ByAnna Steiger , Tessa Hebb, Lisa Hagerman
Community-based organizations promote economic development by assembling investments in affordable housing, mixed-use real estate, community facilities and small business in specific geographies. There are calls for the community development sector to have an increased impact on communities by tapping large sources of institutional capital as a new source of funding for these activities. However, these community-based organizations are generally small and limited in their capacity to put together community investments that attract large institutional investors such as national banks, public-sector pension funds, insurance companies and foundation endowments.
Some community-based organizations have found a way to tap institutional investors for deals by partnering with investment intermediaries who manage the risk of the transactions by pooling assets, spreading risk across investors and pricing the transaction up to the associated risk.
Communities are by definition embedded in location-specific geography. As a result, community investments tend to be small as well as hybrid and individual in nature. In contrast, institutional investors seek opportunities to invest large sums of money in easily replicable financial instruments that generate market-based returns with minimum risk.
While institutional investors have significant assets that if deployed in communities would have substantial impact, given the inherent mismatch between these investors and the investment opportunities offered by communities, such investment is unlikely to occur without bridging mechanisms that overcome these problems.
Our research suggests that investment intermediaries with expertise in working with community-based organizations are required to unlock value for institutional investors and communities alike.
Such partnerships allow investment intermediaries or "investment vehicles" to use their expertise to structure a deal that delivers high financial returns to institutional investors while ensuring that the investment provides a community benefit. The investment vehicle actively manages investor funds, allocating them to community projects and creating a capital structure for the deal. The community partner, usually a community development corporation, draws on its local knowledge of the community to identify potential deals and work with the investment intermediary to structure the deal so that it has benefits for neighborhood residents. Such benefits include job creation, affordable housing and environmental sustainability through, for example, brownfield redevelopment and investments in clean-tech companies.
Investor benefits are measured first and foremost in market-based financial rates of return and secondarily in the ancillary benefits generated by revitalized communities. Several for-profit and nonprofit organizations have begun to track these benefits for the purposes of quantifying the community impact of these projects.
Our research examines several models such partnerships can take. Two of these models hold the greatest promise for unlocking value for investors and communities because they recognize the role and capacity of the community partner.
The first is the contractual model, where a not-for-profit community partner or fund sponsor organization (e.g., the Bay Area Council in the Bay Area Family of Funds) affiliates with a proven for-profit fund manager in delivery of the community development. The second is the ownership model, where a not-for-profit community organization embeds a for-profit development arm within its own structure.
These two models ensure the diversification, scale and rates of return necessary to attract large institutional investment dollars while simultaneously ensuring the revitalization goals of the existing community.
A good example of a not-for-profit community development financial institution with an embedded for-profit development arm is Coastal Enterprise Inc. (CEI) in Wiscasset, Maine. CEI owns several for-profit subsidiaries, including CEI Capital Management LLC (CCML), which manages CEI's $249 million New Market Tax Credit (NMTC) allocation. CCML is the investment vehicle intermediating between institutional investors and communities.
In 2003, the Nature Conservancy, a nonprofit conservation organization, approached CCML to be a working partner in an NMTC deal that would tap private-sector capital to help conserve the environment while promoting economic development in a rural region of Maine near Millinocket.
The partnership ultimately attracted equity investment from GE Commercial and Industrial Finance in exchange for the federal tax credits. This equity allowed two recently shuttered paper mills belonging to the Great Northern Paper Co. to reopen, retaining jobs for 650 people. The deal also provided for the Nature Conservancy to purchase 41,000 acres of land from Great Northern and called for a perpetual conservation easement on an additional 200,000 acres of land owned by the paper company.
In this deal, the Nature Conservancy was the community partner, connecting CCML to the investment opportunity and ensuring that the deal provided social returns to the area. CCML was the investment vehicle, connecting the institutional investors to a community-based investment while ensuring that the deal provided the financial returns required by investors.
The cases examined in our research provide insight into how investment and community intermediaries partner in a community development transaction. A working relationship between an investment vehicle and community partner becomes a formalized one, and the best partnerships have clearly defined roles. These partnerships can be initiated by either entity. Both investment vehicles and community groups look for partners that have a level of financial sophistication and proven experience with successful community-driven economic revitalization.
Community partners are organizations and businesses rooted in the community with an explicit mission to promote community benefits and work with the investment vehicle to identify and structure community investments. They bring with them various "tools" that help them unlock community benefits.
Financial tools allow community partners to work with investment intermediaries to structure deals that provide the financial returns required by institutional investors. These tools include philanthropic grants, below-market-rate funding, and tax credit allocations sponsored by the federal government, such as NMTCs, the SBA's program for Small Business Investment Companies, and the Low Income Housing Tax Credit.
Social/political tools include a community partner's deep knowledge of local conditions and history, ties to key community stakeholders, mission to benefit the community, and track record of contributing to local economic development. These tools engender trust with the community, which can help to get a development project approved, structure the development to meet local market demand that yields high financial and social returns, and leverage additional resources for these community investments.
Material tools include land or a community facility owned or managed by the community partner.
Our research examines several types of community partners, including not-for-profit fund sponsors; not-for-profit organizations such as CDCs and CDFIs; mission-driven lending intermediaries-either not-for-profit, for-profit or public intermediaries; local governments and officials, such as mayors; and underserved businesses, including minority- and women-owned businesses. Not-for-profit fund sponsors and not-for-profit affiliates help ensure robust community benefits because of their strong community development mission and role in identifying investments. They also bring with them powerful tools that can make the deal work from a financial point of view.
There are many social benefits that can be derived from community-based investing. The social metrics are slowly being measured; and, while there is not yet any standardization, various funds are beginning to define and report on the nonfinancial returns. Some of the social returns being tracked include:
Economic development benefits, such as the creation of livable-wage jobs, affordable rental and ownership housing, and mixed-use real estate developments. These benefits can result in other returns for local areas that are more difficult to measure but are important, such as increases in the tax base due to the growth of businesses and an increase in property values.
Community impacts, including the creation of community facilities, such as day care centers; open spaces; job training programs; and technical assistance services for entrepreneurs.
Environmental sustainability, such as promoting mixed-use and transit orientation; green building construction and operation; energy conservation and waste reduction; and alternative energy utilization.
In addition to these direct benefits, our research demonstrates that community-based organizations that partner with investment vehicles to develop large-scale projects can also benefit organizationally. For many, the experience has been transformative in nature, bolstering the capacity of the community partner, spurring them on to greater innovation and strengthening their overall sustainability.
Challenges remain to connecting institutional capital to community-based investments. They include increasing deal flow, overcoming market prejudice and creating models that can deliver smaller amounts of capital to investment opportunities. Notwithstanding, institutional investors have placed large amounts of capital in economic development investments, and the numbers are growing.
To date, public pension funds have committed $11 billion of their capital to targeted investment in underserved capital markets (or emerging domestic markets, as they are sometimes called). And market-rate, mission-related investments from foundations now stand at $2.3 billion. Increasingly, foundations are using both their program funds and their endowment funds for these investments.
Moreover, lessons learned from public pension funds in California, New York and Massachusetts demonstrate that these investments yield both high financial returns and social returns.> While more research is needed to examine the financial and social returns of these investments, it is clear that this is a growing sector for community development finance.