After my recent post on inclusionary zoning in Ontario, I was asked to provide my comments on the draft regulation and on how inclusionary zoning could and will impact development feasibility. So I will endeavor to do that today.

It’s important to first understand the costs and inputs that go into a development pro forma and how overall project feasibility is determined. For simplicity, let’s breakdown the costs as follows:

- Land

- Soft Costs

- Financing Costs

- Municipal Fees/Charges

- Hard Costs

All of these costs buckets are significant. For a project to be feasible, you obviously need the revenues of the project to be greater than the above costs. There also needs to be a remaining profit margin that is commensurate with the risk profile of the project and that meets your investor’s return expectations. Most developers rely on outside equity and debt to finance their projects.

One of the misconceptions that I often hear is that people seem to think that the profit margin on projects is so great that developers could simply build affordable housing (or do many other things) if they weren’t so greedy. The reality is that development happens on the margin. It’s not easy to find sites and projects that make any sort of financial sense. More often than not they don’t.

The other reality is that in a growing market all of the above costs are also continually increasing. If revenue (i.e. rents and condo prices) is also growing, as has been the case here in Toronto for many many years, then developers can generally absorb reasonable increases and continue building. But if revenue stops growing, grows at a slower pace or, worse, shrinks, then feasibility could disappear and development would stop.

Now let’s talk specifically about inclusionary zoning. IZ is typically an incentivized or mandated requirement to provide a certain number of below-market housing units as part of new developments. Affordable housing is important. That’s why a number of cities already have inclusionary zoning policies – though it remains a fairly controversial tool.

From a development feasibility standpoint, a mandatory inclusionary zoning requirement represents a decrease in revenue. There’s now a percentage of the units that can no longer be rented or sold at market prices. And so to maintain the project’s feasibility – because remember development happens on the margin – something has got to change.

There are a few options.

Option One: You could simply try and pay less for the land. As we have talked about many times on this blog, land is supposed to be the residual claimant. Work backwards from revenues and your other costs to determine what can be paid for the land. The problem with this option is that land prices tend to be sticky.

Many or most landowners don’t give a shit about your development pro forma. They often have a number in mind and if you try and tell them that development charges just went up and you can’t pay as much for their land, they’ll simply sit on it and wait for someone else – even if that means waiting for the market to catch up (i.e. waiting for rents to go up).

Option Two: Charge more for the remaining market units. If the market is sufficiently robust, perhaps this is an option. This is one of the reasons why inclusionary zoning often produces more units in markets where there’s already strong demand for new housing.

But it’s also one of the reasons why IZ is controversial. You’re asking the other renters/buyers in the project to effectively subsidize the below market units. And there is research out there (previously posted on this blog) suggesting that in some instances IZ policies have created additional upward pressure on market rents and home prices.

Option Three: Incentives are provided by the municipality to offset some or all of the additional burden placed on the project. This could come in the form of a density bonus, financial contribution, a waiving of other municipal charges/fees, and so on.

Though I have questions about the details, this is something that was proposed in Ontario’s draft regulation (albeit not to the extent that the industry wanted). Now you know why I said and why I believe that these offsets are important to the industry and to overall housing affordability.

My hope with this post was to provide the developer’s perspective, but also take a very matter of fact approach to inclusionary zoning. Most people recognize the importance of affordable and accessible housing. The question is how best to execute.

Photo by Toa Heftiba on Unsplash

On Monday the province of Ontario posted a draft regulation intended to establish a framework for inclusionary zoning. It builds on a bill that passed last year allowing municipalities – should they choose – to require affordable housing in new developments and redevelopments.

Below are some, but not all, of the things that are being considered in the draft regulation. Some of these items were recommendations made by the development industry through the Ontario Home Builders’ Association (OHBA) and the Building Industry and Land Development Association (BILD).

- The total number of affordable units or gross floor area dedicated to affordable housing units would not exceed 5% of the total units or 5% of the total gross floor area (excluding common areas). This number increase to 10% in high density transit station areas.

- The affordable period would be a minimum of 20 years but no greater than 30 years.

- There may be opportunities to provide the inclusionary zoning units off-site.

- The policies would only apply to developments / redevelopments with 20 or more units.

- The affordable component could not be used to determine community benefits under Section 37. Section 37 would also not apply if the proposed development (with IZ) is in a location where a development / community planning permit is used.

- Municipalities would be required to offer incentives to help offset the IZ cost burden, but only if the development is not subject to a development / community planning permit. The incentives could include a waiver or reduction in application fees, parkland dedication fees, development charges, and so on. These offsets are very important to the industry and the affordability of the market rate units. But interestingly enough, increases in height and/or density are not being contemplated as a possible incentive or financial contribution.

- The financial contribution would be based on the following formula: (A - B) x 0.4. A is the total sum of the average market price for all of the affordable housing units and B is the total sum of the affordable price for all of the IZ housing units. In other words, the intent is that municipalities would be required to offset 40% of the costs associated with providing the affordable units.

Click here for the rest of the draft regulation. The OHBA also published this media release following the draft. They like the “partnership model” but were advocating for a 50/50 public/private cost share on all government-mandated units.

If you’re looking for more reading on inclusionary zoning, check here, here, and here.

Photo by Omair Khan on Unsplash