November 19, 2003 - From the November, 2003 issue

The Promise And Downside Of Inclusionary Zoning In Los Angeles Addressed By Housing Developers

Housing developers throughout the region are watching closely as the LA City Council prepares to craft an inclusionary zoning ordinance. TPR recently caught up with Bill Witte, principal at the Related Properties of California, and Jeff Lee, principal at the Lee Group, to discuss their hopes and concerns for how the city should approach the crafting of the ordinance and how the city will address the lingering housing crisis.


Bill Witte

The fact that we are in the midst of a housing crisis is clear. And, the likelihood of an inclusionary zoning ordinance moving forward in City Council is real. However, the need for that ordinance is not necessarily clear. Can you talk about what makes inclusionary zoning attractive to the city?

Jeff Lee: Inclusionary zoning makes the city feel like they are solving a need in the market to have more affordable housing while perhaps not recognizing that there already is a tremendous amount of affordable housing being provided for the lowest income people in the city.

Bill Witte: The policy is attractive to the city for a couple of reasons. First, as a matter of social policy, whenever you build housing, some of it will be for people of modest means. Second, and perhaps a little more subtle, is that are only so many housing development opportunities-if you let them go forward without including affordable housing, you are somehow forgoing an opportunity for all time to provide more affordable housing.

From a developer's vantage point, at one level there is nothing attractive about inclusionary zoning per se, except to the extent that one believes, as we do, that in some hypothetical vacuum, it's a good idea to have a mix of incomes. Also, and the key to this debate, is that the need for affordable housing can be leveraged to create real incentives for the production of more housing, which is what the real issue is.

What are the levers available to the city to help subsidize or help to mitigate the costs of inclusionary zoning to developers? And, what would you as developers like to see them take advantage of? What levers would have the greatest impact on increasing production with this ordinance?

Bill Witte: The greatest levers are always in the land use arena, because that is something that, in theory, is under the auspices, if not always the control, of the city. Even that gets misunderstood because density can be helpful at times, but sometimes it pushes you into construction types that add so much expense that you're better off not doing it.

Then the question that remains is if you can't deliver the incentives, or are unwilling to, does the requirement go away? In other words you can't, in our judgement, fairly impose a requirement that imposes costs on a developer without being able to provide and deliver incentives.

Jeff Lee: Go back to the mid-80s and to AB 283, the general plan consistency legislation. What that did was make the city bring their specific plans and community plans and general plans into alignment with the zoning on a particular site. The result was that in most instances, the City Council down-zoned the city. They took R4 lots and made them R3 lots, and they took R3 lots and made the RD1.5 lots. In 1987, Proposition U cut the floor/area ratio to 1.5-1 on commercial lots, which is now reducing residential development.

What the city needs to do is up-zone a tremendous part of the city, especially on the transportation corridors. To allow for more density and more height, they've gone ahead with this RAS zone, which allows you to up-zone sites on the transportation corridors. But, unless you can up-zone corridors through a pending specific plan, you have to do it on a site by site basis. That opens you up, whether you're doing rental or for-sale, to the discretionary hearing process.

We've seen over and over that in every council district there have been projects that are cut back in density because of issues with community approval. So, it's a real quagmire to have incentives on the books that cannot be delivered in practice. In the rental market, there are many projects in the city that are by-right projects and they don't need discretionary approval. But every subdivision, every for-sale project, has to have a subdivision and has to have public hearings.

The housing market in Los Angeles addresses a very diverse city, and there is diversity in markets as well. Is it possible to craft one ordinance that can appropriately achieve the goals that the city wants, and at the same time be profitable for developers?

Bill Witte: Jeff cited data at the hearing that of the X-thousand units that have been built or had permits pulled for housing in the city over the last Y years, something like 44% of them were for low-income housing. There is a school of thought, which I don't think we share, that even if requirements like this limit production, it's better to have just a higher percentage of whatever gets built be affordable. So let's even assume that production were limited by this. If, again, 60% of it were affordable then that's good. I don't share that view. I think that exacerbated the problem.

The city does have to think about areas where they are currently providing incentives for virtually any kind of market-oriented development, or where the city wants market-rate development and has had virtually none. Do they want to impose a requirement that might curtail it in some fashion?

Jeff Lee: Incentives would make a difference in certain parts of this city. However, there are parts of this city where no incentive will matter because it's almost impossible to produce market-rate units. So an incentive to go higher or to use a different construction type is no good, because if you can't make something work already, how are you going to make it work with more exaction?

Also, you have to look at why we have redevelopment agencies and redevelopment project areas. The CRA has had to contribute to all of those projects-NoHo Commons, the Ralphs grocery store in downtown with residential units above it, and sites in San Pedro, and Santa Barbara Plaza-because you can't do market-rate deals. If you can't do market-rate deals without agency help, then to put another layer on it with no agency help is the kiss of death.

In a companion interview, Councilman Garcetti comments on the addition of density bonuses to the NoHo Commons project that, "it's not adding complexity, it's adding profit, plain and simple." He suggested that the inclusionary zoning ordinance would nudge developers in to doing more affordable housing and to realizing that it's a profitable venture for them. How do you respond to that?

