Economic Innovation International, Inc. 








Making Markets Work for Inner City Revitalization                                    

Presented at the Inner City Economic Forum, NYC

October 16, 2003

Belden Hull Daniels and James Hurd Nixon

Belden Hull Daniels is the founder and President of Economic Innovation International, Inc., an international development firm that has created more than $50 billion of development capital in this country and overseas since 1970.   In the past five years Economic Innovation has helped design and build more than $500 million of regional second generation funds across the country.

James Hurd Nixon is Chair of the Board of Directors of Sustainable Systems, Inc.  Sustainable Systems is the Initiative Building Consultant to the Bay Area Council for the Community Capital Investment Initiative and the Bay Area Family of Funds, as well as developer and manager of the Communications Technology Cluster, a business incubator and business acceleration center in Oakland, California.

The Inner City Economic Forum finds that investing in inner cities is an economic imperative for the country's long-term prosperity and equity, and that substantial untapped market opportunities exist in inner cities.  Successful, large-scale inner city revitalization depends on the private sector and on market strategies to wholesale large-scale equity and debt assets for profitable return.  A new approach—"double bottom line" market-rate Community Equity Funds—is attracting world-class fund managers and investors because of opportunities to capitalize on imperfections in inner city markets that can produce risk-adjusted market rates of return for investors and measurable job and wealth creation for community stakeholders. 

This paper traces the evolution of this market from a first generation of smaller, below-market, grant and debt funds to an emerging second generation of larger, market-rate, equity-based inner-city investment funds.  Many of these funds show promising returns and community impact, but their combined capital is still far below the scale of the need and opportunity in inner cities.  Further, very few of these funds have been in existence long enough to have a track record to prove the market to a wider investor base.  Accessing larger pools of capital in the next few years requires market sensitive innovations that are consistent with the behavior of capital markets and do not distort them.

This market cannot be capitalized to scale without uniform, transparent and timely reporting of both bottom line returns by first and second-generation funds to investors and community stakeholders.  Easy access to information of attractive returns to investors and communities will draw the attention of large institutional investors.  We urge public pension funds and foundations to establish joint standard reporting mechanisms for both internal rate of return (IRR) and measurable job and wealth creation, and to require that community equity funds in which they invest report these returns.


The First Generation—Supplementing the Market with Below-market Capital

During the first three quarters of the 20th century, the financial and investment markets left extensive portions of the United States behind.  Community investing is a response to poverty and disinvestment in urban and rural America.

To address this need, the field of community investing has grown significantly and produced important results over the past 30 years.  Historically, predominantly below-market community investing has sought to supplement the market, making socially and environmentally important investments at a below-market cost of capital to investment recipients and a below-market return on investment for investors.  The great majority of these earlier organizations and funds were structured as not-for-profit corporations.

Because of its below-market character, this first generation of community investing was only able to access smaller amounts of private capital, so the proponents of community investing pursued government assistance.  As its major community investing initiative, the Clinton administration sponsored the Community Development Finance Institution (CDFI) Fund housed in the U.S. Treasury.  As of September 2003, this Fund has certified 660 CDFIs and invested $534 million in CDFIs.

This below-market system of community investing has become a mature field.  According to the National Community Capital Association (NCCA), the trade association for community development finance institutions (CDFIs), a snapshot of community investment shows:

ü      total lending/investing pool: $8.2 billion,

ü      total financing outstanding: $5.7 billion,

ü      housing units financed in FY 2001 alone: 43,428,

ü      businesses financed in FY 2001 alone: 7,484,

ü      jobs created or retained in FY 2001 alone: 52,798, and

ü      community service organizations financed in FY 2001: 501.

According to the NCCA there are more than 800 CDFIs, including 200 community loan funds, 250 community development credit unions, 40 community banks and numerous micro-credit organizations. A key affiliate, the Community Development Venture Capital Alliance, supports 70 first-generation community development venture funds that currently manage $548 million.

Most recently, the Federal New Markets Tax Credit Program was established—a $15 billion program that provides taxpayers with a credit of 39% against federal income taxes over seven years for qualified equity investments in designated Community Development Entities (CDEs).  The Treasury’s CDFI Fund has certified 1,181 CDEs as of September 2003.  In 2002, $2.5 billion in credits have been allocated, but not yet issued.  The 2003-4 allocation is $3.5 billion. 

In addition to government programs, the Social Investment Forum and Coop America are leading a "1% for Community" campaign among socially responsible investors to commit $15 billion in community investments.  To date, 54 social investment groups have committed $7.6 billion.  

