In March 2015, local housing builder Johnson Carr submitted preliminary plans to Seattle’s Department of Construction and Inspections, seeking permission to erect a four-story, 57-unit apartment structure in the city’s Phinney Ridge neighborhood. The proposed building would conform with existing zoning: it would sit in a designated neighborhood center, on a commercial street of shops and small businesses, close to a bus stop. Indeed, mid-sized apartment buildings are exactly what the city’s plans call for at such locations.
It’s also all too common: a perfect example of one of the most important but overlooked causes of housing shortage: delay.
Today, after almost two and a half years of grinding administrative process, Johnson Carr is still waiting for approval. In a city that tops the United States for ballooning home prices and rent, where population and jobs are growing faster than at any time in history, that delay is a travesty. It’s also all too common: a perfect example of one of the most important but overlooked causes of housing shortage: delay.
“Time is money,” goes the saying, and it’s the cardinal truth in the business of building homes. When a city’s regulations stretch the time from blueprint to move-in, the homes end up more expensive. Or they end up never built, because the delay makes them money-losers. In cities already suffering from a shortage of homes, either way, delay sends prices even higher.
In my last article, I spotlighted how fees make housing more expensive. This time, I’ll shine a beam on the cost of delay. For Johnson Carr’s Phinney Ridge project, unnecessary delay has so far had about the same effect as if the firm had built an extra nine apartments, then torn them down again before earning a penny in rent.
Delay also kills homebuilding by jacking up uncertainty, scaring off would-be homebuilders and their investors. And it’s not just a menace to market-rate housing; a time-consuming approval process can be an even bigger hazard to non-profit affordable housing development because the cost constraints are so tight.
How much money is time?
Recent analysis by real-estate firm Trulia indicates that delay may be the biggest regulatory factor in the lag of homebuilding that sends prices spiraling in booming cities (see end notes). In 2002, economists documented a “strong positive relationship” between permitting delay and high home prices. This 2015 study from Austin, Texas, estimates that the city’s average avoidable delay of 3.5 months raised the rent of a typical apartment by 4 percent. Meanwhile in San Francisco, approval alone may consume four years or more.
Overall, like any complex undertaking, housing development becomes less efficient when the flow is interrupted. Specifically, delay makes homebuilding more expensive through four main direct mechanisms. First is interest on the land. Imagine you’re trying to construct apartments. Typically, your first task is to secure land on which to build. In most cases, you have to borrow the money to buy it. You’ll pay interest on that debt until you finish the project. The interest adds up fast.
Second, more time to complete a project means more overhead: more paychecks for your managers and office staff, more retainers for attorneys, designers, and other consultants. Third, delay imposes an opportunity cost: you cannot start your next building while you’re still assembling this one. Fourth, the longer your project takes, the more inflation, taxes, or additional fees may take a toll.
Seattle’s Housing Affordability and Livability Agenda (HALA) recommends revamping the city’s design review process to reduce delay. To assess the savings yielded by a two month shorter process, city planners assumed the following cost reductions:
- Interest: 2 percent
- Developer management: 10 percent
- Consultant fees: 15 percent
- Permit fees: 10 percent
If those numbers are right, and you’re trying to build an ordinary 135-unit apartment complex, a two-month time reduction converts into a savings of $4,000 per unit. That’s $540,000 for the whole project, which is roughly the same as the full cost of building two apartments. In other words, every month’s delay costs as much as building and throwing away a free apartment. If the delay stretches out to six months (not unusual), your estimated loss swells to $1.6 million, approximately the same as the affordable housing fee the project would be required to pay under Seattle’s proposed Mandatory Housing Affordability program (see end notes).
In the city’s list of assumptions above, interest payments are the single largest expense, so the 2 percent bump represents the biggest hit. Consider this example from a previous article: imagine you’re building a 210-unit, six-story apartment structure with a total development cost of $66.7 million, of which land accounts for $12.3 million. Because development is a high-risk investment, loans for land come with relatively high interest rates, typically around 15 percent. So holding that $12.3 million land for a year would cost $1.8 million in interest, which is almost 3 percent of the building’s total cost to develop—roughly equal to one free apartment sacrificed for every two months of delay.
