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Linkage Fees Will Impede Housing Production

2015 June 1
by dan bertolet


At the heart of the debate over Seattle’s proposed linkage fee is the question of whether it undermines its own intent to provide affordable housing by either raising rents or impeding the production of housing. A recent post by Owen Pickford at The Urbanist argues that a linkage fee would have no negative impact on the housing market, and therefore “urbanists must support it.” This post will explain why that position has no merit.

Other than cases of unique developments that have limited substitutes, a linkage fee will result in a reduction in land values rather than increased rents. So what we need to examine is the effect of depressed land values on the production of housing.

The most widely used metric for predicting whether a piece of property can be redeveloped is the ratio of the value of the improvements on the land, to the value of the land itself. The larger the ratio, the less likely a property will redevelop. Right away we can see that because a linkage fee reduces land value but not improvement value, it skews that ratio towards predicting no redevelopment.

To put a finer point on it:  Pickford’s position contradicts the standard methodology used by the City of Seattle, King County and countless other municipalities to estimate “buildable land,” that is, land that can be redeveloped. This alone should be enough to cast serious doubt.

Overall, on my assessment Pickford’s argument that a linkage fee would not impede housing production is flawed for two primary reasons:  It neglects the role of the property seller and existing uses; and it relies on supporting evidence that is highly tenuous, if not irrelevant.

The Role of the Seller and Existing Uses
Housing production in Seattle almost always involves redevelopment of property that has income-generating existing uses on it. The typical owner of a property that is being considered for redevelopment will evaluate an offer from a buyer based on the net present value of the property (i.e. including income from existing uses), compared to what the cash from the sale could earn if it was put into other investments. Add a linkage fee to this equation and the buyer’s cash offer will be lower, tipping the scales towards holding on to the existing income-generating use—that is, not selling. And not selling means no new housing.

A linkage fee’s level of impact on these hold/sell decisions will depend on the value of the existing uses relative to the land. And where it will have the greatest tendency to hinder sales for redevelopment is in areas with lower land values where feasibility is currently marginal, such as the Rainier Valley, Northgate, and the International District—in other words, the very locations where the City most needs new housing to meet its goals for sustainable development.

Furthermore, most larger-scale housing developments require the assembly of parcels with multiple owners. The reduced likelihood of a sale caused by a linkage fee will be compounded by every individual sale that’s necessary—and it only takes one refusal to kill the whole deal. Anyone with experience in development knows that land acquisition and assembly is one of the most challenging steps in the process.

Sellers can be motivated by numerous reasons, but one scenario that’s easy to understand is the owner who wants to sell out and retire: the higher the price, the sooner they can retire. Slap on a million dollar linkage fee, and maybe they’ll wait it out through the next development cycle—perhaps 7 years or more—until market rents rise enough to offset that million dollar hit to their nest egg caused by the linkage fee.

The relationship between land values and redevelopment can be readily observed in neighborhoods all over Seattle where the market has become hot. As localized demand for housing increases and market rents rise, developers can pay more for land. And that’s when you start to see an uptick in property transactions for redevelopment—it’s the reason there are too many cranes to count in Pike/Pine, but none in Rainier Beach.

Given that every development project is unique, and given how the market varies over both geography and time, it’s delusional to believe that the City could set a linkage fee rate in some kind of “sweet spot” that wouldn’t end up sabotaging land transactions for redevelopment. Pickford asserts that a linkage fee could actually increase housing supply by directing more funds to housing production, but the risk is that each typical midrise housing project made infeasible by a linkage fee will mean another couple hundred people competing for existing housing and pushing the poor out of Seattle. And for each project rendered infeasible, it would take roughly 25 feasible projects to create the number of affordable units equivalent to the market units not built due to the linkage fee.

Lastly, for cases in which the developer already owns the land, it is even more clear why a linkage fee would impede redevelopment. The decision to invest in redevelopment will be based on the risk versus the return, and the linkage fee will reduce the return. It’s really that simple. Even property owners with deep pockets can opt to do other things with their money if redevelopment becomes a less attractive investment. They can just wait it out until rents rise enough to offset the loss of returns caused by the linkage fee.

Debunking the Evidence
The first piece of evidence Pickford presents to make the case that the factors I describe above would not impede housing development is historical data showing that the number of homes and condos for sale in Seattle is not influenced by average sales price—that is, people aren’t more inclined to sell their homes when prices are high, and vice-versa. However, most people who are selling homes live in them, and therefore most will be purchasing (or renting) another home in the same housing market with the same price trends. Therefore it makes all the sense in the world that sales price wouldn’t effect sales volume—for homes.

