New apartment buildings are shown under construction on the east end of the Burnside Bridge on March 9, 2017. (Stephanie Yao Long/Staff)

Portland’s apartment-building binge appears to be headed off a cliff.

Applications for new housing developments have nearly ground to a halt over the past year, and there are plenty of reasons for that. Construction costs have ballooned, as have land prices. The glut of new construction, meanwhile, has taken the wind out of rising rents, at least at the high end.

But Portland officials are increasingly worried the city's inclusionary zoning policy, which compels developers to set aside rent-restricted units in large apartment and condo projects, might be playing a role, too. And if home construction dries up, it could ultimately push housing costs even higher.

Only 12 privately financed developments large enough to trigger the mandate, totaling 654 units, have sought building permits since the policy took effect last year. A more typical year in the recent housing boom has seen thousands of new apartments proposed.

Those projects would create 89 units geared toward households earning significantly less than the median income.

It’s difficult to say, given the many conflicting variables, whether or to what extent inclusionary zoning is to blame for the drop-off. Meanwhile, there’s a backlog of projects that had been submitted before the rules took effect, representing up to two years of future development.

Nonetheless, a city economic planner tasked with monitoring the program says it might be time to consider changes that could give developers a better deal — or risk putting an artificial cap on the housing supply, driving rents higher in the long run.

“It’s not that the policy is currently broken,” said Tyler Bump, a senior economic planner with the Bureau of Planning and Sustainability. “It’s that we need to track it before it breaks.”

The 12 large projects are set to create 89 units geared toward households earning significantly less than the median income.

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Policymakers are trying to walk a fine line, between using private development to create affordable units and avoiding a policy that shrinks housing stocks and drives up rents. They created incentives — including allowing more density while waiving fees and taxes — designed to offset the cost of the discounted rentals.

But developers say the market has shifted dramatically since those offsets were created. Rents in high-end buildings have been stagnant over the last year, which has prompted some landlords to throw in a few weeks of free rent to land tenants.

And it’s getting more expensive to build.

Urban Asset Advisers, a local developer, started construction on the six-story, 63-unit Lower Burnside Lofts in 2014. At the time, according to company President Tim O’Brien:

The company paid a contractor $156 per square foot for construction materials and labor, totaling $7.8 million. Today, the company would budget $220 a square foot, or $10.8 million.

The building cost $15,400 per unit in permit and development fees. Today, O'Brien estimates it could be $22,000. A 1 percent construction excise tax to pay for affordable housing has been created since and could add thousands more.

Land prices have climbed. That site, acquired in 2012 for $700,000, is now valued at $1.2 million for the land alone.

Today, Urban Asset Advisers is working on two projects that will fall under the inclusionary zoning mandate.

Both developments, at 39 and 54 units, are smaller projects. They’re financed with a collection of local investors, rather than money from an out-of-town institution.

They work, O’Brien said, because small-time investors are willing to accept a smaller return.

But the big real estate trusts, retirement funds and other big-time investors that fueled the recent building boom expect a higher return, of about 6 percent.

That’s a much harder target, given the rise in costs and the required discounted units. And if those institutional investors can’t get that return in Portland, they can build in other growing cities where they can.

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Lower Burnside Lofts, an apartment building developed by Urban Asset Advisers and opened in 2015. (Elliot Njus/Staff)

O’Brien says the policy can work without pulling the plug on new housing. But, he said, the city might have to reduce the number of affordable units it requires. The rule requires that one in five units be affordable to households making 80 percent of the city’s median family income, which was $74,700 for a family of four in 2017. Developers can choose to offer deeper discounts on a smaller number units.

“We want to produce IZ stuff,” O’Brien said. “We want to be part of the solution. We really want to find a way to get this right.”

Some local developers have stopped pursuing new residential developments altogether.

Cairn Pacific LLC, whose founders have developed nearly 700 apartments in Northwest Portland under two different companies, is working on two apartment projects that it submitted to the city before the inclusionary zoning policy took effect. Though it has considered buying land for future developments, the rate of return would be too low for banks to make a construction loan, said co-founder Thomas DiChiara.

“The impact of inclusionary zoning is big enough that most deals that are already on the fringe fall below the threshold to be financeable,” DiChiara said. “Most projects are on the fringe anyway because of what the costs are.”

Of the private projects proposed under the inclusionary zoning mandate, not one is in Portland’s central core, where the incentives are the most generous.

The city is extending a 10-year tax abatement for the discounted units in the central city. That’s because buildings there are expected to be taller, and concrete-and-steel construction is more expensive than wood-framed buildings elsewhere.

But the uncertainty of where tax rates might fall when the abatement expires makes lenders and investors who would still have an interest in the building in year 11 nervous, DiChiara said. The rent, meanwhile, is locked in at affordable rates for another 89 years.

“How do I get an investor to buy off on that?” he said. “You have to underwrite it as if there’s no abatement.”

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Shannon Callahan, the interim director of the Portland Housing Bureau, said the permit drop-off isn’t unexpected, and that the program is operating as expected.

“We committed at the very beginning of passing inclusionary zoning that we would always assess it against market realities,” she said. “In the first year, we’re watching it carefully. But we have to look at the other factors in the market and can’t have any knee-jerk reactions.”

Mayor Ted Wheeler already plans to propose some changes to the inclusionary zoning program, a spokesman said. They would extend a 10-year tax exemption to developments that aren’t subject to the mandate because they were submitted to the city before the policy took effect.

That could squeeze more affordable units out of the existing pipeline, but it would do little to address the looming drop-off.

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Close to 10,000 apartments were in the development pipeline before inclusionary zoning took effect, said Bump, the city economist. Half of those are near approval to break ground.

Those projects could keep a steady stream of housing coming online for the next two years. Some, however, may simply not happen. It’s not uncommon for developers to drop projects because of unforeseen logistical or financial problems.

That means the city needs to see more housing proposals in the next year, Bump said, to avert a deep lull in development.

The Great Recession demonstrated the consequences of such a lull. In the throes of the economic downturn, housing production slowed to the lowest levels in recent memory.

As the economy recovered, from 2010 to 2017, average rents climbed 60 percent.

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-- Elliot Njus

enjus@oregonian.com

503-294-5034

@enjus