Uncertainty is money too
In addition to driving up costs in direct ways, delay also breeds a more abstract but no less potent deterrent to homebuilding: uncertainty. When a city’s permitting process eats up time, uncertainty festers. It can easily break a project. Construction costs can fluctuate wildly, and the more time passes, the more vulnerable your project is to these variations. Just a 10 percent increase could obliterate your return on investment. Demand—and therefore rents—for your apartments could plummet if your competitors finish their new buildings first, or if the local economy falters. Even the rules may change during the wait, and in expensive cities that change usually means more restrictions and fees. All this uncertainty raises the risk of any upfront loans or early stage investment in a project. Higher risk makes borrowed money more expensive.
Furthermore, as a home builder, you don’t know if your project will take perhaps two years or three, while at the same time, you know that every passing week shrinks your effective rate of pay and the value of your finished building becomes more unpredictable. The uncertainty caused by long permitting timelines prevents many otherwise financially viable homebuilding projects from ever getting past the idea stage.
Uncertainty’s full financial penalty is hard to quantify. One way it could be gauged would be by comparing interest rates developers pay on land in different cities. Presumably longer permitting times would be reflected in higher interest rates and vice-versa. Another method would be to compare the market prices of unpermitted land with land that’s fully permitted. All else being equal, that difference should equate to the monetary value of getting a project through the permitting process. Unfortunately, I was unable to identify a source of robust data for either approach.
But real estate professionals with whom I spoke estimated a cost premium for permitted land ranging from 15 to 100 percent. It varies with project scale, type, and location. If permitted land is worth twice as much as unpermitted land, process delay is effectively adding about 10 percent to the total cost of a typical homebuilding project, assuming land typically accounts for about 20 percent of total development costs. For comparison, according to the Seattle planners’ estimate above, a two month delay adds about 1.5 percent to total project cost. These figures suggest that the value-erasing power of uncertainty may eclipse the cost penalties from delay in financing, fees, and management.
By adding both expense and uncertainty, delay boosts the minimum sale price (or rent) new housing must yield for a project to pencil. In the conceptual diagram below (explained in detail here), the cost imposed by delay translates to removal of the orange bars, rendering homebuilding sites in the green shaded area infeasible. Also, if the project has early stage investors, they will want to see a higher potential return on investment to compensate for elevated risk. That pushes up the horizontal dashed line, also trimming the number of sites that pencil. Fewer feasible sites means fewer new homes.
Stopping the bleeding of time
The fix is simple in concept: shorten the time and increase the predictability of the permitting process. Some of that can be accomplished with straightforward administrative improvements. For example, the City of Portland’s 2017 “Strategies for Accelerating Housing Development” recommends improving interdepartmental coordination, filling vacant reviewer positions, consolidating billing, and implementing electronic plan review.
Most large cities, though, likely need more intricate fixes. Circling back to Johnson Carr’s 57-unit apartment example, the ridiculously long struggle for a permit—29 months and counting—has two main causes: Seattle’s design review process and Washington’s environmental review rules.
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Most projects of this scale would go through two public design review meetings, but the governing board mandated two extra meetings in response to a tsunami of concerns voiced by neighborhood residents. Most of these concerns were beyond the purview of design review—no air conditioning!—and in many cases were patently absurd—the sidewalk will be too crowded with people! In recent years the average time between application for design review and receipt of permit was about 11 months. Here, it took 16. Financial data for the Phinney Ridge project were not available, but under the city’s assumptions, that five month delay cost about as much as two apartments in the building.
