End Inclusionary Zoning

How Janeese Lewis George Can Advance Her Housing Goals

Revitalizing homebuilding in the District of Columbia is Janeese Lewis George’s best idea. And she has some very good ideas for how to make it happen.

The District benefitted for most of the 21st century from a prolonged boom in the construction of apartments and condominiums, mostly in quasi-greenfield areas like NoMa, the Navy Yard, and the Wharf plus infill construction on riot-scarred commercial corridors like 14th Street, U Street, and H Street NE. This has been in some respects a tremendous YIMBY success story — the Economist touted NoMa as “the YIMBYest neighborhood in America” — but it actually took place without much in the way of YIMBY reforms. The land available for these kind of projects is inherently limited, and the District is running low on it. To push growth forward we absolutely need the kind of land use changes that Lewis George championed on the campaign trail.

And yet, zoning reforms alone do not cause new housing to develop out of the ether. The blunt fact is that investor interest in DC projects has collapsed. This is in part a downstream consequence of economic woes from elsewhere, but it’s in part a cause of those woes since new construction and new residents are the lifeblood of the city’s public sector economy.

Addressing the thicket of non-land use regulatory concerns that have made our city an unattractive destination for real estate investors is going to be a challenging problem. George has already committed publicly — albeit non-specifically — to addressing the crisis of non-payment of rent afflicting many of our buildings. Clearly having confidence that you will be able to fill your building with paying customers is the sine qua non of anyone wanting to build in the first place. But not only are there an overlapping series of regulatory burdens on housing operators that need to be untangled, the question of investor confidence is simply difficult objectively. Large buildings are very expensive to build, and the thesis is that the investment will pay off over a long span of time. This necessarily involves not just an estimate of the current outlook, but guesses about the future. The statements and track-record of most of the rising political stars in DC are not friendly on any level to profit-seeking businesspeople, with a result that they are inclined to go seek their profits elsewhere.

A mayor who wants to achieve her stated goals is going to have to address both the substance and the psychology of investor reticence, and one of the best ways to do that would be to move quickly and decisively to roll back — or ideally scrap — the city’s misguided Inclusionary Zoning rules, a set of policies that sound nice but actually ensure that our housing shortage will never be solved no matter what the mayor or the council do on any other topic.

How D.C.’s Inclusionary Zoning Works

Exclusionary zoning is when a city or town takes expensive swathes of land and zones them exclusively for single-family homes built on large lots. You can see mild forms of exclusionary zoning at work in the rowhouse neighborhoods of Capitol Hill, Logan and Dupont Circles, and other in-demand parts of the city. More egregious versions are in place in Wesley Heights, Spring Valley, American University Park, and other tony neighborhoods west of Rock Creek Park. Even more egregious versions are plentiful across the border in the suburbs, perhaps reaching its highest manifestation in the so-called Agriculture Reserve of Montgomery County, in effect an ultra-large-lot zoning rule that requires all homes to be expensive.

If exclusionary zoning is bad, then inclusionary zoning sounds like it should be the opposite.

But this is a sleight of hand. Inclusionary zoning does not mean that apartments and rowhouses are allowed everywhere, it means that apartments and condominiums get hit with extra regulatory burdens. Notably, the presence of aggressively inclusionary zoning policies in the District of Columbia does not mean we lack exclusionary zoning. They are in fact two forms of anti-housing policy imposed in tandem. First, apartments are banned in large swathes of the city thanks to exclusionary policies. Then across most of where they are allowed, their construction is penalized thanks to “inclusionary” policies.

The core baseline IZ rule in DC is that any steel and concrete building with ten units or more must set aside 8-8.33 percent of its floor area for units that are sold or rented at non-market rates to families who meet specific income criteria — either 60 percent of DC-are Median Family Income (adjusted for household size) for rentals or 80 percent for condo projects. In effect, it’s a tax on new market-rate development to create subsidized homes. If you attempt to build with cheaper wood materials, the tax goes up and you need to set aside 10-12.5 percent of your floor area for subsidized units. Starting in 2021, the city created additional IZ+ rules raising the tax up to 20 percent of floor area for projects that required zoning changes to be permitted. Most recently, the city adopted two phases of IZ-XL, expanding the geographic scope of IZ requirements and also applying them to conversions of buildings from non-housing to housing uses rather than just to brand new construction.

Notably, despite IZ-XL office-to-residential conversions in the downtown central business district are still exempt from IZ. Martin Austermuhle recently noted that downtown conversions are the one remaining bright spot for residential investment in the city, and it is probably no coincidence that it is easier to attract investment dollars to projects you are not also burdening with punitive taxes.

There are tons of specific administrative problems with the District’s specific IZ process. Over and above the basic burden of the mandate, actually getting apartments filled with qualified residents in this city involves an unnecessarily slow and cumbersome process. These problems are a kind of double disaster. On the one hand, building an “affordable” unit is useless if nobody actually gets to live in the unit. On the other hand, while no investor particularly wants to build a unit that he is forced to rent out at a loss to a low-income tenant it is much worse to be forced to build a unit that is not rented to anyone at all. Emilia Calma of the DC Policy Center has provided much thoughtful testimony about how to improve administration of this program and steps along these lines would be welcome.

