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Following the release of The Economics Inclusionary Development, a report issued by the Urban Land Institute’s Terwilliger Center for Housing, ULI Toronto hosted an exclusive Members Only event focused on the report’s findings. Hosted by Stikeman Elliott, the sold out lunch and learn focused on a study contained in the report that examined the use of inclusionary zoning (“IZ”) in the United States as an affordable housing tool. The discussion sought to contextualize the proposed introduction of IZ in Ontario to address housing affordability issues.

The proposed Promoting Affordable Housing Act, 2016, was introduced on May 18, 2016, in Ontario. If passed, the proposed inclusionary zoning would aim to help municipalities increase the supply of affordable housing units and achieve housing and homelessness objectives.

IZ is a policy tool in which new developments include a portion of units at an affordable level or below market pricing levels. IZ can be a mandatory or voluntary policy and can apply to ownership or rental properties. It can also be provided on- or off-site or with a fee-in-lieu.

The discussion was led by Michael Wilkerson, Ph.D., one of the authors of the study. Wilkerson is a senior economist with ECONorthwest and has more than 10 years of economic consulting experience.

Laying a foundation, Wilkerson introduced value capture as a basis for understanding the economics of development feasibility. Value capture is the recovery of the value that public infrastructure generates for private landowners and can thereby create some public benefit by means of developing positive externalities for public investments. For example, the development of new transit infrastructure could potentially impact property value premiums near the new public infrastructure. Wilkerson remarked that all of the precursors are here in Toronto which allow for private development.

The term “affordable housing” can have varying definitions depending who’s using it, but for the purposes of the study, Wilkerson defined “affordable housing” as following the Department of Housing and Urban Development (“HUD”) guidance in the U.S. where 30% or less of gross income is spent on housing, including utilities. Unfortunately, there are no formal metrics in Canada. The affordable housing metrics are tied to a percentage of area median income (“AMI”), which is a different measure than family income and based on a household size of 4. For example, affordable housing could represent 90% of AMI for a  two-bedroom unit or 75% of AMI for a one-bedroom. One of the challenges of determining affordability is that the HUD guidance only considers fixed costs, like mortgage or rent payments, and excludes variable costs, like transportation.

To contextualize housing affordability issues in Toronto, Wilkerson presented a graph of US housing market appreciation from June 2015 to June 2016 and asked, “Can we increase incomes without increasing housing values?” Portland is ranked at number one in the U.S. with 12.60% 12-month appreciation. Seattle is trailing in second place. Toronto surpasses Portland at 13.25% 12-month appreciation. While the data sources are not the same for the U.S. and Canada, the imbalance is still effectively illustrated, demonstrating that income levels are not increasing at the same pace as the housing market.

IZ policy design is highly dependent on the relevant market to determine which inputs and attributes require more flexibility. “There is no such thing as ‘best practice’ – the market that you’re in matters drastically,” Wilkerson said. The following outlines some of the flexibilities in IZ policy design:

• Mandatory or voluntary IZ
• Higher or lower number of units set-aside ranging from 5% to 30%
• Income targets ranging from 0% to 120%
• Rent restriction terms ranging from 10 years to permanent
• Coverage from jurisdiction-wide to spatial calibration ranging from city to neighbourhood
• All housing types or specific housing types
• Opt outs, in lieu or off-site policies
• Public sector funding in incentives

Wilkerson disclosed that the study was focused more on rental accommodation given the dramatic increase of apartment development in certain markets. Portland, as an example, saw approximately 18,000 units enter the market in comparison to 150 units for condo ownership. On the other hand, he recommended the importance of looking at ownership accommodation in Toronto given the prevalence of condo ownership in the city. The IZ policy design is more complex for ownership units.

Next, Wilkerson discussed how the market generally builds high-end housing. Through a process known as filtering, the housing market moves from luxury housing (120% of AMI) to workforce housing (100% of AMI) to moderate income housing (80% of AMI). Filtering is a process by which affordable housing units can be provided in private developments as the movement of housing from higher household income units deteriorates and becomes less expensive for lower-income households. Based on the U.S. National Estimate, the filtering rate for rental accommodation is 2.5% annually while the rate for ownership is 0.5% annually. To understand how filtering would apply to Ontario, AMI data, which is not easily available in Canada, is required. Wilkerson suggested that in his experience in other markets, the average premium of new construction rent to the market average was 15% to 40%.

In order to understand the economics of development, Wilkerson introduced four fundamental pillars: land, public policy, market feasibility, and capital. With the presence of these four fundamental pillars, the development can occur. The developer’s perspective looks at the land value based on the concept of Highest and Best Use and assesses it based on a residual land value to determine the range of development feasibility. According to the Appraisal Institute of Canada, Highest and Best Use is defined as “the reasonably probable and legal use of property, that is physically possible, appropriately supported, and financially feasible, and that results in the highest value”.

A key highlight from the results of the study that Wilkerson discussed is that it is essential to understand the difference between the market rent and affordable rent, as it varies within regions. Secondly, without properly calibrating incentives, this will ultimately alter the feasibility outcome of the project. For example, the development feasibility is highly sensitive to the set-aside requirements of the IZ policy. Wilkerson states that an ongoing concern and debate about inclusionary zoning relates to the potential escalation of costs from building new IZ housing, which therefore could restrict supply and further impact affordability issues.

In summary, the reassessment of incentives is required to build policies that are flexible with the changing marketplace. The key debate lies between aligning interests of the developers and the municipalities – developers want more specificity whereas municipalities want more flexibility.

IZ is only one of several incentivized policy tools to accommodate affordable housing issues in Ontario. Wilkerson closed the discussion by stating that IZ is not intended to be the sole solution for affordable housing issues, but is anticipated to offer and encourage incentives to generate development of new affordable housing units that would otherwise not be built.

Ministry of Municipal Affairs and Housing’s Inclusionary Zoning Consultation Discussion Guide

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