What Now? Understanding What CBIA vs. City of San Jose Means for Inclusionary Housing in California’s Cities

This blog post was co-authored by Sasha Hauswald and Michael Rawson, Director of the Public Interest Law Project, and written into an interview-style format.

On Monday, June 15, the California Supreme Court issued its long awaited decision on the “San Jose Case.”  In a landmark opinion, the court affirmed that Inclusionary Housing is legal in California and is a legitimate use of land-use authority.  The opinion found that San Jose’s inclusionary housing ordinance was not an unconstitutional exaction, or an illegal taking, of developer’s property, as the California Building Industry Association (CBIA) had argued.  This was an exciting win for California cities, which have been reeling from earlier court decisions that led many cities to water down or stop enforcing their inclusionary housing policies.  Michael Rawson, Director of The Public Interest Law Project, represented affordable housing advocates on this case and is a leading expert on housing law in California.  Cornerstone Partnership spoke with him about what this decision, along with earlier decisions in the Patterson and Palmer cases, mean in practical terms for inclusionary housing program design in California.

Sasha Hauswald:  Mike, could you explain why this opinion on the San Jose case is so important?

Mike Rawson: The Court held that jurisdictions throughout California can impose inclusionary housing requirements as part of their “police power” to regulate land use and development without having to show that the need for the required affordable housing is caused by new housing development.  The existing need for affordable housing is enough to justify an inclusionary requirement.  No “nexus” or connection between new housing development and the required affordable housing must be shown.  Likewise, in-lieu fees in inclusionary housing programs are not exactions, coming within the justifiable exercise of local police powers and zoning authority.  The Court expressly disapproved the Patterson decision, which holds that inclusionary in-lieu fee levels must be reasonably related to “mitigating the impact” of market rate development.  In concrete terms, this means that inclusionary housing programs can be implemented without the need to conduct a nexus study.

Sasha:  What about the Palmer decision?  Does this opinion change that?

Mike:  No, unfortunately the Palmer decision was not before the Court in the San Jose case, but perhaps Governor Brown will hold true to the promise he made in 2013 and reconsider a legislative fix to Palmer now that the San Jose case has been decided.  When Brown vetoed AB 1229, which would have overturned Palmer, he cited his desire to benefit from the San Jose court’s thinking before passing any new inclusionary-related legislation.

The Palmer decision, which I believe was decided incorrectly, held that price restrictions on inclusionary rental units violated California’s rent control preemption law, the Costa-Hawkins Act, which prohibits rent restrictions on new rental developments.  The Palmer court failed to recognize the Act’s exception, which allowed rent restrictions on developments subject to contracts or regulatory agreements requiring affordable housing.

The San Jose case makes it clear that inclusionary housing policies in California can require or mandate creation of affordable for-sale units, but Palmer muddies the water on what is legal for rental developments unless it is overturned or modified by the Legislature.  To address the situation, some communities have developed alternatives to an on-site rental inclusionary requirement.

Sasha:  Before we get to rental models, let’s touch on for-sale inclusionary housing requirements. In terms of practical guidelines, what are some allowable models?

Mike: Well, because the Palmer decision didn’t apply to for-sale development, inclusionary requirements on for-sale (both single family and multi-family for-sale units) housing continue to be completely legal in California.  But an important outcome of this case is that a ”nexus study” is neither required nor recommended before inclusionary housing requirements are adopted.  The goal of a nexus study is to demonstrate that the affordable housing need addressed by inclusionary requirement is caused by new market rate housing development and that there is a quantified “rough proportionality” between the requirement and the need.   Some city attorneys had recommended preparing a nexus study as a legal safeguard to possible attacks on inclusionary requirements by developers.  However, the Court, as we’ve discussed, found that inclusionary housing laws require no determination that the need for affordable housing is caused by market rate housing.  That said, examining the financial feasibility of a particular inclusionary requirement is still a best practice when implementing a new inclusionary program.  A lot of people do not understand that feasibility studies are distinct from nexus studies.  The goal of a feasibility study is to determine how a new inclusionary policy or fee might affect market rate housing development costs and profit margins.

Sasha: Is it also possible to have a fee-in-lieu option without doing a nexus study?

