March 7, 2022 - From the March, 2022 issue

Patrick Condon: Should Cities Now Mandate Affordability & Inclusionary Zoning?

With the ink barely dry on SB 9—the new state law effectively eliminating single-family zoning in California—and despite pleas from renters and tenant advocates, the California Assembly recently rejected AB 854, which sought to limit the ability of real estate speculators to evict and demolish existing rent-stabilized housing stock. In light of the state-sanctioned (and feared) windfall that demolition and private redevelopment of single-family neighborhoods is anticipated to bring Wall Street fund managers, TPR shares this excerpt from University of Vancouver Professor Patrick M. Condon’s book, Sick City, which examines the relationship between urban land values, affordability, and wealth inequality. And with high housing costs unaffected bynew supply in cities like Toronto, Condon concludes and pleas that through mandated affordability and inclusionary zoning, cities can and must capture the exorbitant and inflated land wealth currently hoarded as equity for global finance markets to increase supply of stable, affordable, or “non-market” housing.


“If city authorities are going to create many millions of dollars’ worth of new value by the stroke of the pen, adding new density in the hopes of creating more affordable housing, they have the power, the right, and indeed the obligation to – not to just upzone in the hopes of producing affordability – but to insist on it.”—Patrick Condon

INTRODUCTION

Housing affordability has reached the crisis stage and urbanists can no longer escape responsibility for understanding how their actions may impede or enhance access to secure affordable housing. This chapter introduces readers to what is unique about this historical moment, why former strategies for mixed income urban design strategies may no longer be adequate, and what practices have been taken up recently to address this problem.

What is happening.

During the past two decades the asset value of urban land has skyrocketed. In the USA the urban land price collapse of 2008 has been reversed with urban land prices far above what they were in the pre-collapse “bubble” year of 2006. The jobs rich coastal cities (e.g. Boston, Washington DC., San Francisco, and Los Angles) have seen urban land price increases of over 400 percent[1] in many districts in just the seven years between 2012 and 2019.

The situation in other parts of the English-speaking world (UK. Australia, Hong Kong, New Zealand, Canada), having escaped much of the dramatic collapse in urban land value experienced in the  US during 2008 are suffering even more unmanageable increases in urban land price. Canada is the most extreme example with a 200 percent rise in inflation adjusted housing prices in Vancouver and Toronto in just 10 years. The statistics are just as alarming in the other countries mentioned. In no case are these  increases in home prices matched by increases in salary. Average hourly wages in these countries have stayed flat, (in inflation adjusted terms), since the 1980s. The link between average wages and average home prices, which for decades was considered a real estate “fundamental”, no longer applies.

Many economists and aligned pundits explain that this extreme situation, which defies the “fundamental” of wage/housing cost balance, and the so-called laws of supply and demand, must be a function of “exogenous forces”. This term is used by economists to explain away instances where presumed neo-classical economic rules seem broken by empirical observation. If supply is not matching demand, they say, it must be because something is blocking new supply from entering the market. The handy and intuitively reasonable culprit offered to explain this market failure are zoning controls. Zoning controls place limits on the “highest and best use” of urban land, they say. Their removal would presumably open up a floodgate for new supply to rush into urban markets lowering prices, they say.

 

But as Yogi Berra was reported to have put it: “In theory, theory and practice are the same.  In practice they are different.” It seems Mr. Berra was right, because in theory, no place in North America should have seen greater cost reduction benefits from adding density than the city of Vancouver, Canada. Over 30,000 new units have been added to our miniscule downtown making that city famous for “Vancouverism” in the process. Accessory dwelling units were legalized 15 years ago legalizing and opening up 60,000 more. More recently “laneway housing” units were allowed city wide authorizing 60,000 more. Then within just the past few years the city abolished any remnant of single-family zoning making every small 4,000 sq. ft. lot owner eligible to build 4 units (which works out to a net density of 40 du per acre, which is townhouse density).  This last change authorized up to 150,000 new dwelling units in a city that only had roughly 200,000 to begin with. Add all this together and Vancouver has either built or authorized more than a doubling of housing units since the 1990s. And the results? A larger housing price increase than any other city in North America, including New York and San Francisco, and a gap between wages and home prices second only to Hong Kong. Clearly the empirical evidence in this case does not support the “fundamental’ rules of neo-classical “supply and demand” economic theory.

How then do we explain this?

