Procedural and zoning barriers are proving to be only the beginning of the gauntlet for adding new ground-up residential supply to America’s housing-starved communities.
While removing red tape and outdated zoning laws might formalize more homes on paper, local fee structures still decide whether those homes are actually built.
California is a poster child for this tension.
Gov. Gavin Newsom and state lawmakers pursued housing abundance to improve affordability. The state desperately needs more units. Yet, lawsuits in California federal court reveal collisions between local fees and state reforms.
Those collisions – and the fees at their center – in and of themselves loom as entitlement, business and project risk if they stall projects or layer on new costs beyond the point where their sponsors can keep their upfront dollar investments in place.
The latest challenge focuses on inclusionary zoning fees in San Luis Obispo. This Central Coast city is located midway between San Francisco and Los Angeles.
The Pacific Legal Foundation sued the city on behalf of developers. The nonprofit public interest law firm challenges fees on a project that adds eight units. The plan includes four houses, each with an accessory dwelling unit.
The developer paid nearly $100,000 in inclusionary fees. Developers faced an alternative: a deed restriction on one parcel for income-restricted housing. That parcel – with a house and ADU – would have to sell for $450,000 with the city restriction. Each costs $1.325 million to build, according to the lawsuit.
“The City presented plaintiffs with two bad choices: give up their property rights by acquiescing to a deed-restricted IU, or pay nearly $100,000,” the March 4 lawsuit argued. “Of course, there was an unspoken third option: don’t build at all.”
The foundation argues that the fees violate the U.S. Constitution. It references Supreme Court rulings calling them “extortion.” The group has won similar cases in Healdsburg and East Palo Alto, leading to fee refunds.
City’s Ordinance
San Luis Obispo enacted its inclusionary housing ordinance in 1999. The city revised it in 2022 in response to state housing reforms. The ordinance’s goal is to ensure the development of permanently affordable units in new housing projects as part of mixed-income and anti-segregation efforts.
For-sale residential or mixed-use developers must construct inclusionary units equal to 10% of total units or pay in-lieu fees based on the square footage of habitable space.
The ordinance supports the city’s Affordable Housing Fund, which uses in-lieu fees and other sources to finance nonprofit, deed-restricted projects. Since 1999, it has helped create over 1,300 deed-restricted or affordable housing units through planning, entitlement, or construction.
Fee Impact
Developers say that fees often kill projects before public review. Inclusionary fees and set-asides look like fixed costs in pro formas. They require coverage from limited rents or sale prices.
Lenders and equity partners require minimum returns, such as 5% on cost or 15% margins in San Luis Obispo. Projects that don’t meet these returns after fees stall.
The fees are especially burdensome for affordable housing. According to a study by the Terner Center for Housing Innovation at the University of California Berkeley, those fees have increased significantly in recent years.
Extra in-lieu dollars or below-market units reduce debt-service revenue. Developers cannot always increase rents or prices in expensive markets. They offer less for land, but owners often refuse discounts.
Projects then stall or die before hearings. Ambitious fees thin housing pipelines. Red ink on spreadsheets reveals the stopping point.
YIMBY Push
California YIMBY advocates for legislation to reduce fees that hinder housing development and they’re making another push this year. The group scored major victories last year.
One bill would standardize housing applications across the state. The state housing department must develop the form by July 1. Cities and counties can accept it starting October 1.
The measure bars additional charges for using the form. It prevents “penalty” fees or submittals that increase costs. Existing impact or inclusionary fees remain uncapped.
Another bill, passed by the Assembly, awaits Senate action. It directs state officials to study simpler codes for 3- to 10-unit multifamily projects. It also mandates reports on the cost impacts of building standards.
National Tension
California lawmakers have revised zoning laws and approval processes to promote “housing abundance.” Cities like San Luis Obispo manage these outcomes through complex fee structures.
Three small San Luis Obispo builders invoked state laws, including ADU regulations, for a derelict lot. Local requirements increased costs.
The lawsuit highlights national tension. States streamline housing processes.
Local fees create barriers again, making projects only on paper.
“Unfortunately, that’s all too common an attitude among the city councils of America,” David Deerson, a Pacific Legal Foundation attorney, told The Builder’s Daily.
