Affordable Housing Innovations 04: What price impact?

(Or, how many beeps is a photo worth?)

By David A. Smith

When it comes to pro-poor affordable housing, there must always be an element of subsidy, direct or indirect, because inescapable rules of land-use economics assure that market-quality housing will be priced at levels affordable to the median customer, not the poor one. Absent subsidy, the yield on capital must be concessionary, and that runs up against the CFO's self-righteous mantra: We have to achieve a risk-adjusted market return, to which is often appended, infuriatingly, It's for your own good.

Such thinking is smug nonsense. It views the transaction only from one perspective, the capital consumer's. As inclusionary banking goes global and corporate social responsibility requirements gain teeth, capital providers will increasingly need to put out money in ways that yield not only economic return but also impact – and if they want impact, they will have to pay for it in reduced economics.

TR = E + I + O

For a socially-motivated investor, Total Return is a mixture of Economic return, Impact, and Optics.

  • Impact is actual enduring positive change. This could be people's lives improved, or new institutions created, or permanent changes in government policy and resource flows
  • Optics are how we demonstrate impact to others. Numbers are intangible and many people are innumerate; words can be dry, policy changes abstract and unsatisfying. So we devolve to visual anecdotes – photos, videos, field trips to work sites – using the optic to stand for the impact.

Impact is what investors want[1]; Optics is what program sponsors offer.

Optics matter, and so does impact

Whether or not they admit it, social impact investors evaluate Total Return, because that is what they tout to the outside world. Nevertheless, no matter how much CEOs and Chief Marketing Officers like impact and optics, neither is readily quantifiable, so their CFO or Chief Risk Officer colleagues value them both at zero. This may be fine in the pedagogical economics classroom, but is useless in the real world of making impact.


[1] Optics is a problem for AHI in particular. Though what we do has enormous impact, it is visually indirect – we change ecosystems or business models, both of which are invisible.

You really want 20% IRR for helping us?

Meanwhile, although risk is every bit as subjective[1] as impact, the CFO and CRO rate impact investments as high risk, mainly because they are new. As a result, impact investments get whipsawed in the underwriting.

In short, what the CEO wants, the CFO will not pay for by lowering yield hurdles based on expected impact.

More than once I have been told, "we love the project, but we need a market rate of return on the investment." To which I have only one unanswerable question: "If I could provide a 20% IRR, why on earth would I give it to you? I'd just go to private equity sources and eliminate the moral hassle."

The necessary genius of quantifying impact metrics

Money's genius – what makes money an indispensable part of civilization's intangible infrastructure – is its ability to quantify human desires. What we can quantify, we can trade, and when we trade, aggregate human productivity increases, and with it aggregate human quality of life.

It is sometimes said rhetorically that one cannot put a price on human happiness, but all of us do this all the time; whether it's wine ratings, votes (a crude unitary quantification of political choice), charitable contributions (give money, get a good feeling), or employment (where we work and why), we are constantly converting intangible and unquantifiable abstracts into monetary units. That leads to two conclusions:

  • Capital providers must make clear the numerical score they will assign to different levels of impact or optics.
  • Capital consumers must develop algorithms that provide observable, verifiable estimates of impact and optics. One approach is randomized control trials (RCTs), currently a hot topic, or one can build econometric models or impact proxies (e.g. capital levered by our investment).

Creating subsidy media of exchange: examples from around the world

That's easy to say, I hear readers grumble, but hard to do. But it's far from impossible.

  • US: The Community Reinvestment Act (1977) and the Low Income Housing Tax Credit (1986). Under CRA, the world's first inclusionary-banking statute, banks are scored every three years on their capital provision into disadvantaged communities; low scorers are unlikely to be able to buy other banks. Today's market for LIHTCs (the ideal CRA-qualifying investments) is so sensitive that not only can one price the yield differential between CRA and non-CRA, one can also see a price difference between high-CRA-demand 'hot spots' (places, like New York City, which are in the assessment area footprint of many banks) and low-CRA-demand.
  • US: LIHTC Qualified Allocation Plans (1990). Before a developer can win an award of LIHTCs, the developer must receive an allocation from the state by applying. Every state has an annual Qualified Allocation Plan (QAP) in which the state sets forth a complete set of rules by which it will score applications for everything from location to income and rent levels, to sustainable technology, walkability, and social service programs. Because highest score wins the award, the QAP rules effectively monetize impact.

The complementary roles of program participant and rule-maker

In an ecosystem that prices impact and optics, there are two distinctive and complementary roles in play: rule-makers and participants.

  • Participants are capital consumers, Mission Entrepreneurial Entities (Mee's, rhymes with bees) as AHI calls them, seeking to do good things in the world and make positive cash flow along the way. If money is dangled, Mee's will compete for it.
  • Rule-makers are those with the power of money or laws. They care about impact – indeed they want to turn their money into money-plus-impact, and if they want to get impact, they need to provide a scoring system that program participants can compete against.

These two roles are symbiotic: participants take risks and innovate furiously and competitively, while rule-makers set priorities based on where they place their money. Rule-makers that make their preferences manifest and quantitative will get much more bang for their bucks than those who don't.

What you don't pay for, you don't get

If you get what you pay for, what you don't pay for you don't get. And if you can't quantify what you want, measured in basis points (beeps), then the market will blunder about unable to give it to you.

Any ranking system is better than no ranking system. Come up with one, publish it, invite comments on it, and award money based on it. Do this several years running and the unquantifiable will be routinely being quantified, and achieved.


[1] Much has been made, in light of the financial meltdown, of 'new and improved' risk-rating algorithms such as Basel III or Dodd-Frank, but these too are simply a mathematical compilation of a series of judgments.