So, if it’s not about “supply and demand,” how do we explain this? Well, let’s start with the basics: workers don’t get paid enough. The overarching background to the housing crisis is of course the inequality crisis. While productivity has more than doubled (in the developed  world) in the past 40 years, those gains have not gone to wage earners. They have instead been captured by owners. What was also, until relatively recently, construed as a “fundamental” part of the neo-classical rule book, that as productivity increased, owners (“capital”) would get 40% of new value and wage earners (“labor) would get 60% has not held true. Now 100% of productivity gains go to capital.[2] Labor gets none of it. In consequence owners of capital are enjoying a flood of new wealth. They are not storing that new wealth under the mattress but are pouring it into assets, setting off a raging dumpster fire of asset price inflation. And asset price inflation would not be so bad if it only affected gold, stocks, bonds, and bitcoin. Unfortunately, the lion’s share of this wealth is being poured into, you guessed it, urban land. The value of just the urban land in the 100 largest metro areas in the US now exceeds the country’s annual GNP. A 100 percent increase in 10 years.

The second and related problem, also unfamiliar to us and not such a large problem before the turn of the millennium, is the way that land appears to have an infinite capacity to absorb whatever value is created by the human activities occurring around it (capital creation). This one is a little bit more complicated than the inequality problem so bear with me.

Why is land price a problem?

Going back all the way at least to Adam Smith,[3] the “landlord” was seen as essentially parasitic on the machinery of capitalist wealth creation. Smith had deep respect for the industrialists or farmer (owners of capital) and their workers (labor) seeing in their collaboration a goose that laid the golden egg: capital creation. However, you need more than capital and labor to create wealth. You also need land. And it is in the essential nature of the landlord/capital/labor relationship for the landlord to take as large a share of the new wealth created by capital and labor  as s/he can get away with - up to and sometimes over the point where all the value beyond what’s necessary to keep the laborer alive and the factory running gets taken up in land “rent.”[4] This view is the fundamental underpinning of what is known as “classical economics.” These three factors were acknowledged as the necessary triad of wealth creation, with land having no contribution of its own, but rather absorbing wealth passively in the form of rent.

Henry George’s Urbanist Insight

More recently, in the 19th century, it was left to American economist Henry George to apply this concept to what he observed in the emerging American industrial city. His work was in alignment with the classical tradition. He explained that as urban areas mature, more and more of the new wealth created in cities gets poured into land price, up to the point at which the economy strains and buckles under the weight of this land “rent”, (with poverty and homelessness an obvious manifestation of this problem).[5] His analysis of land markets is presently being rediscovered by urbanists.

Henry George had a simple insight. By George’s time, the late 1800s, land value was no longer primarily tied up in agricultural estates as in the time of Smith, but increasingly by wealthy holders of urban real estate (i.e. urban land). Updating Adam Smith, George complained that as cities became more and more wealthy, most of that wealth ended up locked up in the value of urban land. Such well-located land would produce massive “rents” (either actual rents or payments to banks to amortize the full cost of land purchase paid monthly). His conclusion was that there was no way to limit this phenomenon besides taxing that land value. By taxing urban land at its full value, it would reduce to the point of insignificance its price (its rent value), while providing tax funds to maintain the social safety net. His work was important in establishing US state and local tax systems that fall differentially on land value and improvements.

Unfortunately for us, this tax rate, usually in the form of local property taxes, is usually set at about  1 percent of full value of the land per year. At these rates, land taxes do not approach the 9-12 percent annual tax he suggested – too low to quell speculative land price increases sought by ”rent seeking” investors.  A 10 percent tax would approach the full annual “rent” value of the land. Such a high tax would both squeeze out the normal speculative pressures that urban land is subject to,[6] while providing funding for social requirements and city infrastructure.

All of this is explained in his very lucid and accessible book Progress and Poverty[7] so that will have to do for now: but interested readers should go to the source. His book is lucid, accessible, riveting, and passionate.

George’s book hit the world like an explosion, and for more than a decade his book sold more copies in the US than the bible, and provided the political underpinning for the  Progressive Era.[8]  It was translated into over a dozen languages and influenced land policy from China to Hungary.

Where we are today.

However, the years since his death (near the turn of the 20th century) have not been kind to his legacy. The multiple conflagrations of World War One, the Depression, and World War Two, interrupted this pathological accumulation of wealth into land rent – so that by 1945 urban land price (relative to other goods) had fallen dramatically. Secondly, after WWII the expansion of urban areas allowed by the car made vast areas of new urban land available so quickly that its raw abundance lowered its price.  But that huge new suburban supply has met the limits of urban expansion, and we find ourselves, yet again, in the grip of excessive demands for land “rent,” at prices yet again beyond the capacity of average wage earners to afford. [9]

Why don’t urbanists generally see this problem in these terms.