In 1996, the not-for-profit Partnership for New York City sponsored the creation of the $95 million New York City Investment Fund (NYCIF), an inspiration for and bridge to the large-scale, market-oriented, second-generation regional community equity funds that have been developed since the late ‘90s.  The New York City Investment Fund is both similar to and different from the second generation funds described below.  Both NYCIF and the second-generation funds are large-scale and designed to create significant job and wealth creation.  The second-generation funds differ from NYCIF in their conventional ten-year limited life partnership structure, and their focus on both job and wealth creation, and market-rate returns to investors.


The Second Generation—Guiding the Market with Market-rate Funds

Second-generation “double bottom line” market-rate community equity funds are designed to attract large-scale capital managed by proven fund managers with outstanding track records.  Community sponsors structure the funds to provide investors with market returns and community stakeholders with community revitalization and measurable job and wealth creation. 

Preliminary financial returns of second-generation regional funds to private equity investors suggest that risk-adjusted market rates of return are achievable.  To date, the operating experience of these funds is divided roughly 60/40% between real estate equity funds focused on mixed-income and mixed-use housing, commercial, and industrial development that rebuild inner city neighborhoods (60%), and business equity funds focused on the rapid expansion of business enterprises that can make a measurable impact of job and wealth creation in these same neighborhoods (40%). 

Fund managers may be new to “double bottom line” inner city equity funds, but they are not new to successful fund management of real estate equity and venture capital for sophisticated investors.  Pacific Coast Capital Partners, now manager of two such regional inner city real estate funds—the Bay Area Smart Growth Fund and the Nehemiah Sacramento Valley Fund—manages an equity real estate portfolio of $1.8 billion generating investor returns of 25-30%.  Similarly successful is Shamrock Capital Advisors, manager of the Genesis LA Real Estate Fund (more than a billion dollars managed for the Disney family), Advantage Capital ($550 million managed for large insurance companies), as well as American Ventures, Phoenix Realty, JPMorgan H & Q and others who have been chosen through a competitive process by national and regional investors in partnership with community sponsors to manage these new regional second-generation funds.  Like other investors, each is also at risk as an investor in its own fund. 

Second-generation community equity funds work if proven fund managers are paired with community stakeholders capable of delivering measurable second bottom line returns.  These community stakeholders are responsible for working directly with fund managers and investment recipients to ensure that the second bottom line is as rigorously achieved as the IRR.  These community stakeholders, as special limited partners, are then rewarded for their success with a small portion of the management fee and carried interest.  The Bay Area Council, Nehemiah Corporation and the St. Louis Regional Chamber and Growth Association (RCGA) are community sponsors with the capacity to deliver both CEO and community leadership that will provide the necessary double bottom line support for the affiliated for-profit funds.

These new regional funds need to be large enough to create a deal flow large enough to attract a proven, high-quality fund manager that, in turn, can attract large regional and national investors.  The not-for-profit community sponsors and the key lead investors then structure the funds to:

ü      embed the goals of the funds in the operating agreements,

ü      protect the final investment decisions of the fund manager behind a firewall, and

ü      structure the fund to support the not-for-profit sponsor with an income stream to produce measurable job and wealth creation that is then post-audited for value received.

The income stream to the not-for-profit, special-limited-partner community sponsor must be earned only for proven value received by investors, fund managers and community stakeholders—it is not a grant or birthright.


Investors in Second-generation National and Regional Funds                                                        

In the last five years, national investors have invested almost $2.5 billion in national and regional  funds, including more than $500 million in regional funds that are the heart of the emerging national system:

ü      Bank investors include Bank of America, Citibank, Fleet, JPMorgan, USBank, Union, Washington Mutual, Wells Fargo and many local community banks.  The Community Reinvestment Act (CRA) brought them to the table, but market returns keep them there.

ü              ü    Insurance investors include AXA, California State Automobile Association, John Hancock, Mass Mutual, Mercury, Met Life, Liberty Mutual,  Pacific Life, PMI,  New York Life, Northwestern Mutual, Allstate and State Farm Insurance.

ü      Foundation investors include California Community, Annie E. Casey, Ford, Jacobs, F.B. Heron, MacArthur, Knight and McCune Foundations, as well as local community foundations.  The Ford Foundation investments to date are Program Related Investments (PRI); however, an increasing number—including California Community, Heron and Knight Foundations—are choosing to invest corpus directly because the funds are producing risk-adjusted market rates of return.

ü      Public pension fund investment is led by the California Public Employee Retirement System (CalPERS), the California State Teachers Retirement System (CalSTRS) and the New York Common Public Pension Funds, with a number of other state, county and municipal funds currently weighing investments.  Under the leadership of California Treasurer Phil Angelides, CalPERS alone has committed $500 million in market-rate funds targeted to inner city emerging markets.

ü      Large not-for-profit corporations can also be investors, as Nehemiah Corporation has demonstrated.  Nehemiah is the sponsor of the Nehemiah Sacramento Valley Fund and the Maryland Family of Funds, as well as a $5 million investor in the Genesis LA Real Estate Fund and a $3 million investor in the Nehemiah Sacramento Valley Fund.

