Each jurisdiction must determine how to set their fee level. There are several common approaches, but no single “right” formula. A key factor that shapes the decision about which formula to use is whether a jurisdiction wants to encourage on-site performance or collect the revenue to leverage other sources of funding to build affordable units off site.
All other things being equal, the higher the fee, the higher the chance that developers will choose to build units on site. A number of communities have made the mistake of setting in-lieu fees far below the cost of on-site performance, and this practice has resulted in poor overall performance of the affordable housing program.
Affordability Gap Method
The in-lieu fee is based on the typical difference in price (or rent) between market rate and affordable units. For example if a typical market rate home sold for $300,000 and the affordable price was $200,000 the fee would be $100,000.
Production Costs Method
The in-lieu fee is based on the average amount that the public has historically invested to actually produce each additional off-site affordable unit. For example if it generally cost $250,000 to build a new unit and qualified low income buyers could generally afford $200,000, then the fee would be $50,000.
Pasadena calculates fees by subtracting the affordable Below Market-Rate (BMR) price of a for-sale unit from the typical market price of a comparable unit. For rental units the math is slightly more complex; they calculate the difference in the ‘capitalized value’ of a market-rate unit and an affordable unit.* This “affordability gap’ approach should have roughly the same economic impact on the average project as building the affordable units.
San Francisco, California
San Francisco contracted with Seifel and Associates to complete an economic feasibility study for their inclusionary housing program in 2012.* Among other things, this study evaluated the average cost to construct new housing units in several different project prototype configurations.
The consultant calculated an average construction cost per square foot and used that to estimate the average cost to construct units of each bedroom size. The city revised their ordinance and established their fee based on the difference between this cost and the affordable price that would be allowed for each unit size. The ordinance calls for this fee to be adjusted annually based on the Construction Cost Index (CCI) for San Francisco.
Most commonly, cities determine the in-lieu fee levels based on a consultant report that estimates for the market prices and rents for the kinds of units that are typically being produced by local developers. The City then sets a single fee that applies to all projects citywide for a year or some other defined period of time.
A few cities use actual sales prices or rents for market units to calculate fees, though this creates a number of very significant administrative challenges.
Boston implements a fixed fee for rentals and a scaled fee-in-lieu for homeownership.
- In 2015, Boston adopted a map identifying three different zones based on average housing cost and they set different fee levels for rental projects in each zone. The in-lieu fee is $200,000 per affordable unit in the lowest cost zones, $300,000 in the middle cost zones and $380,000 in the high cost zones. The idea is that it costs developers more to provide onsite units in the higher cost zones so they charge a higher in-lieu fee in those areas in order to make the cost of the two alternatives more comparable.
- For homeownership projects, however, Boston’s in-lieu fee is the greater of the base rental fee for that zone or 50 percent of the difference between the price of the average market-rate unit and the price of an on-site affordable unit.
The scaled fee is administratively burdensome and it creates uncertainty for developers. The developer must estimate the fee upon building permit application and pay 50 percent of the fee at that time. The city collects the rest of the fee after sale and prior to occupancy, at which time the sale price must be verified, compared to the developer’s estimate and any difference must be compensated for and appropriately paid.
However, Boston has large variations in home prices. In some areas homes top $1 million on average and fall below $500,000 in others. The additional revenue the city receives from the scaled fee may make the additional administration worth the effort.
One point that sometimes causes confusion is that some cities calculate the fee per market-rate unit and some per affordable unit. For example, a city could require developers to pay an in-lieu fee of $200,000 for every affordable unit they would have been required to build. Another city could require developers to pay $20,000 per market-rate unit in their development.
It is important for cities to be aware of market conditions when they set their inclusionary housing requirements, both for the entire city and for various neighborhoods.
Most cities do not adjust their inclusionary requirements at a neighborhood level. For cities without wide variations in neighborhood market conditions, this may be appropriate because incentives and inclusionary requirements automatically compensate for differences in market conditions. For example, it may be more expensive to build in high-cost neighborhood, but a density bonus is worth more in neighborhoods where home prices or rents are higher.
Some cities, however, have responded to concern about the impact of inclusionary requirements in certain sensitive neighborhoods by varying their requirements or incentives by neighborhood. This is called geographic tiering.
Rather than vary the requirements by neighborhood, some cities vary their requirements based on construction type. These are generally places where local market conditions make higher-density construction economically marginal enough that affordable housing requirements can become a barrier to development.
The decision to vary affordable housing requirements by neighborhood or construction type should typically be made based on the findings of an economic feasibility study. In general, a city may want to pursue these varying requirements if the feasibility study showed that citywide supportable requirements would have an adverse impact on the feasibility of otherwise desirable development in certain areas.
When considering in-lieu fees, it is important to decide if a city wants to always allow developers the option to pay the fee or restrict its use to some developers. Some cities allow an in-lieu fee by right, while others require developers to demonstrate either some net benefit to the city, or a substantial hardship.
Generally, whatever method cities use to arrive at a fee level, they should apply that single fee level to all projects of the same type. Many cities will have different fee levels for rental and ownership projects. Some cities adjust their in-lieu fees based on the size of the development. These cities typically offer a lower fee for smaller projects. Cities often do this because they want to simplify the management of their program by discouraging a pattern where market rate buildings have only one or two affordable units. Also, the economics of smaller developments may be more marginal and a lower in-lieu fee could help make them feasible.