As of 2013 there were 7.7 million Americans living in severely inadequate housing but earning too much income to qualify for government housing assistance, according to the Department of Housing and Urban Development. The population of “worst case” renters, which has grown by 49% since 2003, cuts across demographic categories. They are living proof that many communities still face persistent and complicated economic challenges.
We know the key to helping such communities rise above their dogged problems is economic development. This is more than just a job for the public sector. Private investors can direct funds to these communities by purchasing securities backed by the federal government that target low- to moderate-income communities and families. These securities can earn returns comparable to those untargeted securities of the same type.
There is no shortage of capital pursuing such altruistic ends; the so-called impact investing market as of the end of 2015 had reached $77.4 billion, up from $25 billion in 2014, according to the Global Impact Investing Network, and it's still growing. These investors have myriad choices for putting their capital to socially beneficial use globally, from public market securities to privately placed microloans and social impact bonds, yet they may be overlooking some proven vehicles for helping communities right in their own backyards.
Investors can use public bonds and other incentives to drive capital back into American communities. Well-established programs — the Low Income Housing Tax Credit, Small Business Administration, and mortgage-backed securities — allow investors to direct capital toward economic development in targeted communities.
The LIHTC, for example, has been around since 1986. Since then, HUD has certified LIHTCs at an annual rate of $8 billion to develop affordable housing. According to the National Association of Home Builders, a typical 100-unit apartment building will create $11.7 million in additional wages for local workers and $2.2 million in additional local, state, and federal taxes. For investors, the credits generate a competitive rate of return of around 4%-5%.
The federal government's involvement in the secondary mortgage market also creates attractive opportunities to support housing for individual families below the median income level.
Impact investors can purchase residential mortgage-backed securities focused on affordable housing in specific communities. These “specified pools,” made up of loans to low- and moderate-income households, tend to have more consistent cash flow than loans made to higher-income households.
Commercial mortgage-backed securities are also available to support multifamily affordable housing rental buildings and other projects such as nursing homes.
The federal government, via the SBA, also backs loans to small businesses needed to help low-to-moderate income communities thrive. These loans are originated by a variety of institutions including banks and community development finance institutions. Like mortgage-backed securities, they're also pooled and resold, allowing investors to participate.
The Community Reinvestment Act, enacted in 1977 as a means of requiring banks to lend in underserved communities, has become a powerful vehicle for promoting investment in economically challenged locales. Since its implementation, “the number and dollar amount of mortgage loans to lower-income borrowers have grown dramatically…and research shows that this growth did not come in the form of poorly underwritten subprime loans,” according to research by O. Emre Ergungor, an economist at the Federal Reserve Bank of Cleveland. “Recipients of CRA prime loans…were less likely to default and be foreclosed upon.”
To see the impact these programs can make, look no further than New Orleans. In 2006 the city, ravaged by Hurricane Katrina, faced an estimated $108 billion in damage and thousands of decimated homes and businesses. As local, state, and federal leadership set about the herculean task of rebuilding, they leaned heavily on LIHTCs. According to the State of Louisiana, such credits have been used to develop 59 multi-family developments in nine parishes, creating 7,475 rental units — well over half of which offer affordable rental rates.
To the uninitiated, it might appear that impact investing is a trendy form of do-gooder capitalism. But, the truth is, the concept of directing private funds at community needs has been around for years. Investing in local communities allows investors to foment meaningful change, providing not only reliable economic returns, but personal ones as well.
Catherine Banat is the institutional portfolio manager at RBC Global Asset Management