Twin Cities housing: The 'flaming hoops' separating builders and cities

A consensus seems to exist that we're not building enough housing in the Twin Cities, especially the relatively affordable housing we need for a workforce that will keep our economy growing.

By the Metropolitan Council's estimates, the average of 9,500 housing units we've been building per year over the past decade is 30% less than the 14,000 units per year we need to keep up with demand. The affordable housing picture is worse; we're building just one-fifth of what's needed.

At present, 9 of 10 of our existing affordable housing units are "Naturally Occurring Affordable Housing" (NOAH). They were originally built as market-rate housing units and are only affordable now because they're older and have gone through the "chain reaction" depreciation process described in a recent D.J. Tice column. ("Luxury begets affordable housing?" Jan. 26.)

Met Council demographers can predict where the region's affordable housing will be 20 years from now based on the era of construction.

We can't build our way out of this affordability crisis through government subsidies alone. Last year, the Legislature appropriated $60 million in affordable housing bonds; however, officials at Minnesota Housing tell me that will only build about 1,000 units of new affordable housing — a small fraction of the need. This implies that an annual appropriation over $300 million would be required to satisfy the need for affordable housing through new construction in the Twin Cities alone. The unsubsidized private market is going to have to supply the lion's share of the region's new housing of all kinds.

Demographic trends complicate the need for different types of housing in coming decades. Most seniors living in single-family homes will prefer to age in place as long as possible. At present, downsizing younger baby boomers are competing for a limited supply of modestly sized single-family homes with millennials who are just beginning to form their families. This is driving the prices of these older starter homes through the roof.

However, we are coming up on another demographic inflection point. Like it or not, as we boomers reach our late 70s and early 80s, large numbers will have to transition to some level of assisted living. This will drive a surge in demand for affordable senior housing.

What there will not be demand for over the next 20 years is large, single-family homes in the exurbs. Demographers tell us is that if current generations behave like proceeding generations as we age, more than enough large homes in the distant suburbs will be vacated by elderly boomers over the next two decades to accommodate the entire demand by millennials for this type of housing — without building a single additional unit.

And yet, large single-family homes in distant suburbs are the only type of housing that homebuilders are currently allowed to build without jumping through flaming hoops created by the region's cities.

If we are unable to address this extreme mismatch between supply and demand for housing, we are doomed to a future in which aging boomers are trapped in homes no longer suitable for them while their children are unable to realize the American dream of homeownership for themselves. Minnesota will find itself in the same position as large coastal cities whose economic growth is constrained by a severe shortage of workforce housing.

The causes of this dilemma are complex. In my quarter-century of service in local and regional government, no problem I have studied appears to be more intractable than this one.

The biggest roadblock lies in a tangle of state laws that place the interests of cities and homebuilders at loggerheads. The solutions will, in many cases, seem counterintuitive.

For example, Minnesota has a "progressive" property tax structure under which the portion of a home's value in excess of $500,000 is taxed at a higher rate than the first $500,000 of value. Since a city's cost to provide municipal services to a large home is generally no greater than the cost of servicing a small home, this gives cities a fiscal incentive to zone exclusively for large homes, which generate more in property tax revenue than they cost to service.

Building-fee structures based upon home values provide an additional incentive for cities to favor more expensive homes.

Cities respond by establishing large minimum lot sizes and setback requirements, knowing that builders cannot profitably build homes if the cost of land is more than about 25% of the cost of the finished property.

It's worth noting that the customary minimum lot sizes in Twin Cities suburbs are a historical accident resulting from failed experiments in municipal infrastructure planning dating back to the 1960s and have no other empirical basis. The customary minimum lot sizes in the residential areas of Minneapolis are only 6,000 square feet (about one-seventh of an acre) because those neighborhoods were built during the streetcar era, when lot widths were narrow to fit as many homes as possible within walking distance of a streetcar stop.

When urban sprawl reached as far south as Bloomington, Minneapolis balked at extending its sewer lines. Bloomington's city fathers therefore decreed a quarter-acre minimum lot size in the mistaken belief that with large enough lots homes could be serviced with wells and septic systems. Within a decade, it was discovered that Bloomington residents were essentially drinking their own sewage, leading to a crash program to install municipal water and sewer. However, the quarter-acre minimum lot size for single-family homes remained.

