In order to examine the Incentive Zoning (IZ) Program, the city hired analysts to model some different outcomes based on various assumptions. The analysts were trying to tease out how different structures of the program would affect affordable housing in the city. Ultimately, a 43-page report was published by the analysts to tackle the issues surrounding the city’s IZ program.

The background

The incentive zoning program has been in place since 2001 and affects particular zoned areas in Downtown and South Lake Union. The program is structured so that developers can get certain advantages, such as increased height if they build affordable units in their structure or pay a fee. Over the 13 years since the inception of the program, analysts found that it produced 714 units of affordable housing. Overall, the program makes up 11% of the total funds for affordable housing.

The analysts’ task

To be clear, this is not an analysis of the best way to make housing affordable in Seattle. Instead, this is an analysis of whether or not it is possible to increase the production of affordable housing under the IZ Program–an important distinction. John Scholes who commented on behalf of the Downtown Seattle Association noted that the analysts said it would be difficult to significantly grow the program, and even if it were doubled, it would barely put a dent in the need for affordable housing. In other words, the report shouldn’t be viewed as an attempt to tease out a solution to the affordable housing problem, instead it is only an attempt see potential impacts of the IZ Program.

The surprising findings

The image below forms the basis for most of the report. Essentially, the analysts wanted to tease out different potential returns on development under various scenarios. As an example, the ‘middle scenario’ of low-rise or mid-rise development that doesn’t utilize the incentive zoning programming shows an 18% return. Returns in red indicate development that is unfeasible while those in light green indicate the development is feasible.

The analysts assumed that if the return on development is 5% or more, developments are considered feasible, while those under 5% are not. As you can see, the study indicates that development is feasible under nearly all the different scenarios. In this sense, the study would lead people to believe that fees could be raised on nearly all private development and developers would still make a profit. This implies that they would continue to build housing, but our understanding deepens with the most important finding by the analysts.


In this analysis, the darker green highlights the most preferred type of building. What it shows us is that in nearly all scenarios, the most preferred option is not utilizing the incentive. Regardless of whether or not the numbers are accurate, this shows the logic of developers. It doesn’t matter whether or not they can still be profitable after paying a fee. Instead, it matters what options they are going to choose given the costs of various options.

This basically means that you can’t simply offer incentives to developers, like upzoning, if the costs of those incentives make them less profitable. Specifically, the 6-7 story buildings show the lowest returns and are the only building types that become mostly unfeasible (disregarding whether they are preferable) under the incentive zoning program. In other words the program is most at odds with building types that help walkability, transit, density, environmentalism, lowering the per capita cost of city services, sustainability, and much more.


From these observations, a number of recommendations were made. The analysts were careful not to say that Seattle shouldn’t pursue the IZ program. Instead, they indicated how the money could be used better by by focusing on the right income groups, making sure incentives don’t discourage high-density development, increasing the amount of funding that goes to particular housing types, and more. In addition, the analysts made an unexpected recommendation. They indicated it would be worth studying the impact of converting the program from an incentive zoning program to a linkage fee program. Specifically, the analysts would like the city to commission a Nexus Study to better understand the impacts of linkage fees.


I think the study shows a lot of great work and is exactly the type of effort we need from the city. With that said, I think we can learn a lot about pursuing future studies. There are a number of critical questions left unanswered. If the city pursues the IZ program or decides to study linkage fees, I think it’s important that the following issues are addressed:

  • Are there programs that could have bigger impacts? Council Member Clark acknowledged that the results from this program may seem small, but they are still important. There is no doubt that all affordable housing has real impacts, affecting people with important needs. It is also important to acknowledge that we face opportunity costs. If we spend all our time and effort working on a program with a small impact we may be missing programs or ideas that have much larger impacts. The city has spent nearly equal time studying the IZ program as it has studying numerous alternative options and there are even more programs that haven’t been examined at all. If a better alternative is found, the time, money and housing lost that could have been used studying another program is opportunity costs.
  • How do Incentive Zoning or Linkage Fees affect the larger housing market? It’s fine to tailor a program to raise more money, but the ultimate goal is to lower everyone’s housing costs in addition to ensuring everyone has affordable housing. It is entirely conceivable that increasing the production of affordable housing by one program could consequently negatively affect overall housing costs. In fact, some attendees asserted the study indicated this was already happening.
  • Are these scenarios accurate? There are a lot of assumptions being made. Determining return on investment is fraught with unknowns. It requires guessing future rents, land values, development costs and much more. Additionally, I see some of these numbers extremely skeptically. Indicating 33% return on equity requires further scrutiny. It’s one thing for a model to produce this estimate and entirely different for evidence from actual development to show that.

