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Chapter 7: Conclusions and Policy Challenges

Summary Of Projections And Findings

Household Demand Projections

Barring a major disaster or depression, California's population will grow from its current size of just under 34 million to 40 million by 2010, and to 45.5 million by 2020. While these are smaller growth increments than had previously been forecast, they represent a huge and ultimately transforming increase in the state's population. In terms of households—the basic building block of housing demand—California will add just over three million additional households between 1997 and 2010, and just over five million additional households by 2020. Because of California's changing demographic structure, the number of households will increase at a faster rate than the population. By 2020, California will be home to more than 16 million households.

More than half of California's projected household growth will occur south of the Tehachapi mountain range. Between 1997 and 2020, the greater Los Angeles metropolitan region (including Imperial County, but excluding San Diego County) will, we project, gain nearly 2.4 million additional households. In San Diego County, 1997-2020 household growth will exceed 400,000. Elsewhere in California, the San Joaquin Valley Metropolitan Region, stretching from Stanislaus County in the north to Kern County in the south, will add three-quarters of a million new households between 1997 and 2020. The nine-county San Francisco Bay Area will grow by more than 700,000 additional households. In the Sacramento Metropolitan Region, household growth between 1997 and 2020 will be just under 400,000.

Altogether, 95 percent of California's projected household growth will occur in existing metropolitan regions. This growth will put significant pressure on California's urban housing markets. Assuming that each additional household will need a housing unit, and no increase in overcrowding, California's single- and multi-family housing stock would have to expand by an average of 220,000 units every year between 1997 and 2020. Producing this amount of new housing on a sustained basis will be a stretch. Since 1987, average annual housing production in California (as measured by the number of permits) has averaged only 140,000 units per year. Annual production since 1990 has been much lower, averaging just over 100,000 units per year.

Cumulatively, statewide housing production lagged demand growth by 660,000 units between 1980 and 1989, and by 141,100 units between 1995 and 1997. (Because of the demand-depressing effects of the 1990-93 recession, housing production exceeded demand by 275,000 units between 1990 and 1994.) Production most lagged demand both in percentage and absolute terms in the state's coastal markets.

Should annual rates of housing production during the next twelve years mirror those of the last twelve, the future of housing in California will be one of extreme shortages. Among the state's major metropolitan regions, the six-county Greater Los Angeles Metropolitan Region would suffer an average yearly production deficit of 48,400 housing units. The eight-county San Joaquin Valley Metropolitan region would experience an average yearly deficit of 15,000 units per year, while the annual production deficit in the nine-county San Francisco Bay Area would exceed 12,000 units. New housing production would also lag demand in the San Diego and Sacramento area markets.

If current tenure trends hold, two-thirds of California's new households will want to be homeowners. Should annual rates of housing production during the next twelve years mirror those of the last twelve, the future of housing in California will be one of extreme shortages.

(Homeowners currently comprise an estimated 57 percent of California households.) Without some change in policy and development patterns, this preference for ownership—and for single-family ownership housing in particular—will favor suburban and "exurban" areas over older cities as the preferred location for new residential development.

Caveat: How Reasonable are These Projections?

At the heart of this study are projections of future household growth. How realistic are the assumptions underlying those projections, and how reliable are they likely to be?

The two key inputs into household projections are population projections and headship rates. This report draws on the most recent population projections published by the California Department of Finance (DOF). DOF's population projections are based on the assumption that current fertility rates, as disaggregated by the age and race of the mother, and current migration rates, as estimated from school enrollment and driver's license records, will remain valid for the foreseeable future.

What could happen to change these rates? Should the California economy grow more slowly than projected, migration rates would likely decline. With fewer people moving in—and more possibly moving out—the number of births would decline. The result would be a decline in projected population growth. If the economic situation were to become dire enough, out-migration could begin to exceed in-migration, something that has happened only once in the last 50 years. If this were to happen on a prolonged basis, California's population would begin to level off.

One way to think about this is to compare DOF's current population projections, which fully account for the effects of the 1990-93 recession, with its previous 1993 population projections, which did not. According to DOF's 1993 projections, California would have been home to 42.5 million residents by 2010 and 49 million by 2020. Instead, according to DOF's more recent 1998 projections, California will be home to 39.9 million residents in 2010 and 45.5 million in 2020. Despite some significant changes in the state's economy, the differences between these two sets of projections are not very large. Thus, barring some natural or economic calamity, California will, in all probability, add six to seven million new residents by 2010, and twelve to thirteen million residents by 2020. Even at the bottom end of these ranges, California will still grow a lot, and remain the nation's population growth leader.

Headship rates are the second determinant of projected household growth. Headship rates measure the tendency of a population with particular demographic characteristics (e.g., age, gender, and ethnicity) to form households. All else being equal, higher headship rates will generate more households from a given population. Lower headship rates will generate fewer households. The household projections presented in this report were generated assuming no change in 1990 headship rates as calculated from the 1990 Census.

How are headship rates trending? From the end of World War II through 1980, U.S. and California headship rates trended upward fairly consistently. Headship rate trends since 1980 have been harder to identify, mostly because of increased rates of foreign immigration.

In fact, headship rates for many of California's age and ethnic cohorts trended downward during the 1980s. If this were to continue, we estimate it would reduce projected 1997-2010 household growth from 3.0 million to 2.5 million; and 1997-2020 household growth from 5.1 million to 4.4 million. Instead of needing 220,000 additional housing units every year, the State would need 190,000. This is a significant reduction to be sure, but it still represents a substantial increase over recent production levels.

Because California's population is changing so rapidly, it is also conceivable that headship rates for some cohorts might increase, not decrease. If this were the case, the demand for housing from those cohorts would also increase. The fact that there are so many uncertainties surrounding the forecasting of future headship rates points to the need for more detailed research into the long-term determinants of headship rates and household composition.

Another question mark concerns future homeownership rates. Based on their demographic characteristics, most new California households will be strongly inclined toward homeownership. Yet if becoming a homeowner were based on demographic characteristics alone, the state's homeownership rate would quickly rise from its current level of 57 percent to well above 65 percent.

