Wed, Jun

California Senate Bill 9’s Unintended Consequences - To A Hammer, Everything’s A Nail

SB 9 ANALYSIS - In July of 2021, some months before the final version of Senate Bill 9 (SB 9) was signed into law, The Terner Center for Housing Innovation at Berkeley published a report entitled, “Will Allowing Duplexes and Lot Splits on Parcels Zoned for Single-Family Create New Homes?

It purported to be a definitive assessment of the impacts of SB 9. The Terner Center was founded by real estate developers and its financial partners. Normally, this might be neither here nor there, but in this case it’s worth noting. Some of The Terner Center’s major funders, such as the Chan Zuckerberg Initiative (Facebook), have been consistently using their do-gooder organization as a marketing arm to promote a self-interested housing agenda that is solidly pro-development at any cost.

The Report makes the case that SB 9 will have very minimal impacts on the number of housing units built in California. In fact, it makes such an effort to downplay the law’s outcomes that one gets the feeling its authors started with that premise then set out to justify it. As such, it makes no mention of the seminal nature of the legislation, which has essentially eliminated all single-family zoning in the state. And it fails to acknowledge that laws like SB 9 start processes of valuation expectations and market transformations that become self-reinforcing and can dramatically alter the motivations of property owners and investors, alike.

The Report’s conclusions about development feasibility and the motivations of homeowners and investors may sound logical at first, but don’t fully reflect real-life circumstances. Times change and economic realities change quickly, these days. Going forward, increased development resulting from the passage of SB 9 may be as much driven by financial necessity for debt-burdened, savings-return-starved homeowners seeking passive income as it is by statistical metrics.

This is just one of the things the Report fails to consider.

As with all studies, results depend on the quality of the inputs, the assumptions made, and what biases that might have been brought to bear in determining what is or is not important to consider. In this case, common sense compels us to question the Terner Center Report’s results.

Based on the Report's conclusions and the timing of its publication, it appears to have been created to make it easier for lawmakers to support the passage of SB 9. Perhaps, downplaying SB 9’s impacts helped make supporting it more palatable for (provided cover for) legislators who were either on the fence or fearful of being on the record voting for it (public opinion polls show widespread public opposition to SB 9).

Laws such as SB 9 and SB 10 are likely to bring about significant changes in how single-family properties are remodeled, torn down, replaced, or redeveloped as something else, entirely. And although the Terner Center Report makes predictions of future outcomes with great confidence, the economic challenges facing the average middle-class family, leave me less assured.

The impacts of SB 9

In my first article, I argued that SB 9’s lot splitting, duplex building provisions, combined with all the other zoning-restrictions-removing bills passed in the last few years, plus recent laws allowing multiple accessory dwelling units (ADUs) on single-family lots, by right, would have a significant impact on housing growth. Regarding SB 9, I gave the example that about half of the 16 single-family homes on my block have the physical capacity to do lot splits, an attached ADU, or add stand-alone ADUs.

If I am correct that my neighborhood’s parcels are fairly typical of the residential lots in my city (my neighborhood actually has the smallest single-family lots in the city; most other areas have much larger lots), then if just a couple of these homeowners do a lot split and redevelopment or build an ADU over the next 30 to 40 years, Mill Valley will meet its RHNA quota for many decades to come even if it never changes any other zoning to allow for high-density housing.

To put a finer point on this, I can say with confidence that at least 3 of my neighbors intend to build some type of second unit, mostly driven by the desire (or necessity due to high real estate costs?) to age-in-place and have some type of passive income, which their savings no longer provide. Whether those will be ADUs, or lot split homes is unknowable. But considering that creating two lots where there was formerly one lot will release greater “trapped” value/equity in their property (because “a” fee simple, saleable parcel/home is automatically worth much more per square foot than an added ADU), the odds are the majority of those homeowners will now be taking advantage of SB 9 as much as they can.

The Terner Center Report did not consider changes made to the final draft. For example, it notes that the requirement for owner occupancy of the existing residence on the property (the homeowner’s principal residence) after the lot split and redevelopment is 1 year, whereas the final version requires an owner to attest to the fact (by signing an affidavit) that they will occupy one of the residences as their primary residence for a period of 3 years from the date of the approval of the lot split. The Report also states that SB 9 doesn't apply in high fire hazard zones, but the final version makes no exceptions for that. But it is the Report’s assessment of project feasibility that is most problematic.

Financial Feasibility

As noted above, the Terner Report fails to recognize the importance of the new “wealth-building” strategy now available to the average homeowner by adding separately deeded units. Considering that rates of return on savings are unlikely to recover to historical levels any time soon, this suggests that SB 9 may be far more impactful to overall housing density growth than the Report forecasts. A few homeowners on a suburban block adding ADU units and/or splitting a lot and building a single unit or a duplex isn’t a very high bar to forecast over future decades, considering the construction boom and housing demand that towns in Southern Marin have been experiencing in recent years.

