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The Mixed Messages and Misplaced Burden of Taxes on New Development

2013 October 31
by dan bertolet

Note: This post is part of an informal series that addresses the interplay between development, regulations, housing supply, and affordability. See the rest here.

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In a previous post I probed the dark depths of Seattle’s Land Use code to critique the convoluted, but lawyer-approved logic that is officially put forth to make the case that additional development capacity causes adverse impacts that must be mitigated by developer fees. But most people who support exacting developer fees to pay for public benefits have a rationale that’s less arcane, though trickier to unpack.

The basic idea is that when a city changes regulations or makes public investments that increase the value of development, then the public has a right to capture some of that value to use for much-needed public benefits such as affordable housing. It all sounds quite reasonable on the surface, but unfortunately, upon closer examination it becomes hard to ignore that this approach is likely to be self-defeating.

The most common instance is when a city changes zoning to allow more development capacity, which lets a developer build a larger building and presumably make more money. That value is a viewed as a public gift to the developer, which justifies the public taking some of it back in the form of a special fee.

One hole in the above rationale is that an upzone doesn’t really create any value at all—it merely removes regulations that were preventing value from being realized. The actual source of the value is demand for new buildings from people who want to better their lives by living and working in a great city. Furthermore, existing zoning was not written in the sky—it’s a more or less arbitrary restriction that destroyed potential value when it was enacted.

But the fundamental flaw in the rationale for charging a fee for additional development is that the reason upzones are done is not to benefit developers, but to enable outcomes that benefit everyone—at the local, regional, and even global scales.

The debate is over: Absorbing growth in urban centers is the first and foremost strategy for sustainable development in growing places such as the Puget Sound region. That’s why cities upzone.

But when we put a toll on the additional capacity granted by an upzone it totally contradicts the original intent. The reality is that such encumbrances can be expected to either drive up rents or, if the fees are high enough, cause developers to opt against building additional capacity. And every new housing unit that is not built in a dense, transit-rich urban center means one more housing unit that is likely to end up in a less sustainable place. And every potential housing unit that is not built in a high-demand market such as Seattle means housing supply becomes more restricted and prices rise faster, hurting everyone, especially the poor.

Likewise, public investments in roads, light rail, or parks benefit everyone, not just developers who have projects nearby. In fact, one could argue that businesses gain a lot more than developers do from mega road projects such as Seattle’s deep bore tunnel, since transportation improvements are all about providing better access to jobs for commuters. Of course all businesses—including development firms—already help pay for public investments through existing taxes. And the higher property value and new jobs that result from development projects generate even more revenue from those existing taxes, property tax in particular. Indeed, for any given piece of land, the greater the development capacity, the greater the potential tax revenue. Here again, developer fees discourage maximizing the public benefit from a given piece of land.

Seattle’s expanding light rail system will boost the value of surrounding property, but that doesn’t mean it should be a target for extraction. It’s actually a good thing if increased value makes development more attractive, because those areas are exactly where we want development to happen. Light rail investments remain vastly underutilized until there’s lots of housing and jobs built up around the stations. But at the future light rail station in Seattle’s Capitol Hill neighborhood, for example, the City has encumbered the adjacent properties with a heavy list of public benefits—including affordable housing—that will be required as a condition of additional development capacity. Time will tell how realistic those expectations are. (As an aside, a similar scenario of inflated expectations is currently playing out in Yesler Terrace, but that’s a long story.)

For some perspective on what Seattle’s current regulations require from private developers to subsidize affordable housing, the developers of a recently proposed downtown hotel/convention center project would have to write a check for $12.4 million to be allowed to build their desired additional capacity. For comparison, that $12.4 million burden on a single development project is equivalent to almost 10 percent of Seattle’s total seven-year Housing Levy. The burden of the Housing Levy—shared between all of the hundreds of thousands of property owners across the entire City of Seattle and spread over seven years—looks pretty puny in comparison.

