The Challenge of Affordable Housing – Part 2 The Cost of Regulation
As I noted in my previous blogs, during the Building Contractors Association of Southwestern Idaho Political Action Committee interviews of candidates for public office, the majority of the candidates cited the lack of affordable housing as one of major the issues facing us. But we are not alone. An August 2019 nationwide survey conducted by Morning Consult(1) on behalf of the National Association of Home Builders (NAHB) found that four out of five American households believe the nation is suffering a housing affordability crisis and at least 75 percent report this is a problem at the state and local level as well.
The poll is also consistent with the latest findings from NAHB’s Housing Trends Report for the second quarter of 2019, which finds that 80 percent of buyers say they can afford to purchase fewer than half of the homes available in their local markets.
“Housing affordability is near a 10-year low and this poll confirms the challenges hard-working families face to keep housing within reach as rising costs continue to outpace wage growth,” said Greg Ugalde, NAHB chairman and a home builder and developer from Torrington, Conn. “Policymakers must roll back inefficient zoning rules, costly impact fees and outmoded land development regulations that are driving up housing costs, contributing to the mounting lack of affordable housing and hurting middle and low-income households.”
More than half of the respondents—52 percent—said they would support proposals to reduce regulations, such as restrictive zoning and permitting procedures, that increase the costs of constructing new homes.
The housing affordability crises is an issue affecting both single-family and multi-family housing. NAHB analysis shows that regulatory requirements alone account for 25 percent of the cost of a single-family home and 30 percent of the cost of a multifamily development.
Let’s begin by
examining multi-family housing. The affordability of rental housing and how
difficult it has become to address the problem through new construction is an increasing
concern. In addition to rising labor and material costs, a 2017 report on
America’s Rental Housing published by the Joint Center for Housing Studies at
Harvard University cited “Tight land use regulations” as adding to costs ”by
limiting the land zoned for higher-density housing and entailing lengthy
NAHB and the National Multifamily Housing Council (NMHC) undertook a joint research effort to find out how much government regulation adds to the cost of building new multifamily housing. Results show that well over 90 percent of multifamily developers typically incur hard costs of paying fees to local jurisdictions, both when applying for zoning approval, and again when local jurisdictions authorize the construction of buildings.
However, government regulation can impose costs in other ways as well. Over 90 percent of multifamily developers also incur costs of delays caused by sometimes lengthy approval processes, development standards that go beyond what would ordinarily be done, changes to building codes over the past decade, and OSHA requirements. Other regulations, such as requiring developers to dedicate land to the government, are somewhat less common, but can be quite costly when they are encountered. The bottom line is that regulation imposed by all levels of government – local, state or federal – accounts for an average 32.1 percent of total multifamily development costs and quartiles averages ranging from 21.7 to 42.6 percent.
A substantial amount of regulation is well intentioned and some of it undoubtedly serves a worthwhile purpose. Few would argue, for example, that basic safety standards for structures and workers are unnecessary. But regulation that exceeds 30 percent of a project’s development costs raises questions about how thoroughly governments are considering the consequences of their actions. Are they aware of how much regulation currently exists? Do they realize how multiple regulations with conflicting standards can cause delays and increase costs? And do they understand the extent to which these increased costs translate into higher rents and make it difficult to build new housing that families with modest incomes can afford?
Regulatory costs fall into several categories—fees, development standards, building codes, land dedicated to public purposes, etc. The range of these regulations can be broad, and the cost of complying with them substantial. Figure 1 shows the incidence of different types of regulations imposed on multifamily developers, as well as the average cost of complying with those regulations when they do exist.
The first significant interaction between a multifamily developer and the government usually occurs when the developer applies for zoning approval to allow multifamily housing to be built on a particular parcel of land. Local governments pass zoning ordinances that divide their territories into districts and specify how land in each district can be used (single-family versus commercial versus multifamily, for example). While it’s not impossible for a developer to acquire land that allows multifamily structures to be built on it without going through a rezoning process or obtaining some type of exemption to an existing ordinance, this is the exception rather than the rule.
98 percent of projects were subject to costs at the zoning approval stage. Regulatory costs incurred at this stage can include fees paid directly to a government but may also include other types of costs. Developers may have to pay for environmental impact, archeological or other types of studies. When they exist, these regulatory costs average 4.1 percent of the total development costs.