ü      Faith-based investors are an important—and largely untapped—asset class.  Catholic Healthcare West has invested in the Bay Area Family of Funds, and Nehemiah is both a not-for-profit and a faith-based fund sponsor and investor.

ü      Union pension funds are another important asset class.  The Carpenters Union is considering an investment in the St. Louis Revitalization Fund. 

ü      Wealthy individuals are a logical next source of investment capital in second-generation funds.  The first market-rate community equity fund  to engage wealthy individuals as investors is the Bay Area Family of Funds.  A number of individuals have committed from $50,000 to $150,000 in the first closing of the Bay Area Equity Fund.  One national broker-dealer is considering offering these funds to wealthy clients.


Building a National System of Second-generation Funds                                                    

Although the experience of these second-generation funds is still young, the elements of a self-reinforcing national system are beginning to emerge.  Regional families of multiple funds addressing a broad range of inner city revitalization goals are now investing from coast to coast, and are coming on line in a number of additional inner cities.  Large-scale national private equity funds for inner city real estate and business finance are also evolving rapidly.  Specialized funds to wholesale below-market gap financing, local land and site assembly, and brownfield cleanup are being developed within regional families of funds to facilitate more efficient deal making.  Taken together, this national system of second-generation funds is moving to scale to facilitate larger deals, greater impact, better returns and the more efficient leverage of scarce federal, state and municipal government tax dollars and credits.

      Regional Families of Funds                                                                                                

The core of the emerging national system are regional funds that wholesale capital for direct investment in targeted low-income neighborhoods to accomplish specific job and wealth creation goals that are commonly shared by private, civic and community leadership at the regional level.  This shared civic commitment distinguishes these regional families of funds from other elements of the developing national system. 

These regional families of funds have innovated a broad range of funds to address multiple tasks—market rate, affordable and “workforce” mixed-income housing; commercial and industrial mixed-use real estate development; and job and wealth creating business investment.  Having successfully built these market-rate inner city real estate and business finance funds, these regional families of funds are now designing specialized funds to provide land and site assembly, environmental cleanup, and wholesale gap financing to package real estate deals faster and more efficiently:

ü      Three Massachusetts private equity funds to accomplish specific public purposes have been capitalized by the Massachusetts insurance industry since 1977:

¨       The 26-year-old Massachusetts Capital Resource Company (MCRC) has now invested almost $500 million in 275 mature shoe, leather, paper, fish-processing and technology companies in the $10-40 million sales rangecreating over 15,000 jobs in the state since its initial capitalization in 1977.  Two thirds of the investment has been in disadvantaged areas.  Originally scheduled to end after a five-year tax credit if the insurance industry was not satisfied with the returns, MCRC has rolled over its capital five times and has consistently produced a net 18-20+% IRR, with the result that investors are committed to the partnership to 2023.

¨       The $100 million Massachusetts Life Initiative, created in 1998, has invested more than $100 million in community-based developments in low-income areas in the past five years, and is now rolling over its capital to begin a second investment cycle.  Investments are divided roughly 50-50 between inner city real estate and business enterprise.  As an example of how first-generation, below-market funds and second-generation, market-rate funds can collaborate, the Mass Life Initiative is an $8 million investor in the Boston Community Loan Fund.

¨       The $80 million Massachusetts Property and Casualty Initiative, LLC has been in operation for three years and has successfully issued commitments totaling more than $50 million to housing developers, businesses, not-for-profit organizations and community loan/venture funds.

¨       These community equity funds join 28 other specialized for-profit, not-for-profit and quasi-public equity and debt (both private and publicly traded) financial intermediaries which, for the past 20 years, have collaborated to invest $10 billion in low-income community development in the state. 


ü      Three Genesis LA funds are sponsored by the not-for-profit Genesis LA Economic Growth Corporation to champion community development in Los Angeles County:

¨       The $85 million Genesis LA Real Estate Investment Fund managed by Shamrock Capital Advisors is 80% invested in commercial and industrial development, has provided investor returns exceeding the promised mid to high teens.  As a result, a second fund is now being launched in which the community sponsor, fund manager and investors are committed to a more significant second bottom line impact. 

¨       The $100 million Genesis Workforce Housing Fund, managed by Phoenix Realty, will invest in workforce housing targeted to 80-120% of average median income (AMI), a housing gap for crucial workers in most inner cities.

¨       The $20 million Fulcrum Capital Fund is investing in growing minority and women-owned enterprise that impact underserved communities in the County.


