The Planning Commission scheduled to hear proposed amendments on March 25, 2010.

On November 26, 2009, the California Supreme Court decided to leave intact the appellate court decision in Palmer/Sixth Street Properties v. City of Los Angeles (2009) 175 Cal.App.4th 1396. This decision limits the enforceability of inclusionary housing ordinances, such as San Francisco Planning Code Section 315, that require residential developers of rental housing to set aside a portion of their rental units as low-income units with restricted rents. For-sale projects are not affected by Palmer.

Generally, San Francisco's inclusionary ordinance requires developers of both for-sale and rental housing projects either to provide on-site or off-site a certain percentage of the project's units as affordable units or to pay a very hefty in lieu fee to be used by the Mayor's Office of Housing. Whether a unit is "affordable" is based on its restricted rent or sales price. For example, Section 315 sets rents for an affordable rental unit at 30% of household income for a household earning 60% of San Francisco median income, and sales prices are capped at a level affordable to households earning an average of 100% of San Francisco median income.

Because of a similar rent restriction feature in Los Angeles's inclusionary ordinance, Palmer held that the ordinance conflicts with and is preempted by a state law known as the Costa-Hawkins Act (California Civil Code §§ 1954.50-1954.53). The Costa-Hawkins Act provides that "an owner of residential real property may establish the initial rental rate for a dwelling unit."

Because Palmer addresses only rent restrictions, it does not affect those features of inclusionary ordinances that require production of affordable for-sale units. Further, the Costa-Hawkins Act includes an exception to its rental restrictions when the owner has "agreed by contract with a public entity [to build affordable housing] in consideration for a direct financial contribution or any other forms of assistance specified in [the State Density Bonus law]." Therefore, rental units in projects that receive any such financial assistance, such as from CDLAC bond financing, a Redevelopment Agency subsidy or a density bonus, are also unaffected by Palmer.

In response to the Palmer decision, San Francisco proposes amending its inclusionary housing ordinance to generally eliminate the option of providing rental units as a means of satisfying the inclusionary requirement, and instead requiring all developers to pay the in lieu fee unless the project qualifies for an exception. Some means of avoiding payment of the in lieu fee is needed because the advance payment of a large fee is simply not feasible or financially viable for most rental projects. The proposed changes were introduced jointly by Mayor Newsom and Board of Supervisors President David Chiu in January, 2010.

Under the proposed amendments, there are three alternatives developers can elect if they choose not to pay the in lieu fee: (1) provide an affidavit to the Planning Department that any affordable units will be ownership units for the life of the project; (2) provide proof that the developer has entered into an agreement to obtain some form of public subsidy, financing or density bonus; or (3) execute an agreement with the City that includes a covenant to provide on-site rental units in exchange for a waiver of the in lieu fee. This office was instrumental in drafting and having incorporated into the legislation this last option.

Hopefully, these provisions will preserve the flexibility for developers to find the most economical alternative for satisfying the City's inclusionary housing program. The Planning Commission is scheduled to hear these amendments on Thursday, March 25, 2010. Once the Planning Commission has reviewed and made its recommendations on the ordinance, the Board of Supervisors will consider it.

While there are groups looking at amending the Costa-Hawkins Act to exempt rental units provided under inclusionary ordinances, past efforts to amend the Act have met with great resistance in the State Legislature. Thus, for the foreseeable future, inclusionary requirements for rental projects in San Francisco will require payment of an in lieu fee unless the project includes public subsidiaries or a density bonus or enters into a specific agreement with the City with an enforceable covenant to provide on-site or off-site inclusionary units in exchange for a waiver of the otherwise required in lieu fee.