Financing with Locally Sourced Equity

Changing the way real estate is financed is a key to reducing the auto-dependence of our cities. As I’ve discussed before, organizing local wealth for local benefit is critically important. Up until now, we’ve only really been able to marshal local wealth to fund development project’s debt. However, thanks to some long-awaited new rules regarding direct investment by non-accredited investors, we have a new opportunity to invest equity into development projects that improve our community.

In 2012, the Jumpstart Our Business Startups Act (JOBS Act) was signed into law, which provided for “crowd-sourced” financing of equity. The way it worked before, for an individual to buy a part of a company, that company would need to be publicly traded on a stock exchange (unless the person is fabulously wealthy, in which case they could invest their wealth in companies that are not publicly traded.) The JOBS Act was suppose to level that playing field a bit, and allows regular people to invest in non-publicly traded companies within some limits. Unfortunately, it has taken the Security and Exchange Commission more than three years to draft rules implementing this portion of the JOBS Act, but on October 30th they finally approved those rules.

This sets the stage for crowd funding for small businesses. There are already companies primed to take advantage of these new rules for funding real estate development projects, some even with a social mission. What we don’t see yet are community based companies focused on matching small business owners, including small developers, with investors right in their own community. If communities can establish their own crowd funding financial institutions, they will be able to retain and grow the community’s wealth, not just by loaning their savings to local businesses, but by buying a piece of those businesses and watching their investments grow.

For individual developers or small business owners, this also opens an opportunity to find groups of people within their community who can now invest in their projects or business. So now it will be possible to collect a few thousand dollars or less from a larger group of people to make a project happen. This has the added benefit of reducing the risk for any individual investor, because it’s much easier for ten investors to lose $10,000 each, than for one investor to lose $100,000.

Small businesses and developers should be reaching out to their patrons and friends now so they can take advantage of these new rules once they go into effect at the beginning of 2016.

This is a great opportunity for communities, or individual business owners, that take advantage of it. Combined with a community credit union, investing locally can transform the prosperity of communities. It simply takes a renewed focus on growing local wealth.

Local Wealth

One point that has been mentioned several times, but not examined, is the need for local businesses to have access to local sources of wealth, for both debt and equity1. In many cases, multi-national banks won’t lend to small businesses, so local financial institutions are the only way for local businesses to access the capital they need to grow. A community that shows broad-based support for its local financial institutions is one that will bootstrap the growth of the community’s wealth by ensuring existing wealth is reinvested locally, instead of globally.

For most communities, the financial system works something like this: people save and invest some part of their income. The savings are deposited in their account with Bank of America, Chase, or Wells Fargo; the investments are made through a mutual fund. The bank takes their deposits and lends that money to large borrowers around the world. The mutual fund manager purchases stocks from companies generally based in Delaware, with their headquarters in a major metropolitan area and operations globally. None of this money that the community saves is loaned or invested to the businesses in their neighborhoods. Continue reading Local Wealth

Homeownership is not an investment

Investments, by their very nature, can generate income without being sold. They are productive assets. Stocks generate dividends, bonds are redeemed over time, commercial real estate generates rent. Owner-occupied homes are not productive assets because they do not generate income unless they are sold. Homes are not investments, they are a cost.

Most home-buyers think of owning a home as an investment. In many cases, this leads them allocate their resources differently than if they thought of their home as a cost. There are many good reasons to own a home, but owning a home as an investment vehicle is not one of them. While it’s true that real estate generally appreciates in value, it does so roughly at the pace of inflation. Some cities and neighborhoods will appreciate faster because those areas become more desirable, but as a whole the real estate market appreciates with inflation over the long term.

If homeowners think of their homes as an investment, the only way they can get a return on that investment is by selling it to someone else for more than they paid for it. If the new buyer is also thinking of the home as an investment, the only way they can see a return on the investment is if they, in turn, sell it to a third person willing to pay even more for the home. Each subsequent buyer is betting that they’ll be able to find somebody to pay a higher price for the home in the future.

This behavior of people buying an unproductive asset for ever higher sums of money has a name, it’s called a bubble. We’ve seen, very vividly in 2008, what happens when homebuyers start thinking of their homes as investment assets and an bubble is created and bursts.

Not only do we end up with real estate bubbles when we think of our homes as investments, we distort our asset allocation. This negatively impacts the economic and environmental sustainability of our cities because it causes us to have a greater desire to be homeowners than we might otherwise. The desire to own a home for investment purposes often forces people to live further out in the suburbs, where homes are more affordable, and commute longer distances. This has a direct impact on the number of miles they drive which increases the wear and tear of our streets and the amount of CO2 in the atmosphere. In addition, it encourages people to spend more, because they are “investing”, causing them to be “house poor” and reducing their disposable income and slowing the economy as a whole.

There are many good reasons to own a home, even good financial reasons for owning a home, but home-ownership is not an investment vehicle. As a society, we need to stop thinking of buying a house as an investment. Without this change in attitude towards home ownership, we cannot encourage enough suburban communities to rebuild as sustainable and walkable.