ü      The Bay Area Family of Funds, created by the Bay Area Council (the regional CEO-led public policy organization) and community stakeholders, are investing $160 million in equity to leverage $ 1 billion targeted to the 52 neighborhoods in the Bay Area with high levels of poverty:

¨       The $66 million Bay Area Smart Growth Fund, managed by Pacific Coast Capital Partners (PCCP), invests in mixed-income housing and in mixed-use commercial and industrial real estate development.  The Fund, which had its final closing on December 31, 2002, is now more than 50% invested in an array of community revitalization projects that are projected to produce the net 15-18% financial returns expected by investors, and the social and environmental returns expected by its community sponsors. (See Appendix A for a description of Bay Area Smart Growth Fund “double bottom line” investments.)

¨       The $60-75 million Bay Area Community Equity Fund, managed by JPMorgan H & Q, is investing in rapidly growing technology, health, specialty food and life style companies at the moment of inflection when firms move from early stage to take off.  The Bay Area Council and fund co-sponsor, the Alliance for Community Development, have developed a “double-bottom line” implementation system to assist investees with local hiring, neighborhood wealth creation, environmental and workplace benefits, and community engagement. The Fund has had its first close and is now investing in its first deals.

¨       The $40 million California Environmental Redevelopment Fund is a brownfield cleanup fund, 25% of the assets of which will be invested in the Bay Area.


ü      The $29 million Nehemiah Sacramento Valley Fund, a community equity Smart Growth real estate equity fund investing in mixed-use, mixed-income developments in low income neighborhoods in the six-county Sacramento Valley, is sponsored by Nehemiah Corporation and managed by Pacific Coast Capital Partners.  The Fund is a part of a complex set of community development tools developed and managed by not-for-profit Nehemiah Corporation—including the nation’s largest down payment assistance program, low-income tax credit housing developments, and a community land trust.  Nehemiah is, as noted, an investor, and now a sponsor of other funds across the country.

ü      The $60 million San Diego Smart Growth Fund, managed by Phoenix Realty, is the first of a series of funds sponsored by the San Diego Capital Collaborative.

ü      The Portland (Oregon) Family of Funds, a private sector initiative linked to the Portland Development Commission, is soon to launch the first two of a large array of market and gap financing funds to continue the rebuilding of Portland—a Portland Communities Fund in partnership with FNMA and the Portland Historic Rehabilitation Fund, both of which wholesale critical below-market capital to partner with second-generation market-rate funds in the Portland Family of Funds.

ü      The $55 million St. Louis Revitalization Real Estate Fund is sponsored by the St. Louis Regional Chamber and Growth Association and managed by Advantage Capital, a $550 million fund manager with a $110 million federal new markets tax credit allocation.

ü      The Urban Initiatives Fund, managed by American Ventures Realty Investors, is a unique hybrid national investment vehicle with a series of regional initiatives—a pattern that may well become more common in the near future.  The Fund provides mezzanine capital to targeted community development real estate projects, with an expected net 10 – 14% return to investorsThe first two initiatives in the national series, with others soon to come, are:

¨       $30 million in New Mexico, with the McCune Foundation as lead investor, and

¨      $75 million in South Florida, with the Knight Foundation as the lead investor. 

¨      $7

American Ventures, Phoenix Realty and Pacific Coast Capital Partners are large fund managers engaged in managing multiple regional funds in multiple locations.  These and other fund managers of regional initiatives may now begin to expand these efforts into larger regional and national funds.  Other regional funds are now being designed and built in Boston, Massachusetts; Baltimore, Maryland; Atlanta, Georgia; and Shreveport, Louisiana, to name a few.  As is true of all the regional initiatives to date, each will have both common and unique characteristics, and each will add to the already rich body of growing national experience.

      National Funds                                                                                                            

Independent of the development of these relatively large-scale market-rate regional funds, a number of national market-rate private equity funds have also been created, and are making a significant economic impact with proven fund managers, successful track records and substantial private investment capital.  These national funds could co-venture with the regional funds and do provide an alternate, competitive source of capital for large local deals.  Sharing a common investor base with the regional funds, they focus either on large-scale inner city real estate or on the rapid growth of business enterprises that can significantly impact inner city job and wealth generation.  The total capital committed to these national funds now approaches $2 billion:

ü      The $750 million California Urban Investment Partners (CUIP) is a joint venture private equity fund between CalPERS and MacFarlane Partners, a leading real estate investment firm that has previously invested over $3 billion primarily in inner city mixed-use real estate development as a core investment manager.

ü      The $300 million Canyon-Johnson Urban Fund is a real estate equity fund managed by Canyon-Johnson Realty Advisors LLC, a partnership between Canyon Capital Realty Advisors LLC, with over $3.5 billion in assets currently under management, and Johnson Development Corporation, which now has a presence in 65 cities in 16 states capitalizing on its blend of relationships with Magic Johnson Theatres, T.G.I Fridays, and Starbucks. The Fund focuses on emerging inner city real estate markets and on fostering economic opportunities for the underserved residents of the urban neighborhoods in which it invests.  The Fund will invest $1 billion over the next three years. 