A developer may also need to obtain a wetlands, stormwater and/or endangered species-critical habitat permit. Many states manage the wetlands permits under federal guidance, and states and local jurisdictions may have their own sets of requirements, each of which is overseen by a different federal government agency. It can be difficult to identify which level of government is ultimately responsible for some regulation and trying to reconcile conflicting requirements is one factor that can drive up the cost of compliance.
It is also common for governments to charge utility hook-up, impact fees, and other fees on a multifamily development when site work begins. the authority of local governments to charge impact fees on new development is established by state legislation. In Idaho, that legislation is Chapter 82 Development Impact Fees of Title 67 State Government and State Affairs. As stated in the §67-8202, the purpose of impact fee legislation is to develop “an equitable program for planning and financing public facilities needed to serve new growth and development in order to promote and accommodate orderly growth and development and to protect the public health, safety and general welfare of the citizens of the state of Idaho.” The intent of impact fees is to “(1) Ensure that adequate public facilities are available to serve new growth and development; (2) Promote orderly growth and development by establishing uniform standards by which local governments may require that those who benefit from new growth and development pay a proportionate share of the cost of new public facilities needed to serve new growth and development;” and “ (4) Ensure that those who benefit from new growth and development are required to pay no more than their proportionate share of the cost of public facilities needed to serve new growth and development and to prevent duplicate and ad hoc development requirements.” Impact fees may be charged for the construction of roads, water facilities, sewer facilities, stormwater management, parks, fire, police, libraries, solid waste management, and general government. A particular development may be subject to fees from more than one government entity. In Ada County, a development may be subject to impact fees the Ada County Highway District and Ada County or the city in which the development is located. 93 percent of multifamily developers in the NAHB-NMHC reported paying fees when site work begins and, when they exist, these fees average 4.5 percent of total development costs.
Some local governments charge developers guarantee or other fees that are refundable when the project is completed. Although these fees are also usually imposed when site work begins, the survey treats them separately, due to the different cost implications. If the fee is eventually refunded, the developer ultimately pays only the interest that accrues on the development and construction loans until that happens. Approximately 50 percent of typical multi-family projects were subject to these fees which, when present, averaged half a percent of the total development cost.
Local governments may also require new development to conform to community design standards, including standards for streets and sidewalks, parking, height of buildings, landscaping and the architectural design of individual buildings. These standards can impose little extra cost if they don’t significantly exceed the developer’s ordinary practices. In the absence of regulation, for example, developers will still ordinarily provide spaces for walking and parking, landscaping, and employ architects who attempt to design buildings that are attractive to potential tenants. Almost 95 percent of the typical projects of the developers surveyed were subject to design standards that go beyond what the developer would otherwise do. When these beyond-ordinary requirements were present, they accounted for an average of 6.3 percent of the overall development cost.
Half of the typical projects required developers to dedicate land to the government or otherwise leave it unbuilt. This requirement can take many forms, such as creating a park on the property or reserving part of the property for the government to use in some way. In these cases, the developer must pay for the land but is not allowed to derive revenue from it, driving up the cost per unit for the housing that can be built. For those projects subject to this regulation, it represented an average of 4.3 percent of total development cost.
93 percent of multi-family developers reported paying some sort of fee when construction in their typical project was authorized. This could be limited to a building permit fee, but additional impact, hook-up or other fees may also be charged at this point. When they exist, the fees charged at this point average 4.2 percent of development costs, large enough to suggest that they often encompass more than the building permit fees.
Local jurisdictions are increasingly beginning to consider imposing affordability mandates to attempt to create new affordable housing. These mandates without any offsetting incentive like a tax exception typically create few units and effectively tax some housing units and ultimately their occupants to subsidize others. In some cases, developers are allowed to pay a fee to avoid the requirement, but that amount gets added to the overall amount the developer must pay, thus raising the rents required. If they are not allowed to pay a fee, the regulation may require them to lose money on some of the housing they build, which is effectively a tax, resulting in higher rents on non-subsidized apartments. 30 percent of developers indicated that their typical projects incurred costs related to complying with such mandates. These costs, when they exist, averaged 5.7 percent of total development costs, enough to result in substantially higher rents.
Virtually no one would argue against public standards for basic soundness and safety of residential structures, but over the decades building codes have expanded well beyond this and are increasingly being used as a vehicle to advance various policy objectives. A leading example is energy efficiency. There is now a model International Energy Conservation Code® (IECC).
