Inclusionary Housing: Affordability Crisis Solution Or Policy Mirage?

As part of strategies that seek to make housing more attainable, local jurisdictions have been leaning into inclusionary housing (IH). These programs have been instituted since the mid-1970s in San Francisco and Washington, D.C. They are now being proposed or have been instituted in an ever-growing number of municipalities around the country.

Perhaps we should investigate how well they have worked.

California, New Jersey, and Massachusetts have the most IH programs, by far. The lack of affordability in those markets speaks for itself. If you want to check for yourself, try the St. Louis Fed's excellent website and compare it to US home prices over time.

These programs have been around long enough that we can look at the evidence of their effectiveness. Which is simply not in the data. Why haven't these programs worked?

We have an excess of demand relative to the highly restricted housing supply. Inclusionary housing programs are designed not to increase the amount of housing created but to change the mix of rent/sales prices through municipally chosen restrictions. Without an increase in the total amount of housing created, these programs, at best, change who buys/rents which unit.

As a result, builders typically have to upscale the remaining units, making them more expensive. Alternatively, when a builder can pay a fee in lieu, they usually do, driving up housing costs.

How is making homes more expensive part of our solution to high home/rent prices?

Why pay the fee vs. build affordable homes? The risks of building affordable homes are significant. We’ve all experienced massive cost increases, and there is reason to think that, given the geopolitical situation, supply chains will continue to be periodically disrupted. When costs go up on a market-rate unit, a builder might be able to raise prices to cover it. That’s not the case for income-restricted homes. So, the subsidy can turn out to be more than anticipated.

With a for-sale product, you have the added risk that mortgage rates rise, lowering the price you can charge for the units. When layers of risk are added, builders and developers must find a way to increase the price of the remaining units or drop the deal entirely. This is what happens all too often.

Musical Chairs

I have used the analogy of musical chairs in the past. We played the game as kids. There are more people than chairs, and when the music stops, someone does not have a chair. It is the same in housing, although we bid for the chairs. But the result is the same. By not increasing the number of housing units, we simply change who gets a new one, which would otherwise be determined by the market. But we have not changed the number of people with a problem, just the ones who face it.

Some will argue that we are still achieving a social good by adjusting who has a housing problem—helping those less fortunate. But have we? Administering these programs over time is complex, time-consuming (usually requiring a housing agency to monitor compliance, approve sales, etc.), and often fraught with conflict, especially when an income-restricted buyer goes to sell and has a hard time finding a buyer.

If units had not been price-restricted, they would have been bought by people with higher incomes than those under IH restrictions. Where do they go? They bid up the price of the next best alternative. And where do those who would have acquired/rented those units go? To their next best alternative. This continues until you get to the bottom of the housing ladder and find out who did not "get a chair" in our game of musical chairs. The same people at the bottom got hurt as before. We have done nothing to help them.

Here is a thought experiment. How would we explain what we are doing to those who would have bought/rented price-restricted units but are no longer allowed to – they make a little too much money?

I am sorry, Mrs. Jones, you could have bought this home, but we have decided someone else should."

I think she would reply:

I understand why you want to help other people, but why do you want to hurt me?"

A fair question, and not one I think there is a good answer to.

But wait, what if we pair inclusionary housing requirements with density bonuses? This can help mitigate the damage, although these programs are designed by most municipalities to try and achieve break-even for the developer. They have neither been helped nor hurt by the policy, at least in the estimation of the governing authorities. Of course, one would think the goal would be to get the most housing built possible. Are we worried about builder profits or a lack of housing? Denver's 2022 inclusionary housing ordinance is an example of one designed to "break even." Here is how that turned out.

Proponents of inclusionary housing will tout the number of affordable units built under their programs. But those are not units in addition to what would have been built anyway in most cases, and it does not adjust downward for those not built because they do not pencil under the ordinance. Nor does it adjust for the fact that with fewer units of a given price point built (those restricted below market), all other units in the marketplace rise commensurately to balance supply and demand.

Besides being simple logic, you can see it in the numbers. Those localities that have instituted these programs have not seen their house prices flatten, let alone fall. They have risen. Insanity is doing the same thing repeatedly and expecting a different outcome.

An Alternative Approach: Lower Barriers

OK, but what would work?

We would be better off addressing the root causes:

Large minimum lot sizes and setback requirements. See the success Houston had and continues to have with infill for-sale housing by reducing minimum lot sizes by-right to 1,400 square feet;
Insufficient by-right zoning that supports attainable housing;
Tap and impact fees based per unit, not per square foot;
Speed up the process. Time kills deals (which the opponents of housing know well) and adds to the needed price to make them work;
Maximum density vs. maximum floor area ratio (FAR). As an example, a five-unit per acre suburban development might have 4,000 square foot homes – 20,000 square feet of home on an acre, so roughly a FAR of 0.5. If an FAR were used, we could have ten 2,000 square foot homes, or better yet, twenty 1,000 square foot cottages. Why is residential development zoning based on density as opposed to most other commercial real estate types that use FAR?

Why are people surprised we do not build many small homes?

All housing solutions should answer the question: how will this policy increase the number of units that would otherwise be created without it?

Otherwise, we are misleading the public as to whether we are doing something and simply picking winners and losers in the housing game.

We should be trying to create more winners overall.

There is simply no alternative to solve our housing problems other than building more than we do and reducing barriers to building smaller attainable units. NONE.