Many Developers Maintain That the Costs Associated with Inclusionary Housing Requirements Can Determine the Economic Feasibility of a Project 

HIGHLIGHTS:

  • The California Supreme Court unanimously rejected the California Building Industry Association’s (CBIA) challenge to the City of San Jose’s ownership inclusionary housing ordinance in California Building Industry Association v. City of San Jose.
  • This decision paves the way for the adoption, implementation and enforcement of similar inclusionary housing ordinances throughout the state.
  • Cities that have held off on enforcing their ownership inclusionary housing programs during the pendency of the San Jose case are expected to reevaluate and begin enforcing their programs once again.

In a highly anticipated case affecting residential development throughout California, the California Supreme Court unanimously rejected the California Building Industry Association’s (CBIA) challenge to the City of San Jose’s (City) ownership inclusionary housing ordinance in California Building Industry Association v. City of San Jose. This decision paves the way for the adoption, implementation and enforcement of similar inclusionary housing ordinances throughout the state.

Specifically, the Court held the City’s inclusionary housing ordinance is subject to the deferential standard of review afforded to traditional legislative land use regulations. Under this standard, the ordinance will be considered invalid only if it is arbitrary, discriminatory and without a reasonable relationship to any legitimate public interest. The Court held that inclusionary housing requirements are not subject to takings claims because they do not require a property owner to dedicate an interest in land to the government. Then, in distinguishing previous cases which had previously suggested that similar conditions were subject to heightened review, the Court emphasized the purpose of the condition, distinguishing regulations that are imposed to mitigate impacts from conditions imposed to serve distinct, constitutionally legitimate public purposes (such as meeting the City’s regional share of housing needs and providing for residential integration among low and market rate households as was articulated here).

In emphasizing the purpose of the condition, the Court adds another nuance to a patchwork of legal opinions relating to takings claims that previously focused on other factors such as the manner of application (e.g., as an ad hoc condition or via generally applicable legislation). In the context of affordable housing, cities are likely to move swiftly in adopting, implementing and enforcing ownership inclusionary housing ordinances given the relaxed standard, though the likelihood that CBIA petition for certiorari to the U.S. Supreme Court and challenges to other ordinances “as applied” to actual development could reduce the inclusionary housing momentum.

Background of the San Jose Ordinance

San Jose’s ordinance required developers of "for sale" residential units to set aside 15 percent of their project units as affordable units. (See Holland & Knight's alert "California Supreme Court to Review Inclusionary Housing Requirements," Oct. 16, 2013.) In the alternative, developers could satisfy the Ordinance's obligation in one of the following four ways:

  1. build inclusionary units off-site
  2. pay an in lieu fee
  3. dedicate land suitable for construction of inclusionary units equal to the value of the applicable in lieu fee
  4. acquire and rehabilitate a comparable number of inclusionary units that are affordable to low or very low income households

CBIA brought a facial challenge to the Ordinance, arguing that it was invalid on the ground that the City, in enacting the Ordinance, failed to demonstrate a reasonable relationship between any adverse public impacts or needs for additional subsidized housing units in the City caused by the development of new market rate residential developments and the new affordable housing exactions and conditions imposed by the Ordinance. CBIA cited San Remo Hotel v. City and County of San Francisco (San Remo) and Building Industry Assn. of Central California v. City of Patterson (City of Patterson). In constitutional terms, CBIA argued that the San Jose Ordinance’s conditions constitute exactions for purposes of the takings doctrine.

The trial court agreed with CBIA’s contention and declared the Ordinance invalid since the City had been

... unable to demonstrate ... the constitutionally required reasonable relationship between deleterious public impacts of new residential development and the new requirements to build and to dedicate the affordable housing or pay the fees in lieu of such property conveyances" under the San Remo standard. The Sixth District Court of Appeal reversed and held that the Ordinance should be reviewed under the highly deferential standard of review as an exercise of the City's police power rendering the ordinance invalid only if it is arbitrary, discriminatory and without a reasonable relationship to any legitimate public interest.