All property owners in Seattle are seeing huge personal gains in terms of property value appreciation that is being driven by the success and desirability of Seattle. At the same time, that appreciation is the cause of Seattle’s housing affordability challenges. And that’s why the Housing Levy is a defensible source of affordable housing subsidy that ought to be expanded—it spreads the burden fairly among all those who are basically hanging around and benefiting from Seattle’s success just because they got in first. In contrast, taxing new development unfairly dumps the burden on a very small subset of newcomers who are actually part of the sustainability and affordability solution.

But guess what? Right now, the Seattle City Council is in the process of raising Seattle’s downtown developer fees even higher, just like they recently did as part of the South Lake Union rezone. Neither the Council nor the Mayor’s office seem to be interested in thinking about whether or not taxing new development is a sound policy, or if it could do more harm than good. The only debate is over how much more they can squeeze out of developers.

All in all, it’s pretty simple: A sustainable future hinges on accommodating as many people and jobs as possible in urban centers, and we have no choice but to rely on private developers to build what that requires. That means it’s just really not very smart to treat developers as adversaries. Yet the message Seattle’s policy makers are sending to developers is this: Please build our city so that we can meet our goals for sustainable growth, but we will behave as though your developments are adverse impacts that need to be mitigated, and while you take on all the financial risk, we will impose fees that determine how much profit you can make.

The message ought to be: How can we work with you so that everyone wins? And for one example of that approach look no further than Tacoma, where the lack of development gives quite a different perspective on developers, and where the City is pursuing downtown Subarea Plans that will provide State Environmental Policy Act (SEPA) pre-approval for all development projects. They also removed all off-street parking requirements in their downtown, and created a development authority for the Foss Waterway. In other words, Tacoma is being as proactive as possible to make it easier for developers. And that’s what it’s going to take if Seattle doesn’t want to wait a lifetime for significant development to happen in key locations such as the southeast Seattle LINK light rail station areas, for example, where the real estate market is marginal.

Will making it easier for developers increase developer profit? Yes. But if the increased potential for profit leads to more development projects moving forward, leads to more buildings going up in urban centers where they belong, leads to less underdevelopment of invaluable urban sites, leads to increased housing supply and the resultant downward pressure on housing prices, leads to greater tax revenue that can be used for public benefit such as affordable housing or other social services, leads to more efficient transit and reduced greenhouse gas emissions from cars, leads to a reduction in sprawl swallowing up farms and forests, well, maybe they deserve it?

 

 

27 Responses leave one →
  1. Chris permalink
    November 1, 2013

    I think this post conflates land owners and developers. Some one who buys land under restrictive zoning and then have the zoning rules lifted enjoys a windfall profit whether or not the initial zoning was appropriate. Capturing some of those profits in land RENTS (I’m thinking along the lines of Henry George) is exactly the way finance government. Though not ideal, “selling” the right to build higher is one way to capture that value, and it is at least possible, depending on how one tiers the pricing and additional development rights to extract some of the wealth created by relaxing zoning codes without having much effect on the decision or density of construction. Now it’s possible that Seattle is bungling this, I don’t know these markets well enough, but it doesn’t strike me as crazy. Your analogy to light rail is I think telling, in Hong Kong for example, one way that they finance the subway is by seizing a large tract of land around future stations and then developing or leasing it back after they build the new line. The Seattle Monorail tried to do this to some degree if you recall.

    • dan bertolet permalink*
      November 7, 2013

      Chris, the problem is that in practice, there isn’t such a clean connection between the land price and the encumbrance of the developer fees. If it worked as well as you describe, then we wouldn’t have developers in SLU leaving the bonus capacity on the table, as is happening right now.

      The light rail station scenario depends a lot on the strength of the real estate market. In Hong Kong they’re probably building 8oo foot towers on those sites. At the Capitol Hill light rail station, there are what I believe to be inflated expectations for public benefits in exchange for just a floor or two of capacity.

