Rethink Real Estate. For Good.

Investing

Taking the best path forward.

Nowadays, you can’t throw a stone without hitting a “socially conscious” or “socially responsible” residential development project. Let’s assume for a second that most of the firms involved in these projects are genuinely interested in making a difference while making a profit. The question remains: why aren’t we seeing a substantive change in the amount and type of affordable housing available? The quick answer is that many developers are not taking into account how their projects will function in the real world.

Housing is a complex and multifaceted sector. Market conditions and governance factors change from state to state, county to county, and even city to city. Developers can have the best intentions in the world, and the best game plan, but if local authorities or stakeholders are not on board, their project may be dead on arrival. There are significant market forces working against affordable housing. Since housing is an investment for homeowners and commercial property owners, they have a vested interest in stopping new affordable housing from being built.

It may seem that developers working to bring to market affordable housing projects have the deck stacked against them. But with the right mindset and vision going into a project, there is precedent for success.  That precedent requires moving beyond traditional ways of thinking and employing place- and use-based framework to their developments.

Place-based responsibility

When selecting a site to erect community-conscious or low-income housing, it is essential to show respect for the local community, and how that development will affect the day to day lives of the people in the area. Many of the problems associated with low-income housing, like blight, crime rate increases, traffic and density issues, and a whole host of other problems come about as a result of poor planning and not staying true to place-based responsibility. In order to dodge these issues, a focus on the neighborhood as a whole, rather than your little piece, will pay big dividends later on.

Use-based responsibility

Use-based responsibility touches on some of the same areas as place-based, but with a crucial difference: it looks towards how the residents and community will interact with the development on a level that exceeds simply doing what you can to ensure the units are filled. Rather than just creating a sequence of buildings, the goal should be to create eminently livable communities, where the space compliments the way residents live, rather than residents having to adapt to the space.

Determining the best path forward

To ensure that your project is aligned with place and use based responsibility, it is imperative that you somehow engage the community. This can be through educational campaigns, public meetings, or any other means of two-way communication between stakeholders and developers. Going further, crowdfunding platforms have allowed developers to solicit investments from people in the very same communities in which they hope to make a difference. Nothing gets people on board like having a direct financial incentive in a project.

_

Even the best intentions can result in disaster without proper follow-through. They say smart people learn from their mistakes, and smarter people learn from the mistakes of others. The socially responsible development sector is no longer in its infancy, and there is a wealth of data out there to help new developers avoid the mistakes of the past. Recognizing your responsibility as an investor or developer is the first step toward building a profitable, socially conscious property portfolio.

Image by Eve Picker

Can Opportunity Zones provide opportunity?

Since the first New Deal housing policies emerged in the 1930s, governments from the municipal level all the way up to the federal government have sought ways to help alleviate the lack of affordable in this country. While there have been many successes, there have also been notable missteps. Infamous projects like Queensbridge in New York City and Cabrini Green in Chicago tarnished the credibility of projects subsidized by the government for decades and continue to tarnish that credibility today.

Low Income Housing Tax Credit

Low Income Housing Tax Credits (LIHTC, or Section 42 credits as they are sometimes called) support the development of much of the low-income housing product developed today in the United States. This tax credit provides a dollar-for-dollar subsidy to investors deploying capital into affordable housing projects. When investors choose to work with this program, in return for the tax credits they receive, they must abide by rent restrictions to maintain the affordability of these projects for low-income Americans. Rent restrictions can be required to continue for up to twenty years and can wreak havoc on the investor’s ability to project a financial return on a LIHTC project.

Real estate is by definition a depreciating asset, aside from the value of the land. Any structures built will require maintenance, repairs, and capital investment over the life of the building. If you are unable to rely on appreciation in value because the property is located in a depressed economic area, then you’ll find that you have a substantial restriction on how much income that property can generate. As a result, LIHTC projects are relegated to a small niche of developers who have figured out to how to generate returns despite these issues.

For many years those working to solve low-income housing issues focused primarily on the quality of housing- there was at least some lower-tier housing in most urban areas that even the very poorest could access through market means or government assistance. With increased urbanization and the concentration of economic opportunities in cities, these affordable housing opportunities have all but disappeared. Existing residents are forced to move further and further away from job opportunities, exacerbating poverty and environmental issues caused by commuting- and all the while, slowly by surely the fabric of inner-city communities across the country is being destroyed.

Opportunity Zones may help fill the gap

One of the definitions of madness is trying the same thing over and over and expecting a different result. Developers, investors, government and community groups would do well to adopt new, market-based approaches. Channeling capital from traditional markets to these underserved communities in a responsible way may help to reduce the affordability crisis in ways that government initiatives have failed.

A much talked about solution that has been underway since 2017’s Tax Cuts and Jobs Act is the use of Opportunity Zones. These zones (8,000 of them) offer investors tax benefits for investing in designated Opportunity Zones, which are economically depressed regions that have suffered from a lack of capital flow. While LIHTC projects have rent restrictions, Opportunity Zone investments have no such limitations. Investors can invest in market-rate projects that are not hamstrung by onerous rules and regulations that so often come with government-led housing development.