Mike: Yes. Offering for-sale developers the option to pay an in-lieu fee as an alternative to an on-site inclusionary requirement does not require a nexus study because it is simply an alternative related to the underlying on-site requirement.  In terms of best practices, jurisdictions should ensure that any in-lieu fee is related to the gap financing or subsidy needed to develop the forgone affordable units elsewhere.  That will ensure that if developers “fee-out,” the community will be able to facilitate development of the needed affordable housing.

Sasha: Just a side-note that for more information on fees v. units considerations, Cornerstone has a webinar on the topic that folks can access here. Another question I have is whether a jurisdiction can ask for-sale developers to create affordable rental units instead of affordable for-sale units?

Mike: Yes and no.  An ordinance can allow or incentivize single-family and condominium developers to produce affordable rental units instead of affordable for-sale units by offering that option under their policy.  The ordinance can make this option economically and practically attractive to developers, but it cannot require for-sale developments to include affordable rental housing due to the Palmer decision. Ways to incentivize rental housing include offering an extra density bonus, regulatory incentives, and concessions or financial incentives if a developer elects the rental housing option.

Remember, the Costa-Hawkins Act includes an exception for projects where the owner has agreed by contract to build affordable housing in consideration of a direct financial contribution or any other forms of assistance specified in California’s Density Bonus Law.  Although the Palmer decision indicated this exception did not apply to inclusionary laws mandating rental housing, the exception provides a clear basis for choosing to build the rental units.

Sasha: Many jurisdictions in California have switched to housing development impact fee programs in order to comply with the Palmer decision.  Can you talk about whether it is advisable to switch to fees on for-sale development at the same time they change to a fee program on the rental side?

Mike: It is clearly not necessary under the San Jose decision.  Some programs in California are pursuing a hybrid inclusionary/fee program.  In hybrid programs the default requirement of for-sale developments is an onsite set-aside of affordable housing, while the default requirement of rental development is a per-unit or per-square-foot fee.  Other programs have switched entirely to fee-first programs. The fee-first programs are all based on nexus studies which are no longer required for for-sale developments, and may not be required rental housing fees. Indeed, the nexus study can end up restricting the amount of the fee to less than what is needed to replace the on-site percentage.

Sasha: Now let’s talk about inclusionary rental programs, which is a tricky issue in California.  For starters, I want to confirm that a purely voluntary rental program is still safe and legal.

Mike: Yes, it is.  Voluntary inclusionary rental programs where developers opt-in to the program in exchange for some form of city benefit are allowed under the Costa-Hawkins exception. In fact, California’s Density Bonus Law mandates that all communities provide developers with a density bonus and regulatory concessions and incentives if they include a minimum percentage of affordable units—rental or ownership—in their developments.  Affordable rental units sometimes may also be included as a term of a development agreement between a developer and the local government when the developer requests any of a broad range of discretionary land-use benefits such as general plan or zoning changes, additional height or density, reduced parking requirements, or other conditional use permits and variances.  In these cases, the inclusionary policy is essentially “triggered” by the developer’s request or by a discretionary review process.  Affordable units can also be required when developers receive fee waivers, tax abatements, or direct financial assistance from the city.

Sasha: Since it can be hard to get developers to participate in a purely voluntary inclusionary program, many California jurisdictions are imposing a mandatory development fee instead of having a unit requirement for rental developments.  Could you give readers a quick explanation of the legal rationale for this change?

Mike: The Palmer decision held that in-lieu fees on rental housing are inextricably linked to on-site rental requirements and, therefore, do not avoid the prohibition of rental restrictions on inclusionary units the court found were prohibited by the Costa-Hawkins Act. But, a stand-alone affordable housing fee on rental development is not a violation of the Costa Hawkins act because rents are not restricted.  Usually, fee revenue is then invested by the city or county in affordable housing development and preservation projects.

