FOLLOW-UP TO CITY COUNCIL QUESTIONS FROM THE NOVEMBER 18, 2014, APPROVAL OF THE AFFORDABLE HOUSING IMPACT FEE

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1 CITY OF d ^3 SAN IPSE CAPITAL OF SILICON VALLEY TO: HONORABLE MAYOR AND CITY COUNCIL COUNCIL AGENDA: 11/10/15 ITEM: < j. 2. Memorandum FROM: Jacky Morales-Ferrand SUBJECT: SEE BELOW DATE: Approved ^ ^ ^ ^ Date /O/JD/ZY SUBJECT: FOLLOW-UP TO CITY COUNCIL QUESTIONS FROM THE NOVEMBER 18, 2014, APPROVAL OF THE AFFORDABLE HOUSING IMPACT FEE RECOMMENDATION A. Accept an update on the status of the Affordable Housing Impact Fee (AHIF), approved by City Council on November 18, 2014; B. Discuss and provide direction on staff responses to questions posed by the City Council at the November 18, 2014, meeting about the AHIF; and C. Direct staff to return with a resolution modifying the AHIF to exempt rental developments with fewer than 20 units. OUTCOME As a result of this discussion, City Council will: 1) Receive answers to questions raised at the November 18, 2014, Council meeting regarding the potential impacts of the AHIF on different types of projects; 2) provide direction on a resolution to exempt rental developments with fewer than 20 units; and 3) have an opportunity to provide additional direction to the Housing Department, if desired, so that development and implementation of the AHIF may proceed on schedule. EXECUTIVE SUMMARY On November 18, 2014, in response to reductions in available affordable housing resources, the City Council adopted a resolution that established an AHIF of $17 per square foot on new market-rate apartments in San Jose. In addition to establishing the AHIF program, Council directed the Housing Department to research and return to Council to address several questions, pertaining to the potential for pursuing a Commercial Linkage Fee, and whether the AHIF might make certain types of development infeasible.

2 Page 2 This memorandum will discuss how the existing Pipeline Exemption was created in order to provide time for the market to adjust to the new fee - greatly reducing the likelihood that the AHIF will make projects infeasible. Because of this, the Housing Department is not recommending further incentives for micro apartments, residential care and service facilities, or mixed-income projects. Staff recognizes the issues associated with small infill projects, and the importance of coordinating implementation of the AHIF with the Inclusionary Ordinance. Therefore, the Housing Department recommends that rental developments with fewer than 20 units be exempted from the AHIF. Additionally, because the economics of mixed-use residential/retail projects are more challenging than those for all residential developments, and mixed-use residential and retail will be a relatively common prototype for San Jose's future, staff recommends further analysis on mixed-use development be conducted when the Nexus Study is updated in 3-4 years. Alternatively, the City Council could direct staff to determine if necessary findings could be made to alter the AHIF calculation for mixed-use developments within targeted areas, in a process that would be similar to how the downtown incentive zone has been handled. BACKGROUND Program Details On November 18, 2014, the City Council adopted a resolution that established an AHIF of $17.00 per net square foot on new market-rate rental housing developments of three or more units in San Jose. All such developments for which all building permits have not been issued by June 30, 2016, are subject to the AHIF. In an effort to minimize negative financial impacts on development projects that have already started the development review process (the "pipeline), the AHIF was approved with exemptions, contingent upon certain conditions (Pipeline Exemption). To be eligible for the Pipeline Exemption, developers must submit a complete Pipeline Application with evidence of the required permit, and payment of the associated fee. The application and other requirements must be received by April 1, Finally, to qualify for the exemption, the subject development must have received Certificate(s) of Occupancy for at least 50% of its units by January 31, Since the AHIF was adopted, the Housing Department has completed a number of tasks to prepare for the implementation of the program. Staff has developed informational materials for distribution, begun preparation of detailed Program Regulations, hosted several outreach meetings for members of the development community, prepared a draft pipeline application and hired an additional staff member to help track residential developments and answer questions from the public. Detailed information on the AHIF is available on the Departments' website.

