The Problem with Impact Investing

When I first started on my mission to build an impact business ecosystem, I was really excited about the idea of building some very unique affordable housing projects here in Los Angeles. I had been approached by a very good friend of mine—one of the savviest real estate investors in the region—with an opportunity to partner on two large sites in the San Fernando Valley consisting over 500 units of fully deed restricted affordable housing. It was the perfect opportunity or so I thought…

My friend, by the way, is one of those real estate entrepreneurial success stories you only find in a place like Los Angeles. From humble beginnings he’s put together an incredible track record involving over 150 properties, making a small fortune along the way. A very private and humble person, if you ran into him on the street, you’d never know he’s one of the most innovative developers in the region.

Anyway, for the last several months, we’ve been trying to raise equity for these two sites and the experience has been as eye-opening as it has been frustrating. There’s something really broken in the market, especially when it comes to investing for impact. 

To be fair, it’s not like this is a particularly great time to be raising money for real estate deals. In fact, it’s a terrible time! The industry has been in the dumps for 3-years now. Transaction volume is way down. Rents have stalled out. Starts and permits have plummeted. You can hardly even sell a basic single-family house in most markets across the country these days. We’re clearly in the midst of a classic cyclical downturn and it feels like it’s about to get worse.

That being said, it really shouldn’t be this hard to raise equity for deals like ours. Unlike almost every other affordable housing deal in the country, these two need neither tax credits nor Section 8 vouchers to pencil. In other words, even though they are providing classic affordable housing, they can be built without any public subsidy. We thought the market would be ecstatic about this but we were very wrong!

The problem with impact investing is that no one is really investing for impact.

What do I mean by this?

Look, it’s true that there are a whole bunch of funds, individuals, and organizations pursuing impact—so much so, there’s even a professional organization called the Global Impact Investing Network and supposedly over $1.5T allocated to the space. While these groups are deserving of our praise for their noble intentions, most are failing at the exact place that could make a difference.

As usual, it all comes down to money. The impact investing world has gotten very good at pursuing qualitative aims—e.g. providing capital to people who don’t usually have access to it—but it has struggled to make meaningful inroads in disrupting the mentality around financial return expectations. Qualitative measures are important and should not be ignored or abandoned, however, what the impact world needs most is this:  investors who are willing to accept lower returns in exchange for impact.

Imagine a spectrum of investment return expectations:

When you have philanthropy on the one side basically willing to accept 0% and global Wall Street on the other side looking for 20%+, true impact investing should be somewhere solidly in the middle—i.e. 5%-15% depending on the type of impact we’re talking about. But what we’ve found in our discussions is that while impact investors are willing to sacrifice returns for impact, it’s just by the smallest of margins. Instead of 20%+, they want high teens. That’s not nothing but it’s not really enough. 

There are a lot of fair reasons for this mentality: underfunded pensions who desperately need to keep up with their actuarial assumptions, investors struggling with inflation, pressure from opportunity costs, investment managers who need/want to get paid…. Given conditions in the global economy, we should be happy that an impact investing world even exists! And perhaps, we just haven’t talked to enough groups yet. But if impact investing is going to be a thing, this dynamic has to change. 

It's too bad that our government is so dysfunctional these days as this is a perfect place where it could make a real difference. When you consider all the different types of financial players in the market, it’s the government that is best suited to play the impact role. Today it can borrow money in the 30-year Treasury Bond market at 4.8%. Why not turn around and invest that at 7% or 8% in impact projects? That would be a big win for the impact investing world—a capital partner wanting 8% is a lot better than one asking for high teens!. And this would be a significant win for the government. Not only would it enable us to pursue important social aims like equity and housing affordability, it would also be much better than all our other government aid programs which function like traditional philanthropy and earn 0%! I like this concept so much, I’m adding the to create an impact sovereign wealth fund to my list of the top ideas to improve America.  

I realize, by the way, that it’s possible that we simply haven’t talked to enough impact investors yet. There might be plenty out there willing to accept lower financial returns in exchange for some other societal benefit. If you know anyone like this, please send them our way!

I cannot believe I’m writing this but the City Council here in Los Angeles is actually considering doing something pro-housing. The planning and land use commission met this Tuesday to discuss single stair reform and the matter could come before council for a vote. My loyal followers may remember that when Abundant Housing’s Scott Epstein appeared on the podcast this was one of his top ideas for promoting housing abundance. 

Why is this so important? To make a long story, short: by wasting much needed square footage on non-livable space and limiting architectural choices, the double stair requirement makes infill urban development even more expensive than it already is, thus limiting much-needed housing production. 

Impact Story of the Week 

In sticking with our theme this week, I am proud to share that I have become a member of the Yimby Action Southern California Regional Board. Yimby Action is one of the most effective civic organizations in the country right now and the secret organizing force behind a whole slew of much-needed pro-housing policy reforms across the State. If you have any interest in joining or supporting the movement, please hit reply here and let me know. 

For Palisades fire victims looking for a trustworthy, cost-effective homebuilder and any Los Angeles homeowners who need help with renovations or ADUs – Westward Homes

For Los Angeles real estate owners looking for sophisticated, professional property and asset management services — DNY Living

For investors interested in proprietary RE investment opportunities – Metros Capital

For RE developers who need flexible capital / savvy partners – Westward Capital