EAST PALO ALTO
CITY COUNCIL
STAFF REPORT
DATE: June 7, 2022
TO: Honorable Mayor and Members of the City Council
VIA: Patrick Heisinger, Interim City Manager
BY: Karen Camacho, Housing Project Manager
Rachel Horst, Housing and Economic Development Manager
SUBJECT: Inclusionary Housing In-Lieu Fee Update for FY 2022-23 Recommendation
It is recommended that the City Council adopt a Resolution establishing Inclusionary In-Lieu Fees for Ownership/For-Sale and Rental Units for Fiscal Year 2022-23.
Alignment with City Council Strategic Plan
This recommendation is primarily aligned with:
Priority No. 2: Enhance Economic Vitality
Background
On November 19, 2019, the City Council adopted Ordinance No. 425 – Inclusionary Housing Ordinance (IHO), adding Chapter 18.37 to the City of East Palo Alto Development Code. The IHO applies to all new residential development and requires developments of five (5) or more units to provide 20% of the total units at specified levels of affordability.1 The IHO also created an In-Lieu Fee requirement, which applies in the following scenarios:
• Developments of fewer than five units
• Developments where the inclusionary requirement results in a fraction of a unit (e.g., in a 7-unit development, the inclusionary requirement would result in 1.4 units, with the fractional unit of .4 requiring an In-Lieu Fee payment) • Developments where an In-Lieu Fee payment is provided as the Alternative Compliance Option, as approved by City Council (Alternative Compliance Options have a 25% inclusionary requirement)
Section 18.37.050 provides for In-Lieu Fees for both rental and for-sale units, which are 1 The inclusionary requirement for for-sale residential developments is to provide: 50% of units priced affordable to households at or below 80% area median income (AMI) and 50% of units priced affordable to households at or below 120% AMI. The inclusionary requirement for rental developments is to provide: 25% of units at an affordable rent to households at 35% AMI; 50% of units at an affordable rent to households at 50% AMI, and 25% of units at an affordable rent to households at 60% AMI. adopted by the City Council by resolution each year to take effect on or after July 1 of that year. The purpose of the In-Lieu Fee is to fulfill the developer’s obligation to produce affordable units by providing the City with funds for 1.) future development of affordable rental housing or
2.) future subsidy to moderate-income homebuyers.2
An analysis by David Rosen & Associates (DRA) is included in the Inclusionary Housing Guidelines (“Guidelines”) as Chapter 3C, as adopted by the City Council on October 20, 2020, by Resolution No. 141-220. This sets the methodology for calculating Inclusionary In-Lieu Fees and subsequent increases.3 The first Inclusionary In-Lieu Fees were adopted by the City Council on October 20, 2020, by this same resolution.
The data used to calculate the Inclusionary In-Lieu Fees is not released in time to include them the City’s Master Fee Schedule update each April. For this reason, Inclusionary In-Lieu Fees must be adopted separately each year.
The current In-Lieu Fee for an Ownership/For-Sale unit is $197,880 and the In-Lieu Fee for a Rental unit is $255,000. The purpose of this staff report is to update the Inclusionary In-Lieu Fees for both Ownership/For-Sale and Rental and to recommend City Council adoption of the fees for Fiscal Year 2022-23.
Analysis
Inclusionary Housing Guidelines and In-Lieu Fees
The IHO provides direction on the methodology by which In- Lieu fees will be calculated. The actual In-Lieu Fee calculations are provided in detail in the Guidelines, the companion document to the IHO that clarifies and elaborates upon the IHO requirements. The Guidelines are intended to assist potential developers and stakeholders by outlining instructions and further clarifying key components of the IHO.