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Owen does servicing and consulting for a software company to pay the bills. He has an amateur interest in urban policy, focusing on housing. His primary mode is a bicycle but isn't ashamed of riding down the hill and taking the bus back up. Feel free to tweet at him: @pickovven.

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Another study telling us that the city’s in-lieu fee is too low to maximize affordable housing.


Once again we find the city’s in-lieu fee is too low to maximize affordable units.

Dan Bertolet

The chart you show was cherry picked for the low cap rate scenario. For the higher cap rate, the David Rosen report concludes:

“In most cases, prototypes are infeasible at higher cap rates, indicating financial feasibility dependent on market and investment conditions”

Ben B.

We’re currently in a compressed cap rate residential market anyway. It’s perfectly reasonable for the time being. And, somewhat paradoxically, if amazon hires it’s planned workforce and IZ and other policies like it continue their current effect on the market into the future, we may be in a compressed cap rate scenario for some time.

Stephen Fesler

What is compressed cap rate?

Ben B.

Stupidly high prices compared to Net Operating Income.

A Capitalization Rate is a metric used in an appraisal’s income approach to valuation and is the Net Operating Income divided actual sales price of comparable properties.


Ben, do you really think that a 4.25% cap rate is perfectly reasonable even in today’s overheated market? Unfortunately, there’s not a single lender or appraiser who would agree with that. Good luck trying to get a loan based on a valuation anywhere below a 5% cap. While there have
certainly been a number of projects that have sold in the 4.25% range, the overall average is closer to 5.5%. For someone projecting the exit cap on a project that won’t be complete for 3+ years using a cap rate less than 5% is foolish.

Cornerstone (and David Rosen) should be embarrassed by their work. Any real estate professional familiar with our market could tell immediately that their report is amateurish at

For those not familiar with cap rates, they can be thought
of as the return that a buyer can expect to receive from their
investment. For instance, if they are buying a building that produces $250,000 a year in Net Operating Income at a 4.25% cap rate, the price they have paid is $5,882,352. In other words, the $250k NOI represents a 4.25% annual return on their $5.88 Million purchase. The value of that same building producing $250k NOI at a more realistic 5.5% cap rate is $4,545,455. In other words, Cornerstone/Rosen are projecting valuations close to 30% above the actual market.

Pathetic that the City paid good money for such a garbage report.

Ben B.

I believe Harold’s point is that in a historical context (read 15-30 years), compression to sub-5% cap rate is lunacy. In the context of no signs of 10-year US Treasury note going much over coupon anytime too soon, it’s the current normal. There are many apartment sales comps with 4-5% cap rates. However, I’m guessing Harold doesn’t believe it’s a good way to plan, and that’s fair.


Owen, yes, D+S, O’Connor, etc will all sell you the data (or trade you for the info if you have info that they want). The best free sources are probably brokers. The problem with the broker info is that it’s so easy to manipulate the numbers (exclude certain types of assets, geographic areas, etc) and you can never be certain that they’re not pushing an agenda.

One of the more interesting reports I’ve seen lately came out of Colliers (by Dylan Simon). Although perhaps I’m just a sucker for the punchy colors and the exhaustive list of projects broken down by neighborhood. You can find the report at:

Regarding cap rates, you’ll want to check out page 5. You’ll see that for 2013 sales, there were indeed some sub-4% sales, but that there were also many sales of brand new product that sold for caps closer to 5%. You’ll also see that while the average of those sales in 2013 was 4.6%, the average was 5.8% as recently as 2009 and averaged above 7% prior to 2003.

My guess as to why none of your real estate colleagues raised the issue is due to the fact that Cornerstone doesn’t clearly outline their methodology. I wouldn’t have noticed if Dan Bertolet hadn’t raised the issue above.

Ben B.

It says they used 4.25% to 5%*. Am I misreading that?

That’s not unreasonable at all in today’s environment of highly compressed interest rates (3.50% for 10 year term loans on many apartments) and bullish apartment forecasts. If you’re underwriting a 5% cap, true, it’s hard to get that valuation, but if you’re talking market cap: there are comps at those compressed caps.

*I’m not commenting on the nature of the complete report. All I’ve seen is the above presentation.


Ben, my comments were based on their note on page 13 of the report that states that the “Baseline” model used a 4.25% cap. Not sure if the “Lower Baseline” used in the chart on the next page was the same or even lower (I shudder to think).

In truth I didn’t spend much time pouring over their numbers as I had a hard time getting past their cartoonish oversimplification of land residual on page 11.

And yes, I agree with you that there have been trades happening at ridiculously low caps — and that those prices might actually make sense for strong borrowers in our current interest rate environment. However, I can’t think of a single lender that would ever underwrite a construction loan at anywhere near current market caps.

Matt the Engineer

Could you describe what linkage fees are? Is that simply a tax on development used to build affordable housing?