CBIA petitioned the California Supreme Court for review, specifically requesting review of two intervening decisions:

  1. the U.S. Supreme Court’s decision in Koontz v. St. Johns River Water Management District (Koontz) (extending holdings in Nollan v. California Coastal Commission (Nollan) and Dolan v. City of Tigard (Dolan) to instances in which a jurisdiction denies a land use permit and where monetary exactions are imposed on a development proposal)
  2. Sterling Park, L.P. v. City of Palo Alto (Sterling Park) (holding that the longer statute of limitations in the Mitigation Fee Act applied to a developer's challenge to an inclusionary housing obligation, rather than the shorter statute of limitations in the Subdivision Map Act)

Inclusionary Housing: What It Is, What It Isn’t and How Courts Should Tell the Difference

The lengthy opinion spends as much, if not more, time talking about what the Ordinance is not and distinguishing the bevy of related case law before settling on the legal standard.

Inclusionary Housing Is Not an Exaction Subject to the Nollan/Dolan Standard

The Court held, contrary to CBIA’s contention, that the conditions that the “San Jose ordinance imposes upon future developments do not impose exactions upon the developer’s property so as to bring into play the unconstitutional conditions doctrine under the takings clause of the federal or state Constitution.” The Court explains that the special limitations imposed by the unconstitutional takings doctrine derive from Nollan and Dolan casesboth of which involved dedications of property.

  • The "Nollan/Dolan" standards impose a high level of judicial scrutiny. The Nollan test requires an agency to demonstrate a "nexus," that is, a legitimate state interest in advancing the exaction.
  • The Dolan test requires an agency to demonstrate "rough proportionality" between the magnitude of the exaction and the nature and extent of the project impact.

More recently, the Court held in Koontz that the heightened scrutiny standard applies when the government conditions its approval upon the owner’s payment of money.

But the Court retorts that 

... nothing in Koontz suggests that Nollan and Dolan would apply where government restricts use of property without demanding conveyance of property interest. It is the governmental requirement that the property owner convey some identifiable property interest that constitutes a so-called exaction under the takings clause and that brings the unconstitutional conditions doctrine into play. 

In the present case, the Court finds that the Ordinance does not require the developer to give up a property interest or to “to dedicate any portion of its property to the public or to pay any money to the public.” Specifically, the Court rejects arguments that the diminished property value as a result of the Ordinance constitutes a takings. Similarly, the Court notes that the fact that the Ordinance requires restrictions upon resale to be recorded against the residential development and all inclusionary units does not transform the Ordinance’s conditions into a takings. Finally, the Court notes that the Koontz decision makes clear that so long as a permitting authority offers at least one alternative means of satisfying a condition, the property owner has not been subjected to a takings.

Inclusionary Housing Ordinances Are Not Like Mitigation Impact Fees Subject to Reasonable Relationship Standard

The Court distinguishes the “reasonable relationship” standard set forth in San Remo for mitigation fees that “do not serve a broader constitutionally permissible purpose unrelated to the impact of the proposed development.” In San Remo, the challenged ordinance imposed a requirement to replace long-term rental units (or pay an in-lieu fee). This ordinance was explicitly intended to mitigate the adverse effect that a proposed conversion of long-term rental units into tourist units would have on the city’s stock of long-term rental units. Based on the intended mitigation purpose, the Court said it was appropriate for the San Remo court to focus on whether the fee was reasonably related to mitigating the impact of the proposed conversion.

In contrast, the Court said that the San Jose Ordinance’s conditions are intended not only to mitigate the effect that the covered development projects will have on the city’s affordable housing problem but also to serve the distinct, constitutionally legitimate purposes of meeting the City’s regional share of housing needs and providing for residential integration among low and market rate households. According to the Court, these constitutionally legitimate purposes warrant the most deferential standard of review.