3 Page 3 City Council Discussion on November 18,2014 The City Council action that approved the AHIF included a request for staff to research and return to Council to address several questions and key issues, in the following two categories: 1. Determine if the AHIF will make certain types of development infeasible, such as: a. Micro units; b. Small infill developments; c. Residential care and residential service facilities; d. Mixed-income projects; e. Mixed-use projects; and 2. Research the potential of a Commercial Linkage Fee as an additional funding source for affordable housing. This Memorandum provides analysis and recommendations on item #1 above, so that the City Council may choose to take action to amend the AHIF Resolution. The Memo also provides a status update on item #2. The memorandum addressing the AHIF was originally anticipated to be brought to City Council in April The response was delayed due to the need to re-engage the consultant and conduct additional public outreach regarding the items listed in item #2 above. In addition, staff has been anticipating the decision on the Inclusionary Housing Ordinance and how to coordinate its implementation with that of the AHIF. ANALYSIS The following information provides answers to the questions and key issues raised by the City Council on November 18, Potential Feasibility Impacts of the AHIF Community Outreach A robust outreach plan was planned and implemented to obtain input regarding the subjects discussed in this memorandum. As a first step, the Housing Department entered into an agreement with Keyser Marston and Associates (KMA), to determine if the AHIF will make certain types of development infeasible. (KMA is the same firm who completed the Residential Nexus Analysis and Supplemental Report prior to the City Council's approval of the program in November 2014).

4 Page 4 After obtaining the initial analysis from KMA, the Housing Department conducted two stakeholder meetings to discuss and receive input on KMA's analysis and the Housing Department's initial recommendations. The Department invited nearly 600 individuals and organizations who have expressed interest in the AHIF for the purpose of obtaining as much public input as possible. A total of 27 individuals attended the initial outreach meetings that were held on March 4 and 5, In addition, the Housing Department conducted outreach to members of the development community to ensure that interested parties were informed of the forthcoming obligations associated with the AHIF. In April 2015, the Department provided an update on the AHIF at a monthly Developers and Construction Roundtable Meeting hosted by the Planning, Building, and Code Enforcement (PBCE) Department, and a Development Review and Regional Infrastructure Committee Meeting hosted by the San Jose Silicon Valley Chamber of Commerce. Approximately 60 members of the development community and other stakeholders were in attendance at both meetings. On April 23, 2015, staff also provided an implementation update to the Housing Department's Affordable Development Roundtable, with approximately 30 attendees. Finally, at the conclusion of the public process, the Housing Department obtained input from other City Departments including Planning, Building, and Code Enforcement and the Office of Economic Development. Feasibility and the Pipeline Exemption The City Council inquired as to whether the newly-adopted AHIF should be further adjusted to prevent impacts to the financial feasibility of various types of development. The financial feasibility of a project is based on the relationship between a project's revenue potential, its estimated development costs, and ability to realize a reasonable developer profit that is commensurate with the cost of funds and the project's development risk. Before discussing whether the AHIF impacts the feasibility of certain types of development, it should be noted that Keyser Marston Associates (KMA) conducted a comprehensive Real Estate Financial. Feasibility Analysis prior to the City Council's consideration of the Nexus Report findings and the adoption of the AHIF. KMA's financial feasibility analysis looked at three apartment prototypes - a Stacked Flat Apartment prototype, a "Wrap" Apartment prototype, and a Mixed-Use Apartment prototype. The Stacked Flat Apartment and Wrap Apartment prototypes were generally considered feasible as of the late summer/early fall of 2013, while the Mixed-Use prototype faced some feasibility challenges. It should also be noted that for all types of development, the impact of a new fee is typically reduced over time as the market compensates for the increase in development costs. The AHIF was approved with an exemption provision for projects that were in the pipeline at the time the fee was adopted, in order to allow the real estate market time to adjust to the new fee. Below is a description of how the Pipeline Exemption provides for this adjustment, as well as additional