Oddly, however, the Terner Center Report doesn’t even include parcel data for Mill Valley, Corte Madera, Tiburon, Sausalito, Larkspur, or most of the other smaller towns in Marin County in its unit count assessment. The Report only looked at large cities and left out cities they considered too “small” to matter. Yet, any one of those cities generally has a higher percentage of single-family homes and much larger single-family parcels than Marin’s larger cities (Novato and San Rafael were the only Marin cities included in the Terner Center study) and lumped together they have just as many single-family homes.

Considering that the Report made these omissions, statewide, their data assumptions are undoubtedly skewed to suggest impacts will be minimal. This error could lead to a significant under counting of potential units developed. But what is more striking about the Report is the description of its “methodology.”

The Report provides lengthy explanations about its supposedly objective analytical methods and data but shows its hand right up front when it states,

"These [feasibility] models are based on the financial evaluations conducted by developers to assess an investment’s viability early in the development process by balancing the cost of developing the site with expected rental or sale income.” [Emphasis added]

This alone is sufficient reason to be skeptical of the Report because SB 9 is a bill aimed at “homeowners” not “developers.” So, one must ask, why is the Terner Center basing their work on the financial models (and returns) developers use (require) to determine project financial feasibility?

A good question.

Referring to MapCraft, the Terner Center’s data provider and partner in creating the Report (MapCraft, was paid to assist with the Report – read as “conflict of interest”), it states,

"MapCraft calculates stan­dard development “pencil out” models to compute snapshots of market feasi­bility on every relevant parcel, both under current policies and as proposed in SB 9. Financial expectations of investors and lending terms are based on conversations with industry professionals and are updated by MapCraft regularly. [Emphasis added]

“MapCraft’s calculations incorporate data and assumptions about current rents, sales prices, construction costs, and investors’ expected return on investment rates, and are validated by ECONorthwest, a West Coast economics consultancy. MapCraft’s market demand information relies on multiple sources, including CoStar, Zillow, tax assessors, U.S. Census, and transaction records. MapCraft’s construction cost information is based on interviews and RS Means.”

This description sounds authoritative, and the Report claims that the “perspectives of owner-occupants, owner-occupant landlords, small-scale investors” were considered, but there is no evidence of that in the feasibility analysis and the bolded sentences above contradict that assertion.

In truth, the financial expectations of “industry professionals” have little to do with what motivates homeowners to make a long-term investment in their primary residence property. In the real world, homeowners’ and professional third-party investors’ motivations could not be more different.

A typical homeowner’s definition of “return” takes a longer-term view. They rarely consider most of the financial expectations that can make or break a deal for professional investors. Homeowners do not endlessly ponder "capitalization rates" or "internal rate of return” projections or run sophisticated financial models. Since their property is their primary residence (i.e., their “nest egg”) most homeowners usually just want to know how much it will cost, how much can they borrow, the tax benefits, what their monthly expenses and payments will be, and how much the units will rent for (the cash flow) when it’s done.

Property appreciation over the long-term is also a major consideration for homeowners. But for professional, third-party, flip-and-go investors, it’s likely to be the last thing on their list and only considered in terms of, “In the worst-case scenario if we have to hold on to the property, what will it cost us?”

In reality, if homeowners ever required assurances of investment returns even remotely close to what professional developers and their financial backers do, no one would ever improve their homes. One’s home is still more than an investment. It’s a place to live, to raise a family, to be part of a community, and to feel safe. Those “returns” are not quantifiable. No state laws will ever change that. These intangibles cannot be reduced to statistics but must be factored in.

As such, the Terner Center’s mathematical/statistical modeling appears to be sophisticated but is likely to be grossly miscalculating the potential outcomes from SB 9.

Another issue that the Terner Center Report fails to consider is the rapid change we are witnessing in construction methods and costs associated with second units. Prefabricated, stand-alone, drop-in-place second units, almost non-existent a decade ago, have suddenly become the preferred method of creating backyard “granny flats.” And the variety of choices is expanding exponentially.

The cost of this type of construction is astonishingly low compared to on-site, stick-built structures. And I would venture to say that within ten years, prefab, customizable, modular second unit (and duplex/fourplex) construction will dominate the space.

On the issue of construction costs, the Terner Center analysis is outdated, using industry-standard (RS Means) construction cost estimating data (which is typically backward-looking) to determine what type and how many units are likely to result from SB 9.

