Santa Barbara County In-Lieu Fee Update Report. Submitted to: The County of Santa Barbara. Submitted by: Bay Area Economics (BAE)

Santa Barbara County In-Lieu Fee Update Report Submitted to: The County of Santa Barbara Submitted by: Bay Area Economics (BAE) June 2004

Table of Contents 1 Executive Summary...i 2 Introduction...1 2.1 Purpose of Report... 1 2.2 Organization of Report... 1 2.3 Study Methodology... 1 3 Existing Conditions...3 3.1 Current In-Lieu Fee Calculation Formula... 3 3.2 Proposed Inclusionary Housing Program... 4 3.3 Market Trends... 5 4 In-Lieu Fee Case Studies...8 4.1 Santa Cruz County... 8 4.2 Monterey County... 9 4.3 City of Santa Rosa... 10 4.4 Lessons Learned... 11 5 In-Lieu Fee Analysis...15 5.1 Methodology... 15 5.2 Prototype Projects... 16 5.3 In-Lieu Fee Basis Options... 18 5.4 Financial Feasibility Analysis... 23 5.5 Linking In-Lieu Fee to Size or Sale Price of Market-Rate Unit... 25 5.6 Updating the In-Lieu Fee... 27 6 Conclusions and Recommendations...28 6.1 In-Lieu Fee Basis... 28 6.2 Small Projects... 28 6.3 Updating In-Lieu Fee... 29 7 Appendix A: Residential Real Estate Market Trends...31 8 Appendix B: Affordable Housing Sale Price Calculator...41 9 Appendix C: Prototype Residential Projects - Baseline Fees...43 10 Appendix D: Affordability Gap Analysis...49 11 Appendix E: Option 1 Financial Feasibility Analysis...52 12 Appendix F: Option 2 Financial Feasibility Analysis...62 13 Appendix G: Option 3 Financial Feasibility Analysis...72 14 Appendix H: Application of Fee Basis by Sale Price and Unit Size...91

1 Executive Summary 1.1 Purpose of Report The County of Santa Barbara is currently updating the policies and programs outlined in its 2003-2008 Housing Element. As part of this process, the County seeks to refine the methodology for calculating the affordable housing in-lieu fee associated with the County s Inclusionary Housing Program. The County contracted with Bay Area Economics (BAE) to review the current in-lieu fee calculation formula, study other methods, and provide options to the County that take into account the growing need for affordable housing in Santa Barbara County and the fee s financial impact on local development projects. In addition, the revised fee should account for varying market conditions in the County s five Housing Market Areas (HMAs), and address the impacts associated with the ongoing construction of large homes over 5,000 square feet. Homes over 5,000 square feet generate a need for service workers, and as single-unit projects are currently not required to participate in the Inclusionary Housing Program. 1.2 Study Methodology The methodology used to prepare this report included the following steps: Initial meeting with County of Santa Barbara staff to review the County s current inclusionary program and issues. Review of background materials including the Housing Element, Housing Element Implementation Guidelines, and other relevant documents. Preparation of case studies of three comparable jurisdictions with inclusionary housing programs and an in-lieu fee option. Consulting with for-profit and non-profit developers, real estate industry representatives, affordable housing advocates, and County staff to discuss case study jurisdictions, options for a new in-lieu fee formula, and assumptions for BAE s analysis. Collection of detailed development costs for residential projects in Santa Barbara County via interviews with the for-profit and non-profit development community and County staff. This data was used to develop sample pro-formas of residential projects in Santa Barbara County, which were then tested for sensitivity to various in-lieu fees. Preparation of Administrative Draft Report. Review of Administrative Draft Report by County. Review of Draft Report by market rate and affordable developers, real estate industry representatives, and affordable housing advocates. Preparation of Final Report. 1.3 In-Lieu Fee Analysis i

BAE analyzed three possible bases for the Santa Barbara County in-lieu fee. These fee bases and the associated per unit in-lieu fees are as follows: Option 1: Cost to Build an Affordable Housing Unit. This fee basis includes the total development cost to build an affordable unit off-site, and incorporates all land, hard, and soft costs. South Coast: $442,000 Santa Ynez: $338,000 Santa Maria: $265,000 Lompoc: $292,000 Montecito subarea: $657,000 Option 2: Affordability Gap to Purchase Below-Market Rate Unit. This is the fee basis currently used in Santa Barbara County, and calculates the in-lieu fee as the cost to build an affordable unit less the sale price that a household can afford at each HCD-defined income level. The fee ranges according to the target income group of the unit to be replaced. South Coast: $111,000 to $338,000 Santa Ynez: $7,000 to $235,000 Santa Maria: $37,000 to $161,000 Lompoc: $64,000 to $189,000 Montecito subarea: $325,000 to $553,000 Option 3: Cost to Subsidize the Construction of Affordable Unit. This fee basis calculates the fee basis according to the amount of money the County typically contributes to leverage the construction of an affordable unit. According to the County of Santa Barbara Housing and Community Development Department, the County contributes $80,000 to leverage the construction of an affordable unit in the Lompoc and Santa Maria HMAs and $100,000 in the South Coast and Santa Ynez HMAs. However, these fees typically leverage the construction of units serving very low and low income households. Little to no subsidy is available for moderate and workforce income units. To help counter this issue, the County could set the in-lieu fees for moderate and workforce income units equal to the full cost to construct these units. Assuming the County adopts this approach, referred to in this report as Option 3B, the following fee range would apply: South Coast: $110,000 to $442,000 Santa Ynez: $110,000 to $338,000 Santa Maria: $80,000 to $265,000 Lompoc: $80,000 to $292,000 Montecito: $100,000 to $657,000 1.4 Financial Feasibility Analysis BAE conducted a financial feasibility analysis of each fee basis to assess the fees impact on residential projects in the County. The fees were entered into a series of pro-formas reflecting ii