_

Despite the not-insignificant issues that may arise as a result of public-private partnerships, there is incredible value to be created by working hand in hand with government to solve housing issues. Previous efforts that failed to take market forces into account unfortunately had predictable results. With Opportunity Zones and other such market-driven approaches, we can hope to see a greater reduction in housing insecurity in the years to come.

Image Cabrini Green Demolition, by Joe M500, CC BY-2.0

Securing housing.

Homelessness and housing insecurity are among the greatest challenges facing our communities. The US Department of Housing and Urban Development, in their 2018 Annual Homeless Assessment, reported that there were more than 550,000 homeless men, women, and children in the United States. Numerous factors contribute to the growing homeless crisis. The primary drivers include the skyrocketing cost of homes, whether for sale or for rent, flat or low-growth nominal wages, and the scaling back of governmental social and housing assistance programs.

Developers and investors hold some of the blame for housing insecurity. In many of the hardest-hit cities, developers have prioritized constructing luxury buildings. This focus on the higher end of the market can be more profitable, but units in these developments are inaccessible to the vast majority of people affected by rising home prices. What can we, as socially conscious investors and entrepreneurs, do to help resolve this seemingly insurmountable issue?

Housing costs and homelessness

For many years now, even before the housing crisis in ’08, developers have shifted their focus toward luxury construction. There are a few reasons why most new construction is in the luxury space. As properties age, the physical structure that sits on the lot, the actual building, becomes less valuable. While many of the affordable units on the market today did not start life that way, they aged into being affordable. This is known as “filtering.”

In addition, much of the current affordable housing stock in this country was built at a time when regulations, permits, and environmental concerns relating to new construction were a significantly lower burden to developers and builders. Creating low, and even middle-income housing is simply not as profitable as it used to be.

A multifaceted approach

When setting out to solve a problem as complicated as homelessness, there is rarely a “silver bullet” solution. Instead of focusing on a single contributing factor, to make real progress, it is imperative that we employ a patchwork of strategies.

New construction technology

Developers can leverage new construction technologies to reduce the total cost per unit of new housing. New technologies that can help lower the cost of housing include drones to more effectively and cheaply survey lots, self-healing concrete to reduce foundation issues, or even the use of robotics during construction.

Partnering with cities to increase affordable housing stock

While many in the real estate industry take a cautious or even adversarial approach to local governments, they can be fantastic partners when it comes to getting affordable housing projects off the ground. Cities have a vested interest in creating sustainable neighborhoods and offer many tax breaks, land discounts on city-owned lots and other services and benefits to socially minded developers.

Work with social service providers

Social service nonprofits are on the frontline of the housing crisis. These groups step in when there is inadequate governmental or societal response to problems like homelessness. Many of these groups are shifting their focus from a reactive model to a proactive model. Instead of dealing with the consequences of homelessness, they are employing their resources to stop the cycle before it begins.

Investors and real estate professionals can work with these groups to help determine the needs of low-income residents and to find ways to build housing that stops the cycle of homelessness. The cherry on top is that through working with these groups, developers can build grassroots community support for their projects, which will make neighborhood and local stakeholder opposition less of a problem.

_

Homelessness affects all of us in one way or another.  Socially minded developers can use their skills and capital to help end this problem and make all of our communities safer and more livable- and they can do so while still maintaining a healthy return on their capital and time investments.

Image Starter Home Two, courtesy of Office of Jonathan Tate

Private capital. The solution to housing affordability.

Three principal actors are tackling the housing affordability crisis in the United States- government entities, nonprofits and investors. The issues arising from housing instability and affordability are complex, and a patchwork approach is necessary to make a dent in the problem. With that being said, investors should be aware of their crucial role in alleviating or even ending the housing affordability crisis in America. In fact, the role of the private sector will likely be the deciding factor in whether or not this crisis gets solved.

Subsidies may evaporate

One pitfall that comes from relying too much on government aid is the fickleness of politicians and political parties. In tough economic times, the rug can be pulled out from under a wide variety of government initiatives that have been relied on, like social services, school budgets, fire and safety, and housing initiatives. Especially in these days of political extremes, government priorities can change radically from one administration to the next, which can leave local stakeholders or even private-sector partners holding the bag.

Private enterprise is nimble

The idea that private enterprise is more responsive than the government is not a new one. However, when it comes to housing, the government has a particularly checkered history. The first extensive forays into public housing in the United States were an unmitigated disaster, with massive brutalist projects focusing on warehousing residents rather than creating community. Predictably, most of these communities failed, and some have been demolished such as the infamous Cabrini Green in Chicago.

