Housing Production in “Built-Out” Cities
Many cities in California have limited vacant land to build outward. These cities are often referred to as “built-out”, a term that normally feels disingenuous since cities can always build upward. However, building upward has its challenges that cannot be overcome simply by increasing the zoning capacity and relaxing development standards. New development needs to be able to make substantial profits in order to be built, and numerous factors have converged to make that extremely difficult in California.
Over the past several years, California has slowly transformed into a pro-housing state. California has passed numerous laws that have restricted local jurisdictions ability to constrain housing development. Accessory Dwelling Units are allowed nearly everywhere in the state, cities must have objective design standards to bring more surety to the entitlement process, and the State is requiring greatly increased zoning to accommodate housing production.
Despite all of this, new home construction in California has remained persistently lower than it has since prior to 1960 with the exception of the years following the recessions of 1981 and 1992, and a brief period in the mid-1960s.1
The largest challenge facing home builders throughout the state, but which is especially acute in built-out cities, in making more profit on redeveloping property than by operating it with its existing uses. If developers can make more profit from new uses, they will build those new uses. However, if they’re unable to make a larger profit than the land is currently delivering, they won’t build anything new.
Unfortunately, things aren’t quite that simple. Not only do new uses need to make more profit than existing uses, new successful projects need to be profitable enough to offset the losses from unsuccessful projects. The more projects developers propose that don’t get built, the larger the profits need to be for the projects that do. The newer requirements for objective design standards should help with reducing the number of proposed projects that are rejected. However, this new paradigm has not been in effect long enough to change developers’ analysis of the risks involved during the entitlement process. As developers gain more experience and are shown they can rely upon objective design standards, they should start proposing lower profit projects that they’re more confident will get built.
Unfortunately, fear of rejection is not the only thing stopping developers from proposing more housing developments. There are many other factors aligned to limit the profitability of new home construction.
In built-out cities, new development must happen at considerably higher intensity than the existing uses the development will replace. Existing profitable uses make it very difficult to build new housing in built-out cities. This is why HCD requires cities to provide substantial evidence that existing uses on non-vacant housing sites will discontinue in order for cities to use those sties to meet their housing goals. It is simply just as profitable to continue using the existing uses as it would be to redevelopment the property unless the intensity can be increased by an order of magnitude from existing intensity. That means for a single-family home, replacing it with a duplex or triplex doesn’t happen often. Those small incremental increases in intensity do not provide sufficient increases in revenue to provide the additional profits needed to cover the cost of the new construction.
Unfortunately, slightly higher intensities, such as small apartment buildings, are considerably more expensive to build than a triplex. Any building with more than three units is governed by the International Building Code, while buildings with three or fewer units are governed by the International Residential Code. The IBC requires a number of different building techniques and building features that are not required by the residential code. Most impactfully, the IBC requires fire sprinklers, which are not required under the residential code. The differences in building codes drives up the construction cost of any project that has more than three units per building. This results in mid-sized developments being infeasible in most places. As a result, residential developments in built-out cities must be significantly larger than the existing community.
Because of the large increase in intensity that is required to make new residential developments feasible in built-out neighborhoods, existing residents often oppose those new developments because they are out of character for their neighborhood. This opposition often delays projects and makes it more likely that proposed projects are denied.
Between the difficulty in overcoming the profitability of existing uses, the required large increase in intensity, and the resulting community opposition, building new homes in built-out cities is incredibly difficult. These projects simply don’t make financial sense to build for developers most of the time. In order for built-out cities to build more housing, the economics of building needs to change in California, which is not something that’s within the control of cities to do. If California wishes to truly become a pro-housing state, it needs to take a more holistic look at the constraints on homebuilding and determine how to remove those constraints at a state level.
1. The 1991 recession was particularly bad for home builders. In 1990, my dad was president of the Building Industry Association of Southern California. During one trip to DC, he was at a dinner where he happened to be seated next to Alan Greenspan. The Fed Chair asked my dad what he did for a living, and upon telling Greenspan that he was a land developer, Greenspan apologized and said it was going to be a rough few years in the industry. He was right.^