The High Cost of Affordable Housing

There are a number of lessons to be learned from a just-published decision by the Fifth Appellate District of the State of California, which held that a City’s demand for increased in-lieu fees from a housing developer was not “reasonably justified.”  When the developer initially obtained approvals to build 214 housing units, the City of Patterson (Stanislaus County) imposed a fee of $734 per house, to be paid “in lieu” of requiring the developer to build “affordable housing” in the subdivision.  The Development Agreement between the developer and the City specified that the fee would be due when the developer pulled building permits, and noted that the City was working on an updated analysis that would result in an increase to this fee.  When the developer went to pull the building permits, the City announced it had raised the fee to $20,946 per house.  The developer sued the City, lost at the trial court, and then appealed.  The Court of Appeal ordered the City to vacate the fee and remanded the case back to the trial court to determine an appropriate remedy.  Building Industry Assn. of Central California v. City of Patterson.

Looking beyond the inherent absurdity of the extraordinary increase in fees, there are several less obvious but significant lessons here.  First, for real estate investors, the case illustrates the level of uncertainty that lies beneath the routine process of securing entitlements and going through the development process.  The developer initially obtained City approvals and entered into the Development Agreement in January, 2003.  The increased fee was imposed three years later.  The trial court ruled in favor of the City on December 20, 2007.  The Court of Appeal reversed on January 30, 2009 (modified Opinion issued March 2, 2009).  Six years elapsed between the original “approval” and the Court ruling in favor of the developer, and the case still has to go back to the trial court for determination of a “remedy.”

Developers often argue that by building more houses, the costs are spread out so as to reduce the individual price of each home.  In other words, allowing greater density will increase affordability.  The Court noted that the average cost of housing in Patterson was rising from around “$157,000 in 2001, to $247,380 in 2004.  According to the City, this created an “affordability gap” that was used to justify the imposition of the $20,946 “in lieu” fee.  By the time the Trial Court heard the case, the average price of a home in Patterson had increased to around $350,000.  The City of Patterson has a population of around 20,875 and a median annual income of slightly less than $60,000.   In developing its Fee Justification Study, the City had determined that it needed 642 new “affordable” housing units, and based the “in lieu” fee on what it calculated to be the “affordability gap” for moderate, low and very low income families, based on housing prices at the time.  The Study concluded there was a “gap” of $73.5 Million, and estimated there were 3,507 “unentitled” lots in the City, or $20,946 per lot.

The Court ruled that the City’s determination of the fee was based on the estimate of the City’s need for 642 affordable housing units, and had no connection to the need for affordable housing generated by the developer’s market rate project.  Therefore, the fee was not “reasonably justified” as required under the law.  It is interesting to note that the average price for a house in Patterson has dropped to $168,166, and there are approximately 1,278 foreclosures out of slightly more than 5,000 dwelling units in that City.  In other words, the average price of a house in Patterson has dropped almost back to the levels that were in existence in 2001, when the City only imposed an “in lieu” fee of around $340 per lot, the the trend is clearly downward.

The Court case does not provide any detail as to whether the imposition of the extraordinary fee resulted in any delays in building, but the legal proceedings, which extended over a six-year period, certainly cost the developer and the City a fair amount in terms of resources, time, and legal fees.  Moreover, bringing the houses to market in 2007, when the average market price was over $350,000 — would yield a much different ROI than in 2009.  Assuming that the in-lieu fee would have been tacked onto the price tag means that the cost of an average house would have been increased by an amount equivalent to the amount of a down payment required to purchase the market rate home.  Instead of giving the City the funds, the developer could have contributed the down payment for each of the 214 housing units, and effectively provided “affordable housing” for over a third of the City’s estimated shortfall.  Instead, the imposition of the extraordinary fee only served to generate litigation, not housing.

As so often happens, an otherwise well-intentioned but ill-advised policy decision has resulted in what can only be expected to be a financial disaster for the budget and fiscal stability of another California municipality.  No one faults the City for seeking ways to create more affordable housing, but faulty execution of the policy failed to achieve the goal.  Investors probably lost a considerable amount due to delays, and the City of Patterson is faced with an adverse ruling, rising crime rate, and one-in-four of its houses in foreclosure.  Of course, the imposition of the unjustified housing fee was not the cause of the current recession, but one wonders if a more enlightened approach to solving the affordable housing dilemma might have cushioned the blow.