Humanizing real estate investments

Last week, we attended a gathering hosted by the People’s Economy Lab on community wealth building. We explored methods for creating a more equitable society and analyzed the inherent linkage between real estate and community wealth generation. The Democracy Collaborative’s Action Guide for Advancing Community Wealth Building lists “just use of land and property” as a key component of building collective wealth. The guide says:

Land and property ownership is one of the main means of generating economic and political power, and the current state of land ownership is a major driver of wealth inequality in the United States and globally. A conventional economic development approach prioritizes the value of these assets strictly in economic terms, often for development, commodification, and speculation. The result is often displacement and gentrification, particularly in communities of color, and soaring costs of everything from housing to commercial rents. 

At Humanize Wealth we are asking ourselves, our clients and our community the following question:

How can real estate help us achieve shared prosperity and belonging in our region and beyond?

In order to begin to answer this question, we first need to understand how real estate investments are typically structured.

Role of real estate in a portfolio

Real estate is a broad category of investments that includes commercial spaces, housing, community centers, industrial sites, parks, natural spaces and agricultural land.

As portfolio managers, we know the value of investing in real estate on behalf of our clients. Most investment advisors recommend that clients invest a sliver of their portfolio into real estate — often via Real Estate Investment Trusts (REITs) and privately held real estate funds. These “tangible” or “real asset” investments provide portfolio diversification, a hedge against inflation, meaningful income and returns. 

Whereas typical real estate investment opportunities seek “market rate” returns and solely focus on investor needs, our paradigm is broader. At Humanize Wealth, we seek to humanize the way we invest in real estate opportunities. We are thinking critically about the inherent linkage between the way that land is acquired, developed, owned and managed — and how that impacts communities and the environment over the long run. 

Anatomy of a “conventional” real estate investment capital stack

A real estate project (or fund) capital stack is the financing or investment structure used to aggregate the money needed to complete a project from the time property is acquired, through permitting and pre-development, until the project is completed and then sold or leased. The various sources of capital are stacked on top of each other, with investors willing to take the most risk at the top of the stack while those investors requiring the most security and least amount of risk are at the bottom of the stack. A simple, conventional real estate project or fund capital stack looks like this:

As of March 2024, private real estate equity investors generally expect a 15%+ annualized return on project equity investments — often covering 30% or more of the project cost. The remainder is typically financed as debt by government agencies and banks, currently at 6% to 9% interest rates. The blended cost of this capital stack is ~10%+ per year and must be paid for by income generated by the real estate project until the equity and debt is paid back to investors.

This conventional cost of financing is challenging to support over the life of the project, making it cost prohibitive for low income and workforce housing, and high performing sustainable buildings compared to typical projects. Further, the 15%+ return targets can limit the ability of developers to incorporate any meaningful social and environmental goals into their projects, such as affordability, deep green building materials and net zero energy solar power systems.

Maximizing returns

The typical capital stack is focused on maximizing shareholder value. Take this classic business school project: imagine you have a parcel of land, and your goal is to determine its “highest and best use”. You project a future stream of cash flows based on the development potential, and arrive at the project that provides more profit than any other use would generate. What this means from a practical standpoint is that the highest and best use is one that produces the most economic value for real estate owners, developers and investors.

Land use policies have further dictated how land can and cannot be used whether it’s strict single family housing zones meant to limit density, redlining laws created to prevent access to financing for black land owners and developers, or local codes designed to slow development and further restrict development by making projects burdensome and costly to build. Additionally, the conventional financing structure of owner equity leveraged using less expensive debt is centered on maximizing financial returns above and beyond any other goals like affordability, ownership, access to neighborhoods and amenities, and environmental impacts.

Anatomy of an “impact enhanced” capital stack

In the same way that public stock ownership is traditionally focused on maximizing benefits to shareholders, the success of a real estate project is traditionally measured by profitability to the developer or ultimate owner. 

If we want to take a stakeholder approach to real estate – considering the role of developers, community, and neighbors, then we need to approach financing differently as well. What is missing is more equitable access that benefits a wider range of land owners, developers, investors, businesses, families and communities.

A community-centric, social impact real estate development project’s capital stack typically requires a combination of lower cost equity, such as grant funds from private or government sources and below market rate equity from impact-first equity investors. This enhanced equity capital layer is often complemented by flexible debt provided by government programs and Community Development Financial Institutions (CDFIs) with conventional government and bank debt at the bottom of the stack. 

This more complex and flexible capital stack allows for greater emphasis on social and environmental goals. Real estate developers, owners and stakeholders that collaboratively design and build projects to achieve shared prosperity understand that conventional real estate project financing structures and sources cannot meet their project financing needs. 

Impact investor-enhanced capital stacks are critical to successful socially and environmentally impactful development projects that address the needs of specific communities such as housing that incorporates community solar and maintains affordable rents. The Terner Center for Housing Innovation at UC Berkeley research found that 80 percent of affordable housing developments layered between four to eight sources of funding in their capital stack. The research also concluded that as the lower the income of families expected to occupy these projects, the higher the need for more complex funding options.

EFM: A carbon-smart capital stack

EFM is an employee owned b corp that was founded in 2004 that invests in forests locally and across the Americas, to create long-term financial value and alongside positive environmental and social impact. EFM leverages its conservation finance expertise to monetize timber values through conservation easements and climate-smart forestry. EFM manages forests holistically - balancing timber revenues with more creative income streams including tax credits, easements, carbon offsets and non-timber forest products. In this way, EFM diversifies revenues and creates more value from the whole forest - not just the timber.

EFM’s funds employ low cost debt to catalyze its revenue streams and enhance impact investor equity returns. Its third forestland fund secured a $10m, 1% fixed rate loan commitment from the Packard Foundation, lowering the cost of capital.

Beyond this low cost debt, EFMs capital stack boasts grants, new market tax credits (NMTCs), conservation easements and carbon funding. In their first two funds alone, EFM acquired 13 unique properties, achieved solid financial returns, was awarded ~$12M in easements, $25Min NMTC funding, $1.3m in carbon funding and over $5M in restoration grants. This highly diversified, impact-oriented capital stack allows EFM to achieve beyond the mainstream forestland investment model that maximizes timber harvest and generate a variety of social and environmental benefits. 

EFM projects that an investment of $1m will sequester more than 135,000 tons of carbon over the lifetime of the investment -  the equivalent of offsetting the yearly emissions from more than 2,500 U.S. households. Many of EFM’s projects are in Oregon, where forests sequester up to 50% of the State’s annual emissions. EFM states “Over 9 billion tons of carbon are stored within these forests, making this the largest un-priced terrestrial sink in the United States.”

Beyond carbon, EFM ensures that all of their managed properties eventually transition to an ownership structure that benefits community and ensures long term environmental stewardship. Their website states, “working closely with entities like local land trusts, public agencies, governments and tribes, EFM identifies properties of mutual interest, negotiates the sale and purchase of the property, and then manages the property until transition to a strategic owner.” They also partner with local watershed groups and councils to create opportunities for youth employment and implement restoration projects that benefit local communities.

EFM was named an ImpactAssets 50 for 2024. This impact investment that employs a creative, impact enhanced capital stack that helps set the stage for shared prosperity and belonging. 

Humanize Wealth provides personalized wealth management for individuals, families, and foundations who value social impact, environmental justice and shared prosperity. To best guide folks along their investment journey, we are continuously learning and informing ourselves on the landscape of real estate investment opportunities that seek to create shared prosperity in our region and beyond.