current and planned residential patterns in each HMA. For the purposes of this report, a 10 percent profit as a percentage of development cost is considered acceptable. This analysis found that all the fee basis options achieve the 10.0 percent threshold under the current and planned prototypes. 1.5 Conclusions and Recommendations Based on the advantages and disadvantages of each fee, this analysis suggests Options 2 or 3B would be the most appropriate to use in Santa Barbara County. Both options have a number of drawbacks. Option 2 has decreasing fees for higher income units, which have fewer state and federal subsidy programs available to them, and therefore require more County support. Option 2 also cannot be effectively applied to workforce income units in Lompoc, as these households can afford the full construction cost of an affordable unit. To address these concerns, a single average fee could be used across each income category. Option 3B s primary drawback is that it has lower fees for very low and low income units than Option 2, and therefore generates less funding for these income groups. Nevertheless, both options are financially feasible, vary by HMA, are tied to the cost to build affordable housing in the County, and would be effective increases over the current fee schedule. To address the fact that larger homes generate a greater need for service workers and affordable housing, the County can apply the in-lieu fee according to the size of the market rate units. A standard per unit fee, set to the fee basis, would apply to projects with the typical unit size in an HMA, as described by the prototype projects developed for this report. Developments with smaller or larger homes would pay a lower and higher per unit fee, respectively. This approach incentivizes smaller, more compact development patterns which preserve land for affordable housing and other uses. iii

2 Introduction 2.1 Purpose of Report The County of Santa Barbara is currently updating the policies and programs outlined in its 2003-2008 Housing Element. As part of this process, the County seeks to refine the methodology for calculating the affordable housing in-lieu fee associated with the County s Inclusionary Housing Program. County of Santa Barbara staff have expressed a need to update the current in-lieu fee calculation system for several reasons: The current formula reflects outdated cost assumptions from 2000, the last time the base fees were updated. Staff report that the existing system requires a significant amount of labor and research to update the fees annually. As a result, fee levels often remain out-of-date, offering unintended incentives for developers to pay the artificially low fees instead of constructing the inclusionary units. Out-of-date fees also fail to keep pace with the County s rapidly escalating home sale prices, which drive up land values and indirectly increase the cost to develop affordable housing. Staff indicate that the current formula does not account for the larger demand for service workers and affordable housing generated by larger luxury homes. The County contracted with Bay Area Economics (BAE) to review the current in-lieu fee calculation formula, study other methods, and provide options to the County that take into account the growing need for affordable housing in Santa Barbara County and the fee s financial impact on local development projects. In addition, the revised fee should account for varying market conditions in the County s five Housing Market Areas (HMAs), and address the impacts associated with the ongoing construction of large homes over 5,000 square feet. Homes over 5,000 square feet generate a need for service workers, and, as single-unit projects, are currently not required to participate in the Inclusionary Housing Program. 2.2 Organization of Report The Santa Barbara County In-Lieu Fee Update Report begins with a review of existing conditions in the County, including the present fee calculation methodology and current residential market trends. Next, the report profiles three other California jurisdictions with in-lieu fee calculation formulas that inform the Santa Barbara County fee update. Finally, the report summarizes the methodology and findings of the in-lieu fee analysis, and outlines various options available to the County. 2.3 Study Methodology The methodology used to prepare this report included the following steps: 1

Initial meeting with County of Santa Barbara staff to review the County s current inclusionary program and issues. Review of background materials including the Housing Element, Housing Element Implementation Guidelines, and other relevant documents. Preparation of case studies of three comparable jurisdictions with inclusionary housing programs and an in-lieu fee option. Consulting with for-profit and non-profit developers, real estate industry representatives, affordable housing advocates, and County staff to discuss case study jurisdictions, options for a new in-lieu fee formula, and assumptions for BAE s analysis. Collection of detailed development costs for residential projects in Santa Barbara County via interviews with the for-profit and non-profit development community and County staff. This data was used to develop sample pro-formas of residential projects in Santa Barbara County, which were then tested for sensitivity to various in-lieu fees. Preparation of Administrative Draft Report. Review of Administrative Draft Report by County. Review of Draft Report by market rate and affordable developers, real estate industry representatives, and affordable housing advocates. Preparation of Final Report. 2