The city of Minnetonka looked at Bloomington's example and concluded the answer was to establish a half-acre minimum lot size. When their sewage began leeching into Lake Minnetonka, it too was required to establish municipal utilities, except that assessments were twice as large because each mile of sewer line served only half as many homes.

Debacles such as these led to the creation of the regional wastewater treatment system now operated by the Metropolitan Council and, ultimately, to the creation of the Met Council itself.

Quarter-acre minimum lot sizes remain the norm in Twin Cities suburbs, and it is increasingly common to see even larger minimums, ranging from 1 acre to 2.5 acres, in cities that lie along the developing fringe of the region, ostensibly to "preserve their rural character," but more likely to further the objective of "fiscal zoning."

At current Twin Cities land prices and prevailing minimum lot size requirements, it is impossible for homebuilders to profitably build anything but the exurban "starter castles" that are least in demand in today's housing market. The product that is most in demand — smaller homes built on fifth-of-an-acre lots — is technically illegal in every Twin Cities suburb.

A potential answer to this part of the dilemma would be to change cities' fiscal incentives by tinkering with the region's fiscal disparities program. Its rules could be altered to reward cities that pursue zoning policies that promote the creation of more affordable homes on smaller lots.

A second obstacle to the creation of more affordable housing are state laws that limit the ability of cities to collect "impact fees" to offset the cost of providing infrastructure to support new housing. While developers bear the cost of building local streets and water and sewer lines lying within their developments, there is currently no mechanism in state law that enables cities to recover the costs of expanding the arterial streets and trunk water and sewer lines that connect these developments to the regional infrastructure grids.

It is reasonable for cities to expect new development to "pay its own way." But in the absence of impact fees, cities are forced to cross-­subsidize new development from the taxes paid by existing city residents. Raising taxes on existing, voting taxpayers to subsidize new development — which those voters don't really want to see in the first place — is political suicide for any municipal elected official.

The understandable reaction in most newly developing cities at the suburban edge is for officials to tap the brakes on new development, which they can do by imposing temporary development moratoriums and by delaying requests to the Metropolitan Council to extend regional sewer service to new areas in their cities. Both restrict the supply of available land for homebuilding.

In addition, some cities inflate the development fees that are permitted, such as park dedication fees and building permit fees, to compensate for their inability to collect impact fees to cover the cost of new roads, water, sewers and schools.

But the most common method by which cities attempt to evade the ban on infrastructure impact fees is by forcing housing developers into what is called the "Planned Unit Development" (PUD) process. In a PUD negotiation, the zoning code is thrown out the window and city planners play "let's make a deal" with the developer. The negotiated PUD agreement can outline every detail of the planned development, including the amount of open space that will be required and who will bear the cost of all the required infrastructure needed to execute the plan.

If a developer wished to develop affordable homes on 1/5-acre lots, the only way it could build such a development would be through the PUD process, under which, according to the builders, virtually all new single-family housing is now being built in developing Twin Cities suburbs. The process is expensive and risky. There is no assurance of ever reaching an agreement, and the risk that the project will be disapproved increases the ultimate return required by investors, another factor contributing to the high cost of new housing.

Breaking this impasse will require compromise from both developers and cities. Developers must accept the reasonableness of new development paying its own way through impact fees for arterial road, water, sewer and school infrastructure.

On the city side, there must be an enforceable commitment to collect no more in fees than the direct cost of servicing proposed development. In addition, cities must reform their zoning codes to enable the profitable construction of more affordable small-lot development "by right," reducing their reliance on the planned unit development process. We simply cannot build enough housing if every new housing development must be subjected to protracted one-off negotiations.

Large minimum lot sizes, setback requirements and open space set-asides must go. In exchange for the authority to assess cost-based impact fees, cities must relinquish their right to invoke development moratoria at the drop of a hat, and must agree to accept reasonable extensions to the regional sewer system when demand warrants it.

My belief is that by making more land available for relatively affordable small-lot development, by right, developers will find that the reduction in their per unit land costs, project development costs and disapproval risk will more than offset the cost of the new impact fees.

If we can't broker a reasonable compromise between homebuilders and cities over these issues, we are doomed to perennial housing shortages and rising housing prices.

Steve Elkins, DFL-Bloomington, is a member of the Minnesota House and a former member of the Metropolitan Council and the Bloomington City Council.