Notably, in drawing this conclusion, and emphasizing the distinction between an ordinance intended to mitigate an impact versus fulfill a greater constitutional purpose, the Court holds that the City of Patterson decision was incorrect in applying San Remo standard to an inclusionary housing ordinance. Because the affordable-housing in lieu fee in City of Patterson was imposed to further the public purpose of increasing the stock of affordable housing the Court disapproved the decision in City of Patterson, “to the extent it indicates that the conditions imposed by an inclusionary zoning ordinance are valid only if they are reasonably related to the need for affordable housing attributable to the projects to which the ordinance applies.”

Moreover, in drawing a distinction between the San Remo and City of Patterson cases, the Court diminishes the importance of whether a condition is imposed on an ad hoc basis (i.e., on a specific development project or permit) or as a legislative requirement (imposed via a generally applicable ordinance). Courts have generally applied the heightened Nollan/Dolan test to conditions imposed in an ad hoc manner. Some lower courts, however, have applied the more relaxed "reasonable relationship" standard in instances where an exaction is imposed through generally applicable legislation. In both San Remo and the City of Patterson, the challenged requirements were formulaic and legislatively mandated. Despite the similarity, the Court added another layer of distinction to the takings jurisprudence depending on purpose of the requirement.

Inclusionary Housing Is More Like a Land Use Restriction Subject to the Police Power Test

After reviewing the Ordinance’s stated purpose, the Court characterizes the Ordinance as falling within a “municipalities’ general broad discretion to regulate the use of real property to serve the legitimate interests of the general public and the community at large.” The Court likens the conditions to other land use restrictions such as height limitations, set-back requirements, and density limits. Like other land use regulations, the Court explains that this Ordinance places a restriction on the way the developer may use its property by limiting the price for which the developer may offer some of its units for sale. The Court notes that a price control is permissible unless the restriction rises to a “confiscatory” control or constitutes a regulatory taking. Future affordable housing challenges are likely to focus on the bounds of these controls.

No Clarification for Rental Residential Development

One topic on which the Supreme Court does not opine is in relation to rental residential development. The opinion includes only one footnote (footnote 6) on the topic. It notes that the San Jose ordinance provided that it applied to rental housing only if the courts or Legislature overturn, disapprove or depublish the decision in Palmer/Sixth Street Properties, L.P. v. City of Los Angeles (Palmer). Palmer held that Los Angeles' inclusionary housing ordinance requiring affordable units to be subject to long-term rental restrictions violated state law provisions found in the Costa-Hawkins Act. This act allows the owner, and not a city, to set initial rent levels. Since the Palmer decision remains applicable, the rental provisions in the San Jose Ordinance have not come into effect and the Supreme Court did not address the issue.

Implications for Residential Development

Given the Court’s emphasis on the purpose of a condition and the advantage of the more deferential standard afforded by the police power test, cities will have an incentive to characterize inclusionary housing requirements as serving a legitimate general public purpose rather than as mitigation for the impacts of market rate housing. Interestingly, cities have begun to characterize ordinances, particularly those that involve fees for rental residential development, precisely as mitigation for market rate housing impacts in order to distinguish the fees from those admonished as “inextricably intertwined” with the type of rental inclusionary housing requirements overturned in Palmer.

Cities that have held off on enforcing their ownership inclusionary housing programs during the pendency of the San Jose case are expected to reevaluate and begin enforcing their programs once again. Cities that commissioned detailed “nexus studies” in order to justify in lieu fees may now abandon those efforts or characterize requirements not as impact fees but as serving a legitimate public purpose.

Nonetheless, while adoption and implementation of inclusionary housing requirements move forward, CBIA is likely to appeal to the U.S. Supreme Court. Further, challenges to inclusionary housing requirements “as applied” to actual developments could still determine the bounds of the relaxed standard. Despite the low bar, many developers maintain that the costs associated with inclusionary housing requirements can determine the economic feasibility of a project, and determine whether a project will “pencil” or not in this climate of heated land value. Time will tell whether additional inclusionary housing requirements will result in the desired affordable housing units or whether they will tip the infeasibility scale such that fewer residential developments, and therefore affordable homes, will be built as an unintended consequence.