Regrettably, without some change in state housing and land use policies, many households who want and should be able to afford to become homeowners will not be able to do so. Instead of going up as it should, California's homeownership rate might actually decline, especially in expensive-yet-fast-growing coastal areas. Should this happen, it will put even more pressure on the already-sluggish rental housing sector. Developers will respond by building apartments where they can make money and where the entitlements process allows them to build. This may not be in the same places or market segments where there is the greatest demographic demand.

If California developers and homebuilders are to meet projected homeownership and rental housing demands, they will need an adequate supply of sites and capital. They will also need to operate within a regulatory environment that makes it possible to build housing when and where it is needed, and at prices that future Californians can afford. To what extent are these essential inputs into the housing production process likely to be available?

Land Availability

California is a huge state, and except in a few locations, has ample land to grow. To determine how much land is potentially available, we went through a process of successively eliminating sites deemed inappropriate for development because they were either too far from existing services, currently in high-value agricultural use, or environmentally unsuitable. As of 1996, the 35 metropolitan counties for which data are available included approximately 3.5 million acres of urbanized land, 32 million acres of public or undevelopable land, and nearly 25 million acres of potentially developable land.

Excluding sites more than 10 kilometers from a major highway or urban area reduces this total to 17.2 million acres.
Eliminating wetland areas further reduces it to 16.3 million acres.
Prohibiting urban development on lands designated as in prime or unique agricultural use would leave 11.3 million acres of potentially developable land.
Excluding floodzones and sites identified as habitat to significant numbers of endangered species would reduce developable land supplies to 8.1 million acres.

Statewide, this amount of land would be sufficient to accommodate projected household growth through the year 2020 more than three times over. As with everything in California, land availability and development capacity will vary by region. Allowing for appropriate reserves, Los Angeles, Orange, and Santa Clara will lack sufficient vacant suburban land to accommodate projected household growth through 2010. Four other counties, Alameda, Contra Costa, San Diego, and Ventura, will start running low on vacant or raw land soon after 2020.

If development were to be further restricted by public policy, say through the adoption of a series of one-mile urban growth boundaries (UGBs), three counties with otherwise adequate land supplies—Fresno, Stanislaus, and Yolo—would start running low on vacant developable land before 2010. Five other counties—Kern, Los Angeles, Madera, San Joaquin, and Santa Clara—would not have sufficient land reserves.1* The constraining effects of UGBs would be most strongly felt in the Central Valley, where many cities are already flush-up against prime farmlands.

In fact, California's residential development capacity may be much greater than these estimates indicate. Residential development densities rose significantly during the last decade, particularly in metropolitan areas. This trend suggests that it may be possible to accommodate much of California's anticipated population and household growth in housing forms that consume less land than has traditionally been the case. Assuming, for example, that future housing were developed at more recent "marginal" densities rather than at traditional "average" densities, the amount of raw land required to accommodate projected 2010 household growth in the 35 urban counties studied would decline by 48 percent.

Two sets of caveats apply to these findings. The first is that they are not based on local general plans or zoning ordinances. We did not consider, for example, whether or how particular jurisdictions might or might not increase their developable land supplies and zoned densities to accommodate projected housing demand.

A second set of caveats concerns redevelopment, infill, and land reuse. From 1988 through 1996, California's 360-plus active redevelopment agencies (RDAs) produced 42,000 new housing units and rehabilitated 32,000 existing units. Statewide, housing production by RDAs accounted for 4.2 percent of total 1988-96 residential production. Some RDAs did more than their share. In Santa Clara County, for example, RDA-sponsored housing accounted for 21 percent of total residential permits between 1988 and 1996.

Measured on an annual basis, RDA-production varied from a low of 2,000 units in 1991, to a high of 7,000 units in 1994. These findings suggest that redevelopment agencies as currently structured can play a significant, albeit moderately-sized role in meeting projected housing needs through both new construction and rehabilitation—especially in older areas. However, if infill development is to play a larger role in accommodating California's housing demand, the function of local RDA's may need to be expanded.

Infill and smart growth are current popular planning concepts. Supported by a host of "good development" organizations, cities around the country are trying to figure out how they can promote residential development in downtown and in-town neighborhoods. If these efforts are to be successful, they must rest on a strong factual and experiential basis —which, as of yet, does not exist. No one knows how much infill housing has or is being developed anywhere in California. Nor is the potential for future infill housing well understood. No one in any major California city knows how much land is available for infill development. Site availability, by itself, is only part of the infill equation. Market conditions, relative land prices, local regulatory policies, and subsidy availability influence infill construction levels far more than land availability. Until these diverse factors are systematically inventoried, assessed, and analyzed, pro-infill policies will be mostly guesswork.

Capital Availability and Cost

Real estate development is incredibly capital-intensive. Without a regular—and hopefully affordable—supply of equity and debt for land and infrastructure development, building construction, and long-term mortgages, housing production in California would grind to a halt.

Will California have access to enough private and public capital to meet its long-term housing needs? And will it be available in the right forms and for the types of products that are needed most? Short of a major meltdown in world financial markets, the answer to the first question is yes; the answer to the second is maybe.

Successive rounds of financial deregulation and the emergence of a vital secondary market have for many years provided liquidity for single-family mortgages throughout the United States, and provided strong and consistent funding for homeownership. More recently, a broader secondary market has also emerged for multi-family mortgages. So, while more capital is available for housing today than at anytime in the past, it is highly disciplined capital. What this means is that the ability of a particular project or housing sector to attract equity and/or debt capital will depend foremost on its ability to generate competitive, risk-adjusted returns.

By these criteria, single-family mortgages should be readily available for the foreseeable future throughout California. The risk of lending on single-family housing remains low, even during recessionary periods. For lenders, California's long-term history of escalating home prices makes it comparatively easy to underwrite home mortgages, whether they are resold in the secondary market or remain in portfolio.

For moderate-income households (those with incomes between 80 percent and 120 percent of area median income) and those seeking to buy homes in places where prices are not rising—principally central city and rural locations—the future availability of single-family mortgages will depend on the willingness of HUD, the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC), the USDA's Rural Housing, and to a lesser extent, the Federal Reserve, the Federal Home Loan Bank, and the Office of Thrift Supervision to work with private lenders to expand the pool of available loan capital.

