June 2014

Last month Calgary mayor, Naheed Nenshi expressed an interest in mandatory inclusionary zoning to force developers to apportion a percentage of the units they are building for affordable housing (Nenshi senses housing crisis, G&M Mar 28th). While this will no doubt confront resistance from the development community, it is founded on a fair and reasonable argument, the concept of “planning gain”.

It is the public act of regulation and granting development approval that creates the value in land. As such, using this regulatory power is one of the few tools that governments have to generate revenues or “in kind” contributions without dipping into the tax-payers pocket. Although developers will argue that this is an onerous and unfair tax targeting developers, their case is weak. This is a widespread practice in the UK and in over 300 jurisdictions in the US, including high cost cities like Boston and San Francisco. Enabling legislation in some Canadian provinces also permits bonusing (exchanging density for a public benefit).
In effect, granting development permission creates money from nothing. The value of land is based on what an owner can do with that land. If it is zoned as bare land it has no value. If zoned to allow a single dwelling the land will have a value based on its potential price less the cost to build the house. So, for example, if the house can potentially be sold for $400,000, and it costs $300,000 to cover the cost of materials, labour and related soft costs like permits, legal fees and developer profit, the value attributable to the land is $100,000.

This is the maximum amount a rationale developer would pay to buy the land for development.
If a land-owner goes to bed early on the evening of a council meeting, and while sleeping the council approves a rezoning plan to permit a density of 10 dwellings on that lot, the value immediately increases. If we assume all costs and prices increase by 10, the total sales value is now $4 million, total costs are $3 million and the land value is $1 million. This increase in value is entirely attributable to the decision by council to increase the density. It is a pure windfall gain to the land owner who wakes up next morning as a millionaire.

Under such circumstances it is not unreasonable for the council to impose a condition in the rezoning that some percentage of the units (e.g. 15-20%) be built to a more modest standard and made available at prices or rents that would be affordable. So the land owner still retains the majority of the planning gain, but also contributes to creating a community asset.
Some US jurisdictions and the UK require such units to be built at cost (i.e. no profit, but builder recovers his costs) with ownership then transferred to the municipality which then used the units in the municipal affordable rental programs; other municipalities sell them as affordable entry level homes, with conditions restricting resale.

Obviously this over simplifies the case. In reality, rezonings don’t occur without the active involvement of the landowner or a conditional purchaser. And the developer incurs costs and risks as part of this process, but there is nonetheless a direct benefit and planning gain related solely to the council decision to rezone.

Land values are also influenced by the planning framework. If the City’s Official Plan proposes intensification, developers anticipate in advance that they will be able to build more units and thus are willing to bid more for land.

Effectively the market capitalizes the expected future value in bidding up the land value. This is why developers argue that it is an unfair tax. But they bid based on expectation of a favourable public decision to increase density.

If the planning system signals in advance that inclusion of affordable housing is a condition, the market will factor in this cost. To avoid such capitalization and thus resistance, it is critical to reform the planning process to give advance notice and to establish an as of right density and additional conditional density provisions. The developer will then price in the cost to provide the conditional uses or amenities.