3 Existing Conditions This section describes the current in-lieu fee calculation formula used by the County of Santa Barbara, and presents current housing market data for the County as a whole, as well as the South Coast, Santa Ynez, Santa Maria, and Lompoc HMAs. 1 3.1 Current In-Lieu Fee Calculation Formula 3.1.1 In-Lieu Fee Overview Under the County of Santa Barbara s current Inclusionary Housing Program (adopted in 1993), for-sale residential project that create five or more new units must reserve a portion of the total units for households earning up to 110 percent of the Area Median Income (AMI). 2 Each HMA has a particular set of inclusionary options ranging from five to 20 percent of the total number of units in a project and targeting various income levels. For the following types of projects, a developer may pay fees, develop the units off-site, or propose a combination of both options in-lieu of providing the inclusionary units on-site: Residential developments on properties designated or zoned at densities of 4.6 or fewer units per acre. Lot-sale subdivision applicants creating five or more lots. All projects in the Santa Maria and Lompoc HMAs. Projects that generate the need for three or fewer affordable units based on the maximum inclusionary requirement for that particular HMA. Should the developer choose to satisfy the inclusionary requirements through the in-lieu fee, the County places the collected fees in its Affordable Housing Trust Fund, and directs the funds towards the development of affordable units or special needs facilities. Fees must be used within the HMA in which they are collected. 3.1.2 In-Lieu Fee Calculation Methodology The base in-lieu fees are set according to the difference between the average development cost of an affordable unit in a particular HMA and the maximum affordable sale price of a two-bedroom unit. The maximum affordable sale price is set by the County, based on state HCD-defined income limits and standard financing terms. Per unit base fees were last updated in 2000, using the average inclusionary requirement for a particular HMA in the calculation. The following shows the current per unit base fees by HMA: 3 1 The Cuyama HMA is exempt from the County s Inclusionary Housing Program and in-lieu fees, as its affordable housing needs are currently being met. 2 The County s AMI for various household sizes is set annually by the California Department of Housing and Community Development (HCD). 3 The Cuyama HMA is meeting the affordable housing need in all income categories and therefore has no inclusionary requirement. 3

South Coast HMA (based on 12.5 percent requirement) - $74,115 Santa Ynez HMA (based on 12.5 percent requirement) - $37,342 Santa Maria HMA (based on 7.5 percent requirement) - $53,150 Lompoc HMA (based on 5.0 percent requirement) - $44,380 To determine the total in-lieu fees for a project, the following formula applies: [Total Units in Project] x [Average Inclusionary Requirement for HMA] x [Base In-Lieu Fee] = Total In-Lieu Fee The following demonstrates the application of the in-lieu fee formula in each HMA, using a 30- unit project as an example: South Coast HMA 30 units x 12.5% x $74,115 = $277,931 Santa Ynez HMA 30 units x 12.5% x $37,342 = $140,033 Santa Maria HMA 30 units x 7.5% x $53,150 = $119,588 Lompoc HMA 30 units x 5.0% x $44,380 = $66,570 The County allows a reduction of in-lieu fees for projects with fewer than 13 units. This policy permits smaller projects to pay between 20 and 90 percent of the applicable base fee, reflecting the County s approach to providing affordable housing while assisting developers of smaller residential projects. In cases where the inclusionary requirement results in a fractional unit (e.g., 15% of 30 units leads to 4.5 affordable units), the developer may round up the required number of units to the nearest whole number or pay a pro-rated in-lieu fee for the fractional unit. 3.2 Proposed Inclusionary Housing Program Although this study only addresses a small component of the County s inclusionary housing program, the program s requirements do impact the assumptions used in-lieu fee analysis found later in this report. As such, this section briefly outlines the proposed changes to the County s inclusionary housing program, as found in the 2003-2008 Housing Element Appendix E. In the South Coast and Santa Ynez HMAs, for-sale residential developments of two or more net new lots or units must reserve: Five percent of units for very low income households; Five percent of units for low income households; 10 percent of units for moderate income households; and 10 percent of units for workforce households. 4 4 Very low income = Up to 50% of AMI, Low income = 51 to 80% of AMI, Moderate income = 81 to 120% of AMI, Workforce income 121 to 200% of AMI 4

At each income level, developers may donate land instead of providing the units on-site. In addition, payment of in-lieu fees would be allowed to satisfy the requirements for very low and low income units. Developers would be required to show infeasibility to pay the fees for moderate and workforce units. A density increase is proposed for building moderate and/or workforce units on-site. In the Santa Maria and Lompoc HMAs, the same requirements apply for very low, low, and moderate income households. However, no workforce-serving units are required, as the market is currently meeting this need. The inclusionary housing program requirements have not yet been finalized and potential for change still exists. This in-lieu fee update will be considered by decision makers in conjunction with the proposed inclusionary program requirements. For the purposes of this analysis, the proposed inclusionary housing requirements as set forth by the 2003-2008 Housing Element Appendix E are assumed. 3.3 Market Trends This section analyzes residential market trends as a general indicator of the need for affordable housing in Santa Barbara County. Housing price data also offers a view on the health of the local market and the relative price differences between each HMA, which both serve as useful benchmarks when assessing the financial feasibility of residential development projects in Section 5. More detailed tables regarding sale prices and rents in the County and each HMA are contained in Appendix A. Table 1 contains a distribution of all full and verified home sales in Santa Barbara County for two sample periods: September/October 2002 and September/October 2003. Home sale data is reported by First American Real Estate Solutions (FARES), a private subscription service that compiles County Assessor s data. 5 Santa Barbara County as a whole saw an increase in the median sale price for single-family homes between the 2002 and 2003 sample periods, with prices increasing 17 percent over the year from $310,000 to $361,500. At the same time, however, in looking at full and verified sales, volume dropped 18 percent between sample periods. As shown in Table 1, condominium sales in Santa Barbara County showed even greater price increases. The median sale price for condominium units in the County increased 46 percent between 2002 and 2003, to $382,000. Unlike with single-family homes, the number of condominiums sold actually increased from 130 to 137 between sample periods. Although the extreme price difference between the sample periods is at least partly due to some sampling error, these trends suggest a growing market for condominiums as single-family home values escalate 5 County Assessor s data for home sales in Santa Barbara County showed significantly lower median prices than California Association of Realtors (CAR) data for similar time periods. This inconsistency may be attributable to the fact that BAE only included full and verified sales in this analysis, which could exclude higher-priced homes. As a result, comparisons between FARES and CAR data prove problematic. 5