Bill Witte: First of all, in a city as large as LA, I don't think you can answer that in a general way-it completely depends on where the project is. But once again, if the existing or by-right density allowed for a Type-5 wood frame construction and the bonus pushed you into wood frame with metal studs or even concrete, the added capital cost may hurt the viability of the project. Those costs aren't recoverable by the rents or for-sale value that you could get. So it's very difficult to generalize. It is true that sometimes it works out.

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Jeff Lee: If just adding density made the NoHo Commons work, why do they need all of this money from the city? Even with the density bonus, if the project still needed a huge amount of subsidy from the city, clearly the project doesn't work on its own. No market-rate projects have been built in ten years. How is adding density and making a lot of that added density be affordable units going to make a market-rate projects work when it hasn't worked in ten years? If a developer can see a way to make more money by building some affordable units, he will seriously consider it. But, he must weigh all of the complexities of community opposition, which could include litigation, financing, etc.

Bill Witte: The Bond capital project at Sunset and Vine seems like a great project-very dense. I don't know that density bonuses were given, but certainly it was built about as densely as possible without going mid-rise or high-rise. The economic engine that makes that project work is income from the sale or lease of billboard rights. That's not a subsidy, but without that income, the deal is not viable given the cost of construction and the cost of land. So, there are a lot of ways to skin the cat, and they are going to differ from neighborhood to neighborhood. But, Jeff's point is valid. In high density, high cost urban environments, which only get costlier when the economy gets better, usually you need something extra-often, but not always, involving government assistance-to make it work.

Councilman Garcetti also suggested that markets, while often quite efficient, can have a psychological barrier to being efficient. How do you respond to and deal with psychology in the marketplace?

Bill Witte: The only psychological part of it, which is refutable, is that having low income units as a part of a market-rate project diminishes significantly the real estate value. I don't believe that to be true in most cases. But, in the rental case, you underwrite a project based on the net operating income that it can generate. If you have an affordable requirement, the net operating income is less. It's not much more complicated then that. There are some financing vehicles, like the use of tax-exempt bonds, that can mitigate lower revenues. But absent financial incentives, it's just a less feasible project, plain and simple.

Jeff Lee: In for-sale development, tax credits are not available. So, the same incentives available to the rental developer are not provided to the for-sale developer. So, if there is a mandatory affordable component to a for-sale project, the only incentive available is to go higher and denser and to have enough market-rate units to offset the affordable units.

And, if you're going to take the risk of going into the community to propose a five or six story building instead of a four story building-which will take you into the discretionary process-you should have the ability to make more money. The psychological reason why a lot of people don't do this is that they know they are going to get beat up in the community-it's all but certain.

Bill Witte: Frankly, I see a disconnect in LA today between the elected officials, who I believe are truly committed to trying to do the right thing and trying to find effective ways to provide affordable housing, and the staff at the bureaucratic level in the agencies charged with implementing these projects and policies. You're told, I think honestly and sincerely by the City Council, "we want to help you do this, we want to get this right." And when you get in to the bureaucratic realm, you get the run around and it takes forever. Frankly, when we're dealing with financial incentives, sometimes we feel like we're treated like thieves-it's almost punitive. The use of tools like tax-exempt bonds is considered a give-away instead of an incentive. And, this Council could begin to correct that significant disconnect.

Jeff Lee: Ultimately, it comes down to a councilperson telling their community that they have to accept larger and more dense buildings with fewer parking requirements, and deciding that they can risk the political capital to make those hard decisions. Another disincentive is that in addition to the typical appeals and excruciating length in the process, the higher you go and the denser you get, the more apt you are to get sued.

In terms of process, as the ordinance gets crafted, how do you envision being pulled into the dialogue? What would be the ideal process for crafting this ordinance and having input on the incentives included?

Jeff Lee: That's a complicated question, because the city is going to try to craft the ordinance with the help of the private sector, for better or for worse. However, I'm still not sure that inclusionary zoning is a foregone conclusion. It is so complex that when you try to marry this ordinance to the diversity of the city, it's a quagmire. If in fact you believe in what the mayor says, that he wants to not do anything that's going to hurt housing production, it's a very difficult ordinance and set of rules to write. The incentives, if there are incentives, are going to need to be codified. And, you're going to have to up-zone the city. The private sector has been involved and will continue to be at the table. The business community is well represented and will continue to be well represented.

Bill Witte: One of the things that is positive about this dialogue is that it shows a very healthy interest on the part of the mayor and the Council on housing. That, in and of itself is a positive. Second, out of this dialogue, hopefully, will come some real focus on topics such as, what are appropriate incentives to encourage housing production of all kinds and affordability? How can they best be applied? That is a much needed and healthy dialogue. It is possible that it could result in some form of an ordinance, but maybe there's a transitional step, where some of these incentives are tried out.

Jeff Lee: If the 44% figure was supplied by the city and if it is accurate, then production is as high as it's been in a long time and we're doing a much better job of producing affordable housing than we have in many years. But to increase production further, the city is going to have to spend more money on staff. You can't expect to increase production by another 50% and have a hiring freeze in the Planning Department and Building and Safety. There is only so much these people are capable of doing and they are stretched to the limit. So the city is going to have to spend some significant money to try to increase production.

How amenable would the development community be to paying higher fees to support staff increases?

Jeff Lee: I actually think that developers right now would do that.

Bill Witte: We probably would.

Jeff Lee:Planning fees haven't risen in ten years and I would be happy to pay double. If I could save three months, I'd probably pay triple.

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