The Cost of Affordable Housing: What Drives It and How to Address It

Affordable Housing

Introduction

The attached document, authored by BAE Urban Economics for the San Diego Housing Commission (SDHC), is a landmark study titled "The Cost of Affordable Housing: What Drives It and How to Address It" (dated April 14, 2025). This report tackles one of the most pressing economic challenges facing high-cost coastal cities: the escalating expense of producing Low-Income Housing Tax Credit (LIHTC) projects. Unlike market-rate developments, which are not obligated to reveal cost details, affordable housing developers must submit exhaustive data, allowing for a transparent, data-driven analysis.

The core finding is that while construction inflation labor and materials drives costs industry-wide, affordable housing faces unique financial burdens. These include prevailing wage requirements, Project Labor Agreements (PLAs), stringent green building mandates, and off-site improvement costs that are rarely imposed on market-rate peers. The study analyzes 391 LIHTC applications and 171 "Placed in Service" (PIS) workbooks from California and Washington, including 65 San Diego projects. Through developer interviews and deep-dive case studies, the report identifies why San Diego’s per-unit costs are converging with other expensive metros (like Los Angeles and San Jose) and offers actionable strategies to contain costs and expand funding.

The Escalating Cost Trajectory

The data reveals a stark upward trend. In San Diego, the average total residential development cost per unit for new construction projects has increased dramatically. Between 2019 and 2023, costs rose from approximately $394,558 to $586,525—a compound annual growth rate (CAGR) of 10.5%. When adjusting for unit size, the cost per square foot grew at a slower but still significant CAGR of 4.6%, from $338 to $559 per square foot.

Looking forward, the report projects several scenarios. If construction inflation continues at the current California Construction Cost Index (CCCI) rate of roughly 2.3%, average per-unit costs could hit $763,276 by 2030. However, in a high-growth scenario (8% CAGR), costs would exceed $1 million per unit. This trajectory puts immense pressure on the capital stack, as LIHTC equity and gap funding struggle to keep pace.

Breaking Down the Development Budget

Understanding what drives these numbers requires dissecting the typical budget. For a 2023 San Diego new construction project, the average total residential cost is $67.8 million. The single largest line item is "Total New Construction Costs" (hard costs), comprising 38.7% ($26.3 million). This includes site work, structures, general requirements, contractor overhead/profit, and liability insurance.

The second-largest category is "Land Cost/Acquisition Cost" at 26.2% ($17.8 million). Together, these two categories make up nearly two-thirds of total development costs. Other significant contributors include Developer Fees (8.7%), Construction Interest & Fees (7.3%), and Soft Costs like architecture and engineering. Notably, for acquisition and rehabilitation projects, the dynamic flips: Land/Acquisition costs balloon to 64.6% of the budget, while new construction costs become negligible.

Peer City Analysis: San Diego in Context

The study compares San Diego to Los Angeles, San Francisco, San Jose, Sacramento, and Seattle. San Francisco remains the most expensive market, with new construction costs averaging $744,434 per unit. However, the most striking insight is the convergence of costs. While San Diego’s per-unit costs increased 48.7% between 2019 and 2023 (from $394,558 to $586,525), Los Angeles, San Jose, and Sacramento saw similar percentage jumps. By 2023, most California cities were clustered in the $560,000–$630,000 per-unit range, suggesting that regional inflation is now a shared burden.

Land costs vary wildly. Per-acre prices for multifamily land (Nov. 2021–Oct. 2024) range from a median of $25.7 million in San Francisco to $749,414 in Sacramento. San Diego sits in the middle at $6.76 million per acre. Labor costs are a differentiator: San Francisco electricians and elevator constructors command the highest wages, while San Diego’s data was unavailable (ENR doesn’t track it). However, developers interviewed uniformly cited prevailing wage requirements as adding 19.5% to 30% to hard costs, with PLAs adding another ~10% on top.

The Hidden Culprits: Off-Site Costs and Insurance

Two less-discussed drivers are off-site improvements and builder’s risk insurance. Off-site costs (roads, utilities, landscaping outside the project boundary) are a significant burden. San Diego projects with off-site expenses averaged $1.8 million, representing 3.7% of total residential costs the highest percentage among peer cities. For context, Los Angeles projects averaged just 0.9%. The report identifies master-planned communities as a primary culprit: affordable projects within these developments are often required to subsidize general community improvements like dry utilities, creek restoration, and traffic improvements.

Insurance costs are spiraling. Builder’s risk insurance (covering construction site damage) increased from 0.5% of total residential budgets (2016–2020) to 0.8% (2021–2023) a 76.9% proportional jump. Developers report that property insurance post-construction is an even greater existential threat, with premiums rising 26% annually, threatening operating budgets and debt service coverage ratios.

Deep Dives into High-Cost and Overrun Projects

The report examines five San Diego projects exceeding $650,000 per unit to identify specific drivers:

  1. Humble Heart (23-648): $913,365/unit. The primary driver is podium construction (Type I concrete base with wood-frame above), which is inherently more expensive than all wood-frame. Preservation of a historic facade added complexity.

  2. Horton House (23-538): $787,614/unit. An acquisition/rehab of a Type I residential tower. The driver is extremely high land/acquisition costs ($519,935/unit) in the Marina District, plus rehabilitating a legacy tower.