On the multi-family side, the picture is more muddled. Except in overheated markets like San Francisco and Silicon Valley, average apartment rents are far below the levels required to attract new investment capital. Average rents must rise if enough new apartments are to be built to meet demand. The multi-family debt market is also in disarray. Recent volatility in the commercial mortgage-backed securities (CMBS) market has put a number of commercial mortgage conduits and mortgage REITs under financial pressure. Following investors, most commercial banks are not interested in originating new multi-family loans. Large pension funds like CALPERS, who made major equity and debt commitments to apartments in the early and mid-1990s, have shifted their recent investments toward better-performing assets.

Inevitably, the multi-family market will straighten itself out. Investment and debt capital will return as rents rise. Increasing security for apartment mortgages by private conduits as well as by Fannie Mae and Freddie Mac will increase the supply and lower the cost of mortgage debt. When this resurgence takes place, and whether it occurs where new multi-family units are most needed, is not certain.

The availability of debt capital for developing public infrastructure will depend on how it is used. At the municipal level, the availability of unrestricted debt —which in California is raised through the issuance of general obligation bonds—remains limited under the 2/3-voter-approval requirement imposed by Proposition 13. Over time, California municipalities have moved away from general obligation bonds and toward more restricted debt forms such as revenue bonds, lease obligation bonds, special assessment district bonds, and revenue anticipation (redevelopment) bonds. Because bond repayments are tied to particular assets and income streams, not general revenues, voter approval is rarely required. Depending on a jurisdiction's credit rating, and whether or not interest payments are tax-exempt, the cost of public debt financing is usually 25 to 200 basis points below the cost of comparable corporate debt.

Worries and frequent statements to the contrary, most California jurisdictions are not over-indebted, and have had little trouble accessing additional public debt. Adjusted for inflation, per capita borrowing by California city and county governments has more than tripled since the early 1980s.

More significant than changes in the amount of debt are changes in its use. Continuing a long-term trend that began with Propositions 13, California cities are finding it ever more difficult to fund housing-related public facilities and infrastructure. Instead, such infrastructure is increasingly being funded through impact fees and developer exactions. In the Bay Area, impact fees and required exactions may already exceed $30,000 per unit and account for more than 15 percent of total housing production costs.

Alternatively, developers and homebuilders have funded more localized public facilities through the creation of Mello-Roos and Marks-Roos districts. Cumulatively, this patchwork system provides a uniformly high level of infrastructure quality to upper-income developments, a moderate and uneven level of infrastructure quality to middle-income developments, and no net improvement in infrastructure quality to infill and entry-level developments. How much further this patchwork system of infrastructure finance can be extended without collapsing under its own weight is uncertain.

Land acquisition and site development are the riskiest steps in the homebuilding process. Accordingly, the capital provided by banks and investors for these purposes has always commanded relatively large risk premiums. More recently, according to some sources, the availability of institutional debt financing for land acquisition and improvement loans—at any rate—has declined. If the supply of land development capital remains constrained on an ongoing basis, it would adversely affect the pace of land development and ultimately housing construction.

Funding availability for affordable housing can only be evaluated in comparison to current and future needs. If, as projected, the number of California households grows to 16.2 million by 2020, and if the current percentage of households who are both low-income and are over-paying for housing stays constant at 22 percent, then the number of low-income households needing some form of housing assistance would increase from its current level of 2.4 million to 3.7 million by 2020. In fact, this projection may be too low. Because affordable housing needs track with rents, a slowdown in rental housing production (for whatever reason) will cause rents and therefore affordable housing needs to climb.

Most funding for affordable housing in California, as in every state, is provided by the federal government. In 1998, we estimate, federal housing assistance to California totaled approximately $1.2 billion, not including tax expenditures associated with the mortgage interest deduction. Future funding levels for some federal housing programs, including Community Development Block Grants, the Low Income Housing Tax Credit program, and Section 8, look generally secure, and may actually increase. The future of other programs is less clear, and will likely depend on who occupies the White House and which party controls Congress. Regardless of which way the political winds blow in Washington, federal housing assistance levels to California in the future—as in the past—will be substantially inadequate when measured against the level of need.

Lastly, many affordable housing non-profits are finding they have to work harder just to keep pace. Competition for LIHTC funds remains keen, from other non-profits and from for-profit developers. Non-profit sponsors are also having problems competing with for-profit developers for well-located sites.

Regulatory Constraints

The local regulatory process in California is hugely irritating to builders and developers, yet it is difficult to assess what exact effect it has had on housing costs and production levels. Part of the difficulty lies in the fact that the approvals process is administered differently in every city and county. Under California law, the local regulatory process is highly discretionary. It is, moreover, constantly changing in response to shifting fiscal conditions and popular concerns over growth. Never overtly friendly to housing, the process has in recent years become even less so.

The development-approvals process in California is supposed to be plan-driven. Plans imbue the development approvals process with a degree of consistency and certainty. De-emphasizing plans robs the process of those characteristics. All California cities and counties are required by law to have valid general plans (including detailed housing elements) and zoning ordinances that are supposed to be fully consistent with them. In fact, the existence of the California Environmental Quality Act (CEQA), the ease with which general plans may be amended, and the widespread adoption of various growth management programs and alternative planning structures have all served to increase the amount of discretion local governments—and thus indirectly, citizens and neighborhood groups—can exercise over private development proposals. The effect of these supplemental measures has been to elevate the importance of fiscal, traffic, and environmental issues in the development approvals process and to reduce the importance of general plans. None of these changes have favored housing.

California law gives cities and counties wide latitude in how they administer development regulations, as well as in the adoption of new regulations and programs. The initiative process also gives citizens and interest groups a tremendous say in how growth is regulated. Given such discretion, 50 years of steady population growth, mounting concerns over the natural environment, and voter-imposed fiscal constraints, the fact that California communities have steadily expanded the scope and purview of the development approvals process is not surprising.

The passage of the California Environmental Quality Act (CEQA) in 1970 took the granting of development approvals out of the back room. Led by San Diego in 1973 and Petaluma in 1975, nearly a fifth of California communities adopted some form of growth staging plan and/or annual development cap. When those programs proved inadequate, jurisdictions turned to adequate public facilities ordinances (APFOs) and density and floor-area-ration (FAR) restrictions. About a third of California cities and counties have now adopted some form of APFO and/or permanent density reduction. More recently, and increasing number of California municipalities have followed Portland, Oregon's lead in adopting urban growth boundaries—but without Portland's attention to balancing housing demand and land supply.