      • Josh Mahar permalink
        November 7, 2013

        Completely agree with Chris here. I think our fundamental disagreement is that I ((and I assume Chris) don’t believe that developer profits change at all, regardless of zoning capacity. The “extraction” of profits is from the LAND OWNER, who, if the system is set up correctly, will still make a healthy profit, the profit they anticipated when the purchased the property in the first place, they just won’t get the windfall profits from changing regulation.

        Let’s use your example of light rail planning:

        Ok, so Sound Transit owns a bunch of properties around their new light rail station. When they sell those properties, they are legally obligated, due to federal requirements, to sell at “fair market value”. That means if they sold today, the price to developers would be calculated using the potential profit under current zoning regulations, 6 stories. Now, let’s say, like Hong Kong, zoning was set at 800 ft. Well Sound Transit would then have to sell at a massively higher rate because the potential profit is so much higher. Thus, regardless, any additional value isn’t absorbed by the developer, it is absorbed by the land owner.

        In the actual situation, developers have the opportunity to build to 8 stories if they also add public benefit. So a developer will pay less for this property than they would for a no-restrictions 8-story zoned property because they have to account for the public benefits that will cost them money. The loser here is Sound Transit, not the developer.

        It also shouldn’t affect rents because that price is set by the market. When a developer bids on some land they are doing it based on the maximum price they can extract out of rents, but with the downward push from the other side because they want to set rents as low as possible in order to underprice competitors and attract tenants.

        Now, this doesn’t mean that developers are neutral on height. They still make more money on bigger buildings. This is because the risks are much higher. Taller means more technical challenges, it means bigger loans, it means more units to push. So, just like in any other business, a riskier venture means more potential return. But it shouldn’t affect their decision to do the project because there are profits to be made either way. You can make more on a big office building downtown, but that doesn’t stop plenty of developers from doing townhouse projects out in the neighborhoods.

        If developers in SLU are opting not to take advantage of the additional height bonus, it isn’t because the concept is bad. It because the system must be set up to take more than just the windfall profits, so it becomes less lucrative to build taller than it does to build shorter. This is absolutely counter productive if the goal of the legislation was to create more development capacity. Essentially its just a zoning limit but couched in a way that makes it seem like a choice. It’s kind of similar to the Obamacare rule that you don’t legally have to have health insurance, you just pay a penalty large enough that no rational person wouldn’t (just to be clear, in that case, I’m all for it).

        So to wrap it up (finally!) I would just say that really I hear you arguing against the way this bonus system was implemented in SLU (rightly so) and for additional height in general (also fine.) Regardless, done right, a density bonus system shouldn’t have any real effect on the development market.

        • dan bertolet permalink*
          November 7, 2013

          Josh, I do think part of the problem is that most regulators don’t understand the development process well enough, and so tend to overvalue the additional capacity, and also undervalue the cost of producing affordable units. That bias is also driven by politics and a culture that demonizes developers.

          Also, my sense is that it is very difficult to set up a system that works as cleanly as you describe in practice. Why do developers dislike the fees so much if it makes no difference to their business? This is something I plan to dig deeper on.

          Regarding Capitol Hill, like I wrote, time will tell how realistic the equation is in that developer agreement that was written without a developer. Hopefully the RFP will allow for a lot of flexibility and input from developers.

  2. November 1, 2013

    Chris, you’re making my argument for rolling back and eventually ELIMINATING zoning. Regulation leads to windfalls, gray and black markets. What takes time to understand is that by deregulating land use in cities we can truly capture value for the public in the form of lower prices, innovation, and effective use of limited resources. Mark Twain said ‘buy land, they’re not making more of it.’ We can, in effect, make more land when we build more floors. It’s called density. And when we fret over profits when people innovate and try to regulate and attenuate that innovation we discourage it; that just drives up prices because housing gets scarce.

    Let’s worry less about windfalls and more about the broad benefits to everyone of unleashing innovative uses of land that generate jobs, housing, and more opportunity.

  3. November 1, 2013

    One other point about the business model implied here; buying land speculatively, holding it, then engineering zoning changes and entitlements that increase the value of the land, then laughing all the way to the bank.