beyond the reach of many households. Although condominiums in most areas command lower sale prices than single-family homes, almost 60 percent of the condominiums sold in the County during this sample period were located in the high-cost South Coast HMA. In contrast, almost 70 percent of single-family home sales occurred in the more low-cost Santa Maria and Lompoc HMAs. As a result, the median price for condominiums in the County actually exceeded the median price for single-family homes during the 2003 sample period. County market trends generally parallel statewide trends between 2002 and 2003. 6 Home sale prices in California saw a 15 percent increase over the year, while sales volume fell 3.9 percent from mid-2002 to mid-2003. The County s strong and rapidly escalating sale prices point to the growing need for affordable housing in the area and suggest that market rate residential developments can absorb a greater inlieu fee and inclusionary requirement. In addition, the data shows the need for an in-lieu fee which keeps pace with increasing values, and can be updated relatively easily on an annual basis. 6 As reported by the California Association of Realtors Mid-Year Housing Report, 2003. 6

Table 1: Home Sales in Santa Barbara County, September and October 2002, 2003 (a) Single Family Residences 2002 2003 Number % of Number % of of Units Total of Units Total Less than $200,000 23 4.2% Less than $200,000 13 2.9% $200,000 to $299,999 231 42.2% $200,000 to $299,999 119 26.4% $300,000 to $399,999 140 25.6% $300,000 to $399,999 135 30.0% $400,000 to $499,999 40 7.3% $400,000 to $499,999 45 10.0% $500,000 to $599,999 39 7.1% $500,000 to $599,999 30 6.7% $600,000 to $699,999 37 6.8% $600,000 to $699,999 35 7.8% $700,000 to $799,999 19 3.5% $700,000 to $799,999 26 5.8% $800,000 to $899,999 13 2.4% $800,000 to $899,999 18 4.0% $900,000 to $999,999 3 0.5% $900,000 to $999,999 9 2.0% $1,000,000 to $1,999,999 2 0.4% $1,000,000 to $1,999,999 18 4.0% $2,000,000 + 0 0.0% $2,000,000 + 2 0.4% Total 547 100.0% Total 450 100.0% Median Sale Price $310,000 Median Sale Price $361,500 Average Sale Price $375,041 Average Sale Price $465,967 Avg. Square Feet (b) 1,463 Avg. Square Feet (c) 1,499 Avg. Price per SF (b) $275.28 Avg. Price per SF (c) $323.32 Condominiums 2002 2003 Number % of Number % of of Units Total of Units Total $100,000 to $200,000 49 37.7% $100,000 to $200,000 19 13.9% $200,000 to $299,999 24 18.5% $200,000 to $299,999 30 21.9% $300,000 to $399,999 21 16.2% $300,000 to $399,999 22 16.1% $400,000 to $499,999 23 17.7% $400,000 to $499,999 37 27.0% $500,000 to $599,999 6 4.6% $500,000 to $599,999 10 7.3% $600,000 to $699,999 3 2.3% $600,000 to $699,999 7 5.1% $700,000 to $799,999 0 0.0% $700,000 to $799,999 8 5.8% $800,000 + 4 3.1% $800,000 + 4 2.9% Total 130 100.0% Total 137 100.0% Median Sale Price $261,250 Median Sale Price $382,000 Average Sale Price $324,569 Average Sale Price $398,055 Avg. Square Feet (d) 1,156 Avg. Square Feet (e) 1,185 Avg. Price per SF (d) $290.20 Avg. Price per SF (e) $362.46 Notes: (a) Represents all full and verified Home sales in Santa Barbara County from September to October 17, 2003. (b) Includes only records where square footage was available (281 of 547 records) (c) Includes only records where square footage was available (270 of 450 records) (d) Includes only records where square footage was available (38 of 130 records) (e) Includes only records where square footage was available (37 of 137 records) Sources: First American Real Estate Solutions, 2003; BAE, 2004.