5 Page 5 information about the different development types that the City Council asked Staff to investigate further. The purpose of the Pipeline Exemption was to allow developers with land acquired for projects (and actively pursuing projects on those sites) to be exempt from the AHIF if certain conditions were met, and for both developers and landowners to factor the AHIF into the cost of new land. Over time, developers will factor in the AHIF when evaluating future projects and negotiating the purchase price for development sites. The Pipeline Exemption acknowledges that projects farther along in the predevelopment phase, and that have already purchased sites, have less ability to adjust because they cannot obtain concessions on land costs to offset costs of a new fee. The Pipeline Exemption is structured in a way that considers financial feasibility in terms of short- and long-term impacts. The Pipeline Exemption exempts from the AHIF projects that submit a Pipeline Application prior to June 30, 2016, and that finish on schedule, with at least 50% of units receiving a Certificate of Occupancy by January 31, For those exempted projects, the AHIF has no impact. Projects that are not as ready to proceed, and therefore do not qualify for the Pipeline Exemption, will be required to pay the AHIF. Due to the Pipeline Exemption, the Housing Department does not expect to collect any AHIF revenue until FY Based on current development activity, the Housing Department expects to collect $5 Million in AHIF revenues in FY This figure may increase over time as it applies to more developments. The next section of this memorandum provides a brief discussion of whether the following types of projects: micro apartments; small infill projects; residential care and service facilities; mixedincome projects; and mixed-use projects, require additional fee reductions or exemptions to ensure their financial feasibility. Exemptions to the AHIF would need to be implemented in the same manner as the Downtown High Rise exemption - i.e. supported by contemporaneous findings, reasonably time limited, and operating in a specific geographic area. Small Infill Apartments PBCE defines small infill developments as those with 19 units or less. This building type is likely to occur in future Urban Villages. Many development sites in built-out infill locations have added costs associated with offsite infrastructure upgrades and building demolition, and, in some cases, sites require environmental remediation or existing tenant buy-outs. Small projects do not benefit from the economies of scale that accrue to larger projects, with fixed costs such as land being spread over a smaller number of units. Staff anticipates only a small number of rental projects at 20 or below to be developed because of the economic challenges of maintaining and operating projects at this scale. In addition, the Inclusionary Ordinance exempts developments of fewer than 20 units. For these reasons, the Administration recommends that small infill apartment projects be exempted from the AHIF..

6 October 19,2015 Page 6 Mixed-use Projects The large majority of mixed-use projects in San Jose are ground floor retail with residential above. In virtually every case, the ground floor retail was required by existing zoning. The KMA 2014 financial feasibility analysis indicates that the feasibility of mixed-use residential projects are generally more challenging than projects that are solely residential. This is because retail space per square foot values are roughly two-thirds of residential space values. Retail space's relative value, and its resultant impact on project feasibility, depends upon whether the project is in a strong or weak retail location. Retail projects that are part of a larger commercial district will be less adversely impacted than those that are not. Since, in most cases, mixed-use projects only occur when the land is zoned to require an element of ground floor retail within a residential project, developers will have already incorporated retail space values in the economics of their projects. It is expected that developers of these mixed-use projects will have already accounted for the impact of the retail component on the project. Staff recommends further analysis on mixed-use development be conducted when the Nexus Study is updated in 3-4 years. This will allow staff to acquire additional data to provide a more informed evaluation of the complexities associated with mixed-use projects. However, if the City Council wanted to incentivize mixed-use development for a geographically targeted area (for example, a specific Urban Village) in the near term, the Council could direct staff to conduct further analysis. This analysis would determine if necessary findings could be made to support an incentive for mixed-use developments within a specific targeted area. This is analogous to how the downtown incentive zone has been handled in the existing AHIF resolution. Micro Apartments Micro apartments are a relatively new development trend in high value markets such as San Francisco, where a few micro apartment projects are being built in the South of Market (SOMA) and mid-market neighborhoods. Micro apartments in these areas are economically feasible because high per square foot rents offset the higher costs of land and costs. In large part, residents of micro apartments are attracted to them because they represent the most affordable option in extraordinarily high housing cost areas, and they provide housing close to desirable amenities. Micro apartments appeal to young, single professionals who want to live in urban settings and spend more of their time in social/communal environments, rather than in their own apartments. In San Jose, few developers are proposing micro apartments. It is likely that micro apartments will represent a more viable alternative to traditional apartments over time as local rental rates continue to climb. If the City Council wanted to incentivize micro apartments, the City could subsidize this development type by reducing the AHIF for micro apartments. However, staff does not recommend this action because the fee is naturally smaller on a micro apartment than for its traditionally larger counterpart. Additionally, KMA's analysis concluded that micro apartments are no less feasible than typical apartments as they have a much higher per square foot return