And there’s another problem with the Report. There is the academic method of determining financial feasibility in the abstract, and then there’s how it works in the real world. In the Report’s view, feasibility is based on price and development costs. In practice, feasibility is highly dependent on the cost of funds (which varies considerably from one opportunity to another) and the terms of purchase. So much so, that it explains why you might find a vacant parcel asking for an all-cash offer, sitting idle, while a mid-rise building next door was just purchased on favorable terms, to be torn down and replaced by a high-rise building. Feasibility is in the details.

Finally, the Report boasts about how its impact projections are sourced from “industry experts.” But where was the Terner Center’s outreach and input from the hundreds of local community organizations who have voiced continuous opposition to SB 9 and the gentrification and displacement of residents their neighborhoods are experiencing? After all, as I said in my first article, disadvantaged and under-served areas like South Central Los Angeles are huge targets for impacts from SB 9 and other recent state housing legislation.

The Terner Center would, of course, argue that it is only serving its nonprofit, public purpose by giving legislators facts to base their decisions on. But the Report's conclusion that SB 9 doesn’t go far enough to move the needle on California’s housing shortage supports the position that we need more laws eliminating local planning and zoning to achieve our housing goals.

This point of view is not aligned with the average, middle-class, single-family homeowner in California or the many grassroots neighborhood organizations that represent them. 

But then, none of this even matters

Neither the Terner Center’s Report nor my arguments matter one way or the other. Regardless of what any private, third-party believes, there is nothing in California state housing law that HCD can point to that deny a city or county the right to count these newly-zoned, single-family parcels, under SB 9, as qualifying parcels to address their RHNA housing quota.

The HCD cannot base a legal argument on the Terner Center Report’s opinions to deny any city or county the right to RHNA quota certification of Housing Element units any more than a city or county can use my comments to support the opposite contention. This is about what state housing law requires. Private opinions on either side are irrelevant.

As such, there is nothing presently stopping any California city or county from doing an assessment based on its own metrics and historical data to argue what percentage of their existing single-family parcels are eligible to qualify as providing “reasonable capacity” (an HCD term) for higher density housing units at various levels of affordability that must be counted toward their total RHNA housing quota.

To do otherwise, would create an artificial double-standard whereby multi-family parcels zoned by a local agency, which qualify against RHNA quota requirements, are held to a different standard than single-family parcels that have now been re-zoned by state law.

So, what are a developer’s options, here?

The Terner Center obviously spent considerable time and money to produce a Report that concludes SB 9 will not create a significant amount of housing. Most of the Terner Center’s funders also spent political capital lobbying for more aggressive versions of the law that would have eliminated the owner-occupancy provisions and increased the “by-right” provisions for for-profit, third-party developers, without interference by local planning and zoning agencies.

Both of these approaches have the same end goal, which is to continue to bolster the argument that private, for-profit businesses know how to best address the state’s affordable housing needs if the local government would only get out of their way. Their pitch remains unwavering that the “market” and trickle-down economics is the best solution to promote housing development. At times, they have even gone so far as to say that the reason we have affordable housing problems is because local zoning laws exist in the first place.

This, of course, is laughable in light of the fact that the current lack of affordable housing in California (and affordability, in general) is the direct result of decades of trusting that the “market” can solve all our problems.

As it stands, SB 9’s 3-year owner-occupancy requirement creates an obstacle for the development community. It is important to note that owner-occupancy requirements in SB 9 were only added in the last drafts and were strenuously opposed by developers, major tech corporations, construction labor unions, bankers, and so-called housing advocates (funded by the same developer/corporate interests). Affordable housing requirements were also heavily opposed by the same interests to the point that they were never even allowed to be included in the legislation.

Although some feel that the penalties for violating the 3-year owner-occupancy requirement are too vague, it still decreases the ability of third-party developers to buy up massive portfolios of single-family homes to redevelop and pump and dump for quick profits. It forces developers to consider joint ventures and co-equity deals (an anathema) with under-capitalized homeowners. But that would result in much lower rates of return because the developer would then have to split the profits.

Look for developers and corporate-funded “housing advocacy” groups to push to find ways around or remove the owner occupancy “obstacle,” in the near future.

The bottom line is that facts and statistics can be engineered to make any case one wants to make, whether that’s on the left by the Terner Center or the right by the Heritage Foundation. Statistics are like lawyers; you can find one to argue any position you want to take. The irony in all this is that for all its data, statistics, and charts, in the end, the Terner Center’s Report is overly simplistic.

Sustainable, socially equitable solutions are far more nuanced and complex and are best when determined locally. 



(Bob Silvestri is a Marin County resident and the founder and president of Community Venture Partners, a 501(c)(3) nonprofit community organization funded by individuals and nonprofit donors.)