But it is also worth saying that the core problem with IZ is not with the administration of its details. It is a fundamentally bad idea, in principle, that never should have been adopted and certainly should not have been expanded. The intention to help low-income families with their housing costs is laudable, but the IZ mechanism imposes enormous costs on the city’s economy while doing literally nothing to help the most vulnerable. Even with totally optimal administration, IZ ensures the housing shortage will never end and should be scrapped.

IZ guarantees housing scarcity

The thought behind IZ is easy enough to understand. When a city is facing a housing supply shortage, granting permission to build new market-rate units creates a kind of financial windfall. By mandating that some of the floor area be dedicated to subsidized units, you cut into the windfall and also address the folk objection that new luxury housing doesn’t do anything to help the needy.

You can’t take the politics out of politics, but it is worth saying that the folk objection is factually mistaken. Housing scarcity is like a game of musical chairs in which someone inevitably gets displaced because there aren’t enough chairs to go around. Adding new chairs — even if they are high-end chairs that only affluent people can afford — leaves more of the existing stock of chairs for everyone else and reduces the pace of displacement.

But beyond politics, the core problem with IZ is that it both exacerbates scarcity by making it less attractive to build new units, and also relies on scarcity to generate the financial windfall that covers the cost of creating the new units. In a well-functioning housing market there is intense competition between developers and landlords and the price of housing is approximately the cost of construction. In a balanced market like that, IZ would make all new projects financially infeasible. Indeed, because the IZ tax is not small — especially under IZ+ for projects that require zoning changes — it shuts down new construction well before the market achieves balance. This is part of the explanation for how the District could end up in its current dead zone.

A weak economy means rents have fallen enough that investors no longer want to build. But comparing housing costs in DC to those in low-cost markets shows that we are still in a state of housing shortage. Under current policies, if the District’s economy recovers housing costs will soar and displace many families before demand becomes robust enough to re-ignite construction. And that’s the optimistic scenario. The pessimistic scenario is that the current fiscal crisis will push the city into a downward spiral of weaker demand where the construction bust continues and eventually the housing shortage evaporates because nobody wants to live here.

A much better idea is to suspend, roll back, curtail, and repeal IZ policies as quickly as possible to try to restart the construction market. IZ rollback will complement the upzonings George has promised and serve as a credible commitment that the administration understands the value of market-rate housing.

It is true, of course, that without IZ fewer “affordable” units will be built. But building more overall units will accomplish more for citywide affordability. It’s also worth saying that while the 60 percent of MFI threshold is a significant discount, these programs do not help the truly poor. MFI is analyzed on the basis of the entire DC metro area, which is very wealthy, so 60 percent equates to $68,850 for a single person or $88,500 for single mother of two. We’re talking about a program that raises average rents citywide and reduces construction activity without doing anything at all to help our neediest residents. A far better way to help those in need is to simply have a strong economy and use general tax revenue to meet social needs.

The fiscal cost of a shadow tax

Last but by no means least, it’s worth evaluating IZ in the context of the District’s current budget crisis.

There are two ways to plug a budget hole, cut spending or raise taxes. Nobody on the Council seems particularly interested in either of those options which is why, as Stan Veuger observed, there is currently so much focus on the idea of creating exotic new taxes rather than raising existing rates. I’ve been referring to IZ as a kind of targeted tax on new construction. But it’s a shadow tax that does not raise any actual revenue, and in fact significantly reduces tax revenue. The District, for starters, levies property taxes on residential real estate so any regulation that impairs construction tends to depress revenue. But new market-rate units are also important because they bring new market rate residents to the city.

In particular, while during a boom time it’s easy to disparage “yuppie fishtank” projects — large buildings full of mostly one bedroom units targeting affluent young professionals as residents — as not meeting our highest aspirations for the city, these kind of residents are major fiscal assets. The District levies a marginal tax rate of 8.5 percent — higher than the top bracket in Maryland or Virginia or 40 other states — on income between $60,000 and $250,000. Singles in that bracket consume few city services and contribute a lot of revenue, over and above being prime customers for the city’s food service and entertainment industries. Over the past 20 years, even as the fundamentals of the YIMBY analysis of housing regulation have become more and more mainstream, local policy has become more and more hostile to these kind of developments. Our first IZ statute was adopted in 2006, it was fully implemented in 2009, the AMI rules became more stringent in 2017, and then we added the IZ+ and IZ-XL rules in subsequent years.

None of this — but especially not the considerable Bowser-era tightening of IZ regulations — was consistent with the city’s stated housing production goals. A new mayor with appropriately higher aspirations for housing production and a wholly correct determination to roll back exclusionary zoning should pair that with an attack on exclusionary zoning’s phony opposite.