    This might seem realistic at first, but it’s the real estate equivalent of buying in web addresses in the hopes someone will come along and buy them for millions of dollars, or cornering the beanie baby supply. It’s just not going to be viable unless an individual has the cash to spend and can have it tied up for years.

    It is true that land costs are recovered in rents as all costs are. The suggestion that we ought to finance government operations based on taxing land transfers is medieval and it would add even MORE costs to rents. Think about it. Tax the land at point of sale after the fabled, engineered rezone and who pays that tax? The buyer. How does the buyer get that cost back? HIGHER RENTS!

    Sorry for the caps, but all costs including any and all taxes end up being paid by the renter. Always. The idea of capturing windfalls can’t happen. It’s a punitive way of generating revenue.

    We need to do the opposite by reducing costs. When we do that it results in competitive pricing where we want and need it the most.

    • Chris permalink
      November 7, 2013

      So I think the business model you describe above is the CURRENT MODEL. People have bought up a bunch of land in areas that may be redeveloped and are sitting on it, letting the structures depreciate and maybe using cleared lots for parking and in some cases giving lots of money to local politicians to get it re-zoned. Now, in our shared utopia this zoning would never had occurred, but its there now. I say effectively re-zone and tax away the gains with density bonuses. You’re the one advocating that we reward the speculators deserve a windfall.

    • Chris permalink
      November 7, 2013

      “It is true that land costs are recovered in rents as all costs are. The suggestion that we ought to finance government operations based on taxing land transfers is medieval and it would add even MORE costs to rents. Think about it. Tax the land at point of sale after the fabled, engineered rezone and who pays that tax? The buyer. How does the buyer get that cost back? HIGHER RENTS!”

      I see now the point of confusion. The statement above is exactly wrong. The market value of the land is the present value of the future rent net the conversion cost. from the perspective of a given project, the rent is exogenous. That’s Josh’s point. The buyer (developer) is competing with a lot of other developers to convert land to housing and tends to earn a nominal return no matter the zoning. Raise the cost of the conversion and he’s just willing to pay less for the land. Raise cost too high and the project just won’t happen. The owner will keep it in its current use. But there is, in many cases, room to marry the relaxed zoning which increases the value of the land with an implicit tax like a public benefit provision that lowers its value and you can get the development and the public benefit without the economic distortion that arises from a conventional property tax.

  4. Ben Broesamle permalink
    November 7, 2013

    Dan,

    I never completely disagree with you. But as the project you’re talking about is a project that provides no “affordable” housing, or take an alternative theoretical example of an office tower that provides no “affordable” housing are both ok to tax for “affordable” housing. If you were arguing that Via6 shouldn’t have been taxed for the housing fund (I don’t know that it was or not), that is perhaps a valid argument–Via6 doesn’t provide “affordable” housing by any means, but it does at least add housing supply that reduces pressures on sub-sub-markets elsewhere. If we’re talking about low paying jobs at a hotel, convention center, or even retail centers and not talking about a housing project, I think it may be valid to tax those for “affordable” housing funds. Because that’s who is working at those projects.

    Hope that hotel/convention center developer is paying you for these words though, someone ought to. :)

    Cheers buddy,
    Ben

  5. dan bertolet permalink*
    November 7, 2013

    Ben:

    First: No one is paying me for anything on Citytank.

    Are you saying that anyone who runs a business that provides jobs should be required to help pay for housing for the people in those jobs if they can’t afford to live within some certain distance of the jobs? If yes, then shouldn’t that include every business that has low paying jobs downtown, e.g. existing restaurants, retail, etc? Why single out new development?

    If we put an additional tax on new projects in downtown like that convention center, it makes it more likely for development to end up somewhere less urban and less sustainable.

    • Ben Broesamle permalink
      November 7, 2013

      First: easy there, I was totally kidding.