4 In-Lieu Fee Case Studies This section profiles the inclusionary housing and in-lieu fee programs for three other California jurisdictions. BAE selected case studies with varying in-lieu fee formulas that would inform the County of Santa Barbara s fee update process. BAE also included case studies of jurisdictions with housing markets comparable to Santa Barbara County. Specifically, BAE selected Santa Cruz and Monterey Counties because both areas face rapidly escalating home values, and encompass areas with distinct housing market conditions. Santa Rosa s in-lieu fee program was included because it calculates the fee according to the size of the market rate unit. This strategy may help address Santa Barbara County staff s concerns regarding the impact of large luxury homes on the need for affordable housing. Table 2 summarizes these case studies. 4.1 Santa Cruz County Measure J, approved by Santa Cruz County voters in 1978, requires all residential projects in the County to reserve 15 percent of units for low and moderate income households. As a result of this law, approximately 750 units of affordable housing have been constructed in unincorporated Santa Cruz County. In-lieu of constructing the inclusionary units on-site, developers may pay a fee for each affordable unit required. As shown below, the in-lieu fee is based on the average price of the market rate units. Average Sale Price of Market Rate Units Per Unit In-Lieu Fee (as % of average sale price) Up to and including $600,000 40% $600,001 to $999,999 45% $1 million or more 50% For projects using the in-lieu fee alternative, the minimum fee shall be no less than $200,000 per whole affordable unit. In addition, fractional units must pay a pro-rated amount based on the inlieu fee for a complete unit. This in-lieu fee calculation formula was implemented two years ago when the County found that housing prices had escalated dramatically, thereby driving up land values and the cost to produce affordable housing. Basing the in-lieu fee on the sale price of market rate homes allows for the fee to adjust as market rate sales prices rise. In addition, a sale-price based fee helps account for the County s varying housing markets. To pay the in-lieu fees, residential developers must set up an escrow account during the predevelopment stage, based on the estimated prices of the market rate units in the project and the resulting in-lieu fees. As sales occur on market rate units and the actual price is determined, the fee is calculated and paid out of the escrow account. Fees are re-calculated and paid as market rate unit sales occur. The escrow account assures the County that the project maintains adequate 8

reserves for in-lieu fees, and allows developers to pencil in that cost into their pro-formas early in the development process. As another alternative to constructing the inclusionary units on-site, developers may purchase an existing unit in the County and re-sell it at an affordable sale price. The County requires a similar number of bedrooms as the units in the market rate project. County staff, based on their own calculations, report that this option is more financially attractive to developers, and still leads to the provision of the same number of affordable units as if they had been constructed on-site. As a relatively new system, County staff report that no developer has opted to use either the inlieu fee or the replacement unit approach. Since these programs inception, developers have either provided the affordable units on-site or dedicated land to non-profits for the construction of affordable housing. County staff indicate that the developer s decision on whether to build the affordable units on-site is often based on the nature of the market rate units. For example, developers of high-end projects often choose an alternative to construction because they feel the affordable units negatively impact the marketability of luxury homes. 4.2 Monterey County Since 1980, the County of Monterey has required all new residential development to comply with the County s Inclusionary Housing Program, which requires at least 15 percent of units be reserved for low and moderate income households. Between 1980 and 2000, the program generated a total of 777 affordable units. The County s Inclusionary Housing Program allows projects with three to four units to satisfy their requirements through payment of an in-lieu fee. In addition, while projects with five or more units must typically produce the inclusionary units on-site, in rare and limited circumstances, a project with five or more units may meet its inclusionary obligations by paying in-lieu fees. To do so, the developer must conclusively demonstrate that provision of on-site inclusionary units is infeasible due to specific characteristics of the development site or other factors. Until recently, developers were not required to construct inclusionary units on-site, and most opted to pay the in-lieu fee instead. As a result, between 1980 and 2000, the County collected $5.3 million in in-lieu fees, which were directed to the County s Affordable Housing Trust Fund for the subsidy of other affordable housing projects. The current requirement reflects the County s new desire to prioritize the construction of affordable units alongside market rate units. Since 1980, the County has updated its fee calculation system a number of times, and is currently in the process of revising its fees once more. The new fee calculation system is based on the difference between the cost of developing a market rate home and the sale price affordable to a four-person household earning 100 percent of AMI. Base fees are calculated for a five-unit project, and the per unit fees derived from this calculation are applied to a project s total number 9

of units to determine the total in-lieu fee. Projects with three to four units pay a pro-rated fraction of the base fee. To take into account the wide variation in land costs in Monterey County, two separate in-lieu fees are used; one covers the Greater Monterey Peninsula and Coast Planning Areas, and the other accounts for the remaining Planning Areas. Development costs are calculated assuming a cost of $182/square foot which includes all hard and soft costs, but excludes land. In the Greater Monterey Peninsula and Coast Planning Areas, land costs are assumed to represent 50 percent of the development cost. In all remaining Planning Areas, land costs are assumed to comprise 30 percent of development cost. Although per unit fees must still be finalized, County staff expect the fees for the Greater Monterey Peninsula and Coast Planning Areas to fall around $100,000 per unit, and fees for other Planning Areas to be approximately $40,000 to $50,000 per unit. County of Monterey staff plan to update the new in-lieu fee annually, but have not yet established a system for this process. The update would require revising the affordable sale price, as well as the construction cost of market rate homes. For the former, the County can simply revise mortgage financing assumptions and calculate the affordable home price for households at each HCD-defined income level. HCD income limits are released on an annual basis. For the latter, County staff report that they may update construction cost assumptions based on interviews with the local development community, or simply apply an inflation index to costs and conduct a more detailed update every four or five years. 4.3 City of Santa Rosa The City of Santa Rosa s Housing Allocation Plan (HAP) was first established in 1992. It has undergone several revisions since then, with most of the changes designed to expand the original plan s ability to provide affordable housing. The program has shown limited success at producing actual affordable units; in 11 years, just over 60 affordable ownership units and 26 rental units are directly attributable to HAP. However, the City has collected several million dollars through in-lieu fees which have subsidized the financing and construction of affordable units by local non-profit housing developers. The HAP allows for inclusionary units to be located on- or off-site. If the allocated units are to be located on-site, 15 percent of the total project must be reserved as affordable housing. If the allocated units are to be located off-site, the requirement rises to 20 percent. The HAP does not specify a minimum project size trigger for the construction of inclusionary units. Even small projects are required to contribute to the program by paying the in-lieu fee. City staff do not report any issues regarding the application of the in-lieu fee to small projects. However, it should be noted that Santa Rosa s in-lieu fees are relatively low, and may therefore be effectively absorbed by small projects. An in-lieu fee option is also available for projects of less than 15 gross acres. Historically, almost all developers with projects under fifteen acres (which includes most of the projects in Santa 10

