Court of Appeal Upholds San Jose Inclusionary Housing Ordinance as Legitimate Exercise of Local Police Power

In a recent decision, California's Sixth District Court of Appeal reversed a trial court order and upheld the City of San Jose's Inclusionary Housing Ordinance as a legitimate exercise of the local police power. California Building Industry Association v. City of San Jose (2013) 157 Cal.Rptr.3d 813. The court held that the city was not required to provide evidentiary justification that the affordable units set-aside or alternative in-lieu fee requirements of the ordinance bore a reasonable relationship to the deleterious impact of new market-rate residential development. Rather, the court ruled that the ordinance was an exercise of the city's police power, subject to a highly deferential "reasonable relationship" standard of judicial review.

This opinion still leaves critical issues regarding affordable housing requirements unresolved and exacerbates the confusion surrounding a city's ability to require residential developers to provide affordable housing as part of their projects. In fact, both the petitioner and San Jose have filed petitions for rehearing. The ruling fans the flames of an already-heated debate around affordable housing requirements in California, teeing up these issues for resolution by the California Supreme Court, particularly in light of the subsequent U.S. Supreme Court decision in Koontz v. St. Johns River Water Management District (June 25, 2013, 2013 WL 3184628). (See Holland & Knight's alert on the Koontz ruling.)

San Jose's Inclusionary Housing Ordinance

At the heart of the Sixth District's opinion is the ordinance, which was adopted by San Jose in January 2010 based on its "legitimate interest" in alleviating the shortage of affordable housing in the city. It applied to residential developments of 20 or more units and provided three ways for developers of "for sale" residential units to fulfill the city's inclusionary housing requirement: (1) set aside 15 percent of the units for purchase at a below-market rate to households earning no more than 110 percent of the area median income on-site, although the units could be sold to households earning at most 120 percent of the area median income; (2) construct affordable housing on a different site at specified percentages; or (3) pay an "in-lieu fee" not to exceed the difference between the median sale price of a market-rate unit in the prior 36 months and the cost of an "affordable housing" unit for a household earning no more than 110 percent of the area median income. The ordinance provided incentives to the developer if the affordable units were constructed on the same site as the market-rate units.

The Court Applies a Deferential Standard of Review

The California Building Industry Association (CBIA) sought a writ of mandate to set aside the ordinance, asserting it was invalid on its face. CBIA alleged that the ordinance was not reasonably related to the deleterious impact of market-rate residential development. Several non-profit entities and one individual intervened in opposition to the CBIA's complaint. The trial court declared the ordinance invalid and enjoined the city from implementing it "unless and until the City of San Jose provides a legally sufficient evidentiary showing to demonstrate justification and reasonable relationships between such Inclusionary Housing Ordinance exactions and impacts caused by new residential development."

On appeal, the city argued that the ordinance was a land use restriction, similar to a zoning regulation adopted pursuant to a local government's police power. As such, San Jose argued that it must be accorded a highly deferential standard of judicial review and must be upheld if it "merely has a reasonable relation to the public welfare." CBIA characterized the ordinance as a dedication requirement, rather than a zoning ordinance or regulation of the use of property, since it required a developer to "dedicate or convey property (new homes) for public purposes" or to pay a fee. Thus, CBIA contended that judicial review of the ordinance "clearly calls for the highest scrutiny."

The Court of Appeal disagreed with CBIA and reversed the judgment, finding that the trial court applied the wrong standard of review and that the ordinance did not prescribe a dedication, i.e., "the transfer of an interest in real property to a public entity for the public's use." Instead, according to the Court of Appeal, the ordinance should be reviewed as an exercise of the city's police power stemming from the California Constitution, invalid only if it is arbitrary, discriminatory and without a reasonable relationship to a legitimate public interest. Under this standard, the ordinance withstands constitutional attack "if it is fairly debatable" that the ordinance "reasonably relates to the welfare of those whom it significantly affects," including the surrounding region if affected. The opinion cautioned, however, that judicial deference is not judicial abdication and there must be a "reasonable basis in fact, not in fancy, to support the legislative determination." The court found that it was CBIA's burden to establish the facial invalidity of the ordinance, not the city's, to prove that it survives the challenge. Accordingly, the Court of Appeal remanded the case back to the trial court and left it to that court to determine whether CBIA had rebutted the presumption that the ordinance is reasonably related to the city's legitimate public purpose of ensuring an adequate supply of affordable housing in the community.