7 Page 7 then typical apartments. For these reasons, the Housing Department does not believe it necessary to reduce the AHIF for this type of market-rate housing in our local, healthy real estate market. Assisted Living Facilities An assisted living facility would likely be considered a residential service facility or residential care facility under the San Jose Municipal Code. If the facility rents apartments to its residents, it may be defined as a rental residential development subject to the AHIF. KMA's research indicates that assisted living developments tend to be more profitable that other types of rental housing, so it is unlikely that the AHIF would make any such development infeasible. Similar to other developments discussed above, residential facilities in these categories are infrequently developed in San Jose. Those that are currently being developed may benefit from the Pipeline Exemption, if appropriate. Future residential developments will have the opportunity to incorporate the potential AHIF costs into their project's financing plan. Therefore, given that future developments could incorporate the AHIF in advance, and that this development type is relatively rare and not likely to be rendered infeasible by the AHIF, Staff does not recommend a special reduction or exemption for assisted living facilities. Mixed-income Developments Mixed-income projects are those in which certain units within an apartment complex are restricted by covenant for low-income residents, while other units are available at market rates. These types of projects are often funded with equity from "tax credit" financing. Tax credits financing requires projects to provide a minimum of 20% of apartments to households with incomes at or below 50% of the Area Median Income (AMI) (an "80/20" project"). Alternatively, developers may elect to price-restrict 40% or more of a project's apartments to households whose income is at or below 60% of AMI (a "60/40" project"). Using a 100-unit apartment development as an example, the chart below shows these two options when using tax credits to build multifamily rental units: Options # apartments at # apartments at # market-rate total# 50% AMI 60% AMI apartments apartments Staff acknowledges that apartment projects which include a percentage of affordable units onsite are mitigating a portion of their affordable housing impacts on-site. However, any unit that is restricted at 60% AMI or less is already exempt from the AHIF, so these projects are already receiving a deduction from the AHIF fees based on the number of affordable units in the project. Therefore, staff does not recommend an additional reduction for these projects.

8 October 19,2015 Page 8 Alignment with the Inclusionary Housing Ordinance On January 12, 2010, the City Council approved the City wide Inclusionary Housing Ordinance ("the Inclusionary Housing Ordinance"). The Inclusionary Housing Ordinance was scheduled to take effect on January 1, However, the Ordinance was challenged in Santa Clara County Superior Court (California Building Industry Association v. City of San Jose) and the Court imposed an injunction which prevented its implementation of the Ordinance. On appeal to the 6 th District Court of Appeal, that injunction was overturned, the Ordinance was held to be valid, and the case was remanded to the Superior Court to render a decision consistent with the decision of the Appellate Court. However, the plaintiff appealed the decision further to the California Supreme Court. On June 15, 2015, the California Supreme Court issued its decision affirming the Court of Appeals' determination, thus upholding the Inclusionary Housing Ordinance and remanding the case to the trial court. On September 14, 2015, the California Building Industry Association (CBIA) filed a petition for a writ of certiorari with the U.S. Supreme Court seeking review of the California Supreme Court's unanimous ruling that upheld the City's Inclusionary Housing Ordinance. CBIA's filing does not automatically stay the California Supreme Court decision. Thus, the June 15, 2015, decision remains valid. The U.S. Supreme Court accepts only a small percentage of cases seeking review. Staff will update the City Council regarding the implementation of the Inclusionary Housing Ordinance in the near future. At this time, the Housing Department is evaluating means to ensure that the Inclusionary Housing Ordinance and the AHIF program work together in a coordinated manner. Staff is continuing to develop forms, procedures and informational material that will facilitate the administration of the two programs.. Potential of Pursuing a Commercial Linkage Fee The Housing Department has been working with the Office of Economic Development (OED) and the Department of Planning, Building and Code Enforcement (PBCE) to explore conducting a nexus study and other feasibility research of a potential Impact Fee on commercial development. A specific area of coordination is assessing how such a fee would intersect with other City goals, such as San Jose's desire to change its current jobs/housing balance. The Housing Department has researched similar commercial impact fee studies from other jurisdictions and obtained information on nearby communities that have such fees or are studying them. The staff team has investigated the possibility of joining a regional nexus study effort supported by the Silicon Valley Community Foundation. This effort is about to commence work with the participation of several jurisdictions. Staff believes that a regional study may not yield results with the highest possible accuracy and applicability for San Jose. In addition, the City recently ran a nexus study to support its

