In California Building Industry Association v. City of San Jose, 2013 Cal. App. LEXIS 447, 2013 WL 2449204 (Cal. App. 6th Dist. June 6, 2013), a California appellate court upheld an inclusionary housing ordinance ("IHO") adopted by the City of San Jose ("City"). The trial court had struck down the ordinance and ruled that the City failed to demonstrate a reasonable relationship between the challenged ordinance and the public impacts of new residential development. This is the standard applied by courts in a number of recent decisions addressing the imposition of affordable housing requirements on new development projects. The Sixth Appellate District concluded that the trial court applied the incorrect standard for this facial challenge to the IHO and that it was the burden of the challengers to demonstrate that the IHO was an improper exercise of the City's broad police power. This standard provides great deference to local jurisdictions. If this decision stands it will encourage many more cities and counties in California to consider adopting similar IHO's and will make it virtually impossible to avoid a significant increase in the cost of producing market rate housing in those communities that adopt IHO's. Home builders and their industry groups will need to become strong advocates at the local level to educate cities and counties of the increased costs of housing that could result from the adoption of IHO's.

Background

The City adopted an IHO which required residential developments of 20 or more units to set aside 15% of those units as affordable, 9% for moderate income households, and 6% for very low income households. This obligation could also be met by constructing affordable units off site, or by paying an in-lieu fee. It was estimated that the in lieu fee would be approximately $122,000 per affordable unit required. The ordinance also included a waiver, adjustment or reduction if a developer could show that there was no reasonable relationship between the impact of a proposed residential development and the requirements of the new ordinance or that applying the requirements of the ordinance would take property in violation of the state or federal constitution.

The California Building Industry Association ("CBIA") filed a complaint to set aside the IHO as invalid on its face. CBIA argued that the City had adopted the ordinance without demonstrating any reasonable relationship between the requirements imposed by the ordinance and any increased public needs for affordable housing created by new residential development and that such action violated controlling state and federal law. In support of this position, CBIA argued that in order to adopt such an ordinance, the City must provide evidence showing that the fees and exactions to be imposed on new development are reasonably related, and limited, to the City's reasonable cost of addressing the negative impacts cause by the new development. The trial court agreed with CBIA and the City appealed.

Holding and Analysis

On appeal, the City argued that CBIA was misstating the law and relying on the wrong standard of judicial review. The City argued that the IHO should be regarded as a land use restriction similar to a zoning regulation adopted pursuant to the local government's police power and, as such, must be accorded a highly deferential standard of judicial review and must be upheld if it bears a reasonable relation to the public welfare. Intervenor affordable housing groups argued that the ordinance was reasonably related to the legitimate government purpose of creating affordable housing and therefore was within the City's police power.

The appellate court agreed with the City and intervenors, and remanded the matter back to the trial court: "We thus leave it to the superior court to determine whether CBIA has rebutted the presumption that the [IHO is] reasonably related to the City's legitimate public purpose of ensuring an adequate supply of affordable housing in the community." In reaching its conclusion, the appellate court reviewed the facts and the holdings in a number of prior affordable housing decisions. In particular, the court focused on Homebuilders Association of Northern California v. City of Napa (2001) 90 Cal.App.4th 188 ("Napa"), San Remo Hotel L.P. v. City and County of San Francisco (2002) 27 Cal.4th 643 ("San Remo"), and Building Industry Association of Central California v. City of Patterson (2009) 171 Cal.App. 4th 886 ("Patterson").

In the current case, CBIA relied on San Remo and Patterson and argued that the IHO is neither a zoning ordinance nor a regulation of the use of property but, instead, establishes a dedication or fee on covered projects. In San Remo, the plaintiffs challenged a development impact fee that was specifically designed to mitigate the loss of housing caused by the conversion of residential units to tourist uses. In that case, the court held that a "reasonable relationship" must exist between the development mitigation fee and the deleterious public impact of the development. The appellate court in the current case distinguishes the facts in San Remo by concluding that the IHO at issue does not appear to have been enacted for the purpose of mitigating housing loss caused by new residential development but, rather, was for the purpose of enhancing the public welfare by establishing policies which assist in the development of affordable housing. Thus, according to the appellate court, whether the ordinance was reasonably related to the deleterious impact of market rate residential development in the city is irrelevant and the wrong question to ask.

The court then addressed the Patterson decision. The court acknowledged that in Patterson the "reasonable relationship" standard from San Remo was appropriately applied but, based on their lengthy analysis, concluded that the standard articulated in San Remo is not applicable in the  case of a facial challenge. In the case of a facial challenge, the court held that the ordinance should be reviewed as an exercise of the City's police power. Pursuant to this standard, an IHO is a valid exercise of the police power if it bears a substantial and reasonable relationship to the public welfare and is invalid only if it is arbitrary, discriminatory, and without a reasonable relationship to a legitimate public interest. Thus, in reviewing a legal challenge to an IHO, the City is entitled to substantial deference and the ordinance will survive such legal challenge if it is fairly debatable that the ordinance reasonably relates to the welfare of those in need of affordable housing.

Implications of this Decision

Assuming this case survives a likely appeal to the California Supreme Court, it will stand for the proposition that all cities and counties in California may adopt IHO's as an appropriate exercise of their police power and that such ordinances will only be overturned if it can be established that the adoption of the ordinance was arbitrary, capricious, entirely lacking in evidentiary support, bears no reasonable relationship to a legitimate public interest, or is unlawfully or procedurally unfair. Given this standard, a successful facial challenge to such an ordinance is virtually impossible. After Patterson a number of jurisdictions did away with or stopped implementing their IHO's andad hoc affordable housing requirements. This decision will likely encourage those City's and, perhaps, many more, to adopt IHO's along the lines of the one adopted by San Jose. It will be imperative for the housing industry to strongly educate and advocate, at the city and county level, the negative impacts such IHO's will have on housing affordability and development in their communities.

[Note: opinion only touches on Palmer, which holds IHO's for rental projects are preempted by Costa-Hawkins.]