHO: 

Increase the minimum project size to at least 25 units. Twenty-five units is the minimum project size where the lowest inclusionary set aside — 4% for Very Low Income Households in projects with a base density of less than 60 du/ac — will result in the set-aside requirement of one whole Inclusionary Unit. Raising the minimum project size to this level (or higher) will also safely exempt developments on smaller lots, which may have high densities but will result in fewer units and poorer economies of scale compared to developments on bigger lots.  

As an aside, the Agenda Report notes that, “of the [City’s] housing projects [greater than two units from 2014-2021], which were either located in the City’s urban plan areas or along major commercial or industrial corridors, all were more than ten units.” One wonders, though, if those projects would have been built if our IHO had applied to them at the 10-unit threshold at the time of entitlement. Have we asked the developers of those projects if the IHO as drafted would have changed their minds? If it would have been a factor, this would be further evidence that we should rethink the minimum project size.

Lower the inclusionary thresholds and think about the “regulatory cliff” 

I am pleased to see that KMA was requested to reanalyze its findings regarding the likelihood of redevelopment given our sky high land values and profitable “going concern” land uses. However, even if the resulting thresholds are “conservative” under KMA’s analysis, I would encourage the City to be even more conservative. This is due to competitive concerns with our peer cities that share our labor market. For example, Huntington Beach only requires a 10% set aside for low income households at any density, while developments greater than 60 du/ac in Costa Mesa would require an 11% set aside for Low Income Households. And while these thresholds look attractive compared to the requirements in Santa Ana, it is worth noting that Santa Ana has been struggling to get its inclusionary housing program to work as intended. 

Additionally, we should keep in mind that Newport Beach, Tustin, Fountain Valley and Orange are not listed on the comparison chart provided by Staff. That is because, to date, these jurisdictions do not have an inclusionary housing requirement, though admittedly several are considering one. 

In order to remain competitive with our neighbors, I would recommend dialing back the inclusionary housing requirements for the high density developments, perhaps from 11% for Low Income Households or 6% for Very Low Income Households as proposed to 10% for Low Income Households or 5% for Very Low Income Households (or even less).  This brings us more in line with Huntington Beach and offers a competitive advantage compared to Santa Ana. 

Bringing down the requirements for higher densities also reduces the severity of the “regulatory cliff” created by the distinction between 60 du/ac+ projects and those under 60 du/ac. As density will be determined on a project basis, the unit difference between 59 du/ac and 61 du/ac could be minimal, especially in smaller developments. However, as drafted, the regulatory drag for the two projects could be very different. It would be worth investigating how this will impact developer behavior. 

Consider removing ownership requirements entirely. Multifamily ownership projects are already strongly disincentivized by insurance requirements, the Federal tax code and our high construction costs. Therefore, even without inclusionary requirements, it is very unlikely many condominiums will be developed even with the benefit of “free” upzoning. So if we are serious about wanting to make a dent in our “renter-homeowner ratio”, we should be putting as few restrictions on the development of ownership properties as possible. I would also note that, with ownership units targeting moderate income families, an ownership program does not align with the City Council’s expressed interest in “deep affordability”.

Additionally, administering affordable ownership units can be very expensive (especially on a cost-per-unit basis), as it requires extensive vetting of new buyers as well as constant maintenance to ensure the properties aren’t sublet for profit. It may also lead to strange and unintended outcomes, such as persons with plenty of resources occupying affordable ownership units for very long periods of time. As a local example, the Mayor of Huntington Beach, Tony Strickland, lives in an affordable ownership unit that he inherited through marriage, a result likely not intended by the program. 

Consider reducing affordability covenant duration. I recognize that the logic behind the 55-year affordability covenant is that it aligns with the State Density Bonus Law. However, it would be worth investigating the likelihood that all or most developments will avail themselves of the State Density Bonus Law, especially in light of the IHO’s reduced parking requirements. As any development must comply with the most restrictive requirement, the State Density Bonus Law will require 55-year durations for any developments that use it. However, for those developments where using the State Density Bonus Law isn’t feasible, the long tail of affordability is a disincentive as it impacts long-term economics. Therefore, consider whether the IHO’s required duration should be shorter than the State Density Bonus Law to reduce the impact of the IHO on non-State Density Bonus Law developments.

Allow in-lieu fees to always be available, regardless of project size. According to the Agenda Report, the IHO will permit all ownership housing projects to use in-lieu fees, but only rental housing projects fewer than 100 units be permitted to do so. I think there is a reasonable argument that in-lieu fees should be available for all projects. First of all, 100 units is a somewhat arbitrary threshold other than it feels “big enough” to support on-site development, an assumption that may or may not be correct depending on any number of contextual factors. Second, there is no reason why we could not build consideration for improved economics with scale into the fee schedule itself. For example, Minneapolis increases the in-lieu fee as the project size increases (proxied by building height). Allowing the in lieu fee to apply to all projects may give the City valuable data about the value of inclusionary units over time. 

It must be stressed that the in-lieu fee will be much easier to adjust than the inclusionary thresholds or other aspects of the program. Since in-lieu fees are easy to change, they are useful tools to “dial in” the ordinance and to adjust it for changing economic conditions. 

As always I hope that these comments are helpful. As I said above, I believe this is one of the most important ordinances in Costa Mesa’s history. I know you will give it the time, consideration and attention that it deserves. And again I am deeply appreciative that the public will be a part of that process.