As Glickfeld and Levine conclude, most of these programs have been adopted defensively, as a sort of regulatory Magi not Line to protect individual jurisdictions from the threat of runaway regional growth. Whether and how well any of them have worked remains unclear. Indeed, the fact that communities are constantly adopting new approaches to managing growth suggests that the old ones have not worked. Also unclear are the cumulative effects of these programs on housing production levels and costs—whether, for example, the regulatory process has really reduced total housing production, or just redistributed it from more-regulated areas to less-regulated ones. 2*

What is clear is that there is a pattern to the adoption of new regulations. The entitlements process typically expands during periods of high growth, and then goes into suspended animation when development slows down. Fearful that new growth restrictions might be "grand fathered" in, builders rush to stockpile fully or partially entitled sites—usually at the zenith of the market—which they then must sell when the market declines. Construction picks up when the market recovers as previously entitled lands are quickly developed, leading to renewed calls for slower growth. Growth management disappeared completely from California's policy radar in the early 1990s, only to reappear with a vengeance in 1996 and 1997. True to form, 1998 saw a significant upswing in locally enacted growth limits.

Exactly how widespread are local growth management programs? According to the combined results of two surveys of local growth management programs, as of 1998:

More than half of California cities and counties had acted to reduce development densities and/or building heights.
More than 170 cities and counties had enacted a residential APFO. A slightly fewer number had adopted a commercial APFO.
More than 75 jurisdictions had tightened an existing urban limit line or adopted an urban growth boundary.
Residential permit caps were in place in 120 California jurisdictions.

Managing growth does not always mean limiting it. Between 1995 and 1998, more than a quarter of the jurisdictions surveyed annexed new lands for development. And more than 50 of the responding jurisdictions up-zoned sites to encourage higher-density development.

As complicated as the entitlements process has become, some California builders and developers have become very good at it. Based on a diverse sample of 24 single-family subdivisions and 22 apartment buildings entitled between 1995 and 1998, the average single-family development project involved 3.3 separate development reviews and was approved in just under a year. The average apartment project was subject to 2.3 reviews, and was approved in just seven months. Larger single-family projects took no longer to approve than smaller ones. Affordable multi-family projects were approved in an average of 9.8 months, versus 4.9 months for market-rate apartment projects. Projects that did not require a municipal boundary change, a zoning change, a CEQA review, or review by an extra-local agency were approved much more quickly. Among the projects and jurisdictions sampled, the local approvals process did not result in systematic reductions in density. Most of the projects studied were approved at their requested densities.

Almost certainly, the entitlement situation is not as benign as this picture suggests. Many of the sites covered in our analysis were previously or "pre-entitled" during the late 1980s. Some jurisdictions actively use the regulatory process to discourage development—we did not evaluate the project approvals process in those jurisdictions. Nor did we consider the number and types of projects that become regulatory horror stories. We did not consider the effects of delays and mandated project design changes on housing prices. Our time line analysis starts after the first permit application is submitted. Interviews and anecdotes suggest that many of the key activities, and much of the time involved, in the approvals process occurs well before actual permit applications are filed. Lastly, we did not consider the cumulative effects of the regulatory process on the composition of the homebuilding industry: the very large and well-capitalized homebuilders who remain active in California have successfully learned how to cope with the process. Many smaller and less well-capitalized builders have presumably been driven out. To the extent that these smaller builders would have added to the total supply of housing, would have produced different and more innovative housing types, or would have focused their efforts in infill areas, the effects of the regulatory approvals process on California housing markets may be much bigger than anyone realizes.

The regulatory calmness of the 1994-97 period notwithstanding, there are new storm clouds on the horizon. Pushed by agriculture, open-space, and environmental advocates, a significant number of communities have already adopted, or are considering adopting urban growth boundaries (UGBs). When based on sound analysis and designed to accommodate projected growth at reasonable densities—as was the case in Portland—UGBs may be desirable. So far, this has not always been the case in California. Of the more than two dozen local UGBs adopted to date in California, most have been delineated on an ad hoc basis without a careful analysis of development trends or housing market needs and conditions. If additional poorly thought-out UGBs are adopted, they will cause housing prices to escalate and further contribute to urban sprawl as needed development leapfrogs to other areas.

The constraining effects of new development regulations will be compounded by short-term land shortages. The last raw lands that entered the entitlements pipeline during the 1980s will finally be developed in 1999. Thus, there will be a significant need for new supplies of raw land. Since most of that supply is currently outside existing city boundaries, annexing and entitling it—with or without a UGB—will likely prove difficult. Lastly, with development fees already at very high levels, requiring developers to pay for much-needed increases in infrastructure capacity will also be difficult.

Beyond Cookie-Cutter Housing

It is difficult to study recent housing production in California without noticing how remarkably homogeneous and even boring much of it has become. Why is this? And how might future housing projects be designed to promote more livable communities? The answer to these questions is five-fold.

First and most important, homebuilders are generally not encouraged to provide more diverse products and site designs, or rewarded when they do. Quite the contrary, those few builders who pioneer interesting site and project designs are too often left to flail in the wind defending themselves against unimaginative regulators, status quo-oriented neighbors, and dubious lenders. The path of least resistance, in such cases, is simply to stamp out more of the same old thing.

Second, because so many of California's housing markets blow either very hot (due to strong demand and/or supply shortages) or cold (due to cyclical downturns or affordability limits), homebuilders have come to see innovation and variety as characteristics that are rarely rewarded in the marketplace. Quite the contrary: because the costs of innovation are seen as potentially very high (with regard both to construction costs, marketing, and financing costs), and the benefits very low (with respect to price or rent premiums and absorption rates), innovation is something to be shunned. When times are good, interesting and innovative designs do not absorb any faster; and when times are bad, they have higher carrying costs. For every developer who succeeded as an innovator, most developers know three or four who lost large amounts of money.

Third, the combination of high land-prices and market (and sometimes regulatory) resistance to higher densities and attached-housing means that site planning is undertaken primarily to maximize land yields. This results in large houses on small lots, near identical lots with minimal setback variation.

