Three misconceptions about inclusionary zoning
Who really pays for IZ
Inclusionary zoning (IZ) requires developers of new housing to provide below-market homes. For example, 20% of new units in the building have to be offered at 50% of market-rate rents. But this common policy is widely misunderstood. Here are three misconceptions:
IZ makes developers pay for subsidized housing
Fact: landowners and new residents pay, not developers. IZ makes developers pay the cost of providing subsidized homes, which they can pass on to landowners by paying less for land. If the IZ cost is so high that developers cannot cover the landowner’s reservation price, then the project fails. Here, IZ delays supply until prices rise enough for the project to pencil; hence, the subsidized units are effectively paid for by new residents paying higher housing prices. IZ has a ratchet effect on prices, forcing them to only ever increase.
The below-market homes in an IZ building are cross-subsidized by the market-rate units in the same building.
Fact: funded IZ pays for below-market units by capturing surplus land value. Unfunded IZ pays for them by raising market rents city-wide. Developers cannot set above-market rents in their building, because renters would simply find cheaper rents elsewhere. Instead, developers have to wait for market rents to rise until the development pencils; this is the ratchet effect again.
IZ unambiguously improves housing affordability
Fact: unfunded IZ makes developments infeasible, reducing supply and increasing prices and rents. IZ causes a demand cascade from the high-end to the low-end markets, and creates more need for subsidized housing. IZ is a net-negative policy if it creates more need for subsidized housing than the number of subsidized units provided. Simply counting the number of IZ units created does not tell us whether it passes a cost-benefit analysis, since this ignores the harm of reduced supply.
Final thought: if some IZ is good, why not do more? Why not increase density everywhere to capture even more surplus land value? Every IZ building provides subsidized homes, so we should keep upzoning and keep adding more subsidized housing.
See my full writeup on IZ here.