Letting the Dollars Land
To realize the promise of community investment, the capacity of specific places to absorb available capital needs to grow.
By Robin Hacke Posted on March 26, 2014
This chart represents how Living Cities understands the five functions that allow capital absorption.
Practitioners of community investment seek to deploy capital to improve the lives of low-income people and build equitable and sustainable cities, returning cities to their role as engines of national prosperity and gateways to economic opportunity. To do this, community investors finance the creation and preservation of affordable housing, provide capital for small businesses, and finance community facilities and healthy, vibrant neighborhoods with access to transit and good jobs. By definition, they serve the underserved, focusing on markets and communities that mainstream market forces leave behind.
But is having capital to invest enough?
h6. The Integration Initiative
Living Cities found that it wasn’t. Living Cities has been engaged in community investment for more than 22 years, bringing grants, flexible philanthropic investments, and commercial debt to underserved communities in cities across the country.
In 2009, Living Cities embarked upon The Integration Initiative (TII), designed to support collaborative efforts that were improving the lives of low-income people in Baltimore, Cleveland, Detroit, Newark, and the Twin Cities. Understanding that our ambitions were too big to achieve with grants alone, we provided nearly $70 million in loans to finance catalytic investments in the five sites.
Our program design called for Living Cities to lend $10Ð15 million in commercial debt and $3Ð4 million in philanthropic capital to a community development financial institution (CDFI) in each site. CDFIs are specialized financial institutions that work in markets, including economically distressed areas, that are underserved by traditional financial institutions. Knowing that there are over 900 such institutions in the United States, we assumed we would find an appropriate CDFI in each city. We further assumed that these CDFIs would be embedded in the fabric of civic life and would have the specific expertise to serve the programmatic priorities identified by local leadership.
Yet as we began to implement TII, we ran squarely into some difficulties that repeatedly prevent community investment from realizing its full potential:
bq. *_Scale mismatch:_* As part of their credit process, the Living Cities lenders set a requirement: they wanted the $10-15 million they planned to lend to each CDFI to represent no more than 20 percent of the CDFI’s assets. Therefore, CDFIs eligible to participate needed at least $50 million in assets. Yet only a small fraction (about 6 percent) of CDFI loan funds nationwide had the asset base necessary to qualify.
*_Limited expertise:_* Most CDFIs that were large enough to qualify for participation specialized in affordable housing, which for years has been the best developed segment of the community investment landscape. Many of the cities, however, wished to concentrate on other areas, such as small business development or mixed-use, transit-oriented development. Very few large CDFIs have specialized in these fields. For example, as the Baltimore site evolved, local leaders wanted TII to add microenterprise and small business lending, but the existing CDFI partner there was focused on other areas. Eventually, an additional CDFI partner was identified in the state of Maryland and invited into the Baltimore market to handle these loans.
*_Deal orientation:_* Getting community investment deals done is often so complex and time-consuming that practitioners understandably tend to focus at the transaction level. It is difficult to step back from the “brain damage” and take a larger systems view.
*_Perspectives missing from decision-making tables:_* CDFIs often were not regular participants at the table where civic priorities were determined. Their important perspective on markets, the use of subsidy, and the financial feasibility of plans and priorities was generally missing from ongoing civic deliberations. This was true for HUD Sustainable Communities grantees as well; in many communities, developers and CDFIs have not been included at the planning table. As a result, regions moving to implementation must now seek out the market intelligence necessary to develop feasible investment strategies.
As a result of these challenges, fewer deals come together than would be feasible to finance. Investors who would willingly place their capital are left on the sidelines. It’s as though the investment dollars were on an airplane, circling over the TII cities. To land, the plane needed a functioning air traffic control system and a landing strip.
h6. Capital Absorption Capacity
Living Cities, together with the Initiative for Responsible Investment at Harvard’s Kennedy School of Government, began to research how to help places land that plane. We defined capital absorption capacity as the ability to make effective use of different forms of capital to provide needed goods and services to underserved communities, and then asked: How can you create capital absorption capacity? What makes places effective at deploying community investment?
A central conclusion we came to was that rather than looking at the presence or absence of certain kinds of institutions (such as CDFIs) in a place, it’s more important to focus on the overall ecosystem and whether it has some actors that can and will perform a series of functions needed to allow investment capital to be deployed for public purpose.
The five functions are:
* Shared Priorities: stakeholders agree on a vision and support investments that meet community needs.
* Pipeline: stakeholders generate and close deals that meet community investment goals.
* Enabling Environment: stakeholders create policies and systems that direct capital to community purpose.
* Managing and Monitoring: stakeholders provide oversight that keeps investments on track to meet financial and social goals.
* Learning and Adaptation: stakeholders build platforms for ongoing collaboration, improve processes, and identify and address emerging needs.
(See figure on page 39 for more detail on each function.)
The specific actors involved seem not to matter; it is the performance of the function that makes a difference. For example, we found that in some places, philanthropy led the process of developing a vision for the community; in other places such planning came out of the public sector, a nonprofit organization, or a metropolitan planning authority. (We suggest that it not be led solely by someone in elected office, since new mayors often are reluctant to stick to the vision of their predecessors.)
Similarly, a deal pipeline could be assembled by a quasi-governmental development authority, a CDFI, a community development corporation, community bank, or master developer.
We further learned there is no one right size for organizations that make up a healthy capital absorption ecosystem. But you do need organizations of the same scale as the task you are trying to accomplish. If you’re trying to do microlending, a small CDFI is fine. If you’re trying to do mixed-use, mixed-income, transit-oriented development in a hot market, that’s a totally different thing. And if you want innovation, you need either a scale or a business model that allows brainpower to be devoted to it, above and beyond daily transactional work.