Fourth, because the development approvals process in California has become so costly and uncertain, and because homebuilders and developers typically have so much capital at risk, to survive, they must aim dead center for the largest, most mainstream segment of the market. Site plans and designs that might cause them to fall short of their absorption or pricing targets are regarded as simply too risky.

Lastly, the lack of diversity among housing products reflects a fundamental lack of diversity in the homebuilding industry itself. The homebuilding industry in California today is chiefly characterized by large builders and developers who, by virtue of their superior access to capital markets, are better able to weather the high costs and uncertainties imposed by today's development approvals process. Smaller, more niche-oriented, "mom and pop" developers have either had to adapt by becoming larger and better capitalized, or else leave the market. Without such builders to innovate, the competitive impetus for more interesting and diverse products has withered away.

If this diagnosis is correct, then regulatory changes, which reduce risk levels, allow city officials to share the heat for encouraging interesting projects, and make use of incentives and regulations to encourage innovation should result in more diverse and interesting development projects.

The Costs of Under-producing Housing

What might happen should past trends repeat them selves and future housing production fall short of demand? How might future housing production shortages affect California and its residents?

Housing Costs and Burdens: Housing prices go up and down in response to general economic conditions as well as to supply and demand. Over the past 30 years, California (median) home prices have increased at an annual rate of 7.5 percent. Home prices and apartment rents have both increased more and faster in supply-constrained coastal markets; and less and slower in inland markets, where production more closely matched demand.

Housing prices and rents are not the only things that are higher in coastal California. Incomes are also higher. But not that much higher. As a result, Californians must devote more of their incomes to housing. Among urban Californians, homeownership cost burdens are consistently two to five percentage points higher than for residents of comparable metropolitan areas outside California.

For renters, the differences are even larger. In 1995, the typical California renter living in a metropolitan area paid one-third of their income for rent. The comparable percentage for the U.S. as a whole was only 28 percent. Low-income renters suffer even more. According to the 1995 American Housing Survey (AHS), more than half of California's 2.5 million low-income renters—those with incomes less than 80 percent of the area median—paid more than 50 percent of their incomes for rent. Of California renters with incomes less than 50 percent of the area median, approximately three-quarters paid more than half of their income for rent in 1995. Ominously, these differences in housing cost burdens between Californians and other U.S. residents have all been growing over time.

California's housing cost situation has worsened significantly since 1995. In the near-term, it will worsen further, as rising rents displace low-income renters, and rising housing prices push young and middle-income households further to the metropolitan periphery. As Californians devote more and more of their incomes to housing, they will have less available for other goods and services, including education and health care. This will increase the burden on all Californians to provide these services. Already a place mostly for the well off, cities like San Francisco will become even more so in the future.

Homeownership: California homeownership rates have long been below those of the rest of the country; however, in recent years the gap has widened. As of 1995, the homeownership rate in California's largest metropolitan areas averaged only 51 percent; the homeownership rate for the U.S. in 1995 was 65 percent and increasing. Should housing prices continue their upward march, homeownership rates will continue to decline. Given the strong demographic preference for homeownership among current and especially future Californians, this trend is especially troubling.
Commute Distances: The biggest impact of California's low production levels and high housing prices has been on commute times. Nationwide, according to the American Housing Survey, median commute times among recent homebuyers declined from 19.5 minutes in 1985 to 17.5 minutes in 1995. Inside California, the story was far different. Among recent homebuyers in California metropolitan areas, the median commute time increased from 20 minutes in 1985 to 25 minutes in 1995. Among first-time homebuyers—those hardest hit by rising prices—median commute times increased from 20 minutes in 1985 to 31 minutes in 1995. Because all these estimates are medians, they understate the increase in commuting times and distances among travelers with longer commutes. Ultimately, this problem will begin to take care of itself as employers follow their workers to less expensive suburban markets—a dynamic which has been occurring in California for more than 20 years.
Overcrowding: In the short term, overcrowding tracks with in-migration. In the longer term, it tracks with housing cost burdens and production shortfalls. The number of overcrowded housing units (defined as having more than 1.0 person per room) in the state's major metropolitan areas increased by 13 percent between 1989 and 1995. The number of severely overcrowded units (defined as having more than 1.5 persons per room) decreased slightly during this period.

These statewide figures mask important differences by tenure and location. Between 1989 and 1993, renter overcrowding increased by over 20 percent while severe overcrowding of renters increased by about 7.2 percent. Among renters, overcrowding and severe overcrowding was much more widespread—and increased more between 1989 and 1995 in Los Angeles, Orange, and Riverside/San Bernardino counties. Should California continue to under-produce new housing, renter and homeowner overcrowding are sure to increase.

For many, the question is whether and how future housing shortfalls will affect California's now vibrant economy. Will rising housing prices and the ensuing difficulties attracting labor discourage businesses from expanding or locating in California? How many existing businesses will move their operations to less-expensive locations, or perhaps leave the state entirely? Might too-high housing prices be the proverbial straw that breaks the back of California's cutting-edge growth industries? Business interests answer these questions in the affirmative. Slow-growth groups criticize such questions as alarmist. While we cannot ascertain the outcome, the threat is a real one.

During the last 20 years, California has lost many individual businesses to other states as a result of its high housing costs. Yet at no time has the overall rate of economic growth suffered. Quite the opposite, in many ways, California's lead over competing states in such critical sectors as high technology, finance, entertainment and tourism has widened. Exactly why this should be, and whether it will continue to be the case in the future no one can say for sure. 3* In the past, the presence of the Central Valley and the Inland Empire as low-cost alternatives to higher-cost coastal markets has helped California dodge this bullet. Whether this will also be true in the future is an open question.

A Housing Policy Issues Travelogue

California is a huge state with two dozen metropolitan areas, so no single list of housing trends, issues, or constraints applies equally to all areas. From south to north, the major housing issues confronting California's different metropolitan regions are:

San Diego: By our measurements, San Diego County currently has just enough environmentally suitable land to accommodate projected household growth through the year 2020, assuming no reductions in density and no further controls on development. Within the city of San Diego and several of its eastern suburbs, there is considerable interest in promoting infill housing, especially at trolley stops. The San Diego Redevelopment Agency was one of the state's early leaders in funding downtown housing construction, and although recent redevelopment activities have tailed off, it too retains a strong interest in promoting housing downtown.

