Finding Equity for Growth Together

by Tony Chavira

I got a comment on one of my blog posts last week that tried to concisely answer a complicated question: Isn’t the housing sector moving forward? If prices and rates are really that low, why aren’t homes selling? Why is there a need for so many federal incentives?

I think the answer is simple: because there is not enough housing being built.

This is a weird time for developers to invest in more affordable housing. On one hand, it’s exactly what our economy needs, and the more of it we create the more we’ll see real infrastructure growth. On the other, making a huge investment is scary as hell right now. It’s not exactly the go-go 00s anymore, and we now know that fast cash goes just as quickly as it comes. When you know that the front-loaded cost of developing affordable units only pays off in the long run, casually investing a few million dollars in real estate might seem a little foolhardy.

But there are still some good signs that things can work out for the nervous developer. Notably, REITs (Real Estate Investment Trusts) are doing pretty well, considering we’re supposed to be in a construction industry slump. REIT is a tax designation that some corporations take on which requires them to dish out 90% of their income to their investors. And REITs perform in interesting ways. In the short term, they jump around like stocks (since they are using capital raised from thousands of investors to take risks on property). But in the long term, they look more like real estate (shocking as that may seem) and are generally more stable. When REITs are doing well, people are making money and things are getting built; and so far this year, REITs have raised about 15 billion bucks in capital. Since 2009 REITs have raised over $65 billion to bring their companies back afloat, and this is great news for both the investor and the state of development: though most of a REIT’s return is distributed only to existing investors, the extra cash flow can be reinvested to bait new investors and expand business.

I probably sound like a poster boy for REITs and market investing, especially in comparison to anti-corporation advocates who want to systematically dismantle the stock market and redistribute its assets to Main Street (or wherever), but REITs actually serve an important (and somewhat democratic) economic function: they help forward-thinking investors help rebuild America with less personal risk. As propagandistic as that may seem, it’s true. REITs—in general—are a pretty good idea: you can have a steady return and you don’t have to be the only person taking the financial risk. And since 90% of the returns go back to the investors, while only 10% gets cycled back to another real estate deal, it’s a pretty conservative bet, as long as you do your homework.

As a matter of fact, publicly-held REITs go pretty far out of their way to make sure that their investments will pay off both for their investors and for communities. It goes far beyond their current obligations: their target markets are strong, highly populated communities, their strategies help create long-lasting, profitable communities, they work with solid, transparent local governance, and they team up with the best and brightest architects, engineers, developers and contractors an area can provide. REITs thrive on developing in areas that that will pay off, and right now communities that help people thrive pay off.

This is all in contrast with a way of developing we’re all accustomed to: a group of private developers (or one dude with a ton of cash) pool all the resources they can get and build something. Not that this is a bad model; it’s just that it requires stuff that REITs and other, more public ventures have more accessibility to—notably, a huge amount of cash. Most private investors can’t do a development on their own to begin with, and the process of joint venturing, while it can be rewarding, can also be a huge pain in the ass. But it’s just what you have to do to raise the $50+ million needed to pull together larger deals, because anything less would cut into the private equity an investor would be fronting to get the ball moving. Think about it this way: a 10-unit development wouldn’t take as much money to build as a 400-unit development, but would be harder to convince a lot of people to invest in. If you’re going to invest big, might as well shoot for the big payoff.

What’s even harder about private deals is that individual investors have to front something like 5% to 10% of the total cost out of their pockets just to get the equity in the first place. In other words, you need a ton of money to get any equity at all. If you’ve got $5 million lying around for your $50 million development, be my guest. If not, you’re going to have a tough time bringing others (and creditors) on board with your amazing development concept. Right now commingled funds (where a ridiculous amount of people pool their resources to try and pull together a single private deal) have almost no success unless they can raise something like $300 million. So either a few rich people raise exactly what they need and bear all the risk, or a ton of people risk it all on a gamble and it may not pay out at all.

Those are your private options, and that is why no one with money is investing. But public REITs, in their most democratic form, are exactly the apolitical kind of investment in our communities that everyone out there should be rooting for: where thoughtful and well-organized organizations are looking to invest in good structures and spaces that add value to communities and pay off to investors.

We can work together to carefully (and, one hopes, affordably) grow our nation’s infrastructure, and we can even trust our capitalist-pig economy to do it. We just need to do our research and make sure we’re investing in the right properties, built in the right places for maximal community growth and value. Otherwise, how do we expect any natural economic growth at all?

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