The City Council reviewed and adopted the first edition of the Guidelines. Thereafter, the City Manager reviews and approves any changes or updates. It should be noted that if there are any inconsistencies between the Guidelines and the IHO, the IHO takes precedent. The full set of the Guidelines is provided on the City’s website on the Inclusionary Housing page.4 The Inclusionary In-Lieu Fees are updated by Housing Division staff on an annual basis using the methodology provided in the Guidelines. This methodology, including the process for updating the In-Lieu Fees, was outlined in detail in the staff report from October 20, 2020.5 Each year thereafter, the City Council adopts the updated Inclusionary In-Lieu Fees at a public hearing, and they subsequently are published on the City’s website.
Ownership/For-Sale In-Lieu Fee
2 As a reminder, a developer must request approval from the City Council to pursue the In-Lieu Fee payment as an Alternative Compliance Option. Development projects for which an Alternative Compliance Option is requested must therefore be approved by the City Council.
3 The updated chapters for the For-Sale In-Lieu Fee and the Rental In-Lieu Fee methodologies were posted on the City’s inclusionary housing webpage at: https://www.cityofepa.org/housing/page/inclusionary-housing. 4 Please see: https://www.cityofepa.org/housing/page/inclusionary-housing 5 Please see:
http://eastpaloalto.iqm2.com/Citizens/Detail_LegiFile.aspx?Frame=&MeetingID=1285&MediaPosition=9022.756&ID=1435&CssClas s=
The Ownership/For-Sale In-Lieu Fee represents the gap between the market sales price of a “prototypical” unit in East Palo Alto and the sales price affordable to a household at or below 80% or 120% AMI. The affordable housing cost is defined as 30% of the maximum household income at the specified income level (adjusted by household size).
An illustrative calculation of the Ownership/For-Sale In-Lieu Fee is provided in Chapter 2A of the Guidelines. The DRA memo, dated April 27, 2020 and provided in the Guidelines as Chapter 2C, further discusses the For-Sale In-Lieu Fee methodology in detail.
The In-Lieu Fee calculation includes the following baseline assumptions: 1.) a household size of 2.5, which reflects an average condominium size using the occupancy standard of number of bedrooms plus one; and 2.) a maximum household income of 100% AMI, which is the average of the two affordability levels required by the IHO.
The affordable sales price is a multi-step calculation requiring updated inputs on an annual basis. The initial calculation of the affordable housing cost for a maximum household income at 100% AMI is made separately for household sizes of 2 and 3 persons. To arrive at a single affordable sales price for a 2.5-person household at 100% AMI, a weighted average based on the distribution of prototypical condominium types (1- and 2-bedroom units) is calculated from the 2- and 3-person household AMI.
From this initial income calculation, deductions are made to estimate total monthly housing costs: utilities, HOA fees, insurance, and property taxes. This adjusted affordable housing cost is used to calculate the maximum supportable monthly mortgage amount, assuming a down payment of 5% and a fixed-rate, 30-year amortizing mortgage, with the interest rate taken from the Freddie Mac Mortgage Market Survey in the first week of January of the calendar year.
The market sales price is calculated as a weighted average of condominium sales in East Palo Alto over the previous 3-year period. The difference between the affordable sales price and the market sales price is the In-Lieu Fee.
The updated Ownership/For-Sale In-Lieu Fee is summarized below:
Ownership/For-Sale Housing In-Lieu Fee Calculation*
Affordable Price for 100% AMI Household $754,000
Market Sales Price (3-Yr SMC Association
of Realtors Average)
$568,000
Gap for In-Lieu Fee (100% AMI) $186,000 per unit
2% Increase Due to Delay $4,000 per unit
Ownership/For-Sale In-Lieu Fee $190,000 per unit
*Figures are rounded to the nearest thousandth in this chart.
Rental In-Lieu Fee
As discussed in the DRA memo, provided in the Guidelines as Chapter 2C, the In-Lieu Fee estimates for rental housing represent the financing gap required to develop housing affordable to households at 35% AMI, 50% AMI, and 60% AMI, in the percentages required by the IHO.