Enabling environment definitely includes the public sector actors responsible for policies such as zoning and permitting, but other actors contribute to the enabling environment as well: for example, a philanthropy can create a PRI fund; a nonprofit like Data Driven Detroit can make market data available where it hadn’t been; an individual can organize a monthly breakfast for all the people who do small business lending in the region. Programs and practices like these all improve the enabling environment.
Monitoring of investments can be done by a combination of CDFI, CDCs, consultants, and funders.
Learning and adaptation is very much a function for the whole table: whoever notices a problem, lesson, or opportunity can call the question. The basis for learning can come from someone starting to think systemically instead of transactionally, or it may come from cross-pollination, when an individual interacts with counterparts in other places, or moves across disciplines, bringing their previous knowledge and connections with them. The strength of this function in the ecosystem can be assessed by asking: Was your last deal as hard as five deals before? What’s new and innovative that has gotten financed recently?
h6. Trying Out the Idea
Over the past year, we have started to test this function-focused approach to capital absorption in places across the country and to try to understand what actions can be taken—by public, philanthropic, nonprofit, and private sector leaders—to facilitate the flow and usefulness of community investment dollars.
To do so, we developed a self-assessment tool that communities can use to examine how the capital absorption functions are performed in their place and what steps would improve the functioning of the overall system. The tool is organized by function and asks questions like: What are the shared priorities that guide investment in our community? How do we currently build a pipeline of investments to help move us toward our shared goals?
We have used the tool as the basis for a capital absorption workshop, which we have delivered in half a dozen cities. In this workshop, 30 to 40 local stakeholders come together for a day of facilitated discussion, with the goal of identifying concrete actions that would enable community investment to occur more effectively in their area. Actions might include coordination of predevelopment and long-term funding for real estate deals, more strategic use of subsidy to achieve targeted priorities, or referrals between small business lenders to ensure that the most appropriate capital sources are identified for potential borrowers.
Even in pretty small places, getting stakeholders from a variety of institutions together to talk about these issues at a capital absorption workshop results in many people meeting each other for the first time. The first 15 minutes are often devoted to exchanging cards, even though these are people who may be pursuing the same goals in the same places. The workshops connect people and prepare them to take action together—creating a shared sense of urgency, sketching out the way forward, and helping to assemble a leadership group that can carry the work forward.
From the workshops, we’ve seen that the capital absorption framework provides a useful way for people to think about the difficulties they face when moving from regional planning to implementation. Plans often fail to account for market forces or to balance the needs of communities, developers, and investors. The framework generates conversation about what a region is trying to achieve and how to develop and prioritize a pipeline of investments that would contribute to the realization of that vision.
It also helps community investment stakeholders realize that they are participants in a system, albeit one that has developed haphazardly as people do individual transactions. Once people recognize the lack of “systemness” in their existing approach to capital absorption, they can take action to engineer processes that function more smoothly.
One of the common shifts in thinking at the workshops is that many participants come in thinking they need a fund. When we ask them, “What is the fund going to invest in? Do you have criteria? A pipeline?” they pause. We get people to step back from the tool and ask: What is the problem we are trying to solve and what do we need to do about it? It’s almost never just one thing. The good news it’s often a set of simple things, such as regular meetings among people who do different things—nonprofit and for-profit developers discussing mixed-income housing, for example, or those who provide predevelopment and takeout financing. That coordination keeps a lot of money from being stranded, and it only costs time and coffee.
Another step may be bringing in some missing capacity—regional or national developers or CDFIs. Not everything needs to be homegrown.
By identifying functions that need to be performed rather than specific actors that need to be present, the framework has helped sites have difficult conversations without pointing fingers at who is or is not doing a good job.
h6. The Way Forward
As we have reflected on lessons learned so far, we have been struck by the extent to which community investment practitioners struggle heroically to get transactions done under difficult conditions. However, we believe that the “brain damage” involved in such transactions could be reduced by convening sustained, cross-sector partnerships that set goals and priorities, identify a pipeline of opportunities for investment that contribute to achieving those goals, and advance that pipeline using a systematic, rather than a deal-by-deal approach.
One promising example is the Woodward Corridor in midtown Detroit. When we started in Detroit, there had been no commercial capital investment in 10 years. NCB Capital Impact (now Capital Impact Partners) came in and began to assess what’s there, what’s missing, and what’s needed, and to build relationships and connections. Now it has developed a $30 million Woodward Corridor Initiative Fund, tailored to the real needs. This will enable it to go from a deal by deal approach to a batch process. Capital Impact can go to the developer community and say, “This fund was put together based on what you said you need, and now there’s an open deal window.” The fund will help create momentum by concentrating investment geographically.
We are still at an early stage of exploration. We are curious about how places vary in the ways they approach the capital absorption functions and about what interventions will prove to make the biggest different in strengthening capital absorption capacity. We have begun to learn about challenges and opportunities to improve the system as a whole. For example, we have been surprised by the lack of available data about the subsidies used in community investment deals or about the volume and characteristics of such deals.
Generating system change is obviously a process that takes time. We look forward to learning alongside communities that are committed to building their capacity to use private investment for the public good. We intend to share our learning as we go, in the hope that together, we can realize the promise of community investment as a force for revitalizing our cities and creating opportunity for all.
Robin Hacke is the former Director of Capital Innovation at Living Cities (www.livingcities.org), a partnership among 22 major foundations and financial institutions that invests in revitalizing America’s cities. Ms. Hacke lead an effort to increase the capacity of underinvested domestic markets to absorb capital for the benefit of low-income communities .
- The Capital Absorption Capacity of Places: A Research Agenda and Framework,” Initiative for Responsible Investment and Living Cities, March 2012