Energy efficiency is a worthwhile objective, but NAHB and NMHC have argued that the up-front cost needs to be kept within reasonable bounds. NAHB and NMHC have supported some recent changes to the International Energy Conservation Code (IECC) but opposed others as not cost-effective. Manufacturers of building products advocate for code changes that mandate more use of their products and tend to be less concerned than NMHC and NAHB about costs. Past analysis by NMHC on previous code cycles has shown that changes to the IECC have the potential to drive up construction costs by over $3,000 per apartment (depending on type of building and climate zone) and argued that subsequent savings on utility bills come nowhere near justifying the cost.
This is another area where the federal government has become increasingly involved. The Environmental Protection Agency, the Federal Emergency Management Agency, and the Department of Energy (DOE), all actively participate in the development of national model codes, proposing changes to national model codes and testifying in favor of them during code hearings. DOE also has a share of its budget set aside for persuading state and local jurisdictions to adopt more stringent codes. Representatives from NAHB who witnessed all of the recent code hearings have criticized federal agencies for supporting certain code changes that removed flexibility and limited builders’ options, driving up costs without improving energy efficiency, to the benefit of specific product manufacturers.
98 percent of developers said changes in building codes over the past 10 years increased development costs in their typical projects by an average 7.2 percent of total development costs.
Nine out of ten developers said complying with requirements of the Occupational Safety and Health Administration (OSHA) increased costs in their typical projects, and these costs, when present, average 2.3 percent of total development costs. Again, few would argue that safety standards for construction workers are unnecessary. In recent years, however, OSHA has issued a substantial number of regulations imposing costly compliance requirements all without providing any evidence that they would actually improve safety in the residential construction industry.
Even when regulation imposes no direct costs, it can have a financial impact if it delays the development and construction process. If it takes longer to begin leasing and earning income on a property, it will take longer to pay off any development and construction loans and more interest will accrue.
Some regulatory delay is inevitable, as it will naturally take some time for local building departments to review and approve plans and respond to requests for inspections. Precisely how long it is reasonable for a developer to wait for approvals and inspections is open to debate, but there are examples that clearly seem excessive. One academic study, for example, found that it took an average of 788 days to prepare a submission and receive approval for an individual federal wetlands permit.
98 percent of developers said complying with regulations caused some sort of delay for their typical projects. For these projects, NMHC and NAHB estimated that average additional interest was 0.7 percent of total development costs. This is a “pure” cost of delay that regulation would cause even if it imposed no other type of cost. It is calculated by subtracting every other type of regulatory cost, then estimating the additional interest accruing on the share of the remaining development cost that is typically financed.
Figure 2 shows that, when both the incidence and magnitude of the various types of regulation into account, the listed categories taken together on average account for 32.1 percent of development costs for a multifamily project.
Among the listed categories, average cost is highest for changes to building codes over the past 10 years (7.0 percent of total development costs), followed by development standards imposed by government that go beyond what the developer would ordinarily do (5.9 percent of total development costs).
To illustrate the variability in regulatory costs, in addition to averages, Figure 2 shows the upper and lower quartiles (costs are below the lower quartile for 25 percent of respondents, and above the upper quartile for 25 percent). While on average regulation accounts for 32.1 percent of total multifamily development costs, the quartiles give a range of 21.7 to 42.6 percent.
Although the NAHB-NMHC survey sought to be as comprehensive as possible, it did not capture everything. The cost of delays as well as other costs incurred due to neighborhood opposition to the development are such costs. At the local level, governments may encourage or facilitate local groups who oppose multifamily development. One way to do this is by allowing local groups to sue any developer who proposes to build multifamily housing, but there are many more subtle ways to encourage opposition. A developer may have to devote time and financial resources to deal with this opposition, by meeting with local groups before seeking zoning approval, for instance. To quiet the opposition, developers may find it necessary to make concessions to local groups, such as reducing size of the buildings so that land costs are allocated to fewer apartments and cost per apartment is increased. In an extreme case, local opposition may cause a local government to reverse its decision to approve a project after the developer has already invested heavily in it. In many of these cases, there is an obvious cost to neighborhood opposition, but how much responsibility the local government bears for it may not always be clear. Figure 3 below shows that 85 percent of developers experienced added costs or delays due to such opposition.