9 Page 9 Affordable Housing Impact Fee. A regional nexus study that potentially duplicates that work may be an inefficient expenditure of funds. Staff will return to City Council in December with a recommended approach EVALUATION AND FOLLOW-UP If the City Council directs staff to amend the AHIF, staff would need to prepare the appropriate findings, provide any notices required by the Mitigation Fee Act, and return to City Council with a resolution making such amendments. Staff will return in December with a report on research completed on a potential Commercial Impact Fee and an update on the implementation of the Inclusionary Housing Ordinance. POLICY ALTERNATIVES This Memorandum includes several policy alternatives for the City Council to consider as follow-up from its November 2014 approval, which are contained within each topic section. The City Council may consider the Housing Department's recommendations and direct staff to return to Council with a resolution to amend the AHIF resolution. Alternatively, the City Council may decide to leave the AHIF program as is, for now, and revisit feasibility after the program has been implemented and more data is available. PUBLIC OUTREACH Extensive public outreach was conducted pertaining to the issues in this memorandum. The specific outreach efforts are listed in the Analysis section of this document under "Community Outreach." Further, to ensure that the development community is well-informed about the AHIF, more specifically the Pipeline Exemption process, the Housing Department has hosted five additional outreach meetings leading up to the completion of this memorandum. Additional meetings are scheduled for October, November, December, and January. A list of the upcoming outreach meetings is provided below. Date Time Location October 29 2:00 PM- 3:30 PM City Hall - Wing Room 120 November 9 2:00 PM-3:30 PM City Hall - Wing Room 118 November 18 9:30 AM-11:00 AM City Hall - Wing Room 118 December 4 9:30 AM-11:00 AM City Hall - Wing Room 118 December 16 9:30 AM-11:00 AM City Hall - Wing Room 118 January 13, :30 AM-11:00 AM City Hall - Wing Room 118 January 25, :30 AM-11:00 AM City Hall - Wing Room 118

10 Page 10 This memorandum will be posted on the City's Council Agenda website for the November 10, 2015 Council Meeting. COORDINATION Preparation of this report was coordinated with the City's Office of Economic Development, the Department of Planning, Building and Code Enforcement, the City Attorney's Office, and the Budget Office. COMMISSION RECOMMENDATION The Housing Department has provided the Housing and Community Development Commission (HCDC) with multiple updates on the AHIF since the Council established the program on November 18, FISCAL/POLICY IMPACT There are no fiscal impacts directly associated with the recommendations discussed in this memorandum. However, due to the anticipated number of Pipeline and Compliance Plan Applications that will need to be processed, it is anticipated that the budget proposals to add staff and adjust the associated fees and charges to administer the AHIF program will likely be brought forward as part of the City's FY Proposed Budget. The AHIF implements several City policy objectives that are articulated in the Envision San Jose 2040 General Plan, as follows: General Plan Policies H-1.2 H-1.6 H-1.9 Facilitate the provision of housing sites and structures across location, type, price, and status as rental or ownership that respond to the needs all economic and demographic segments of the community including seniors, families, the homeless, and individuals with special needs. Foster the production of housing to serve the "starter" housing market by leveraging financial resources such as purchasing assistance programs and by encouraging marketrate building typologies that service the "starter" housing market. Facilitate the development of housing to meet San Jose's fair share of the County's and region's housing needs. -

11 October 19,2015 Page 11 H-1.10 Facilitate housing that is affordable to those employed in population-serving, businesssupport, and driving industries. H-2.0 H-2.1 H-2.8 Preserve and improve San Jose's existing affordable housing stock and increase its supply such that fifteen percent (15%) of all new housing stock developed is affordable to low-,very low-, and extremely low-income households. Facilitate the production of extremely low-, very low-, low-and moderate-income housing by maximum use of appropriate policies and financial resources at the federal, state and local levels, and various other programs. Coordinate and implement housing policies and goals contained in the City's Consolidated Plan, and its 5-Year Investment Plan. H-2.11 See permanent sources of affordable housing funds. H-3.3 H-4.2 Situate housing in an environment that promotes the health, safety, and well-being of the occupants, and is close to services and amenities. Minimizes housing's contribution to greenhouse gas emissions, and locate housing consistent with our City's land use and transportation goals and policies, to reduce vehicle miles traveled and auto dependency. CEOA Not a Project, File No. PP (a), Staff Report. /s/ JACKY MORALES-FERRAND Interim Director of Housing For questions, please contact Patrick Heisinger, Senior Development Officer, at (408)