ü      The $120 million UrbanAmerica, L.P., a private real estate investment company focused on acquiring and developing commercial real estate in low-income communities in major inner city markets, was launched in 1998.  Sponsored by Utendahl Capital Partners, L.P., UrbanAmerica's  $400 million portfolio includes more than 28 office and retail properties at 96% occupancy, with an expected pre-tax mid-teen return to investors.  UrbanAmerica is now launching a new second Fund.

ü      The $130 million ICV Capital Partners (ICV), sponsored by American Securities Capital Partners and the Initiative for a Competitive Inner City (ICIC), is a private equity firm focused on investing in high-growth companies with revenues between $25 million and $150 million that have strong market positions, experienced management teams, and the capacity to make a major impact in underserved inner city neighborhoods.   

ü      The $575 million Yucaipa Corporate Initiatives Fund invests equity capital in strategic partnership with Fortune 500 corporations in high-growth, high-impact firms owned or managed by minorities or women, or located in, serving or employing persons from underserved communities throughout the nation. The Fund is capitalized by three of the largest peansion funds in the United States—CalPERS, CalSTRS and the New York Common Public Pension Funds—all of which are providing national leadership in inner city emerging market investment.

      Wholesaling Gap-financing Funds to Partner with Real Estate Equity Funds                  

It is essential to wholesale market equity through the regional and national market mechanisms described above.  It is equally important to wholesale gap-financing funds to partner with real estate equity funds, so that fund managers and fund sponsors are not “nickeled and dimed” piecing together gap financing to close otherwise sound inner city real estate deals.  These gap-financing funds are designed to reduce time and transaction costs, which increases the efficiency of deal making and expands substantially the capacity of the regional families of funds.   

Second-generation regional families of funds are building gap-financing funds in partnership with FNMA, Freddie Mac, the Federal Home Loan Bank Board, secondary market managers of federal and state historic and low-income housing tax credits, federal new markets tax credit allocatees and state CAPCOs, and are pooling municipal tax increment financing and not-for-profit tax-exempt bond pools for more efficient real estate deal making.  Helpful in buoyant real estate markets such as San Francisco, San Diego and Boston, these gap-financing funds are essential for success in slower growing markets such as St. Louis, Baltimore and Shreveport.

The partnership between the second-generation regional fund and the provider of gap financing determines in advance the underwriting conditions that will govern investment decisions, as opposed to the current time-consuming and expensive practice of treating each deal as unique.  The resulting reduced information and transaction costs, together with the relative ease of replicating these templates across the country, will accelerate the development of this second-generation national system:

ü      The Portland, Oregon Family of Funds is creating a series of below-market gap-financing funds to partner with its second-generation market-rate funds.  Two are about to close: the $50 million Portland Communities Fund to wholesale affordable housing development in partnership with the FNMA American Communities Fund, and the $50 million Portland Historic Rehabilitation Fund to wholesale historic tax credits for development in partnership with a major commercial bank packager of secondary tax credit paper.

ü      The Nehemiah Corporation is engaged in a wholesale fund discussion with the Federal Home Loan Bank Board.

  ü    The San Diego Capital Collaborative was engaged in discussions with Freddie Mac until the recent change in senior management interrupted the initiative.

ü      The San Diego Capital Collaborative expects that the new San Diego Smart Growth Fund will establish a predetermined underwritng arrangement with the City of San Diego for the new $55 million pooled affordable-housing tax-increment bond-financing faciltiy.

ü      The San Diego Capital Collaborative also plans to establish a  not-for-profit tax-exempt bond pool in which the underwriting criteria are pre-negotiated with potential commercial bank holders of the tax-exempt paper to lower the cost and speed up the process of having this gap-financing facility readily available.

ü      The Bay Area Family of Funds played a key role in building the state-wide California Environmental Redevelopment Fund (CERF) for inner city brownfield cleanup.

ü      The St. Louis, Baltimore and Shreveport funds expect to address their slower growing markets with federal new markets tax credits, and St. Louis and Shreveport may employ the state tax credits of CAPCOs.

Each of these pioneering gap-financing funds can become a template for similar funds around the country, which will, in turn, increase the capacity of the national system. 

      Creating Viable Inner City Land Assembly Funds                                                            

One of the critical challenges of real estate development in inner cities is financing the redevelopment of vacant land.  There is no reliable source of public funds for reclaiming vacant land in cities, and the opportunity for redevelopment is substantial.  One recent Brookings Institution study indicates that in the 100 largest cities, 15 percent of land is “usable vacant land”—the equivalent of the total combined land area of New York City, Los Angeles, Chicago, Houston, Philadelphia, and San Diego. A substantial portion of this vacant land is located in inner cities, just waiting for economic development.  Existing businesses need sites for expansion.  New businesses could be attracted to inner city locations were sites available. 