Based on demographic projections (and compared to the rest of southern California), a disproportionately large share of the future demand for housing in San Diego County will be for rental units. Whether there will be sufficient capital (given current rent levels) and sites to meet the demand is an open question. The regulatory picture is also murky. On the one hand, many San Diego County communities, particularly those along the coast, are already fairly aggressive in limiting development. On the other hand, the San Diego Council of Governments (SANDAG) is working hard to develop and maintain an ongoing countywide consensus promoting growth accommodation and good development practices.

Los Angeles Area: The key constraint affecting the Los Angeles, Orange and Ventura counties housing market will be a lack of developable sites. Most of the easily developable parts of Los Angeles and Orange counties have already been developed. Ventura County has plenty of remaining developable land; however, most of it is outside the county's recently adopted urban growth boundary system.

Much of central Los Angeles County was developed during the 1940s and 1950s, and is now ripe for higher-density private redevelopment. The question is whether and how such development activity will be encouraged by city officials. The success of recent projects in Santa Monica and Pasadena suggests that there is a substantial market in Los Angeles County (and perhaps even Orange County) for higher-density, mixed-use projects.

The coming housing production crunch will manifest itself in different ways in different parts of the LA region. In Ventura County, the conflict will be between households looking to buy new (generally large) suburban homes, and existing residents intent on using all manner of regulations to slow development and maintain the current environment. In Los Angeles County, much of the upcoming demand for housing will be from young, ethnically diverse, and moderate-income households. Given the LA region's comparatively high land and construction costs, finding ways to produce housing that is affordable to these households will be a major challenge. In Orange County, the challenge will be to attract investment and debt capital to fund the construction of mid-market rental housing.

Inland Empire: The Inland Empire (Riverside and San Bernardino counties) is recovering only now from the decline in property values caused by the recession of the early 90s. The Inland Empire has plenty of developable land, a low housing cost and price structure, and comparatively few regulatory constraints. As it has for the last 20 years, the region will continue to serve as a middle-income, overflow zone for more growth-constrained areas to the west. For most Riverside and San Bernardino County communities, this is not an attractive prospect. For them, the challenge will be to find the right mixture of planning and regulation to encourage private developers to build good quality homes in well-designed neighborhoods (with quality public services) at an affordable price or rent.
San Joaquin Valley Region: The situation in the San Joaquin Valley Region (Fresno, Madera, Kern, Kings, Merced, San Joaquin, Stanislaus, and Tulare counties) is similar to that in the Inland Empire. The region is likely to grow a lot by virtue of its low cost structure and spillover demand from coastal areas. However, most of the Valley's new residents will not be particularly well off. Thus, the two housing policy challenges confronting San Joaquin Valley local officials are, first, how to channel the valley's projected growth into well-designed housing and socially-cohesive neighborhoods; and second, given the lower price of housing, how to pay for the region's growing service and infrastructure needs.
Central Coast: Housing policy questions in the Central Coast region will mostly focus on physical planning issues: particularly, how to integrate large-scale subdivisions into the physical and environmental fabric of existing communities. How to provide water to meet growing development needs will continue to be a vexing issue.
Sacramento Area: The Sacramento Metropolitan Region (including El Dorado, Placer, Sacramento, Sutter, Yolo, and Yuba counties) faces moderate growth pressures, has ample room to grow, and overall, is perhaps the most development-friendly of all the state's major metropolitan areas. This is not to say that communities in the region do not face their own growth and development challenges. Planners and elected officials in Yolo County must figure out how to maintain the agricultural and historic small-town feel of their communities while accommodating new, large-scale developments. Communities in El Dorado and Placer counties must find effective ways to protect environmentally sensitive foothill lands from low-density residential development. Officials in Yuba and Sutter face site planning, infrastructure, and fiscal challenges. Sacramento County, like so many of the state's other metropolitan counties, must develop a coherent plan to accommodate projected future development that mixes infill and edge development.
San Francisco Bay Area: Of all the state's metropolitan regions, the San Francisco Bay Area (including Alameda, Contra Costa, Marin, Napa, San Francisco, San Mateo, Santa Clara, Solano, and Sonoma counties) is probably in the best position to address its future housing growth needs. At least on paper. The Bay Area has a strong and resilient economy; is relatively wealthy; will face lesser growth pressures than other metropolitan regions in the state; is home to some of the nation's most sophisticated non-profit and for-profit builders; and has more than enough developable land to accommodate future growth without sacrificing environmental quality. Unfortunately, because many Bay Area political institutions are fragmented, and because so many neighborhood and community groups are opposed to new development in any form, absent any change, the region's housing problems could get worse instead of better. Land and development costs in the Bay Area are far higher than they should be. The local regulatory process is far more ad hoc and far less consistent than it should be. Investments in regional infrastructure are lagging. Whereas Silicon Valley firms are in the forefront of technological innovation, too many public institutions in the Bay Area are absolutely committed to the status quo. Until and unless the Bay Area "un-hardens" its institutional arteries, housing will become less and less affordable.

Policy Challenges

The findings of this report and their implications pose a multitude of planning and policy challenges to State and local officials, to lenders, to advocacy and non-profit organizations, and most of all, to hundreds of small, medium, and large-sized business that make up the homebuilding and development industry. All of these interests must rise to the challenge if future Californians are to have adequate and affordable housing.

Confronting the Challenge: State Initiatives

The foremost housing challenge facing the state is to develop and institutionalize among all sectors—local governments, business, environmentalists and other advocacy groups, the building industry, and the public—a stronger and more broad-based commitment to producing more housing, more diverse housing, and less expensive housing. Housing is not currently a major political or social issue in California, except in it's most stressed housing markets. Ironically, however, it is housing that is at the root of many of many of today's hot policy issues. The state's urban freeways are so badly congested in part because workers cannot find affordable and available ownership housing near their jobs. The high cost of housing means that many middle-income households find themselves forced to choose between the home and neighborhood they want, and sending their children to good-quality schools. To get both, many households must move to faraway suburbs, exacerbating both traffic congestion and sprawl.