  3. Cuatro at City Heights (23-563): $781,050/unit. A scattered-site infill project. Costs spiked due to environmental remediation (vapor barriers, sub-slab venting, soil management plans) and the fact that land was purchased (not donated), doubling the benchmark land cost.

  4. Skyline/Rancho Bernardo Transit Village (23-445): $727,227/unit. This project required excessive parking (201 spaces under a DDA with MTS), a two-story concrete parking structure, and a 14,000 sq. ft. commercial shell. PLA and prevailing wage requirements added further layers.

  5. Iris at San Ysidro (23-485): $678,933/unit. The developer explicitly noted that without mandated public improvements (Howard Land Park, HAWK Crosswalk adding $50,000/unit), the project would not be "high-cost."

Cost Overruns: From Application to Placed-in-Service

Comparing initial budgets to final PIS costs reveals systematic underestimation. Among 171 PIS projects statewide, 45.6% saw modest increases (0–8.3%), while 9.9% saw significant increases (>16.1%). The top five overrun projects in San Diego tell a clear story of COVID-era disruptions and financing complexity:

Across all new construction PIS projects in San Diego, hard costs (Total New Construction) increased by an average of 8.6%, while construction interest & fees jumped 21.8%. For acquisition/rehab projects, rehabilitation costs rose 17.9% and relocation expenses rose 33.7%.

The Capital Stack and Financing Complexity

Affordable housing relies on a layered "capital stack." For the average application project (2016–2023), about 40% comes from LIHTC equity (4% or 9% credits), and 60% from gap funding (local, state, federal sources). San Francisco stands out for relying heavily on "Soft (Other)" funding (e.g., Mayor’s Office of HCD funds), while Sacramento uses more state funding.

The report highlights a critical vulnerability: the failure of Proposition 5 (2024), which would have lowered the voter threshold for affordable housing bonds from two-thirds to 55%. San Diego’s own Measure A ($900 million bond) garnered 57.6% support in 2020 but failed due to the supermajority rule. Consequently, the study emphasizes alternative financing mechanisms, including Tax Increment Financing (TIF) via Community Revitalization and Investment Authorities (CRIAs) and Affordable Housing Authorities (AHAs), as well as Mello-Roos Community Facilities Districts to pay for off-site infrastructure.

Developer-Identified Cost-Control Strategies

Through interviews with eight developers and two consultants, the study identified practical on-the-ground strategies:

Policy Recommendations

The report concludes with a detailed list of recommendations for policymakers, divided into cost containment and financing mechanisms.

Containing Development Costs

  1. Alternative Land Acquisition Pipeline: Beyond the Surplus Land Act, SDHC should consider creating a land bank (philanthropically funded) or partnering with Community Land Trusts to proactively acquire land and ground-lease it to developers, drastically reducing land/acquisition costs.

  2. Minimize General Off-Site Costs: San Diego projects pay a higher percentage for off-site improvements than any peer city. Policymakers should consider using Mello-Roos districts or Infrastructure Infill Grants to cover these costs, rather than capitalizing them into the project budget.

  3. Encourage Microunit Development: The city’s Micro-unit Density Bonus program (allowing 100% density bonuses for units ≤600 sq. ft. near transit) should be expanded. Microunits can significantly reduce per-unit costs (e.g., a Pasadena project achieved $250,000/unit).

  4. Utilities Inspection Prioritization: Nearly every developer interviewed cited delays in utility company inspections (e.g., SDG&E) as a major source of extended construction timelines and increased interest costs. The city should lobby for state legislation requiring utilities to prioritize affordable housing projects.

  5. Facilitate Developer Collaboration: SDHC can act as a convener, hosting summits or surveys to spread best practices like vertical integration and design standardization across the development community.

Financing Mechanisms

  1. Real Estate Tax Reduction Incentives: Modeled after New York’s 421-a/485-x program, San Diego could explore a local property tax abatement for mixed-income projects that provide deep affordability. While California’s Welfare Exemption already exempts 100% affordable projects, a new incentive could spur mixed-income production and improve NOI for projects with substantial tax burdens.

  2. Establish TIF Districts (CRIAs/AHAs): With the failure of Prop 5, bonds are harder to pass. CRIAs and AHAs allow the city to capture property tax increments from rising land values within a district and reinvest them directly into affordable housing and infrastructure. This requires no voter supermajority, though startup costs are high.

  3. State-Level Advocacy: The city should advocate for expanding the Welfare Exemption to cover more mixed-income projects and for state laws that streamline utility company permitting for affordable housing.

Conclusion

This study definitively shows that while market-wide inflation in labor and materials is the primary driver of rising costs, affordable housing in San Diego faces unique, compounding burdens: prevailing wage, PLA, green building mandates, off-site exactions, and a fragmented financing system. The silver lining is that San Diego is already viewed by developers as a leader in streamlining permitting (e.g., "Affordable Housing Permit Now" program). However, without new tools to control off-site costs, stabilize insurance markets, and create reliable local funding sources (via TIF or tax incentives), the dream of producing significant new affordable units will remain financially untenable. The report provides a roadmap; the challenge is now one of political will and inter-agency coordination.

Also Read: Dangiwa Harps On Innovative Housing Finance To Tackle Africa’s Affordability Crisis