With little fanfare, San Francisco’s City Controller released a housing feasibility report that laid bare the reality of housing development in San Francisco. It confirmed what developers, lenders, and housing advocates have said for the past few years: building housing in San Francisco is extremely difficult. Even market-rate rental housing isn’t financially feasible, meaning it won’t make enough money to cover its costs and provide a sufficient return to lenders and investors.
That reality should fundamentally influence how planning commissioners and supervisors think about housing policies. SPUR has argued that the city needs to recalibrate city-imposed costs on development to address the cumulative costs of housing development if it truly wants to make San Francisco more affordable. The feasibility report comes to the same conclusion.
Inclusionary Housing Requirements and Rising Construction Costs Equal Virtually Zero New Housing
Like other California cities, San Francisco requires developers of market-rate housing to include some units for lower income people or pay an in-lieu fee to support the development of affordable housing elsewhere. Every three years, the Controller’s Office releases a report evaluating whether these inclusionary housing requirements remain economically feasible under current conditions. Working with the Inclusionary Housing Technical Advisory Committee and Century Urban, the Controller’s Office examined various ownership and rental housing prototypes (low-rises, mid-rises, and high-rises) across 80 scenarios with different inclusionary requirements to determine whether any scenario would generate enough return to justify the cost of building. The results were clear: the answer is no.
Every rental scenario — including 100% market-rate projects with no inclusionary housing requirement — was financially infeasible. Even if the land were free, a new apartment building would still not provide a sufficient return for lenders and investors to consider it worth the risk to finance it.
Every home ownership scenario is also infeasible. In only one scenario, a midrise condominium with no inclusionary requirement, would development costs and revenues break even.
Historically, San Francisco and other cities across the Bay Area have focused on maximizing affordability by increasing inclusionary housing requirements, development impact fees, and community benefit agreements from private development. This approach, called “value capture,” makes the case that the developer will see significant future increases in land value from the project and should therefore fund various community benefits or amenities. But what happens if a city tries to capture value when there’s no longer profit in private development?
Over the past three years, construction costs have skyrocketed, and interest rates remain high. Insurance, labor, and financing costs also continue to rise. Simultaneously, rents and home prices aren’t keeping up with those costs, leaving insufficient returns on investment to offset the capital and risk involved. If the total costs of building housing are more than the revenue earned, homes simply can’t be built.
Inclusionary housing requirements reduce developers’ revenue because affordable units generate lower returns than market-rate units. Similarly, impact fees increase costs and delays and erect other barriers to building. As SPUR has argued, the cumulative cost of city-imposed fees can render a housing project infeasible, resulting in no market-rate or affordable housing being built. The controller’s report emphasized that, under current conditions, the maximum economically feasible affordable housing inclusionary requirement is 0%.
What to Do?
Given the challenging housing development landscape, the Technical Advisory Committee recommended the following:
- Lower on-site inclusionary requirements from the current 12-15% to 5% if paired with a separate affordable housing funding package or 10% absent such a package. Subsequently, Supervisor Myrna Melgar and Mayor Daniel Lurie introduced a charter amendment proposal to expand the Housing Trust Fund to produce and preserve affordable housing.
- Apply the same onsite and in-lieu affordable housing requirements to both condominium and rental housing projects (In-lieu requirements allow developers to contribute to affordable housing funds instead of building affordable units on site.).
- Adjust income requirements for rental and ownership affordable housing by removing moderate-income tier requirements and slightly increasing the number of low-income units required.
- Exempt projects with fewer than 25 units from any inclusionary requirements.
- Set the offsite in-lieu fee at a level that incentivizes the provision of units on site, currently 10-15% is proposed depending on location.
- Eliminate extra affordability requirements specifically on state density bonus units. (Density bonus units are additional residential units allowed by state law beyond the maximum density normally permitted by local zoning codes. According to state regulators, this practice conflicts with the state law formula for calculating how many density bonus units are awarded per affordable unit.)
- Reduce non-inclusionary impact fees on new development by 67%.
Policymakers can’t ignore the relationship between public policy and housing feasibility, especially when the economy is at a standstill. A housing policy that appears to promote mixed-income communities on paper can be counterproductive if it prevents the construction of housing of all types — both affordable and market-rate.
Doing nothing isn’t an option, because inclusionary rates will automatically spring to 20% in November and increase annually. The temporary impact fee reductions of 33% would expire in November, as well. San Francisco still faces serious housing challenges and affordability issues. If housing remains infeasible to build, the state can seize control of the city’s zoning because the city won’t be able to meet its Regional Housing Needs Allocation goals. The question for policymakers is how the city can adjust its requirements to reduce the burden on market-rate development and pursue other funding strategies to generate much-needed affordable housing.