As the above discussion has demonstrated, multifamily development can be subject to a bewildering array of regulatory costs, including a broad range of fees, standards, and other requirements imposed at different stages of the development and construction process. In view of this, it may not be surprising that regulation imposed by all levels of government accounts for 32.1 percent of multifamily development costs on average, and one-fourth of the time reaches as high as 42.6 percent.
The current estimate that government regulation accounts for 32.1 percent of total development costs is almost certainly understated to some extent, as it was not possible to account for items like the extent to which local jurisdictions may empower their citizens to oppose multifamily housing in their communities. Average costs could be even higher now or in the near future due to regulations taking effect since the multifamily projects in the survey were completed. For example, OSHA’s Silica Rule went into effect in late 2017, a regulation that industry groups have criticized as unreasonably onerous and unnecessarily costly. Similarly, local jurisdictions are just beginning to adopt the 2018 versions of the model international building codes. Home Innovation Research Labs has recently estimated that the difference between the 2018 and 2015 versions of the codes can add thousands of dollars onto the cost of a multifamily building. As is typically the case, federal agencies supported several of the cost-increasing changes to the codes.
When the cost of multifamily development rises, it unavoidably translates to higher rents and reduced affordability of rental housing. Multifamily developers can not secure financing to build their projects unless they can demonstrate to lenders that the rents will be sufficient to cover costs and pay off the loans.
NAHB estimates based on the latest data show that, on average, regulations imposed by government at all levels account for an average of 24.3 percent of the final price of a new single-family home built for sale quartiles averages ranging from 21.7 to 42.6 percent.
Three-fifths of this—14.6 percent of the final house price—is due to a higher price for a finished lot resulting from regulations imposed during the lot’s development. The other two-fifths—9.7 percent of the house price—is the result of costs incurred by the builder after purchasing the finished lot. Moreover, the average cost of regulation embodied in a new home is rising more than twice as fast as the average American’s ability to pay for it. It’s also likely the costs embodied in a new home are understated because some types of regulation impact costs in a way that is difficult for builders to see, and the pace of regulatory cost increases is accelerating due to the number of regulations in the pipeline.
Many of the regulatory requirements that account for the 32.1 percent of the cost of a multifamily development also account for the 25 percent of the cost of a single-family home. As noted in Part 1a, the cost of the average single-family lot as a percentage of the sales price was 20.3% on 2009 and 21.5% in 2017. But the average lot size in 2009 was approximately 21,879 square feet – approximately ½ acre – and the average cost per square foot of a finished lot was $3.50. In 2017, the average lot size was approximately 11,186 square feet – approximately ¼ acre and the average cost per square foot of a finished lot was approximately $8.22 – an increase of approximately 235%.
As shown in Table 1, the regulatory impacts on the price of a developed lot that would typically be sold to a builder account on average for 54.7 percent of the price of the lot and range from a lower quartile average of 29.8 percent to an upper quartile average of 70.7 percent. Among the five components of regulatory costs shown in the table, the average impacts range from 5.1 percent of the lot’s price for “pure” cost of delay to over 16 percent for changes in development standards such as setbacks or road widths.
Based on the assumption that the finished lot cost accounts for 21.8 percent of the final price of the home and that the builder’s mark-up on cost to cover sales commissions, overhead, and profit is 22.3 percent, those same regulatory impacts account on average for 14.6 percent of the final price of the home sold to the home buyer and range from a lower quartile average of 7.9% to an upper quartile average of 18.8%.
Regulatory requirements on single-family lots are similar to those on multi-family development and include the cost of applying for zoning / subdivision approval, costs incurred after approval / before construction, land dedicated to the government or otherwise left unbuilt, changes in development standards, and “pure” cost of delay.
The pure cost of delay in the table refers to the estimated cost that the delays of waiting for approval and complying with development regulations would impose in the absence of any other type of regulatory cost. Delay also factors into other regulatory costs listed in the table through higher interest payments on acquisition and development loans that accrue over a longer period of time. On average, complying with regulation adds 6.6 months to the development process, but the variation is considerable, ranging from no time at all to over 5 years.
