How SJ's rent control, inclusionary zoning policies backfire

Scott Beyer of the Market Urbanism Report continues his exclusive analysis of SJ Housing woes. In Part 1, Beyer examined the negative effects of the supply-side solutions that San Jose has implemented to address its affordable home crisis. “Supply-side” means taxpayer-funded subsidies that let governments increase overall home supply. In Part II, Beyer discusses San Jose’s demand-side policies, which have an even worse effect. “Demand-side” means efforts the city takes not to increase supply, but to manage demand for units that already exist. These include policies to cool prices, such as rent control and inclusionary zoning; and policies to help individuals better afford housing, such as rental assistance.

Rent Control and Inclusionary Zoning

San Jose’s rent stabilization policy has been in effect over 40 years. While there are exceptions to certain units, the policy generally prohibits multifamily housing built before September 7, 1979 from increasing rent by more than 5% annually. The rule applies to 38,421 units. 

But this has simply spiked rents in San Jose’s non-stabilized, market-rate units, causing a broad citywide increase. Year-over-year, rents went up 10.56% between 2021 and 2022; median rent for a 1-bedroom apartment has increased nearly 40% since 2015. 

Critics may argue that this simply means the policy has too many exemptions. But cities with broad ordinances have similar problems. In San Francisco, over 60% of all units are rent-restricted. According to the Brookings Institution, the result of expanded rent caps was a 15% increase in conversion to condominiums, resulting in less rental housing overall and higher rents. The Manhattan Institute had similar findings from Cambridge, MA; when rent control was expanded there in the 1970s, 10% of units subject to the policy were converted to condos.

In theory, rent control seems to attack the problem of high rent, and it might for those already living in the regulated units. But per the examples above, it increases rents for non-regulated units, and more crucially, discourages new home construction. In St. Paul, MN, for instance, new construction collapsed after rent control was authorized in 2021. 

Inclusionary zoning, while slightly different, is also a price control - what I’ve come to call Rent Control 2.0. It takes different forms, but the gist is that it requires certain percentages of newly built units to be set aside as affordable. Sometimes this happens as a voluntary measure, in exchange for upzonings. Other IZ policies, however, are mandatory for most or all new developments.

San Jose has a particularly stringent IZ law. According to the city’s website, the Inclusionary Housing Ordinance “requires all residential developers who create new, additional, or modified For-Sale or Rental units to provide 15% of housing on-site” that is affordable to households at or below area median income (specifications vary). Notably, the law faced a constitutional challenge in 2016. A building trade group claimed that the impact amounted to a burdensome government taking, but the state court ruled in favor of the city.

The literature on IZ’s impacts varies but doesn’t point to a meaningful increase in housing supply. Some studies find a negative impact on supply, including in California; the authors of that study cited a 20% increase in housing costs and 7% decrease in new construction, in markets which instituted “below-market housing mandates.” Research into local IZ policies throughout Baltimore-Washington did not find that it cooled construction but suggested that IZ drove prices up somewhat. A program in New York City, where some 17% of households are “cost-burdened,” produced only 2,888 affordable units from 2005 to 2013.

What’s more, set-aside mandates can and have been used by NIMBYs to delay or sabotage projects. San Jose residents need not look far for an example. Last year in San Francisco, a project that would add apartments on vacant lots near Market Street, and that had a large set-aside, was rejected because some officials claimed it still wasn’t affordable enough.  One supervisor argued all units should have been set aside. As a result, the land remains undeveloped.

Rental assistance

Rental assistance programs are another feature of San Jose’s demand-side approach. The city and county both have emergency rental assistance programs, and there’s a network of local non-profits offering similar help. The State of California as a whole provided rental assistance during the pandemic, hitting $1 billion in relief as of last September. This of course compliments Section 8 vouchers from the federal government.

Unlike rent control or IZ, rental assistance doesn’t discourage new development, and as affordable housing programs go, is better than many of the alternatives. But if it is not coupled with strong housing growth, it can inflate costs. That is because these subsidies get more cash circulating through the local economy; if all that cash is, however, chasing a relatively inelastic number of units, it will drive up their price.

Which gets to the heart of the problem: San Jose, and the larger Bay Area, simply doesn’t have enough housing, and it undermines the efficacy of the city, county, and state’s supply-side and demand-side policies. In part 3 we’ll discuss the free-market-based land-use reforms - many of them radical departures from the status quo - that are needed to fix this inventory shortage and make San Jose affordable. 

This article featured additional reporting from Market Urbanism Report content staffer Ethan Finlan.

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Image by Will Buckner