Questions Left Unanswered

Several key issues were not before the court in this ruling. The opinion only addressed "for sale" affordable housing, and did not indicate whether the result would have been different had the ordinance addressed rental housing (the post-recession demand for which has been steadily growing throughout the state). Thus, the opinion did not reconcile this result with the Second District's controversial earlier decision in Palmer/Sixth Street Properties, LP v. City of Los Angeles (2009) 75 Cal.App.4th 1396. Instead, it noted that the ordinance specifically excluded rental housing until the decision in Palmer was overturned, disapproved, or modified by the legislature. In Palmer, the court struck down the City of Los Angeles' affordable housing ordinance, which required the inclusion of affordable multi-family rental units in a mixed-use project. The Palmer court found that, as applied to the project at issue in that case, Los Angeles' ordinance was preempted by the rent control provisions of state law found in the Costa-Hawkins Rental Housing Act.

The opinion also did not speak to the adequacy of so-called "nexus studies" that many cities have commissioned to support their inclusionary housing requirements by establishing a link between new market rate housing in the community and the need for more affordable housing units. Critics have questioned the validity and accuracy of such studies. CBIA itself commissioned an analysis of nexus studies in 2011, finding faults with such studies, including overly broad jurisdictional scopes, unreliable affordability gap estimates and statistically improbable lower-income household percentages. The CBIA study concluded that "residential nexus analysis, as it has been applied in California to date, is an unreliable means of estimating inclusionary housing percentage requirements and in-lieu fees." The Sixth District's opinion seems to indicate that nexus studies do not need to show the impact of the creation of market rate housing on the need for affordable housing. Going forward, pursuant to the opinion standing alone, such studies may only need to show that there is a need for affordable housing in the community that needs to be filled.

Finally — and critically — the opinion did not specify whether or not the ordinance was subject to review for compliance with the Mitigation Fee Act (Government Code §§66000-66025), which applies to development fees and exactions other than taxes or special assessments. The Mitigation Fee Act requires as a condition to their imposition of most development fees that cities clearly document a "reasonable relationship" (i.e., nexus) between factors such as the need for the public facility, the type of development project on which the fee is imposed, the amount of the fee and the cost of the public facility attributable to the development on which the fee is imposed.

The issue of whether the Mitigation Fee Act applies to affordable housing in-lieu fees has been raised before the Court of Appeal in several instances. See, e.g., Trinity Park, L.P. v. City of Sunnyvale (2011) 193 Cal.App.4th 1014;Building Industry Association of Central California v. City of Patterson (2009) 171 Cal.App.4th 886, 897, fn. 13; Palmer, supra, 75 Cal.App.4th at p. 1404, fn. 12. The California Supreme Court will have the opportunity to address this issue in Sterling Park, L.P. v. City of Palo Alto, Case No. S204771, which is currently being briefed by the parties. In reaching any decision, the California Supreme Court will undoubtedly have to take into consideration the Supreme Court's decision in Koontz, where the high court held that a local government's demand for property or money from a land use permit applicant must satisfy the nexus and "rough proportionality" requirements established in previous Supreme Court cases.

Implications for Developers

Going forward, it appears that the best course of action for developers to navigate local affordable housing requirements is to confer early and often with the particular jurisdiction regarding its expectations for affordable housing. Pending further court or legislative pronouncements, developers will likely raise the limitations on local requirements posited by the holdings in Palmer and Koontz, while cities will raise the great leeway afforded them by the opinion in the CBIA case. In many circumstances, the parties will consider a range of approaches (e.g., a mix of unit set-asides, both on and off-site, alternative fee and deferral arrangements, and enlisting and funding non-profit affordable housing developers) and reach agreement through negotiation.

Furthermore, it is critical that the development community stay involved and provide practical input in the adoption of any local inclusionary housing ordinances, so that such ordinances provide a workable framework for addressing future needs for affordable housing.