Productive employment of the wasting asset of vacant land is consistent with the “Three E” development strategy of successful smart growth funds: Economic viability, social Equity and Environmental soundness. Second-generation smart growth community equity funds are now operating in Boston, Los Angeles, the Bay Area, Sacramento Valley and being built in San Diego.

Ways of mitigating risk and insuring minimum yield must be found if these second-generation smart growth funds are to be successful in financing the redevelopment of inner city vacant land.  The St. Louis Revitalization Fund, supported by Advantage Capital’s $110 million federal new markets tax credit allocation, will provide an important test of the capacity of these funds to assemble sites, package them for development, and successfully exit within the seven to ten year term of the fund. 

Foundation guarantees may also provide a creative way to mitigate risk and insure minimum yield.  The planned Maryland Family of Funds now being developed is a possible test site. 


An Action Plan to Mainstream Second-generation Funds                                             

Second-generation funds are constructed to accept the inexorable rules of the private capital marketplace.  Unless the first bottom line is met for investors, there is no second bottom line.  These funds cannot grow and cannot multiply unless investors first receive an appropriate risk-adjusted market rate of return. 

Each of the elements of a national system of second-generation market-rate community equity funds exists.  This national system can grow to scale only if its evolution is understood and encouraged in ways that are consistent with the behavior of private capital markets, and do not distort them.  This national system can be capitalized to scale only if there is uniform, transparent and timely reporting of both bottom line returns by first- and second-generation funds to investors and community stakeholders. 

Three actions are proposed to take second-generation funds to scale: (1) create transparency for IRR performance; (2) create transparency and consistency in reporting job and wealth creation; (3) remove specific legislative and regulatory barriers that increase the cost and risk of federal new markets tax credits to CDEs and to investors. 

      1.   Action: Creating Transparency for IRR Performance                                           

Private equity investors accept a market niche when multiple fund managers have exited multiple funds over an extended period of time.  Since closed-end private equity funds generally have a ten-year life (and thus ten years to exit), it takes time to establish a track record that private equity investors and their gatekeepers will accept.  Also, in private equity markets, average or even good is not good enough.  Investors prefer fund managers that have demonstrated upper quartile success in multiple funds in multiple vintages.  Finally, the history of venture capital is that (as the name implies) private equity returns have been closely held by fund managers and their investors.  

The market for second-generation funds cannot grow rapidly without uniform, transparent reporting by first- and second-generation funds of returns to investors and community stakeholders in a standard and timely way.  Easy access to information of attractive returns to investors and communities will draw the attention of large institutional investors. 

Public pension funds and foundations have unique roles as the keepers of the conscience of the marketplace with regard to transparency in both publicly traded and private placement markets.  CalPERS, the largest public pension fund and the largest institutional investor in private equity markets, has already changed the industry standard by publishing returns of its portfolio venture capital funds on its website,—including national second-generation funds like the Yucaipa Corporate Initiatives Fund, part of the $500 million CalPERS California Initiative.  The New York Common Public Pension Funds, the second largest public pension system, has historically stood shoulder to shoulder with CalPERS on transparency issues. 

Foundations also have unique roles in addressing transparency, corporate governance and social investing issues, given their standing as large institutional investors concerned with civic and public well being. In the exercise of these roles foundations have been instrumental in helping to build these second-generation funds.

Public pension funds and foundations therefore, are logical institutional investors to establish joint standard reporting mechanisms for both IRR and measurable job and wealth creation, in order to take second generation funds to a vastly larger scale.

      2.   Action:  Creating Transparency for Job and Wealth Creation                                 

The central challenge for double bottom line market-rate community equity funds is to encourage new economic activity in communities with high levels of poverty in ways that generate livable-wage jobs and create wealth for current residents while avoiding displacement. 

If any of these initiatives produces inequitable development, resulting in poor jobs, loss of community capital, environmental problems, or displacement, it has failed.  To accomplish the second bottom line—community equity—these second-generation funds need to focus clearly on establishing and implementing straightforward, measurable economic, social and environmental criteria to ensure that current community residents tangibly and meaningfully benefit from the development.

Again, the market for these funds cannot grow rapidly without uniform, transparent reporting by first- and second-generation funds of returns to investors and community stakeholders in a standard and timely way.  The Ford and MacArthur Foundations have worked with the Bay Area Family of Funds to develop a post-audit reporting and evaluation system to establish job and wealth creation criteria and to measure the results.  The Rockefeller and Heron Foundations have undertaken a similar effort with first-generation funds. These efforts need to be combined in a common system and uniformly applied to all first- and second-generation funds throughout the country.