If California is to build enough new homes to meet the demands of all of its future residents, housing must move to the front burner of State policy efforts. In particular, State agencies must learn to do a better job working in partnership with local governments, lenders, non-profits, and builders to insure that there are adequate supplies of credit and entitled land, and in providing leadership on fronts discussed below.

Increasing the Supply of Financing: The principle challenge facing California is to expand the supply of mortgage credit available to investors in new multi-family projects. Multi-family rents in many California markets are currently too low to attract needed investment capital. By working with local and secondary lenders, the State can help reduce the risk of multi-family lending and thereby expand the supply of mortgage credit available to develop new multi-family developments and rehabilitate older ones.

Along the same lines, the State should explore the possibility of allowing local governments to establish infrastructure development and assessment districts around fully entitled private development projects. When established by individual developers, previous instruments of this type (e.g., Mello-Roos districts) have foundered due to excessive competition. Given appropriate financial controls, local governments are less likely to face this problem.

Last and most critically, California must significantly increase its supplies of tax-exempt and taxable bond financing available to assist in the production of affordable rental and ownership housing. California's affordable housing needs are so great, and the ability of conventional financing sources to address those needs is so limited, that additional State resources are necessary. Exactly how such financing should be secured and which projects should be eligible for it are matters, which require further study.

The Infill Imperative: A second major housing policy challenges facing State government is to find ways to increase infill housing production, especially multi-family housing. Future infill needs to include the development of vacant sites in existing metropolitan centers and the re-use of currently developed-but-underutilized sites. There are many sound reasons to promote more and better infill housing: to make better use of available infrastructure, particularly mass transit; to reduce the social isolation suffered by low- and moderate income households, and to provide them with better access to urban services; to improve the economic viability and fabric of existing urban centers; to take some of the development pressure off suburban areas, and lastly, to provide Californians with a wider variety of good housing choices.

There are many impediments to meeting the infill challenge. The cost of producing infill housing is typically higher than the cost of producing comparable suburban housing. Infill housing is typically smaller than suburban housing, and thus has a more limited market. Unit for unit, infill housing often adds more to neighborhood traffic congestion than suburban housing. Infill housing, especially affordable infill housing, invariably generates neighborhood opposition. Most critical, the quality of public schools in many urban areas repels rather than attracts middle-income families.

State government cannot create a market for infill housing. What it can do is help builders and local governments begin to level the playing field between infill and suburban housing.

By funding local governments to pro-actively develop specific plans incorporating residential development within targeted infill and reuse areas, State government can help mitigate the ability of neighborhood groups to stop good-quality infill projects. Where such plans are in place, the State could identify incentives or rewards such as incentives to assist in upgrading infrastructure and local services for example.

Last, the possibility of amending California redevelopment law to increase the proportion of RDA tax increment funds that must be used to support both affordable and market-rate housing projects in downtown and close-by neighborhoods could be considered.

Identifying and preserving habitat, resources, farm, and open-space lands of State importance: A major challenge facing State government is to help county and local governments identify and preserve environmentally sensitive and "heritage" lands. On a statewide basis, California has more than sufficient land to accommodate projected housing demand, even allowing for the protection of critical environmental resources such as hillsides, wetlands, floodplains, prime agricultural lands, and areas with large concentrations of endangered species. Unfortunately, many city and county governments have neither the laws nor the procedures in place to adequately identify, protect, or acquire critical sites. Together with local and non-profit land conservancies, State agencies should work to help county and local governments systematically identify, assess, and conserve California's critical heritage lands. Identifying which sites should be permanently taken off the development table provides greater entitlement certainty for those sites still on it.

This is not to suggest a wholesale shift in urban development patterns away from suburban areas and toward core cities. Rather, California needs both infill and environmentally-sensitive suburban development as part of a broad and balanced strategy for meeting the diverse housing needs of all Californians; recognizing that new construction is critical to expanding housing supply within job-rich urban areas and to revitalizing our inner cities.

Improving the Land Planning and Entitlement Process: Two additional long-dormant issues require revisiting: new towns and regulatory streamlining. It is by no means clear whether California's current development pattern of layering-on new subdivisions at the existing metropolitan edge represents a desirable urban form. In some places, it may simply be better to start with a clean sheet of paperùthat is, to promote the development of well-designed new towns. Where might they go? How big should they be? What mixtures of land uses might be appropriate? How would their infrastructure be financed? All of these questions are valid, all require further detailed study, and all are far beyond the scope of this report. The State could collaboratively undertake a series of studies identifying the potential demand for, and constraints to, the development of new towns, especially in the Central Valley and Inland Empire.

The Permit Streamlining Act established maximum timelines for individual project reviews, but didn't address the deeper problems inherent in the review process. As currently structured, the development review process is neither consistent nor fair. It functions to extract financial concessions and environmental mitigations from project sponsors, not create better development forms. There are three culprits in this respect: local boundary extension policies, general plans, and CEQA. Municipal boundary-setting practices have become increasingly idiosyncratic and ad hoc. Developers in many counties have no way of knowing beforehand whether their projects will be successfully annexed (and thus provided with services), or remain an orphan of county government. A study of potential revisions to the statutes and policies governing local agency formation sections of State law regarding boundary changes (the Cortese-Knox Act) is underway. The Commission on Local Governance for the 21st Century is scheduled to make recommendations for any changes before July 2000.

The usefulness of general plans for guiding future development has also been eroded over time. There are few rewards for communities that adhere to their general plans, including implementing their housing elements, and few sanctions for those that do not.

It is also important to consider improving CEQA processes for accommodating planned residential development. Although State planning law requires that CEQA be subservient to the general plan, in practice the relationship often runs the other way. Development in California today mostly occurs as the cumulative result of individual CEQA reviews rather than under the guidance of local general plans. While the CEQA review process works adequately most of the time, there are still far too many cases in which CEQA is used by opponents to stop or downsize projects. Few California communities make use of standardized thresholds or plan-based mitigation requirements when conducting CEQA reviews.

As the project case histories presented in Chapter IV reveal, CEQA reviews that are "tiered" off specific plan EIRs tend to occur in a more timely and straightforward manner. If reducing risk and restoring certainty are critical to the construction of more and more desirable housing in California, then requiring greater consistency through use of standardized plan-based mitigation requirements in local CEQA reviews is a good place to start. Development of standardized thresholds is needed to implement the CEQA objective of balancing growth and development needs with environmental protection.