Why was the sense of urgency on the subject of urban land price lost? Unfortunately for urbanists, Classical Economics and the current dominant economic theory “Neo Classical Economics” differ in one key respect. Neo classicists (with one important exception as mentioned below) lump together unproductive land wealth and productive wealth (like a factory or a coffee shop), considering both to be capital.

It is made additionally difficult for urbanists to understand the role of urban land price because land wealth usually serves as equity value backing up the lion’s share of the finance industry (which, like land, is not productive), blending the two in economic discourse. So urban land shows up in most models as “equity” for the “financial industry” and thus does not show up in most accountings as out of control urban land value and as a (perhaps the) main driver of wealth inequality.

To go into much greater detail in this short piece would dull the senses; but before moving on it’s worth pointing out that George’s original insights have been taken up by important successors. Notably by Nobel Prize winning economist Joseph Stiglitz. In his 2015 article “The Origins of Inequality”[10] he explains how urban land “wealth” is the major contributor to our current crisis of inequality while this wealth adds nothing to the productive capacity of the economy. In short, these new trillions in urban land value are, according to him, a cancer on both the economy and the social well-being of our national community.

Why adding density won’t fix the problem.

There is a tremendous amount of debate about whether or not adding density will help solve this problem. The bad news for urbanists is this. The research points in two directions. There are studies that show that adding density pushes housing prices lower (or more accurately that it slows the rate of increases in a particular city district) and others that show it does the opposite (gentrification). Probably the best way for urbanists to understand this conundrum is to read a “meta study” by Gabriel M. Ahlfeldt, Elisabetta Pietrostefani.  They compiled 200 separate studies on the issue to understand the influence of density on cost and on a number of other issues of interest to urban designers (e.g. transportation, pollution, etc). Their conclusion? Maybe adding new density  reduces prices sometimes but, in most cases, it does not. [11]

If for the sake of argument, we accept that adding density by itself does not reduce the price (per interior square foot) of housing, (which certainly is verified by the empirical evidence emerging from Vancouver and other hard-hit cities), we must ask why not? Surely increasing the allowable density on a million-dollar parcel of land by a factor of four should lead to a 75% reduction in the land share component of the price of the new housing.

Unfortunately, the evidence on the ground is unsupportive. In the case of Vancouver attempts to increase allowable density in the hopes of lowering housing costs have failed to produce the desired results.

Why? Because those new land use authorizations are matched in a nearly linear fashion with land cost increases. [12] Land in Vancouver and in other hard-hit cities is no longer sold based on the price of a square foot of the dirt, but rather on how many square feet that foot of dirt allows for in terms of “buildable” square feet of interior space. If the allowed interior area jumps from an FSR (floor to surface ratio) of FSR 1 to FSR 4 you can expect a near quadrupling of the land price almost immediately (and in many cases well before the density increase is allowed - increases sniffed out well in advance by intelligent land speculators). This really matters in high priced urban locations. In Vancouver the price of land per “buildable” is around twice the price of building that same square foot of housing ($600 vs $ 300).

This is of course because land price is “residual” based on the market price of an interior square foot minus construction and “soft costs”[13].  So, the higher the number of square feet of interior space to be sold on a parcel the higher the residual and the higher the price a landowner can demand for the land.

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Of course, some of the most successful developers will capture this land price windfall based on its former zoned allowance and successfully argue for an increase in density, putting this land price inflation in their own pocket. But the land speculation function and the development function are best seen as separate; the first focused on capturing land value increase and the second focused on the process of construction and sales. The first function, the land speculation function, is seen by many economists as not contributing to the economy in a productive way, while the development function is quite rightly seen as adding value to the community.

What can urbanists do about all of this?

Even in the face of this evidence many urbanists will still maintain that this land price inflation is not a caused by adding new density authorization in the way I have described, but rather is because new density authorization is given too rarely, and only here and there (spot zoning for denser projects is an example). What is needed, they say, is blanket rezoning where single family zoning is rendered illegal over vast areas with a stroke of the pent.

