EAST PALO ALTO
CITY COUNCIL
STAFF REPORT
DATE: July 18, 2023
TO: Honorable Mayor and Members of the City Council
VIA: Melvin E. Gaines, City Manager
BY: Karen Camacho, Housing & Economic Development Manager SUBJECT: Inclusionary Housing In-Lieu Fee Update
Recommendation
Adopt a resolution updating the Inclusionary Housing In-Lieu Fees for Fiscal Year 2023-24, an amount of $259,600 for Ownership/For-Sale and $289,000 for Rental, or some other alternative approved by Council.
Alignment with City Council Strategic Plan
This recommendation is primarily aligned with:
· Promote Housing, Economic and Workforce Development
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); and · 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 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; rather than build affordable units, the developer would pay 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 2C, as adopted by the City Council on October 20, 2020, by Resolution No. 141-220 (see Attachment 3).3 This analysis sets the methodology for calculating Inclusionary In-Lieu Fees and subsequent increases.4 The first Inclusionary In-Lieu Fees were adopted by the City Council on October 20, 2020, by that same resolution.5 The Analysis section below provides an explanation for the new methodology being recommended for calculating Inclusionary In-Lieu Fees and subsequent increases (also see Attachment 2).
The data used to calculate the Inclusionary In-Lieu Fees is not released in time to be included in the City’s Master Fee Schedule update which typically occurs in April. For this reason, Inclusionary In-Lieu Fees are considered through a separate resolution each year.
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 2023-24. The current Fiscal Year 2022-2023 (FY 22-23) In-Lieu Fee for an Ownership/For-Sale unit is $190,000 and the In-Lieu Fee for a Rental unit is $259,000. The recommended Fiscal Year 2023-2024 (FY 23-24) In-Lieu Fees are $259,600 for an Ownership/For-Sale unit and is $289,000 for a Rental unit.
Analysis
The recommended FY 23-24 In-Lieu Fees are calculated with different methodologies from those outlined in the City’s Inclusionary Housing Ordinance’s initial Guidelines (see Attachment 2). The initial Guidelines’ methodology, explained below, results in In-Lieu Fees for an Ownership/For-Sale unit increasing 104-percent from $190,000 to $386,700 per unit. The California Department of Housing and Community Development (HCD) provided concerns about the impact of the City’s IHO in their comments on the City’s proposed Housing Element.6 The Council may study the issue to determine the cost impacts of this and other fees and set the level of this and other fees accordingly. Alternatively, staff recommends that the Council approve an alternative methodology that would increase the In-Lieu Fee for Ownership/ForSale units by less than what the Guidelines allow, as explained more fully below.
The Guidelines’ methodology for calculating In-Lieu Fees for Rental units, also explained below, requires a data source that is no longer available. Therefore, staff recommends an alternative data source be used to calculate the In-Lieu Fee for Rental units.
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 on October 20, 2020.
Thereafter, pursuant to East Palo Alto Municipal Code Section 18.37.090(D), the City Manager is authorized to update the Guidelines, including reviewing and approving any changes or updates. 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.7
The Inclusionary In-Lieu Fees are updated by Housing Division staff on an annual basis using the methodology provided in the Guidelines. The initial methodology, including the calculation of the first In-Lieu Fees, was outlined in detail in a staff report8 that was presented at the October 20, 2020 City Council meeting. 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.
Since adoption of the IHO, the Inclusionary In-Lieu Fees have been as follows:
Table 1: Inclusionary In-Lieu Fees
Since Inclusionary Housing Ordinance Adoption
FY 2021-
2022
FY 2022-
2023
Potential FY
2023-2024
(Initial
Methodology)
Recommended
FY 2023-2024
(New Proposed
Methodology)
Ownership/For-Sale InLieu Fee$197,880 $190,000 $386,700 $259,600 Rental In-Lieu Fee $255,000 $259,000 Not Available $289,000 In last year’s FY 22-23 update, the Ownership/For-Sale In-Lieu Fee decreased from $197,000 to $190,000 due to a combination of multiple factors that go into the calculation, but primarily because interest rates decreased from 3.5% to 3.22%. The Rental In-Lieu Fee increased due to the increase in new home sales prices from $1,429,009 in 2020 to $1,452,688 in 2021.
Initial Method to Calculate Ownership/For-Sale In-Lieu Fee 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% Area Median Income (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.9 Please note in Chapter 2A, the figures are displayed without decimals and only show the nearest whole number. The in-lieu fee is not rounded until the very end of the calculation. The DRA memo, dated April 27, 2020 and provided in the Guidelines as Chapter 2C (see Attachment 3), 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. For the calculations in Table 2, below, the 100% AMI amounts used were $140,000 for a 2-person household and $157,500 for a 3-person household, taken from the 2023 HCD State Income Limits.10 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 FY 23-24 Ownership/For-Sale In-Lieu Fee is summarized below:
Table 2: Fiscal Year 2023-2024
Ownership/For-Sale Housing In-Lieu Fee Calculation*
Affordable Price for 100% AMI Household $412,000
Market Sales Price $792,000
Gap for In-Lieu Fee (100% AMI) $379,000 per unit
2% Increase Due to Delay $8,000 per unit
Ownership/For-Sale In-Lieu Fee $386,700 per unit
*Figures are rounded to the nearest thousandth in this chart, with exception of the in-lieu fee, which is rounded to nearest hundredth. Note that numbers are not rounded in actual calculation until the end.