Rosa) have chosen to pay the in-lieu fee. A percentage of the in-lieu fee must also be paid for fractional affordable units. In the summer of 2002, the fee schedule was adjusted to its current format, which is based on the difference between the cost to build an affordable unit and the sale price affordable to various HCD-defined income levels. This difference is considered the maximum fee that can be charged. The maximum fee is then applied according to a sliding scale to the square footage of the average market rate unit in the project. Larger units pay closer to the maximum fee amount, and smaller units pay a smaller percentage of the maximum fee. In practice, units under 900 square feet have no fee attached to their construction. Units of 910 square feet are charged a fee of $0.82 per square foot, and the scale slides up to a maximum of $7.35 per square foot for homes that are larger than 4,500 square feet. Staff report that fees typically range from about $8,500 to $10,000 per unit for single-family homes, which comprise the bulk of new development in the city. The in-lieu fees are adjusted annually according to the percent change in the Engineering News- Record Construction Cost Index for San Francisco. The collected in-lieu funds are available only for the development of housing in Santa Rosa that are affordable to low and very low income households. The City has had significant success in applying in-lieu fees toward the construction of affordable rental units. From 1999 to 2002 alone, subsidies of $3.9 million dollars collected from in-lieu fees were distributed to non-profit developers, accounting for 48 percent of the total subsidies used to construct 410 affordable rental units. Despite this success, City staff report that the use of in-lieu fees in this manner tends to encourage the construction of projects that are solely targeted as affordable housing, thereby geographically concentrating lower income households rather than dispersing inclusionary units throughout market rate projects. This situation sometimes results in more focused community opposition to the construction of affordable housing. However, staff indicate that non-profit developers are generally in favor of for-profit developers opting to pay in-lieu fees because it augments the total amount of subsidies available to affordable housing construction by non-profit developers. 4.4 Lessons Learned The basis for an in-lieu fee is typically linked to the cost to house a low income household. In-lieu fees are meant to replace an on-site unit, and should therefore reflect the cost for a household to purchase a unit or the cost to construct, or subsidize the construction of, an affordable unit. Each of these possible fee bases implies a different fee amount, which Santa Barbara County should consider as it sets its own in-lieu fee. A number of strategies exist for annually updating the in-lieu fee, assuming the fee basis requires current cost data. First, a jurisdiction may develop a streamlined system for regularly interviewing members of the development community, including lenders and non-profit developers, to update costs and other necessary assumptions. Using a simple static pro-forma, the jurisdiction could then input revised assumptions to estimate the current cost to develop an affordable housing unit. 11

As a less labor intensive method, cost indexes such as the Engineering News-Record Construction Cost Index or indexes from the R.S. Means Square Foot Costs Estimating Manual may be used to revise the fees annually. To assure that the in-lieu fee accurately reflects local costs and market dynamics over time, a jurisdiction can perform a more detailed cost analysis every three to five years or in conjunction with Housing Element updates. A fee system like the one used by the County of Santa Cruz does not necessarily require annual updates. This approach allows simple in-lieu fee calculations for both the County and developer. However, this methodology is not directly linked to a specific in-lieu fee basis (i.e., the cost to replace the lost affordable unit), and therefore lacks a certain measure of precision over time. Given Santa Barbara County staff s concerns regarding the ease of updating the fee and its ability to keep track with local housing sale prices, staff should consider using a construction cost index to update its fees annually. As a drawback, this method would not account for increasing land costs, a major factor in the County s housing markets. A more detailed fee update can be done in concert with Housing Element updates. The City of Santa Barbara has adopted an alternate approach to its in-lieu fee that avoids the challenge of annually updating unit development costs. The City sets the in-lieu fee according to the difference between (1) the development cost of a market rate condominium unit and (2) the affordable sale price to a low income household. The development cost of an affordable unit is simply set as the median sale price of a condominium unit in the City less 15 percent to reflect the developer s profit. While this methodology is less accurate than the methods described in this report, it is significantly easier to research and update. Using the market rate sale price as a measure for calculating in-lieu fees is feasible. However, this strategy does require additional steps, such as the possible creation of an escrow account during the entitlement process and the regular re-calculation of fees as market rate sales occur. The City of Palo Alto, which uses a sale price-based fee, includes a written agreement of the fee in a project s conditions of approval and subdivision agreement. Fees are collected at close of escrow and sent to the City by the escrow companies. County staff should weigh the pros and cons of this approach. A sale price-based approach does adjust for rising home prices and housing market variations. City of Palo Alto staff also report that the City occasionally receives greater fees than estimated for a particular project as sale prices rapidly escalate. However, this system does create a significant amount of additional labor for staff, depending on the number of residential developments occurring at any given time and how quickly they build out and sell units. Staff must track each project to assure that fees are collected as sales occur. In-lieu fees can also be based on the size of market rate units in the development. The City of Santa Rosa s program demonstrates one way of basing the in-lieu fee on the 12