Just as with multi-family developments, local governments charge impact fees, and other fees on single-family homes. As noted previously, the authority of local governments to charge impact fees on new development is established by state legislation. In Idaho, that legislation is Chapter 82 Development Impact Fees of Title 67 State Government and State Affairs. As stated in the §67-8202, the purpose of impact fee legislation is to develop “an equitable program for planning and financing public facilities needed to serve new growth and development in order to promote and accommodate orderly growth and development and to protect the public health, safety and general welfare of the citizens of the state of Idaho.” The intent of impact fees is to “(1) Ensure that adequate public facilities are available to serve new growth and development; (2) Promote orderly growth and development by establishing uniform standards by which local governments may require that those who benefit from new growth and development pay a proportionate share of the cost of new public facilities needed to serve new growth and development;” and “ (4) Ensure that those who benefit from new growth and development are required to pay no more than their proportionate share of the cost of public facilities needed to serve new growth and development and to prevent duplicate and ad hoc development requirements.” In other words, to ensure that growth and development pay for themselves.
As with multi-family development, additional costs including the cost of delays incurred due to neighborhood opposition to growth and development may also apply to single-family lot development.
The neighborhood opposition is often based on the mistaken belief that growth does NOT pay for itself. But on the contrary, the actual numbers prove that growth does if fact pay for itself and more. In 2018, single-family residential construction in Ada County generated a total of $77,297,500 in revenue to local governments including $61,290,00 in permit and impact Fees and $16,007,500 in property taxes and other fees. In addition, that single-family residential construction generated $893,637,000 in local income, $303,294,100 in business owners’ income, $590,342,900 in local wages and salaries, $16,007,500 in local taxes, and supported 12,894 local jobs. Finally, over the next 15 years, the single-family homes built in 2018 and the households which occupy them are estimated to generate $319.5 million in revenue over their cost.
As shown in Table 2, the impacts of regulation imposed during construction, after a builder has acquired the lot on average accounts for 14.5 percent of construction costs. Of this, 5.3 percent is the actual hard cost of fees paid by the builder. The remaining 9.2 percent is the cost of changes to construction codes and standards over the past 10 years. The 9.2 percent increase since does not mean all subsequent code changes have been unnecessary, but it does raise a question about how well possible cost impacts are being factored into the code revision process.
Similar to Table 1, based on the assumption that costs incurred during construction account for 56.0 percent of the house price, and that the builder’s mark-up on cost to cover sales commissions, overhead, and profit is 19.2 percent, the impacts of regulation imposed during construction, after a builder has acquired the lot, on average account for 9.7 percent of the home’s final sale price and range from a lower quartile average of 4.0 percent to an upper quartile average of 12.7 percent.
Adding together costs imposed by government at all levels account during both single-family home development and construction accounts on average for 24.3 percent of the final price of a new single-family home built for sale and range from a lower quartile average of 14.0 percent to an upper quartile average of 30.3 percent.
Finally, as noted previously, the average cost of regulation embodied in a new home is rising more than twice as fast as the average American’s ability to pay for it. Previous NAHB estimates of regulatory costs conducted in 2011 estimated the share of a new home’s price attributable to regulatory costs at 25 percent compared to the most recent 24.3 percent. However, according to the U.S. Census Bureau, the average sales price of a new home has increased from $260,800 in 2011 to $362,700 in September 2017.
Applying the average percentages from NAHB’s studies to these home prices produces and estimate that average regulatory costs in a new home built for sale has increased 35.1 percent from $65,224 to $88,136 in the roughly eight-and-a-half-year period from April 2011 to September 2019. The impact of regulation imposed during lot development increased by 24 percent, from $42,709 to $52,954, and the impact of costs imposed during construction increased the by 56.1 percent, from $22,535 to $35,182.
As also noted previously, it is likely the costs embodied in a new home are understated because some types of regulation impact costs in a way that is difficult for builders to see, and the pace of regulatory cost increases is accelerating due to the number of regulations in the pipeline.
The 35.1 percent average increase in the average overall regulatory costs embodied in the price of a single-family home built for sale period from April 2011 to September 2019 is higher than the 32 percent increase in disposable income per capita during that same period which in turn is higher than the 26.6 percent increase in the cost of construction materials. The bottom line is the cost of regulation in the price of a new home is rising faster than the average American’s ability to pay for it.
In The Challenge of Affordable Housing Part 3, I’ll begin discussing possible solutions to the challenge.This national survey of 19,801 adults was conducted Aug. 9-24, 2019 by the polling firm Morning Consult. It has a margin of error of ± 1 percent.
- This national survey of 19,801 adults was conducted Aug. 9-24, 2019 by the polling firm Morning Consult. It has a margin of error of ± 1 percent.