Experts disagree on whether or not affordable housing impact fee ordinances in California should be based on a nexus study that tries to show that the fee is based on the affordable housing need caused by new residential development. Some, including me, believe that a community can adopt, in its general plan, a policy goal that a proportion of all future residential development in the community must be affordable, provided the proportion is based on an analysis of existing and projected housing needs.  Founded on this assessment and under the reasoning of the San Jose case, the fee would be related to a “legitimate governmental purpose.” Legitimate purposes articulated by the San Jose Court include: the existing need for affordable housing, the need provide housing affordable to local job holders and to reduce vehicle trips, the need to address segregation and other effects of exclusionary land use practices, and to otherwise further fair housing.  The California Mitigation Fee Act should not apply, because the fee is not imposed to cover the cost of “public facilities”.  Nexus studies evolved to meet the legal requirements for ad hoc fees for public facilities, not the lesser standard for generally applicable fees.  The amount of the fee, as I mentioned before, should  be based on the cost of developing the proportion of affordable units called for in the general plan policy.

Other experts have recommended conducting a nexus study because, even though the fee is not an “impact” fee, the study will clearly establish the relationship between the fee and impact of the development called for by the California Mitigation Fee Act and the federal and state cases that apply when jurisdictions negotiate permit conditions on individual developments that require property dedication or money (This takings standard is often referred to as Nollan/Dolan standard after those two federal cases.).  Before the San Jose case, this more conservative approach made a lawsuit less likely, but with the San Jose opinion, the strength of such a legal attack is substantially undermined. The problem with continuing the cautious approach is that basing the fee on a nexus study also limits the allowable fee level.  Most California jurisdictions that have switched to housing development impact fees based on a nexus study have new impact fee levels that are far lower than the in-lieu fee levels in their pre-Palmer inclusionary policies.

Ultimately, the two views are not as different as they might seem. There is no disagreement that a legitimate goal and policy of a local general plan—the community’s “constitution”- can be that a minimum percentage of housing in a community be affordable to lower income households and the regional workforce.  The San Jose Court acknowledged as much in citing the requirements of the Housing Element Law.  So, if a community provides in its general plan that as it grows it must become a more inclusive, non-segregated community with an adequate supply of affordable housing, the development of market rate rental housing without payment of an affordable housing fee would have a negative impact on this legitimate goal. From that perspective, an affordable housing fee based on the cost of developing an affordable rental unit is a valid mitigation fee directly addressing the impact of not developing affordable rental housing.

Sasha: With a fee-based ordinance, is it still possible to get on-site affordable rental units?

Mike: Where a fee requirement is placed on new rental development, with or without the justification of a nexus study, the jurisdiction may always offer developers an optional alternative to build rental units instead of paying the fee. If the program is structured so that an on-site construction option is less costly than the fee requirement, developers will choose the construction option and mixed-income housing will result.  However, it is important to remember that whenever affordable rental development is financed by a market rate developer, ordinances should provide some concessions or incentives to developers who voluntarily build rental units.  This will ensure that the policy falls within the Costa-Hawkins exception.

Sasha: My very last question has to do with upzoning.  Can inclusionary rental units be required when a City upzones a specific neighborhood or corridor?

Mike: It depends on the nature and extent of the upzoning.   In California, if a developer offers to build a minimum percentage of affordable housing, whether ownership or rental, state Density Bonus Law entitles the developer to densities above the existing zoning.  If the developer seeks a density in excess of the state density bonus, the community probably can require that those extra units be rentals.  Indeed, a zoning overlay ordinance with the purpose of addressing the community’s need for affordable housing and that offers rental housing development substantial incentives and regulatory concessions in exchange for inclusion of on-site affordable rental housing at greater proportions than would be required by state Density Bonus law would not violate Costa Hawkins and would be right in line with the San Jose opinion.

Sasha:  The San Jose case was a victory.  The court affirmed that localities do not need to prove that their affordable housing requirements or in-lieu fee amounts are “reasonably related” to the impact of a particular development on demand for affordable housing.  This is a step in the right direction.  Ultimately, don’t you think Californians would benefit from a legislative fix to the Palmer decision to allow for full local control and flexibility to design strong, custom-tailored inclusionary housing policies?

Mike:  Yes, though even without that fix, jurisdictions are not without some options.  There is a pervasive myth that inclusionary requirements of rental developments are illegal in California, and that there is only one solution: a fee-only ordinance backed by a nexus study.  I hope this interview will debunk that myth and help jurisdictions come up with creative policy designs to create affordable rental units, while working within today’s legal restrictions.

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