Is Inclusionary Zoning Legal?

Market Urbanism may soon have a hearing in the Supreme Court. Two of my colleagues at the Mercatus Center, Sandy Ikeda, half a dozen other professors, and I argue that the Court should take up the case 616 Croft Ave., LLC, v. City of West Hollywood. The case is an opportunity for the Court to determine whether inclusionary zoning violates its standards for legal exactions from developers. Inclusionary zoning requires developers to rent or sell some units in new projects at below-market prices. The Court has established that local governments can only require benefits from developers when these benefits offset a public nuisance from the project. Inclusionary zoning fails this test.

The facts of the case could have played out in many American cities. Real estate developers Shelah and Jonathan Lehrer-Graiwer purchased two single family homes that they replaced with 11 condo units. West Hollywood’s inclusionary zoning rule required them to either make 20 percent of the units in their new project available at below-market prices or to contribute $540,000 to the city’s affordable housing fund. The Pacific Legal Foundation is representing the Lehrer-Graiwers suit.  They have petitioned the Supreme Court to review earlier decisions from California courts that upheld West Hollywood’s policy.

West Hollywood’s inclusionary zoning policy states that its purpose is to “off-set development impacts” that new housing construction causes. This justification is based on the false assumption that new housing development raises housing prices by replacing older, cheaper housing with newer, more expensive housing. This fallacy may seem reasonable at first glance. New construction is often more expensive than the older homes it replaces. But as these once-new houses age, they become affordable to lower-income residents.

New construction is the only way to increase housing supply, and new units have the potential to become market-rate affordable housing over time. Housing economists call this process “filtering.” One estimate puts the inflation-adjusted filtering rate at between 1.8 and 2.5 percent annually. In other words, a new apartment that costs $2,000 might cost $1,400 in today’s dollars 15 years from now. In a foundational paper on inclusionary zoning, Robert Ellickson explains:

The infusion of new housing units into a regional market sets off a chain of moves that eventually tends to increase vacancy rates (or reduce prices) in the housing stock within the means of low- and moderate-income families. Consequently, an excellent way — perhaps even the best way — to improve the housing conditions of low- and moderate-income families is to increase the production of housing priced beyond their reach.

Inclusionary zoning rules eliminate new construction that would happen in a world without subsidized housing requirements. The Lehrer-Graiwers estimate that the fees they paid to the city’s affordable housing fund amounted to nearly a third of their project’s profit. While their project was still financially viable under inclusionary zoning, other projects are not. These marginal projects don’t get built, and inclusionary zoning takes their potential contribution to housing supply off the market. Empirical evidence confirms that inclusionary zoning reduces housing construction as economic theory predicts. By restricting supply, inclusionary zoning raises the cost of housing.

The fact that new construction makes housing more affordable — rather than less affordable (aka filtering) — is a key consideration in the legality of inclusionary zoning. The Supreme Court has established that exactions from developers (like below-market-rate housing) must be related to the project through nexus and proportionality standards. For example, local governments can require developers to pay sewage access fees for the waste their project will contribute to an existing system. Or if a new development will involve tree removal, the city can require the developer to plant trees elsewhere.

Inclusionary zoning has neither nexus nor proportionality with housing construction. The policy is based on the assumption that new construction makes housing more expensive, but the exact opposite is true. Since new supply is what allows housing to remain affordable in the face of increasing demand, affordable housing subsidies have no nexus with new construction.

Another popular argument in favor of inclusionary zoning is that it requires people of mixed income levels to live near one another to the benefit of low-income people who get higher-income neighbors. Again, this is true if we think about individual projects rather than the housing market. Those who win the inclusionary zoning lottery may not otherwise be able to afford to live in the same new construction buildings that their neighbors pay market price for. But inclusionary zoning has perverse effects when we zoom out to the city or region level. While inclusionary zoning results in mixed-income buildings, it contributes to making entire regions unaffordable. In doing so, it reduces access to jobs in places like Los Angeles, the Bay Area, and New York City for low- and moderate-income people.

With 616 Croft Ave. LLC., v. City of West Hollywood, the Supreme Court has the opportunity to scale back inclusionary zoning policies across the country. While inclusionary zoning advocates say that the policy increases access to affordable housing, in fact it hurts the very people they are purporting to help. Eliminating inclusionary zoning would be a win for low-income renters in the most expensive places in the most expensive real estate markets.