Just as homeownership has long been the primary wealth-building tool for American households, the ownership and development of real estate assets has been one of the most powerful — but also one of the most exclusionary — engines of wealth creation for American entrepreneurs.
Consider this: Less than 1.7% of the trillions of dollars in institutional capital available for real estate investment is allocated to Black, brown and women developers.
This is deeply troubling, highlighting a structural barrier to addressing America’s racial wealth gap. If pathways to entrepreneurship are limited for diverse groups due to inadequate funding, it has long-term negative implications on their ability to build and aggregate community wealth. This is especially true in the real estate sector, where a meaningful share of diverse entrepreneurs are concentrated.
It also helps explain why so many historically underserved communities still struggle to grow, even after decades of urban renewal efforts. Even when local developers with experience and vision work tirelessly to transform them, if they are repeatedly hamstrung by capital constraints, their ability to deliver catalytic change will invariably be limited.
In my work as the co-founder of Diversified Community Impact, I have seen these challenges firsthand. As a community development corporation, we foster economic development by expanding access to capital for emerging real estate developers. Our team provides comprehensive capital readiness education and transactional support for real estate developers as well as impact investment advisory services for foundations, non-profits and CDFIs.
So why isn’t equity capital being more programmatically deployed to diverse and emerging real estate developers? The answer reflects a combination of socioeconomic factors, assumptions and pragmatism on the part of institutional investors, as well as competing impact goals of philanthropic funding sources. Understanding these root causes provides critical insights on how the impact investment community can help address persistent funding gaps to foster both racial wealth equity and community development at scale, while generating competitive returns.
An underinvested developer ecosystem
Real estate is notoriously capital intensive, and many firms get started by fundraising from members of their own communities. But because certain ethnic groups have significantly lower net worth than others, it’s harder for diverse entrepreneurs from those groups to rely heavily upon personal networks. This gap makes them less competitive and more dependent on alternative funding sources like grants, subsidies and federal funding regimes like the Low-Income Housing Tax Credit program, which attracts investors seeking to offset their tax liabilities by investing equity in affordable housing.
In parallel, over the last three decades institutional emerging manager programs have become a growing source of capital, with public pension funds like CalPERS allocating billions to firms led or owned by members of underrepresented groups. These allocations, however, are mostly made to larger enterprises, seldom to organizations still in the early stages of their life cycles.
Many firms struggle to raise equity capital unless they pursue a subsidy-driven business model or are one of the very few that becomes large enough to attract major institutional funding.
The capital trap
There is a common misperception, even among well-intentioned investors, that equity capital into emerging real estate firms must be concessionary to be supportive, despite the fact these firms often target project-level returns in excess of 15 percent per year. This may reflect a reluctance on the part of some impact investors to be viewed as predatory. However, I’ve conducted interviews with over 50 developers nationwide over the past year and almost all would gladly offer their investors market-rate returns, if only the capital were available.
This disconnect may also reflect skepticism on the part of the investors about the capabilities of diverse operators. This assumption would make sense for fledgling operators. However, I routinely have conversations with much larger, highly experienced firms that experience similar difficulties raising equity capital. For most, simply outgrowing the problem has not materialized as a viable solution.
Pragmatically and perhaps most importantly, the concessionary slant reflects the fact that for some investors, returns are of secondary importance to more pressing impact goals such as complying with the Community Reinvestment Act or creating and preserving affordable housing units.
Whatever the cause, these scenarios put developers in a precarious situation. The former makes the availability of equity capital less consistent and reliable. The latter makes capital available, but concentrates it in asset classes with fewer or more restrictive wealth creation opportunities (i.e. affordable housing), forcing undercapitalized developers to decide whether concessionary capital is better than no capital at all.
Plentiful debt but scarce equity
Much of the impact capital deployed by Community Reinvestment Act investors (i.e. banks) in addition to foundations is allocated to Community Development Financial Institutions, or CDFIs, rather than being invested in developers directly.
CDFIs have deep expertise, relationships and connectivity to local markets that many impact investors do not. However, because most CDFIs are lenders, few have dedicated programs to provide equity capital.
The net impact is that developers have access to CDFI debt but woefully few paths to secure equity. Research from the Urban Land Institute has shown that the abundance of debt is a net positive, but it can never be fully leveraged until equity capital is available to complement it.
Costly tradeoffs
Because of their shallow equity options, underserved firms concentrate their efforts disproportionately on affordable housing development, where the combination of subsidies and tax credits minimizes the cash equity they’re required to contribute.
The trade-off is that these deals often take many years to complete, involve large, deferred compensation and provide the developer little economic upside in a project during the 15 years their investors receive tax credits. Unlike mixed-income and market-rate multifamily projects, where owners enjoy the benefits of appreciation as rents increase over time, affordable housing properties often operate at break-even or a loss, with rent growth and property values artificially suppressed during their hold period.
This dynamic puts smaller firms under strain until they hit a critical mass of deals. As with institutional emerging manager programs, only the largest firms graduate to the next level while the rest continue fighting for oxygen.
Beyond affordable housing
Because affordable housing is a major priority for many impact investors and diverse developers are concentrated in the affordable housing sector, there is a tendency for funders to treat such investments as responses to the racial wealth divide.
However, participation in the affordable housing industry does not necessarily equate to meaningful wealth creation for diverse entrepreneurs, especially in comparison to other mainstream real estate sectors, as underscored in the report Breaking the Glass Bottleneck.
There are also knock-on consequences of this dynamic, namely that developers who might otherwise participate in holistic economic development by pursuing other strategies or asset classes are pigeon-holed into the affordable sector, limiting their ability to effect comprehensive change in their own communities.
A developer aspiring to address local needs can do so in many ways, for example by building attainable single-family homes for sale, grocery-anchored retail to eliminate food deserts, or last-mile distribution centers to jumpstart economic activity. Tethering equity capital so rigidly to affordable housing, in the absence of other funding options, almost guarantees unbalanced community development, undermining the cultivation of fertile, diversified economies.
Looking ahead
Impact investors who recognize the untapped potential for outsized financial and social returns can take several steps to deploy more capital. The first is acknowledging that their funds need not be concessionary. Developers do not just need cheap capital, but capital that is dependable, nimble and flexible.
Impact investors must not constrict developers by only prioritizing Low-Income Housing Tax Credit and subsidy-based transactions. Even if addressing housing affordability is a central goal, developers must have the flexibility to be innovative and rewarded for boldness in pursuing other approaches to the housing crisis and fostering economic development.
Foundations and impact-oriented family offices can help drive this innovation by investing in developers directly, by funding research, or by seeding investment funds dedicated to providing early-stage equity capital. A truly flexible fund vehicle could provide both platform-level capital for overhead, due diligence, asset management and reporting, as well as follow-on capital for transactions. This approach aligns with findings from Morgan Stanley’s Sustainable Funds Report on integrating social impact and performance metrics.
Finally, investors should avoid blending impact goals like affordability and racial wealth equity. To close the wealth gap, underserved firms need capital that follows them to compelling investment opportunities, wherever they may lie. These steps, collectively, can help unlock the potential of countless firms, while also producing more prosperous communities and generating compelling investment returns.
Vernon Beckford is the co-founder of Diversified Community Impact.
Guest posts on ImpactAlpha represent the opinions of their authors and do not necessarily reflect the views of ImpactAlpha.
