Inclusionary Zoning: why it does not work

This week the South Carolina Senate held a public hearing before a Judiciary subcommittee to consider legislation to allow South Carolina cities and counties to impose Inclusionary Zoning on home builders and developers.  Inclusionary Zoning is a regulation where government mandates that private home builders and developers sell or rent some homes at below-market prices without any financial participation from government.

Your Home Builders Association opposes Inclusionary Zoning because it does not work.  In fact, it makes the affordable housing problem worse.  We described the problem in a letter to Greenville Mayor Knox White.  The Greenville City Council adopted a resolution in support of the Inclusionary Zoning legislation and actively lobbied for its passage.  We also shared the letter with the rest of City Council, Greenville County Council, and the legislative delegations from Greenville, Pickens, and Laurens counties.  You can read the letter below.  Click here to read our policy paper on Inclusionary Zoning.

April 17, 2017

The Honorable Knox White, Mayor
City of Greenville
206 South Main Street
Greenville, SC 29601

Via Email: kwhite@greenvillesc.gov

Dear Mayor White,

I would like to provide you with some additional research and information on inclusionary zoning and why, in almost all cases, this regulation worsens the affordable housing problem in the communities where it has been implemented.

Attached is our policy paper on the subject. In addition, I have outlined below why an inclusionary zoning regulation would contribute to the affordable housing problem in Greenville, rather than improve it.

Scenario 1
Assume that an inclusionary zoning ordinance in the City of Greenville will require 10 percent of all housing units constructed to be below market prices. Assume also that 400 housing units are constructed in a year in the city (consistent with current activity and about 8 percent of the total new homes constructed in Greenville County). The result would be 40 new below-market housing units constructed in the city as a result of an inclusionary zoning ordinance.

However, we must assume that the developer will pass the lost profit on in the form of an increase in the prices of the remaining 90 percent of their development that is being sold at market-rate prices.

The average price of a newly-constructed single-family home in the Greater Greenville area is approximately $270,000. The average home builders' net margin is about 5 percent. That is their profit. Some are more profitable. Others are not. That is an average.

Therefore, the home builder will need to increase the prices of the remaining 90 percent of market-rate housing units by $15,000 each.

• $270,000 x 5% = $13,500 (average price times 5% net margin is the home builder's profit per housing unit priced at $270,000)
• $13,500 x 400 / 360 = $15,000 (average profit times total housing units produced, divided by market-rate housing units produced is the price increase on each market-rate housing unit)

According to the National Association of Home Builders' Priced Out Effect study (nahb.org/pricedout), a $1,000 increase in the cost of a new home in Greenville, South Carolina, prices out 520 households from purchasing a new home. Therefore, that $15,000 increase in the price of a new home, the result of an Inclusionary Zoning Ordinance mandating that 10 percent of the project be sold at below-market prices, will price out 7,800 families from purchasing a new home as a result of the ordinance—PER YEAR.

The hypothetical ordinance would produce 40 below market housing units, but will cause an increase in the demand for below-market housing units by 7,800 households. And this only assumes that the net profit from the 10 percent of housing units that are below market is $0. If the city demands that the price be less than break even, which is likely, the priced-out effect is even worse.

Granted, I am applying the Priced Out data, which is a regional statistic, to the City of Greenville. However, I believe it fairly describes the cause and effect of an Inclusionary Zoning ordinance.

Scenario 2
The above example assumes that the ordinance regulates the end price of the house. However, some ordinances have regulated the end price of the lot. That method is even worse for affordability.

The lot cost is a combination of raw land cost plus development and infrastructure costs, as well as marketing, commissions, and carrying costs (debt), plus profit. Below is how the final lot price is often determined:

• Land cost of $15,000 per lot ($60,000 per acre divided by 4 units per acre)
• Infrastructure and development costs have risen dramatically and are now typically $25,000 per lot
• The result is a $40,000 lot in hard acquisition and development costs
• Therefore, a 30-lot subdivision would cost $1.2 million
• Add risk, carrying cost, overhead, desire for a profit, and the $1.2 million in hard costs is typically grossed up using a 1.5 multiplier. Therefore, the retail price of the lot will be $60,000 lot.
• The gross margin is $20,000 per lot from which comes business overhead (city license fees, office cost, employee salaries, insurance, utilities, transportation, etc.). That overhead number is about 10% of revenue, or $6,000.
• Then there are the additional costs like sales commissions, marketing expenses, and interest expense.
• The absolute best outcome for the developer is 10% net profit on the lot, but usually it is less.

If 3 of the lots in the 30-lot subdivision must be sold for $20,000 each in order to produce a house affordable to a buyer earning between 80 percent and 120 percent of median income, the lost $20,000 in cost (the lot cost is $40,000) and the lost mark up of 20,000 per lot, will be added back to the remaining 27 lots.

• Therefore, the developer’s lot cost for the market-rate homes is $44,444 ($1,200,000 / 27 lots)
• The retail price of the lot will be $66,666 ($44,444 x 1.5 = $66,666)
• A difference in cost of $6,666 per lot that will be paid by the market-rate buyers in the subdivision

Therefore, the developer will sell the remaining lots to builders at $66,666 rather than $60,000.

In any final product, the lot is typically 17 percent to 20 percent of the cost of the home. To keep it simple, assume the builder uses a 20 percent value for the lot. Therefore, the builder will build a house that is five times the price of the lot.

When the lot cost increases by $6,666, that means the $6,666 increase in the lot will magnify into a $33,330 increase in the final price of the house. This is how it looks on paper:

• $60,000 lot x 5 = $300,000 house price
• $66,666 lot x 5 = $333,330 house price

With this lot-price control method, the city will have priced out of homeownership 19,314 families in the Greenville area.

You will understand from this analysis why the Home Builders Association has concluded that inclusionary zoning does not work. It, like many other government regulations on the housing industry, such as zoning and rent control, often make us feel like we are doing something constructive when we are, in fact, making the problem worse.

The study by the National Association of Home Builders that we reference in our policy paper has been applied to the Greenville area in the attached graphic. It demonstrates that housing in our community is nearly $70,000 more expensive as a result of regulation. As a result, less than 10 percent of all housing units built today are sold for less than $200,000. Just 17 years ago, 90 percent of all housing units were sold for less than $200,000. Inflation alone does not explain that increase in housing prices.

Our recommendation is that the City of Greenville and Greenville County work with the industry that produces housing to develop a meaningful housing policy for our community that will actually meet housing demand for all of our community’s citizens.

Home Builders Association of Greenville, SC, Inc.
Sincerely,
Michael E. Dey
Executive Vice President and Chief Executive Officer

Copy:
Greenville City Council
Greenville County Council
Legislative Delegations of Greenville, Pickens, and Laurens counties