      And yes, you’re correct, but what’s your mechanism then for providing housing to those workers whose jobs are in the hotel in Seattle? Your plan builds convention job centers and not housing. We need “affordable” housing here. Jobs too. How do we get both “affordable” housing and jobs? What are you going to substitute to do both? Nothing? Ok, then your plan fails because “affordable” housing is then in the burbs and the jobs are here. Commute trips go up and the climate is just as screwed.

    • Ben Broesamle permalink
      November 7, 2013

      I realized that I forgot to respond to your new development argument. I don’t disagree with the broader point you’re intimating, but the answer to why new development is: that is the pragmatic way to do it. There is enough developer hate (I am a future developer, so I can say that and call everyone else out: we’re hated by these small-town folk) that we can get the general public to agree that a good place to tax for benefits to the working class is at the point of development. How many people would vote to raise property taxes? See publicly financed council campaigns: few. Sales tax? Perhaps a few more, but not enough. How do you propose we fund “affordable” housing without the tax? Sure as heck ain’t profitable by itself. No one is getting a 10% IRR on it. What’s your plan? Be Tacoma? I agree with everything you’re saying, for the record: I’ve said so many times, but there’s a valid argument about putting working people near jobs that you’ve jettisoned a response to completely in this *particular* post.

    • dan bertolet permalink*
      November 7, 2013

      Ben, politics or not, you will need another solution even if incentive zoning is in place. In the best case, incentive zoning will only cover a small fraction of the need for affordable housing subsidy, because there’s a limit to how high the fee can be raised before it really will shut off development, and at a feasible fee level, there just isn’t enough upzonable capacity out there. And that’s another problem with incentive zoning: it’s a distraction from the reality that we need to find better sources of subsidy, as I’ve written over and over in my posts on this topic. How about we all use our big brains to figure that one out?

      Also, don’t forget that putting jobs in a transit rich place allows people to lose the expense of a car, i.e. jobs in downtown are intrinsically helping with housing affordability.

      • Ben Broesamle permalink
        November 8, 2013

        “How about we all use our big brains to figure that one out?” Absolutely. I’ll start with my big brain, you can finish the thoughts with yours:

        I see some plausible steps (in no real order):

        1) Increase density wholesale (good luck). That’s really what we’re talking about with these arguments against development fees, incentive-zoning and other supply restrictions. We’re all basically agreed that we just need to get everything to at least 74’11” (fire code changes at either 75′ or 85′, I think, so 1″ shorter than that).
        2) Have a carrot and stick with neighborhoods throughout the region–including Seattle– for transit investment: they only get transit investment if they take increased density from 0 walking miles up to 1/2 walking miles from station entrances, otherwise skip them for now.
        3) Realize that upzones in the…for example, Rainier Valley…don’t create a market so require things like parking lots near transit to be built so that they can be retrofitted into office/retail/something else later. (hopefully)
        4) Realize that 4 stories of stick is ok (read: cheap), as long as the FAR is high enough.
        5) Continue to support affordable housing near the jobs we have & transit investments we already have made by whatever means available. (few: mostly taxes on development at the moment) But continue to work to remove development taxes on *housing supply* as much as possible.
        6) More housing=more consumer demand=more retail/jobs. So if we focus getting the housing right in our current job centers we have a shot at getting everything right.

      • paulh permalink
        November 12, 2013

        If you’ve actually indicated a pipeline for creating an ongoing stream of affordable units in any of your posts, I’ve missed it. Simply deregulating/dezoning is not a solution. Developers are not building housing that is affordable. Requiring no input through guaranteed units or cash outlay is not going to help the situation. Redmond requires 10% of units be affordable at 80%AMI, developers are still building over there — are we not better than that?

        • dan bertolet permalink*
          November 12, 2013

          paulh: My point is that incentive zoning is a broken solution. It may result in a relatively small number of “affordable” units produced, but the side effects will end up making the system-wide affordability crunch even worse. If you think I am wrong about that, I would be very interested to hear your explanation.