average size of the market rate units in a project. The City of Santa Barbara also adopted a similar approach in its recently established inclusionary housing ordinance. This approach incentivizes the construction of smaller, more compact units, which can help preserve land for affordable housing and other uses. Creative options to on-site construction or in-lieu fee payments can offer developers more flexibility in fulfilling their inclusionary housing requirements. Santa Cruz County s replacement unit program, for example, achieves the goal of creating more affordable units, while apparently providing a more financially attractive strategy for developers. However, any alternatives to on-site construction, including the payment of in-lieu fees, compromises the social benefits of mixing market rate and affordable units. In addition, as noted by City of Santa Rosa staff, projects dedicated exclusively to affordable housing can encounter stronger neighborhood opposition, leading to a possible loss of affordable units. This finding suggests that Santa Barbara County should use in-lieu fees strategically, and balance the goals of creating mixed-income communities, providing as many affordable units as possible, and targeting deeper levels of affordability. Payment of in-lieu fees should be encouraged only if it achieves another positive impact. For example, allowing payment of in-lieu fees for very low and low income units can help leverage more construction by non-profit developers serving households well below Area Median Income. This benefit helps compensate for the fact that non-profits typically build below-market-rate projects that do not necessarily promote mixed income communities. Jurisdictions with varying housing markets should adjust their in-lieu fees to account for this trend. Monterey County, like Santa Barbara County, experiences much higher housing values in coastal areas. The County s in-lieu fee system recognizes this trend, and adjusts for higher land prices in the coastal areas. Likewise, Santa Cruz County s sale-price sensitive fees account for diverse market conditions throughout the County. Santa Barbara County s current Inclusionary Housing Program already takes its varying HMAs into account. The revised in-lieu fee program should also do the same. 13

Table 2: Affordable Housing In-Lieu Fee Models Jurisdiction Year Enacted/ Updated In-Lieu Fee Permitted In-Lieu Fee Calculation Per Unit In-Lieu Fee Fees Raised Santa Barbara Co. 1981/2000 Properties zoned 4.6 or fewer units/acre Lot-sale subdivision applicants creating 5 or more lots All projects with up to 10% inclusionary requirement Projects that generate up to 3 inclusionary units Fractional units Development Cost of Affordable Unit - County-Specified Sale Price of Affordable Unit = In-Lieu fee Santa Ynez - $37,342 Lompoc - $44,380 Santa Maria - $53,150 South Coast - $74,115 Montecito - $357,335 Also varies by total number of units in project. Developments with fewer than 13 units have reduced fees. $1.9 million Santa Cruz Co. 1980/2003 Developer always has option to pay in-lieu fee. Also applies to fractional units. 40-50% * Average Sale Price of Market Rate Units in Project = In-Lieu Fee Percentage varies according to sale prices of market rate homes in project. More costly homes require a higher percentage. Minimum of $200,000/unit. Minimum fee applies to projects utilizing the in-lieu fee alternative instead of constructing affordable units. $1.0 million since 2000 Monterey Co. 1980/2002 Typically only permitted in projects of 3-4 units, as of 2002. Also applies to fractional units. Development Cost of Average Market Rate Unit - County- Specified Sale Price of Affordable Unit] = In-Lieu Fee County in process of updating fee schedule. Anticipate $20,000 to $30,000 per unit in non-coast areas. Up to $100,000 in Coast areas. $5.3 million City of Santa Rosa 1992/2002 Permitted for projects smaller than 15 gross acres. This includes most projects in the City. Based on size of market rate units. Fee applied on a per sq.ft. basis. Sliding scale from $0 for projects up to 900 sq.ft. to $33,075 for 4,500 sq.ft. units. $3.9 million from 1999 to 2002 Applies to fractional units. Source: BAE, 2004.

5 In-Lieu Fee Analysis This section describes the methodology and findings of BAE s in-lieu fee analysis. It includes a description of three options for an in-lieu fee basis, the various pros and cons associated with each, and the resulting fees generated by each approach. In addition, prototype residential projects based on current and planned development in each of the HMAs are tested for financial sensitivity to the various fee options. 5.1 Methodology Meet with stakeholders. BAE met with County staff and members of the for-profit and non-profit development community to review their concerns, explore their reactions to various fee calculation methods, and discuss the assumptions associated with each of the residential prototypes developed for this analysis. Develop options for in-lieu fee basis. BAE, based on the case studies presented earlier in this report and additional research, formulated three alternative methods for calculating inclusionary housing in-lieu fees in Santa Barbara County. As part of this step, BAE also calculated the actual fees that would result from each of the three methodologies. Prepare residential development prototypes. BAE formulated a series of pro-formas representing current and expected development projects in the Santa Barbara County HMAs. BAE designed these models in consultation with local developers, industry representatives, and County staff. Developers and staff provided financial details associated with specific projects, which BAE then combined with independent research to construct a generic prototype. To determine appropriate market rate sale prices for the prototype projects, BAE interviewed local developers and conducted independent research of comparable projects in the County. Affordable sale prices were based on 2003 income limits, as defined by the California Department of Housing and Community Development (HCD), and standard financing terms. 7 Appendix B contains the affordable sale price calculations. Test prototypes for financial feasibility. As a final step, BAE tested each of the residential development prototypes for financial sensitivity to the various in-lieu fee options. This analysis seeks to determine if profit margins can be maintained at acceptable levels for each project type under the various in-lieu fee options. 7 Under the proposed inclusionary housing program, the County of Santa Barbara sets maximum sale prices for inclusionary units according to the following limits for each income category: Very low income 50% of AMI Low income 75% of AMI Moderate income 110% of AMI Workforce income 160% of AMI 15