But it got worse. To comply with Washington’s State Environmental Policy Act (SEPA), Johnson Carr completed a checklist to show that its four-story apartment would not create “significant adverse environmental impacts.” In March 2017, two months after the city issued a “determination of non-significance,” which is effectively the green light for a construction permit, a neighborhood group called Livable Phinney appealed, as allowed under SEPA rules.
In July, a city hearings examiner charged with adjudicating land use appeals halted the project based on a technicality about how the city measures the level of transit access that’s required to exempt a project from off-street parking requirements (see end notes). So far the appeal has added four months of delay, and it will suck up many more months before it’s resolved. Given that uncertainty, the developer’s best option may be to start over, redesign the project with parking, and eat all that added expense and time. Or, just walk away? Plus, this nightmare story of delay and uncertainty will spread among homebuilders across the region, who will factor it into their decisions about whether to risk time and money building apartments in Seattle.
Fixing Design Review and SEPA
The Seattle City Council is currently considering proposed improvements to the city’s design review program intended to reduce the delay it inflicts. The proposal, unfortunately, does not go far enough, as detailed here and in a future article.
Seattle’s HALA plan recommends raising the number of apartments that triggers SEPA review for multifamily developments to avoid exactly the saga of the Phinney Ridge project, in which frivolous appeals stall much-needed housing. The current standard SEPA threshold is 20 units. Seattle recently reinstated an elevated SEPA threshold of 200 units for projects located within the city’s five designated Urban Centers. To solve the SEPA problem, the city can raise the SEPA threshold to 200 for multifamily developments anywhere in the city. (SEPA, ironically, runs counter to urban sustainability in many ways, a problem that I’ll describe in a future article.)
Not all of the time spent acquiring a permit can be blamed on city process: the design of the building takes time too. With the right set of design review fixes and an exemption from SEPA, let’s assume the typical permitting timeline could be reduced to eight months. Under these rules, Johnson Carr’s Phinney Ridge project would so far have been spared added costs equivalent to throwing away nine apartments. Across the city over time, a savings on that order of magnitude would likely mean that tens of additional apartment structures would pencil each year, that hundreds of additional apartments would get built annually. The boosted flow of new homes would tame rents.
Like fees, delay caused by the permitting process adds expense that manifests either directly through higher prices and rents, or indirectly through the loss of new construction, driving up prices by intensifying competition for scarce homes. The good news is that the necessary fixes are relatively straightforward and come at little cost to cities—in fact, streamlining permitting is likely to cut a city’s administrative expenses. The challenge for policymakers is to get out of the way as much as possible while striking a balance between the costs and benefits of regulation. There’s much to be gained by getting it right: a city that welcomes more people.
City of Seattle assumptions for the cost imposed by a two month delay were provided by city planner Lisa Rutzick in a private communication, April 13, 2017.
Trulia looked at changes in housing supply and prices in the 100 largest US metros over the past 20 years to calculate “elasticity”—low elasticity means that homebuilding doesn’t speed up much even when prices rise because something is preventing the market from responding. They then examined the relationship between elasticity and the Wharton Residential Land Use Regulation Index, finding that of the 11 subcomponents that make up the index, only approval time (“ADI”) had a statistically significant correlation with elasticity. In other words, metros where home prices are shooting up because supply can’t keep up with demand tend to have permitting processes that take a long time.
Seattle’s proposed Mandatory Housing Affordability (MHA) program would charge an in-lieu fee of $13.25 per square foot on apartment projects located in medium market strength areas of the city. Assuming the 135-unit mixed used project has a total floor area of 120,000 square feet, the fee would be $1.59 million. The estimated cost of delay is $270,000 per month, which adds up to $1.62 million for six months.
Over two years ago Seattle’s HALA report identified the problem with the city’s definition of frequent transit (recommendation Prk.3, Definition of Frequent Transit Service, on page 29). It’s likely that the problem could be fixed by simply adding the word “average” to the code language. Seattle’s Department of Transportation is currently developing a package of parking reforms that may include refinement of the definition of frequent transit.