Earlier this year, The New York Times published a sobering examination of diversity in commercial real estate development, highlighting what stakeholders in the industry have long known to be a problem: racial disparities among real estate developers.
Citing a joint report from Siegel Family Endowment, the Initiative for a Competitive Inner City, and Grove Impact, the article noted that 111,000 of the 112,000 development companies in the US are white-owned. Even worse, among top-tier developers – defined as those with $50 million in annual revenue – only one is Latino-owned, and none are Black-owned. Racial disparity in the industry impacts the types of projects that are built and where they are built, often robbing low-income or BIPOC communities of essential resources.
While funding is a top challenge for all developers, a driving force behind the disparity is unequal access to capital. Real estate development is a high-risk endeavor, and the two most severe economic downturns in recent history were catalyzed by dislocations in the real estate and development industries. As such, lenders highly scrutinize construction deals and tend to show preferential treatment to developers who can supply a significant equity stake in a project and those that have an established track record of success. All too often, those barriers eliminate access for BIPOC and emerging developers.
Shining a spotlight on the importance of developer diversity can be a first step in catalyzing meaningful change in the capital markets and creating equitable access to construction capital.
Defining the Capital Gap
Accessing capital is often the most challenging for BIPOC developers looking to scale up their business. Enterprise senior research analyst Ahmad Abu-Khalaf noted the challenge of achieving scale in a recent policy report, saying, “Those who have taken on smaller-scale multifamily developments (either new construction or acquisition-rehabilitation projects) experience systemic challenges in accessing capital necessary to work on larger-scale multifamily developments, as well as scale up their business operations.”
BIPOC developers face challenges accessing early-stage capital, making it difficult to get off of square one and push projects forward. Most developers need $1 million to $5 million on their balance sheet to be considered by a lender or capital partner. Likewise, lenders also require a 20% equity stake in the project to qualify for a loan. Because many BIPOC developers don’t meet this threshold, the standard practices serve as a systemic barrier. These constraints also limit access to later-stage funds that were designed to support disadvantaged communities, like Community Development Financial Institutions Funds or CDFIs.
And yet, when BIPOC developers do make it through, their projects typically outperform those of legacy developers in terms of transaction size, while small BIPOC developers generate more annual revenue than their peers. In addition, BIPOC developers have valuable access to different networks and communities, which can illuminate new and different opportunities that are just as viable and profitable as those pursued by white developers.
The dichotomy, along with necessary national attention, has sparked an industry-wide effort to update capital requirements and application processes to give BIPOC developers equitable access to construction capital. Change is happening at every level, from government agencies to state-led programs as well as in the private sector.
Federal Programs Set a New Tone
In recent years, federal housing finance agency Freddie Mac has shown commitments to advancing financing access for BIPOC developers. In 2020, Freddie Mac launched a Develop the Developer Academy to work closely with emerging BIPOC single-family and multi-family developers. According to Freddie Mac, the program provides “foundational development and financing instruction, technical assistance, community connectivity and access to funding sources for emerging developers.” Developers with limited experience of one to three years are eligible to enroll. Since its launch, the program has helped to support 72 BIPOC developers.
In addition, Freddie Mac’s Equitable Housing Finance Plan includes several initiatives to increase diversity throughout the housing finance industry for both borrowers and developers. The program engages Freddie Mac’s extensive network of national lenders to pursue projects with BIPOC and emerging developers.
Freddie Mac’s program is an example of a push at the federal level to establish more resources for diverse developers. Alternative resources like the American Rescue Plan also award funds to help small businesses and entrepreneurs, including real estate developers.
Finding Support at the State Level
More significant support for BIPOC developers can be found at the state level. Several US states have established programs and funds to support diverse developers and push projects forward. California, for example, has a BIPOC Developer Pool, which awards
developers that have BIPOC leadership or ownership state-sponsored funds for development projects without needing to meet traditional balance sheet and equity requirements.
Several other states offer similar programs. Vermont, Illinois and New Jersey, to name just a few, have launched BIPOC-specific funding resources in recent years to help bridge the capital gap. New Jersey’s program, for example, provides training and certification to nonprofit community developers with a focus on BIPOC entities.
Private Lenders Invest in BIPOC Developers
While more is being done to provide access to BIPOC developers, most of the programs launched by government agencies are focused on affordable housing, not general commercial development. In addition, the impetus of these programs is to bridge the wealth and homeownership gap for BIPOC Americans, not necessarily to support equity in the development community. However, private capital providers are starting to play an important role in supporting diverse developers.
Organizations like the Community Preservation Corp. are filling a gap in equity financing, providing “friends and family” style funds and mentorship. Other organizations are creating funds to invest in BIPOC-led projects. CSH launched a $60 million fund for BIPOC housing developers; Bank of America Community Development Banking and Enterprise Community Partners partnered to provide $60 million in funds for BIPOC housing developers; and Wells Fargo created the Growing Diverse Housing Developers program with a $40 million grant initiative to expand the growth of BIPOC developers. These are just a handful of programs from banks and non-profit organizations that are helping to expand capital access.
BIPOC-targeted programs are a welcome first step in establishing developer diversity, but to create a truly level playing field, equity and debt institutions need to update underwriting and review processes. In addition, BIPOC developers can also utilize alternative strategies to build relationships with capital providers. Utilizing development management technologies, like Northspyre, is one opportunity to build confidence in the borrower-lender relationship when a developer might not meet minimum requirements.
Lenders are concerned about a developer’s ability to see a project through and absorb overages, but technology-supported management software reduces overages, maintains or reduces the overall budget, and keeps a project on schedule, all characteristics that serve to protect a lender’s investment. Northspyre, for example, has been shown to reduce overages by up to 60% and budgets by 6%. This is valuable to a lender and can help increase capital access.
In recent years, the commercial real estate industry has rapidly evolved and embraced diversity and inclusion practices. Providing equitable access to capital for BIPOC and emerging developers is an important step on the pathway to creating a more inclusive industry.
Looking for insights on how to navigate the complexities of growing and scaling your real estate firm? With the right strategy, you can effectively scale your business. Download our ebook Scaling Teams: A Real Estate Developer’s Blueprint to Success to ensure you choose the right time and pace at which to scale up your firm.