The role of community sponsors in collaborating with investment managers to deliver the second bottom line, and then to be rewarded for the value they add as special limited partners, is an important new concept that is now being tested.

The Bay Area Family of Funds and the Nehemiah Sacramento Valley Fund have engaged in the most sophisticated efforts to date to develop, in collaboration with investment managers, a regional infrastructure to deliver the second bottom line.  This infrastructure includes:

ü      legally prohibiting investment that causes any displacement;

ü      facilitating community employment through job training, childcare, and transportation;

ü      facilitating wealth creation through down payment assistance to first-time homebuyers, affordable housing development, individual development accounts, financial management training, career ladders for entry-level neighborhood employees, and stock and bonus plans for all employees;

ü      establishing cost-effective community benefits plans and corporate community engagement;

ü      organizing productive community involvement in project development; and

ü      encouraging joint ventures between mainstream and community developers.  

Delivering the second bottom line through this infrastructure is designed to contribute to the first bottom line as well—by reducing fear and lowering opposition, creating community and government support, and improving economic performance.  This partnership approach has garnered significant support; however, the field is new, and the returns are not in.  Until they are, there will also be healthy skepticism.   

Because the management fee and the carried interest to the community partner for delivering the second bottom line is a direct cost to the fund manager and investors, the second bottom line must be just as rigorously measured and reported as the IRR performance.

Public pension funds and foundations are the logical institutional investors to establish joint standard reporting mechanisms for both IRR and measurable job and wealth creation, in order to take second generation funds to a vastly larger scale.

3.       Action: Proposing Cost and Risk Reducing FNMTC Regulations                                              

At present, specific legislative and regulatory barriers in the provision of federal new markets tax credits (NMTC) increase the cost and risk of NMTC allocations to Community Development Entities (CDEs), fund managers and investors, and therefore reduce their effectiveness.  The following changes are proposed: 

ü      legislative changes: (1) soften the draconian tax credit recapture rules, and (2) adjust the definition of businesses to include a broader range of technology and life sciences;

ü      regulatory changes: (1) ease the ability to invest equity in operating firms via changes in the control test, (2) ease the ability to use the leverage model by allowing lenders to have direct security interests in CDE investments, and (3) clarify a number of tax issues, including guidance on partnership allocations of NMTC, profit motive test, economic substance issues, active business definition, application of three factor test, use of bridge financing, and investment in not-for-profits.


Appendix A:  Bay Area Smart Growth Fund Projects                 October 2003


The $ 66 million Bay Area Smart Growth Fund has made six investments to date, totaling $34.2 million, and is more than 50% invested.  All investments are in one of the 52 high-priority targeted low-income neighborhoods of the Bay Area, have been developed in collaboration with community stakeholders, and are projected to produce market rates of return (mid-teens IRR) and measurable economic, social and environmental benefits. 

1. The Story and King Road Project, in the heart of Southeast San Jose ($10 million investment in a $100 million project), is a community shopping center to be developed on 26.2 acres at a major intersection in an important Hispanic community.  The project will replace an existing center with a mix of current tenants, new stores and restaurants and involve approximately 260,000 square feet of new construction.  There has been broad consensus for many years that the commercial properties at the intersection of Story and King Roads need to be redeveloped and revitalized.  The project will include a 50,000 square foot “Mercado,” a multi-tenanted building with a variety of small merchants serving the Hispanic community. 

The Story and King Road Project meets the Bay Area Smart Growth Fund economic, social and environmental criteria in the following ways:

ü      Serves as the gateway to East San Jose and is key in the revitalization of the whole area.

ü      Locates a supermarket (as well as other retail stores) to serve the area.

ü      Provides 100 local retail merchants with long-term leases in the Mercado, and with affordable rents and business assistance.

ü      Creates opportunities for local, minority, and women sub-contractors.

ü      Provides construction jobs as well as permanent jobs for local residents in the retail outlets.

ü      Employs green design and construction techniques.

2. The North Richmond Land Project, in North Richmond ($2.7 million of an $8 million total investment), involves the acquisition of three non-contiguous parcels of land (48.36 total acres)  in the unincorporated area of North Richmond, California, one of the highest priority African-American areas for the Bay Area Family of Funds.

The developer and the Bay Area Smart Growth Fund will sell the first of three parcels for residential housing upon completion of environmental remediation and the receipt of the full entitlements.  Ongoing rental income from the existing industrial tenant will cover carrying and operating expenses on the other two parcels.  The exit strategy for the remaining land is either to develop the property with for-sale or for-lease industrial buildings or to sell it as subdivided land parcels, or to market as a leased investment. 

The North Richmond Land Project meets the Bay Area Smart Growth Fund criteria in the following ways:

ü      Provides environmental remediation for a brownfield.

ü      Creates 140 units of mixed-income housing—112 affordable at 80-120% of median income (AMI) and 28 units deed restricted to be affordable to residents at 80% AMI.

