[Originally published in The Registry on June 29, 2015]

In a recent case closely followed by the development community, the California Supreme Court unanimously rejected a challenge filed by the California Building Industry Association (CBIA) to San Jose’s inclusionary housing ordinance. The Court upheld the City’s ordinance requiring new development set aside 15 percent of units for purchase at below market rates, under the City’s broad power to regulate the use of real property, and further found that such affordable housing requirements are legal so long as they bear a “real and substantial relationship” to a legitimate governmental purpose.

The Court rejected CBIA’s argument that such regulations must be analyzed as an exaction whereby a jurisdiction must—in order to avoid an unconstitutional “taking”—first show a nexus between the development of new market-rate residential housing and the extent to which such construction creates or exacerbates the need for affordable housing. As a practical matter, the Court’s decision lowers the bar for a public entity’s adoption of inclusionary requirements and will make such regulations more difficult to challenge in the future.

Case Facts

California Building Industry Association v. City of San Jose (Supreme Court Case No. S212072, June 15, 2015) concerned the City of San Jose’s adoption of an inclusionary housing ordinance in 2010. San Jose’s ordinance is similar to those adopted by more than 170 California jurisdictions and requires developers of new projects of 20 or more units to set aside 15 percent of for-sale units to be sold at a below market cost to low and moderate income households. Although developers have the option of meeting this obligation by paying an in-lieu fee, constructing affordable units offsite, or dedicating land of an equivalent value, the ordinance includes numerous incentives encouraging developers to include the affordable units as part of the development giving rise to the requirements.

San Jose’s ordinance is technically applicable to rental housing projects, but states that its provisions regarding rental projects are suspended so long as the 2009 California Court of Appeal decision, Palmer/Sixth Street Properties, L.P. v. City of Los Angeles, remains valid. In Palmer, the court of appeal held that the Costa-Hawkins Rental Housing Act precluded enforcement of inclusionary housing ordinances against newly-built rental units.

Lower Court Rulings

CBIA challenged the San Jose ordinance, claiming that it was an unconstitutional exaction and that the City had to first prepare a nexus study to support the inclusionary requirement, as would be required for a dedication of land or payment of a mitigation fee. The superior court agreed with CBIA, finding the ordinance constitutionally invalid because the City failed to provide any evidence of a nexus between the construction of new residential developments resulting in the need for affordable housing. The court of appeal subsequently reversed the superior court, holding that the ordinance did not represent an exaction but was merely a zoning use restriction (similar to a height, density or setback regulation), and therefore the City need not provide any such proof of a nexus. At CBIA’s request, the California Supreme Court took up the case.

Summary of Supreme Court’s Decision

Many observers predicted that the Supreme Court would follow the logic of two 2013 decisions by the United States Supreme Court and California Supreme Court that made it easier to challenge government requirements imposed on development projects. In Koontz v. St. Johns River Water Management District, the U.S. Supreme Court found that monetary exactions for a land use permit were subject to a takings analysis. In Sterling Park, L.P. v. City of Palo Alto, the California Supreme Court held that an inclusionary requirement was subject to the protest provisions of the Mitigation Fee Act governing challenges to fees and exactions imposed as a condition of development.

Instead, the current California Supreme Court distinguished these earlier cases and found that San Jose’s inclusionary housing ordinance was nothing more than a use restriction, since it merely limited the price the developer could charge for certain units, and thus should not be considered an unconstitutional taking. The Court also distinguished San Jose’s ordinance from the dedication requirements analyzed in two landmark U.S. Supreme Court cases, Nollan v. California Coastal Commission and Dolan v. City of Tigard, pursuant to which government agencies are required to demonstrate an “essential nexus” and “rough proportionality” between any dedication requirement imposed on a proposed development and the impact expected to result from the development. The Court also ruled that the 2009 court of appeal decision in Building Industry Assn. of Central California v. City of Patterson was incorrect in finding that conditions imposed by an inclusionary ordinance are only valid if they are reasonably related to the need for affordable housing stemming from the specific project to which the ordinance is applied.

The Court held that San Jose’s ordinance was not an exaction since it does not require a developer to give up a property interest or pay any money to the public, but merely restricts the way the property may be used by imposing a price control on some units and is within the city’s authority to regulate land use in the public interest. The Court noted that, in support of adopting the ordinance, the City made findings that requiring affordable housing supported the community’s housing element goals of protecting the public welfare by “fostering an adequate supply of housing for persons at all economic levels and maintaining both economic diversity and geographically dispersed affordable housing,” as opposed to only mitigating the impacts of an otherwise all market-rate development. Accordingly, the constitutional limitations found in the earlier cases with respect to public agencies’ ability to require dedications of private property for public use as a condition of development did not apply. The Court sent the case back to the trial court to determine whether the City’s ordinance was valid under the standard ordinarily applicable to general, legislatively imposed, land use regulations—namely whether the ordinance’s requirements bear a real and substantial relation to the public welfare.

The CBIA has not determined whether it will seek review from the United States Supreme Court.

Although the California Supreme Court’s opinion will make it more difficult to successfully challenge inclusionary housing ordinances, it should be recognized that certain of these ordinances—to the extent they are solely fee-based or require such a high percentage of below market-rate units that development would be at an economic loss—may still be subject to challenge as an unconstitutional condition under the well-known Nollan and Dolan cases, and under the rationale relied upon by the Court in Sterling Park.

The Court’s decision in CBIA v. San Jose did not overturn the Palmer decision so new rental projects remain, for the time being, protected from initial affordability requirements. However, in 2013, the California legislature passed a bill to overturn Palmer to allow for affordable requirements on new rental housing developments. Governor Brown vetoed the legislation and stated that he wanted to allow the Supreme Court to issue its ruling in CBIA v. City of San Jose. Now that this has occurred, the legislature may once again attempt to address Palmer.

Furthermore, while the San Jose decision boosts a jurisdiction’s ability to adopt an inclusionary ordinance, whether such ordinances are appropriate and effective in increasing the supply of affordable housing, rather than discouraging residential development due to increased costs and lowered profits, remains an open question and will often depend on the strength of the housing market in the jurisdiction in question.