          Regarding Redmond, I could be wrong but it looks to me like in downtown there is no affordable unit requirement for the first 250 units in a project, and then it goes to 10 percent of units at 90% AMI for the next 250. If I’ve got that wrong, perhaps you could explain how it works, because it’s not very clear in the code.

          http://www.codepublishing.com/wa/redmond/cdg/rcdg20d/RCDG20D3010.html

  6. Chris permalink
    November 7, 2013

    I’m with Dan on this one. It’s very hard to build new affordable housing. What you usually get is something very valuable that then has to be sold/rented below market value with some kind of rationing scheme: lottery, first to apply, married to some kind of income test. So you get a handful of winners and a bunch of loser. But, housing filters! Building new luxury housing frees existing luxury housing for the middle class, which frees existing middle class housing for low income people. Now, I’d rather give some the re-zoning windfall to some random low income person, but my preference is that it be used to finance public goods.

    • Ben Broesamle permalink
      November 7, 2013

      So don’t build <65% affordable housing at all, ever? I have no intention of ever building one affordable unit, personally–it's definitely a pain the butt to do and there's no private market investment for it. But do we seriously not want zero new <65% median income units in Seattle. If you do want more <65% units, how do you want to pay for them? If you don't, I'm impressed with how corrupted by the free market we've become are.

      • Chris permalink
        November 8, 2013

        Ben,
        Most low-income people today do not live in housing that was originally intended as low income. They live in housing that was once middle or upper. There’s still plenty of old, out of fashion housing that could be cheaper, but isn’t because we’ve restrained the supply of new market rate housing. I personally love 2-4 story garden apartments, I own one. But if we allowed more new towers to go up, with pools and gyms and floor to ceiling windows, etc, the rent for those old units would fall, and more <65% households could find places to live. Probably, more households on net than if we force developers to set a few units aside for every project.

        • Ben Broesamle permalink
          November 8, 2013

          My response is simple: I completely agree with the macro issues and that incentive zoning is bad and even that fees/taxes on supply increases are bad, but I don’t see a political mechanism to remove the fees put towards “affordable” housing until AFTER we increase central core housing supply *dramatically*. The burbs aren’t really transit rich even if Seattle’s core is. There is a lack of access to neighborhood services in the burbs for people living car-free. There is not yet any mechanism that allows people to live affordably in the burbs that doesn’t involve having a car, even if housing is far cheaper. That’s the issue I see: chicken and egg scenario.

  7. Dick Burkhart permalink
    November 7, 2013

    Bertolet’s article misses a key point that is hinted at by the “affordable housing” issue. Namely, the extreme under taxation of high incomes wealth in our society, with the consequent extreme economic inequality. This means that our needs for affordable housing and other public services far outstrip tax revenues, so governments try to find other ways to augment tax revenue in response to an increasingly desperate public (just think about the popularity of the $15 minimum wage).

  8. dan bertolet permalink*
    November 7, 2013

    Dick: I totally agree, and this is how a put it about a year ago:

    http://citytank.org/2012/10/15/the-zen-of-affordable-housing/

    “Income inequality is the core reason why housing affordability is such an intractable problem in the United States. In pretty much every other industrialized nation on earth, greater redistribution of wealth helps ease the problem of affordable housing. This includes social investments that significantly reduce other major household expenses, such as healthcare, education, childcare, and transportation, thereby freeing up more income to pay for housing. Here in the U.S, we will be beating our heads against the wall forever trying to provide enough affordable housing to make up for this underlying inequity.”

    And because we’re so desperate for funding sources, we end up clinging to dubious schemes like incentive zoning.

    • paulh permalink
      November 12, 2013

      Right, so when the CEO earning to employee wage ratio gets back to 10:1, we can strip out incentive zoning. In the mean time, we have a housing problem that is not solving itself in the market.

Trackbacks and Pingbacks

  1. Getting Real About The Costs And Benefits Of Affordable Housing | citytank
  2. Workforce Housing in Seattle: Myth vs. Reality | citytank
  3. Council Study Reveals The Inherent Futility Of Incentive Zoning | citytank

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