ü      Builds the type of development envisioned by the North Richmond Land Use Plan and  supported by the Contra Costa County Redevelopment Agency.

ü      Offers the opportunity for additional development on the remaining parcels with potential additional community benefits.

ü      Provides an opportunity to engage the Community Capital Investment Initiative in North Richmond, a major low-income priority neighborhood in the Bay Area.

3. Vallejo Plaza, in Vallejo ($5.2 million investment in a $16. 5 million project), is a 267,500 square foot community shopping center on approximately 29 acres in a neighborhood with a high concentration of Filipino and other Asian Americans.

Three anchor tenant spaces of the Vallejo Plaza, representing over 100,000 square feet, are dark.  The shopping center has been in difficulty.  One of these three anchor tenant spaces contained the only grocery store serving the area.  The Bay Area Smart Growth Fund investment is financing the repositioning and re-tenanting of Vallejo Plaza – the location of a new grocery store specifically serving a Filipino and Asian clientele, a Mercado for local merchants, leasing other spaces including a Filipino banquet facility, upgrading the appearance of the plaza, and construction of seven acres of housing that will provide 200 affordable units.

Vallejo Plaza meets the Bay Area Smart Growth Fund criteria in the following ways:

ü      Brings needed retail services, particularly grocery services, to an underserved area.

ü      Locates ethnic retail services, owned by the ethnic group served, to Filipino American and Asian American residents in the area.

ü      Assists existing local merchants in increasing their income and new local merchants in locating in Vallejo Plaza.

ü      Increases affordable housing in the area.

ü      Supports the Vallejo arts community by providing space for non-profit arts organizations.

ü      Constitutes a mixed-use, mixed income, infill development.

4. The Gateway Retail Center, in Marin City ($7.1 million of a $25 million total investment), is a community-based shopping center in targeted low-income African-American neighborhood with 182,054 square feet of retail space.  The Bay Area Smart Growth Fund is assisting the not-for-profit Marin City Community Land Corporation (MCCLC) to preserve its ownership of the property.  MCCLC exercised its right of first refusal to buy out the for-profit developer, and the Bay Area Smart Growth Fund formed a joint venture with MCCLC to purchase the property and provided the financing for the purchase. 

The Gateway Retail Center meets the Bay Area Smart Growth Fund criteria in the following ways: 

ü      Though this redevelopment has a profound economic development impact on a targeted neighborhood.

ü      Restores/maintains ownership of the property by not-for-profit Marin City Community Land Corporation (MCCLC) with net revenues as a source of funding for community benefits in Marin City.

ü      Constitutes a fifty-fifty partnership with a community not-for-profit.

ü      The Gateway Retail Center will be properly managed, increasing the revenues to MCCLC, which will in turn be used for community benefits.

ü      Facilitates MCCLC’s training necessary to manage the Gateway Retail Center for maximum community benefit.

ü      Refinancing is projected for 2008, with MCCLC becoming 100% owner and the Bay Area Smart Growth Fund exiting with its full financial return objectives.

5. Ascend Residential Properties, Inc, in the East Bay ($3 million investment, generating $45 million in affordable housing), specializes in acquiring, rehabilitating, and selling affordable homes in neglected target areas of Alameda and Contra Costa counties.  Deteriorating buildings in these neighborhoods are becoming attractive homes in communities where there is a critical need for housing and revitalization. 

Since 1999, Ascend has rehabilitated and sold over 100 homes and developed a solid reputation for producing a quality product.  Virtually all of Ascend’s homes have been affordable to moderate-income households, and 75% have been affordable to low-income households, where housing demand is the strongest. 

In November 2002, the Bay Area Smart Growth Fund re-capitalized the current management in a new entity, providing $3 million in equity capital for four years to acquire and rehabilitate approximately 200 single-family homes affordable to low and moderate income residents. 

6. The Hegenberger Airport Business Park, in Oakland ($6.2 million investment in a $25 million project), involves construction of a research and development/flex industrial facility on 14.2 acres near the Oakland Airport. The site plan for the property contemplates construction of four industrial buildings for a total of 197,000 rentable square feet.  The United Brotherhood of Carpenters (UBC) has agreed to occupy one 72,000 square foot build-to-suit building, which is under construction.

The Hegenberger Airport Business Park meets the Bay Area Smart Growth Fund criteria in the following ways:

ü      Location in one of the targeted census tracts.

ü      Produces construction jobs for local residents.

ü      Provides apprenticeship/job training facilities, improving access for local residents.

ü      Transit oriented location near the new BART/Oakland Airport connector.

ü      Uses green design, construction, and operation mechanisms.

ü      Locat in the Coliseum Redevelopment Area, has extensive community involvement.

ü      Meets many Coliseum Redevelopment Area community goals.