 California will soon test that hypothesis. There, Senate Bill 9 of 2021 renders single family zoning illegal, statewide.[14] It requires the newly “stratified” lot to have an owner/occupant in at least one of the units for a certain number of years (to quell speculation hopefully). It will take a number of years to see if those who argue scarcity of building opportunity is the culprit, but this author, sadly, has doubts. My doubts are based on empirical observation and my own failures to see prices lowered by adding supply.

What can we do on Monday?

In the immediate term there are more fruitful ways to stream land value away from the pockets of land speculators and towards social purpose. If city authorities are going to create many millions of dollars’ worth of new value by the stroke of the pen, adding new density in the hopes of creating more affordable housing, they have the power, the right, and indeed the obligation to – not just upzone in the hopes of producing affordability – but to insist on it. Municipalities can insist that new density allowances be only offered if a certain percentage of the new housing units are permanently affordable (through “housing agreements” or through deeding to nonprofit providers, etc). This sort of quid pro quo demand on private property rights has been upheld by both state and federal supreme courts in the US, as a valid use of “police powers” which are the legal foundations of zoning. California has been particularly active in using this tool.

A requirement for affordable units does not increase the price of adjacent market rate units. Rather it lowers the “residual value” of the development parcel below what it would have inflated to without this affordability demand.[15]

A more aggressive use of the inclusive zoning tool would be the one adopted in 2021 by Portland Oregon,[16] where they allowed any “single family” lot to be rebuilt for six units in return for three of the six being permanently affordable. They also lowered the FSR for new single-family homes to make parcels less attractive in the marketplace for that competing use.

Finally, most aggressive of all would be Cambridge Massachusetts,[17] where their council approved an “Affordable Housing Overlay District” covering the whole city which allows a doubling of density anywhere in return for an agreement that 100 percent of all new units be affordable to those making 80 percent of median household income or less. The important point to make here is that inclusive zoning in its various forms does not increase housing prices in cities where land value approaches construction cost per square foot, and that high land cost is a feature of virtually everywhere where housing affordability is a problem.

Further Reading.

The above more or less summarizes the contents of my recent book Sick City and naturally I recommend reading more there. This volume is available from the usual sources and also as a free download here: https://justicelandandthecity.blogspot.com/p/download-sick-city-pdf.html. Also, as mentioned above, Progress and Poverty is a lucid and accessible book on land economics and economics generally. If you liked Piketty’s Capital in the 21st Century, you will love Progress and Poverty. Also available free and on line at: https://www.gutenberg.org/ebooks/55308

[1] Land Price and Land Share Indicators https://www.aei.org/housing/land-price-indicators/

[2] Piketty, Thomas. (2017) Capital in the 21st Century. Cambridge: Harvard.

[3] Smith, Adam (1776). An Inquiry into the Nature and Causes of the Wealth of Nations. Vol. 1 (1 ed.). London: W. Strahan.

[4] Land “rent” is in quotes here because in this chapter the term is used in the way that economists use the term, i.e. as a cost to production that is necessary yet contributes nothing directly to production. Many things demand rent, but currently, urban land is making by far the largest aggregate demand for rent globally.In laymans terms the words land price and land rent are nearly interchangeable. 

[6] This part takes a bit of time to get your head around. The value of a piece of land is not its full price, but rather its value every year during the time period necessary to pay off the financing needed for its “purchase”. So economists often figure the period for that would be 15 years. So, the yearly cost would be about 7% of the total cost plus another point or two for interest. Economists call this kind of thinking the “present value” of money. https://en.wikipedia.org/wiki/Present_value

[9] This brief summary doesn’t do justice to this issue. However, if the readers interest in piqued a more robust explanation is captured in the author’s new book “Sick City”

[11] “The economic effects of density: A synthesis”http://eprints.lse.ac.uk/100482/1/GA_EP_The_economic_effects_of_density.pdf

[12] “East Vancouver property marketed as ‘land assembly’ sold 121 percent over assessment for $2.8 million”

by Carlito Pablo on December 9th, 2021 at 11:23 AM https://www.straight.com/news/east-vancouver-property-marketed-as-land-a...

[13] Soft costs are a grab bag of project costs that include design and permitting fees. Developer profits are also sometimes placed in this category)

[14]   The California Home Act   https://focus.senate.ca.gov/sb9

[15] I go into more detail on this point in my new book “Sick City”, chapter 6. https://justicelandandthecity.blogspot.com/p/download-sick-city-pdf.html

[16] Portland Just Showed Vancouver How to Fix Its Housing Crisis https://thetyee.ca/Analysis/2020/08/28/Portland-Showed-Vancouver-Fix-Housing-Crisis/

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