Local Government

California is a local control state. Although most California municipalities are technically creatures of the state, in practice most city and county governments are autonomous, especially with respect to land use decision-making. Thus, local governments maintain principal control over the approval of needed housing productionùwhether as infill or greenfield development.

Right now, local governments too often view additional housing development as a negative factor for their communities. They perceive housing, sometimes correctly but often incorrectly, to be a drain on local fiscal resources. They must balance the slow- and no-growth preferences of existing residents with the desires of future residents and the legal rights of landowners, many of whom are not local residents. Local government must take the heat for the negative traffic and community quality-of-life impacts associated with residential development, all the while pushing developers to put forward better-planned and more innovative projects.

Thus, if California really is to produce enough housing to meet projected future needs, the heaviest burden will fall on local government. Local officials must want to accommodate more and better housing, and State government must help make it in their interest to do so. This includes providing financial incentives, especially in the areas of infill and infrastructure construction. Among the many other things local governments can do to "raise the roof" are:

Provide financial support for regional and sub-regional planning efforts which result in coordinated and multi-jurisdictional land use, affordable housing, and environmental protection initiatives.
Reinvigorate the LAFCO sphere-of-influence designation process to provide for long-term growth management and capital improvements programming.
Make greater, but more-focused use of special assessment districts and joint powers authorities to provide improved urban services.
Examine the possibility of chartering new cities (or unincorporated new towns) in counties where growth cannot be easily accommodated in existing areas.
Provide support for regional and sub-regional urban growth boundary systems that include sufficient development capacity (including reserves) to accommodate projected housing needs.
Adopt impact fee systems that reward infill and affordable housing development.
Enlist the aid of neighborhood councils and planning organizations to help re-plan declining or stagnant neighborhoods to include higher density housing and mixed-use developments.
Work with landowners and developers to develop specific and area plans; and where feasible, housing -oriented redevelopment plans.
Adopt incentive programs such as parking requirement reductions, reduced impact fees, and density and height bonuses to promote higher density and mixed use multifamily projects.
Adopt multi-year capital improvement plans and financing programs to guide long-term growth and development.
Adopt appropriate design review standards in older neighborhoods so that new projects fit in with the existing urban fabric.
Establish minimum density requirements so that high-value infill sites are not underutilized.
Establish working relationships with institutional lenders to establish permanent conduits for below-market-interest-rate and first-time homebuyer financing.

For local governments to do their part in accommodating California's future housing needs, local officials will have to stop seeing housing as something which must be accommodated—a view which is sometimes reinforced by current State policy—and instead, come to see housing as the fundamental building block of good place-making. To do so requires good models. The State can assist by providing a clearinghouse of such models and best planning practices.

Advocacy Groups and Non-Profits

Per capita, California is home to probably more environmental, business, and social justice advocacy groups than any other state. This is not just because of California's huge size and wealth, but also because the initiative process allows and encourages advocacy groups to become involved at every level of governance. Not surprisingly, the vast majority of local initiatives focus on land use and fiscal issues.

Unfortunately, the initiative process paints just about every public policy issue in "either/or" terms; as in, "either you are for something or against it." This is not a conducive mode for dealing with complicated issues like growth, housing, and the environment, which cross municipal boundaries. So, rather than putting forth practical solution-oriented approaches to dealing with the state's growth and development problems -- approaches which require compromise -- California's many advocacy groups mostly position themselves to fight local political and initiative battles over particular projects, policy changes, or funding decisions. Such battles are inherently negative.

If California is to build enough housing to accommodate projected household growth, the state's major environmental, development, and social justice advocates must all be willing to come together at the state and regional levels to reach an accommodation over growth, land use, fiscal, and housing issues. There are a number of successful collaborative efforts currently underway in California; such efforts should continue and expand.

Builders and Developers

A lot of the responsibility for the indifferent and cookie-cutter form of California housing rests with the local approvals process. A lot of it also rests with builders and developers. California homebuilders should work to ensure their design and development practices build real neighborhoods and communities, sensitive to the local and historic context. Otherwise residents, neighborhood groups, and many advocacy groups will continue to oppose suburban development projects. The building industry could benefit from organizing to actively promote and support infill development, as well as to diversify itself and its products, such that planning commissions and city councils come to see builders not as outsiders, but as partners interested in the long-term development of their communities.

Raising The Roof

Unprecedented Amount of Housing Needed

Two conclusions stand out from this research above all others. The first is that California will need an unprecedented amount of new housing construction—more than 200,000 units per year through 2020—if it is to accommodate projected population and household growth and still be reasonably affordable. It will need more suburban housing, more infill housing, more ownership housing, more rental housing, more affordable housing, more senior housing, and more family housing. It will also need more diverse housing, and more diverse neighborhoods. California's high land and construction costs, coupled with the cumbersome and open-ended nature of the local entitlements process, have served to discourage innovative land planning, site design, and building design.

Housing System Too Fragmented

The second overriding conclusion is that while there are few intrinsic limitations to meeting California's future housing needs, the core of the existing housing production system—including the laws and procedures that govern housing development, the funding and lending programs, and the myriad public, private, and non-profit organizations that produce and operate housing in California—is far too fragmented and haphazard to produce the volume and quality of housing needed. If indeed California is to remain a state where people from all backgrounds and walks of life are able to pursue the American dream of homeownership and secure housing tenure, then substantial investment and innovation in housing development policy, financing, and planning will be required.

Endnote

Setting the width of potential UGBs at one mile is completely arbitrary, as well as generous. Most of the UGBs adopted to date in California are far more confining.
The shortfall analysis presented in Chapter IV indicates that housing production in California during the 1980s lagged demand by 660,000, or 6.3 percent. How much of this shortfall was due to regulation versus other factors is not clear.
Past empirical studies suggest that when making inter-regional location decisions, businesses are much more sensitive to the availability of qualified labor, taxes, and accessibility to markets and suppliers than to metropolitan housing costs. The out-migration of businesses from New England in the 1940s and 1950s, from the New York metropolitan area in the 1960s and 1970s, and from Midwest "rust-belt" cities in the 1970s and 1980s had little to do with housing.