In the intervening years the government approach to housing has had mixed results and unintended consequences. Many experts pinned lax home loan lending policies, intended to increase homeownership, as the cause of the 2008 crash. As a result, the housing crisis festered and then exploded in the decade that followed through to the present day. Local, state and federal responses to this crisis have been lackluster, to say the least, and most innovative work in the space is being carried out by public-private partnerships, nonprofits, and private investors.

Investor priorities are changing

One of the standard and somewhat accurate criticisms of investors is that their priorities are not aligned with sustainable community growth. Take one drive through a Southern California town filled with rows of McMansions, or an empty luxury tower in downtown Portland, and you can see why many believe that investors are not interested in anything other than profits.

Despite the mistakes of the past, a new generation of socially conscious investors in partnership with community groups and nonprofits, is making great strides in developments across the country. Projects that are too niche or not profitable enough for large developers are instead being undertaken by smaller developers and investors working in concert with local groups. Some are even utilizing crowdfunding platforms. Rather than relying on a large lender in Chicago or New York to fund their projects, socially minded entrepreneurs can solicit funds through crowdfunding efforts, from friends, family, socially responsible investors and even residents of the same areas in which they plan to develop.

An excellent example of such a community-centric projects are the redevelopment of vacant urban infill lots, some of them oddly shaped and otherwise unsuitable for traditional or large-scale development projects. These projects are centrally located in already built-up areas, close to flourishing economic zones and neighborhoods. They provide a pressure valve for housing demand and are often embraced by local residents who are eager to remove an eyesore from their community, like an abandoned factory an overgrown lot or a long vacant house.

_

The private sector has a great deal to contribute when it comes to ending the affordability crisis. Responsible investors can work on timescales longer than the period before the next election and have a vested interest in creating spaces in which residents want to live.

Image by Inmacus from Pixabay

The democratization of finance.

Throughout history finance has been the province of emperors and kings. Later it included the merchant classes and the new aristocracy born of the Industrial Revolution. Your average Joe only really got involved in investing during the stock craze of the 1920s. Even today the average investor holds assets in a small subset of classes – primarily stocks, mutual funds, and bonds. If Joe wanted to acquire real estate assets, she was relegated to a mortgage on her home, or her residential rental properties, or publicly-traded real estate service firms like the Simon Group, AvalonBay Communities, and others.

While all those asset classes have value and the potential to generate returns, the ability to invest in other real estate classes without a massive pile of capital has been limited until recently. In the early 2010s other real estate asset classes like commercial, shopping centers and retail became available to the average Joe as a result of the 2011 Entrepreneur Access to Capital Act.

The Entrepreneur Access to Capital Act gave a much wider pool of investors the ability to participate in crowdfunded investments. It did this by providing a crowdfunding exemption from SEC (U.S. Securities and Exchange Commission) regulations, as long as a company raised a maximum of one to two million dollars, the amount set at the time the bill was signed. Under the Entrepreneur Access to Capital Act, anyone could invest up to $10,000 or 10% of their annual income, whichever was lower.

Opening up markets to new investors

When markets open to firms, economic growth tends to follow. A great example of this is the surge in investment capital and growth in China after they gained Most Favored Trading Status in late 2001. China went from third-rate to one of the most dominant economic powers within just a few decades. While not entirely analogous, the democratization of finance could follow a similar trajectory, providing great economic benefit to a much larger pool of real estate investors and the communities in which they choose to deploy capital.

Rather than well-heeled and institutional investors sucking up profits by virtue of being the only ones allowed to play the game, now individual investors can take advantage of commercial real estate opportunities. This includes investing in a wide array of property types, such as multifamily apartment buildings, self-storage facilities, retail and shopping centers. Real estate projects with capital requirements that are out of the reach of most individual accredited investors are now within reach thanks to equity crowdfunding. 

Impact investing and the democratization of finance

One of the most exciting possibilities that the democratization of finance brings, is its possible marriage to socially responsible impact investing. Historically, the type of person who is interested in high-finance has not typically been particularly socially responsible. We can see that through industry’s past opposition to things we take for granted, like the weekend, child labor laws, safety standards, and a whole host of other protections. That is not to say that all investors or capitalists are bad people – just that they are laser-focused on profit, often to the detriment of society at large.

As many new investors enter the scene, bring different attitudes to ethical investing with them, this focus on profit may take a backseat to sustainable, community-led development projects. Impact investing does not need to mean sacrificing returns or investing in unprofitable projects – it is simply a market mechanism for affecting change while also generating a return on your investment.

_

As we’ve seen throughout history, large concentrations of power are not good, regardless of whether that power is financial, political, social etc. The democratization of finance has the potential to avoid or even alleviate many of the corruptive and detrimental effects of the finance system- by spreading ownership and wealth amongst the crowd instead of amongst just a few, and by shifting investment focus to impact investing with the end result of creating better places for everyone.

Image by MTAPhotos, Hudson Yards Real Estate Development Update: April 16, 2015, CC-BY-2.0, image cropped.