In contrast, sales that lead to high-density housing development are most often commercial properties, and the owners are typically investors who have the option to put proceeds from a property sale into other investments that don’t follow the price trends of the housing market. For example, the hit in property value caused by a linkage fee might mean the seller could only buy 800 shares of stock instead of 1000 with the cash from the sale, such that keeping the property makes more financial sense. The upshot is that data on home sales tell us very little about the property transactions that matter most for housing production, and thus are not credible evidence to support Pickford’s argument.

The second type of supporting evidence provided by Pickford is national studies showing that Inclusionary Zoning (IZ) has had no effect on the production of housing. Most of these studies look at cities in California where IZ is common. But a critical difference between a linkage fee and the IZ programs in California is actually emphasized in one of the papers cited by Pickford:

“It is worth reiterating that the programs we analyzed offer housing developers numerous cost-offsets, in accordance with California’s Density Bonus Law, to help make the inclusionary requirement revenue-neutral.”

If an IZ program is “revenue neutral” it means that it would not cause any reduction of land value, and therefore no impacts on housing production would be expected! In contrast, Seattle’s proposed linkage fee offers zero in the way of cost-offsets. Thus the results of all of the California IZ studies should be presumed to have no relevance to linkage fees.

Another shortcoming of the IZ studies cited by Pickford is their focus on single-family houses. For one thing, Seattle’s proposed linkage fee wouldn’t even apply to single-family, but more importantly, suburban single-family home development tends to involve land transactions that differ significantly from those involved in high density urban infill. In any case, perhaps not surprisingly, the one cited analysis for single-family homes outside of California (suburban Boston, where minor cost-offsets are typical) found “some evidence that IZ has constrained production and increased the prices of single-family houses.”

Pickford also highlights a result in one of the studies that multifamily production increased after IZ was imposed, yet neglects to mention that the reason this happened was that production shifted from single-family to multifamily—a process that could not possibly happen in the case of Seattle. This same study found that single family house prices increased under IZ, which, of course, is the expected effect of a linkage fee if it doesn’t push land values down.

Ironically, evidence that a linkage fee would impede housing production is inadvertently provided by one of the papers cited by Pickford:

“The passage of the 1986 Tax Reform Act is associated with a sharp drop in new housing production. The act ended favorable tax treatment of market-rate rental housing, which effectively subsidized that housing. In almost all jurisdictions surveyed, housing production figures dropped significantly after 1986.”

In terms of the impact on land values, eliminating a tax subsidy for multifamily is effectively the same thing as imposing a linkage fee. So it’s completely reasonable to expect the result of a linkage fee to be the same:  significantly less housing produced.

Lastly, Pickford’s citation of two impact fee studies as evidence is even more tenuous than the IZ studies, because the effects are attributed to other factors, as the authors explain:

“The finding that land values fall, despite the fact that the increase in new home prices exceeds the total value of the fees, can be attributed to developer uncertainty regarding future increases in fees.”

“Our theoretical model shows that impact fees may expand housing construction within suburban areas by reducing exclusionary regulations and increasing the percentage of proposed projects receiving local government approval.”

Housing Supply and the Precautionary Principle
In assessing the potential impact of a linkage fee, it is important to remember that the root cause of Seattle’s housing affordability crunch is that housing production has not kept up with demand. Therefore, any proposed policy such as a linkage fee ought to be highly scrutinized to ensure that it won’t hinder the development of new housing.

Given the well-founded reasons a linkage fee can be expected to impede housing production (see above), the burden of proof falls on those who support the fee to prove that it would do no harm—a.k.a. the precautionary principle. By this measure, Owen Pickford’s attempt is clearly a failure, and reads more like a predetermined answer grasping for straws of evidence. And not only does Pickford’s argument lack evidence, it ignores fundamental human nature: In what universe does the option of getting more cash sooner for an asset not incent an investor to sell, and vice-versa?

It would be great if the linkage fee was a “free lunch” solution to fund affordable housing, but as is always the case in the real world, there is no free lunch. And what’s even worse with a linkage fee is that it’s greatest negative impact on housing production will occur precisely in the locations where redevelopment economics are already marginal—the very places where Seattle needs new housing most. There are better solutions to address affordable housing in Seattle, and that is where urbanists should be focusing their effort.


Dan Bertolet is an urban planner with VIA Architecture, a firm that consults to clients who could be impacted by a linkage fee. This post was originally published at Smart Growth Seattle, and has been edited for clarity and emphasis.