Challenges with the Current Ownership/For-Sale In-Lieu Fee Calculation Methodology The principal challenge with continuing using the initial Guidelines’ methodology is that a slight percentage change in interest rates from one year to another creates a more volatile change in Ownership In-Lieu Fees. For example, the Ownership In-Lieu Fee would increase by 104% from FY 22-23 to FY 23-24 if the City Council chose the methodology used in the initial Guidelines. The main factor causing the 104% increase is, in addition to other factors, the change in interest rates for 30-year loan terms from 3.22% to 6.48%. Given HCD’s guidance in the Housing Element on reducing governmental constraints, the City Council may wish to consider an alternative method. A three-year average approach, as described in the next section, may anchor the interest rate to the previous three years, creating more continuity between in-lieu fee updates.
Summary of Ownership/For-Sale In-Lieu Fee Trend:
· Ownership/For-Sale In-Lieu Fee for FY 21-22 = $197,880 (initial calculation) · Ownership/For-Sale In-Lieu Fee for FY 22-23 = $190,000 (-0.28% in 30-year loan term interest rates; -$7,880 or -4% in per unit fees)
· Ownership/For-Sale In-Lieu Fee for FY 23-24 = $387,700 (+3.26% in 30-year loan term interest rates; +$197,700 or +104% in per unit fees)
Alternative Method to Calculate Ownership/For-Sale In-Lieu Fee An alternative method for calculating the Ownership/For-Sale In-Lieu Fee is, all else being the same, taking a three-year average of the 30-year loan term interest rates taken from the Freddie Mac Mortgage Market Survey. A three-year average would help reduce volatility and increase the FY 23-24 In-Lieu Fee by only thirty-seven percent.
The recommended Alternative Ownership/For-Sale In-Lieu Fee is summarized below:
Table 3: Alternative Fiscal Year 2023-2024 Ownership/For-Sale Housing In-Lieu Fee Calculation with Three-Year Average Interest Rate*
Affordable Price for 100% AMI Household $537,000**
Market Sales Price $792,000
Gap for In-Lieu Fee (100% AMI) $255,000 per unit
2% Increase Due to Delay $5,000 per unit
Ownership/For-Sale In-Lieu Fee $259,600 per unit
*Figures are rounded to the nearest thousandth in this chart, with exception of the in-lieu fee, which is rounded to nearest hundredth. Note that numbers are not rounded in actual calculation until the end. **Calculated based on three-year average of 30-year loan term interest rates.
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.
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 (RERCSC). This report is no longer available. In addition, staff were unable to find an alternative data source that calculates the percentage change in new home prices in San Mateo County.
As an alternative data source, staff is recommending updating the annual increase adjustment using the Construction Cost Index (CCI), already used at the City for calculating impact fees.
The CCI can help reduce volatility by using construction costs, rather than new home prices, as an index. The calculation of the updated FY 23-24 In-Lieu Fee is shown below; the calculation of the initial Rental In-Lieu Fee is provided in Chapters 2B and 2C of the Guidelines.
The initial calculation of the Rental In-Lieu Fee, starting in 2020, came to $255,000 per unit.
Last year, the Rental In-Lieu Fee increased by 1.66%, as new home prices in San Mateo County increased from a $1,429,009 to $1,452,688 in 2021. Had the CCI been used last fiscal year, the Rental In-Lieu fee would have increased by 7.25% to $273,800.
The Rental In-Lieu Fee and methodology used last year (in FY 2022-23) is summarized below:
Table 4: FY 2022-2023 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. Rental In-Lieu Fee rounded to nearest hundredth.
Given that the CCI was not used as the index last year, the increase for FY 23-24 is set based on the increase in CCI between 2020 and 2022.
Table 5: Alternative Rental Housing In-Lieu Fee Calculation in Fiscal Year 2023-2024 Using CCI
FY 2021-2022 Rental In-Lieu Fee $255,000
December 2020 CCI 11,626
December 2022 CCI 13,175
Percentage Change +13.32%
FY 23-24 Rental In-Lieu Fee (13.32%
increase)
$289,000
*Figures are rounded in this chart. Rental In-Lieu Fee rounded to nearest hundredth.
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 be spent in accordance with applicable law.
Next Steps
If City Council adopts the proposed resolution approving the recommended In-Lieu Fees, effective through FY 22-23, 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:
First In-Lieu
Fee
Previous Year Calculation
Using Initial
Methodology
Staff
Recommended
Alternative
FY21-22 FY 22-23 FY 23-24 FY 23-24
For-Sale $197,880 $190,000 $386,700 $259,600
Rental $255,000 $259,000 Not Available $289,000
The effective date for the In-Lieu Fees is July 18, 2023.
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 23-24. 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 23-24.
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 July 7, 2023 San Mateo Daily Journal. 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 proposed action does not constitute a “project” with the meaning of the California Environmental Quality Act (“CEQA”) pursuant to CEQA Guidelines sections 15378(b)(4) and (5) in that it is a governmental fiscal, organizational or administrative activity that will not result in direct or indirect changes in the environment.
Attachments
1. Resolution
2. Draft Chapters 2A and 2B
3. Chapter 2C DRA Report