5.2 Prototype Projects BAE developed two residential prototypes for each of the South Coast, Santa Ynez, Santa Maria, Lompoc HMAs and for the Montecito subregion. Table 3 presents development details for these prototypes, and Appendix C contains the full baseline pro-formas reflecting current in-lieu fees. The Cuyama HMA was excluded from this analysis, as little residential development is anticipated in this area, and the County s current and proposed inclusionary housing requirements do not include it. The first set of prototype projects ( current prototypes ) in each HMA reflects the type of development currently occurring in the County. The second set of prototypes ( planned prototypes ) models the type of development the County anticipates seeing in each of the HMAs, based on recent trends and changes to County housing policy. Specifically, the County aims to achieve greater residential densities throughout Santa Barbara County, in recognition of the area s dwindling land resources, the need for additional market rate and affordable units, and the environmental and social benefits associated with more compact development patterns. Note that in Montecito, no significant change in the development pattern is anticipated due to the geographic and service constraints in this area. Therefore, the planned prototype is identical to the current prototype. Unit density, sizes, market rate sale prices, and per unit land costs vary between current and planned prototypes. Market rate sale prices were assumed to be 10 percent lower for the planned prototypes, which have smaller unit sizes than the current prototypes. While actual projects contain a range of unit types, differing in the number of bedrooms, amenities, and price, the proformas in this analysis present an average number of bedrooms and price for each prototype. Please note that all analyses are in 2003 dollars. The prototypes reflect the County s Inclusionary Housing Program in two key ways. First, since the Program does not require inclusionary and market rate units to be identical, each prototype has varying cost assumptions for the market rate and affordable units. Secondly, the prototypes reflect the County s density increase policy, which allows developers who construct moderate and workforce income units on-site to receive a 20 percent density increase. In effect, the increase augments the site s total density, and allows developers to spread land costs across a greater number of units. The description of each residential prototype below contains the base number of units and base density, i.e., the project characteristics prior to the density increase. Table 3 summarizes the total number of units and total density for each prototype. It is important to note that while BAE made all attempts to develop sound assumptions, the analyses carry a margin of imprecision relative to specific real projects. On- and off-site improvement costs, construction costs, fees/permit costs, and unit configurations will vary from project to project. For these illustrative pro-formas, BAE estimated costs for a typical project through interviews with local developers and review of applicable County fee/permit schedules. 16

Table 3: Prototype Projects by Housing Market Area South Coast Santa Ynez Santa Maria Lompoc Montecito PROTOTYPE DETAILS Current Planned Current Planned Current Planned Current Planned Current Planned Base Units (Including Affordable) 15 30 15 35 75 200 75 200 13 13 Additional Mkt Rate Units (w/ Density Increase) (a) 3 6 3 7 8 20 8 20 1 1 Total Units 18 36 18 42 83 220 83 220 14 14 Base Density (Units/Acre) 5.0 10.0 3.0 7.0 3.0 8.0 3.0 8.0 4.0 4.0 Total Density (with Density Increase) (Units/Acre) 6.0 12.0 3.6 8.4 3.3 8.8 3.3 8.8 4.3 4.3 Development Size (Acres) 3.0 3.0 5.0 5.0 25.0 25.0 25.0 25.0 3.3 3.3 Average Number Bedrooms 3 3 3 3 3 3 3 3 4 4 Average Market Rate Unit Size (sq.ft.) 2,000 1,700 2,000 1,700 2,000 1,700 2,000 1,700 3,000 3,000 Average Affordable Unit Size (sq.ft.) 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 Market Rate Sale Price $950,000 $800,000 $600,000 $540,000 $525,000 $472,500 $510,000 $459,000 $2,000,000 $2,000,000 South Coast Santa Ynez Santa Maria Lompoc Montecito DEVELOPMENT COSTS (b) Current Planned Current Planned Current Planned Current Planned Current Planned Land Per Unit $250,000 $225,000 $175,000 $150,000 $100,000 $100,000 $140,000 $125,000 $450,000 $450,000 Market Rate Building Costs/sq.ft. $100 $103 $68 $70 $65 $68 $65 $68 $120 $120 Affordable Building Costs/sq.ft. $55 $58 $55 $58 $55 $58 $55 $58 $55 $58 On and Off-Site Costs/Unit Permit & Fees/Unit Other Soft Costs (c) $50,000 $30,000 20% $45,000 $14,500 20% $45,000 $21,000 20% $45,000 $6,500 20% $50,000 $30,000 20% Total Development Cost Per Mkt Rate Unit $637,485 $609,179 $453,714 $419,197 $406,722 $394,681 $434,653 $405,468 $1,124,831 $1,124,831 Notes: (a) 20 percent density bonus assumed in South Coast and Santa Ynez HMAs, 10 percent in Santa Maria and Lompoc HMAs. (b) See individual prototype pro formas in Appendices for sources of cost data. (c) Percentage of hard costs, site costs. (d) All figures in 2004 dollars. Source: BAE, 2004.