The development and operating cost assumptions were used to calculate the gap for a “prototypical” multifamily housing development in East Palo Alto are based on a review of historical project costs and an analysis of 2017-19 applications for the Low Income Housing Tax Credit program. These can be found in detail in Table A-3 of the DRA memo in Chapter 2C of the Guidelines. Note that the prototypes include housing developments with structured and surface parking; the final In-Lieu Fee reflects a structured parking development.
The annual gross rent calculation was based on 30% of the maximum household income at specified AMI levels and household size, less utilities. The final gap calculation, shown in Table A-10 of the DRA memo, also assumes tax credit equity from 4% tax-exempt bonds.
The Rental In-Lieu Fee is adjusted annually by staff based on the percentage change in new home prices in San Mateo County, as published in the Northern California Real Estate Construction Report by the Real Estate Research Council of Southern California at California State Polytechnic University, Pomona. This report requires an annual membership.
Housing Division staff based the Rental In-Lieu Fee adjustment on the Fourth Quarter Real Estate and Construction Report of the previous year. The calculation of the updated In-Lieu Fee is shown below; the calculation of the original Rental In-Lieu Fee is provided in Chapters 2B and 2C of the Guidelines.
The Rental In-Lieu Fee for 2022-23 is summarized below:
Rental Housing In-Lieu Fee Calculation*
FY 2021-22 Rental In-Lieu Fee $255,000
New Home Prices Fourth Quarter 2020 $1,429,009
New Home Prices Fourth Quarter 2021 $1,452,688
Difference $23,679
Percentage Change 1.657%
2022 Rental In-Lieu Fee (1.657% increase) $259,000 per unit *Figures are rounded in this chart.
Please note that the notice for this public hearing incorrectly cited $259,255 as the increased In-Lieu Fee amount; this number should be rounded to $259,000.
In-Lieu Fee Payments
All In-Lieu Fee payments will be calculated by Housing Division staff and must be paid by the developer prior to issuance of a Building Permit for any unit in the development. If there is a requirement to pay an In-Lieu Fee in addition to building units or any other combination of compliance options, then the requirement will be noted in the Inclusionary Housing Agreement, a document that lays out all inclusionary obligations and is recorded against all units in the development.
To date, no developer has paid the In-Lieu Fee under the Inclusionary Housing Ordinance.
Most entitled projects have chosen to comply with the IHO by building on-site units or another Alternative Compliance Option.
According to the IHO, In-Lieu Fees collected by the City will be placed into a fund that will support ownership and rental affordable housing in East Palo Alto.
Next Steps
If City Council approves the current In-Lieu Fees, effective through FY 2022-2023, staff will publish them on the City’s website. If approved, in summary, the In-Lieu Fees will change from the current to the following:
FY21-22 FY 22-23
For-Sale $197,880 $190,000
Rental $255,000 $259,000
The effective date for the In-Lieu Fees is July 8, 2022.
Fiscal Impact
There is no immediate fiscal impact associated with the actions in this staff report. Future residential developments that are subject to the IHO will require the payment of In-Lieu Fees if they fit one of the descriptions provided above. In-Lieu Fee payments will not impact the General Fund but will be set aside as affordable housing funds.
Given the current housing pipeline, it is not anticipated that significant In-Lieu Fee revenue will be generated in FY 2022-23. However, there are some small projects that have been entitled since the In-Lieu Fees came into effect. If these projects proceed to the Building permit stage, the City will receive a fee payment. If needed, staff will provide an update on projected revenue for FY 2022-23.
Public Notice
The public was provided notice of this agenda item by posting the City Council agenda on the City’s official bulletin board outside City Hall and making the agenda and report available on the City’s website. Public notice was also provided in the May 27, 2022 Palo Alto Daily News.
Additionally, updated Chapters 2A and 2B of the Inclusionary Housing Guidelines detailing the fee calculations were posted as drafts on the City’s website.
Environmental
The action being considered does not constitute a “Project” within the meaning of the California Environmental Quality Act (CEQA), pursuant to CEQA Guideline section 15378 (b)(5), in that it is a government administrative activity that will not result in direct or indirect changes in the environment.
Attachments
1. Resolution