You might have caught Max Levine or his colleagues making their unusual pitch to shoppers at the Los Angeles City College Swap Meet, last fall and winter before the pandemic. Or maybe they knocked on your door in your rent-stabilized building in the Echo Park neighborhood of Los Angeles, where gentrification is a touchy subject.
The pitch goes something along the lines of, “we’d like you to participate in buying up the vibrant and dynamic neighborhood you love and helped create.”
Levine is co-founder and CEO of Nico, short for Neighborhood Investment Company, a real estate startup that is in the business of acquiring buildings in neighborhoods like Echo Park and giving tenants in those buildings and others nearby an opportunity to buy a stake in the ownership structure of the buildings in its portfolio.
It can be a difficult conversation, at first.
“When you talk to folks in Echo Park about real estate investment and capital, people are automatically very defensive about it, and it makes sense because it has been so dis-aligned with them historically,” says Levine.
Nico isn’t trying to stop all the other capital from coming in. But it’s one of a handful of examples featured in a report published today from the Urban Institute on the emergence of new models for community ownership in commercial real estate across the country.
“What the neighborhood means to folks is so powerful and so personal, and when you give them a way to invest and participate in a different way than they thought they’d be able to, there’s sort of a moment of disbelief, and when it lands they’re like okay, great, I’m so excited,” Levine says.
The five different models in the new Urban Institute report come from five different cities and a wide range of circumstances.
Senior Fellow Brett Theodos, co-author of the report, sees the seemingly disparate models as partly a response to the continued and growing racial disparities in wealth, and partly a reaction to absence of federal leadership around community development for the past four years.
“It’s becoming a field or a sector or a model,” says Theodos. “But we struggled initially with what to call it.”
He also sees the trend as partly a reaction to Opportunity Zones — the investor tax break created in the 2017 Tax Cuts and Jobs Act that encourages investment in more than 8,700 designated census tracts across the country. The tax break requires investors to reinvest profits from selling off previous investments, but just 7.3 percent of tax returns —those overwhelmingly filed by wealthy households — reported any such profits in 2017, the most recent year of data available from the Internal Revenue Service.
“The people who were designing Opportunity Zones were always pretty transparent that it was about bringing new money in from wealthy investors, and it makes sense in some ways because that’s where so much money is,” says Theodos. “But that means the only major new policy development in community development over the last ten years is not designed for 90 percent of people to participate.”
The report breaks down each model into five essential features — eligibility, meaning who is able to invest; purchase and ownership pathways, including investment minimums and opportunities to invest; return on investment; exit structures, meaning how investors cash out if and when they want to cash out; and community engagement.
Next City has previously covered three of the models — the Northeast Investment Cooperative, in Minneapolis; the East Portland Community Investment Trust in Portland, Oregon; and Boston Ujima Project, which features a democratically managed investment fund targeting Black communities and other communities of color in Boston.
The oldest model covered in the Urban Institute report is San Diego’s Market Creek Plaza. The local Jacobs Foundation acquired the abandoned 20-acre factory site in the late 1990s, redeveloping it into commercial retail anchored by a grocery store, a restaurant and a bank. When redevelopment was completed in 2004, the foundation extended a one-time offer to residents and workers in the four zip-codes around the property to buy a share of ownership in it for as little as $200. A total of 415 eligible investors bought shares.
As noted in the report, there was initially no plan in place for Market Creek Plaza’s investors to exit early. The entire development is required to be sold in 2025, at which point the investors would receive their proceeds based on how much they initially invested. But since 2004, the Jacobs Foundation has bought back community investor shares upon request. The foundation has also had to shell out an annual 10 percent return to each community investor, as the property itself has yet to generate any profits on its own.
“The exit is important — is there an ability to exit and how has that worked out,” says Theodos. “Also the ability to buy in slowly, I like that about Portland’s model.”
The exit is essential in how it allows local investors to cash out eventually and use the proceeds to help start a business or make a major purchase. It can take time, however, for that wealth to appear, in the form of appreciated value for each local investor’s ownership share. The models in the Urban Institute’s new report are particularly geared toward generating wealth for participants in this way, as opposed to models with different goals like community land trusts, which intentionally limit the appreciated value of properties that participants can capture for themselves.
Cities could nudge more of these examples along, Theodos says, by requiring everything from megadevelopments to smaller developments to incorporate some type of community ownership component as a requirement for receiving public subsidies or incentives.
Nico is the only model in the report to make use of a formal REIT, short for Real Estate Investment Trust, to enable community ownership in commercial real estate. Created by Congress in 1960, REITs pay no income taxes on their profits in exchange for distributing at least 90 percent of their income to shareholders each year. More than 200 REITs are publicly traded on stock exchanges today, and there are also many more privately-owned REITs.
REITs are a common vehicle for pooling capital for real estate from pension funds, insurance companies, foundation or university endowments and other large sources of institutional capital — and that’s exactly why Nico is using the legal structure, despite the significant legal and regulatory requirements to set up, raise capital for and manage a REIT.
“We chose to be a REIT because a REIT is a known, stable, deeply understood structure that all of those investors are intimately familiar with, and real estate lenders are intimately familiar with,” says Levine. “We fully support some of the other models where community ownership is happening, but the second thing you have to do after the mission is explain why you decided to structure this in this totally unique way. We didn’t want to have to have that conversation.”
Conventional REITs are already powering gentrification in neighborhoods like Echo Park, which was featured on the second season of NPR’s There Goes the Neighborhood podcast series on gentrification.
Levine can relate, as an LA transplant born and raised in New York City. “NYC has gentrified to an incredibly significant extent over my lifetime,” he says. He also spent the first 15 years of his career working in conventional commercial real estate, “in the belly of the beast,” he calls it.
“Twenty years ago, real estate was not an institutional asset class the way that it is now,” says Levine. “What that means is, pension funds, endowments, the pools of capital that shape our world, twenty years ago they were not invested in real estate the way that they are today and they certainly were not invested in real estate outside core business districts. That’s changed. That capital, and the professionalization of the developers and companies that manage that capital is one of the big forces that has made the story around gentrification what it is over the last 20 years.”
What Nico is looking to do is bring renters who are normally left out of the investor bonanza into the wealth-creation party.
A lot depends on the fact that there are still many rent-stabilized buildings in Echo Park — out of 800,000 multi-family housing units in Los Angeles, some 80 percent are rent-stabilized, meaning annual rent increases are limited to a rate set by LA’s Rent Adjustment Commission. The first three buildings acquired for the Nico Echo Park REIT are all rent-stabilized, with 84 units of housing and five retail units, including four storefronts along LA’s iconic Sunset Boulevard.
Rent-stabilization means there are tenants normally locked out of creating wealth still living in neighborhoods that are or have been appreciating in value. Across the city of Los Angeles, rent-stabilized tenants pay $270 less per month on average than market-rate tenants, making these units a safer haven for the working-class Latino and Black households that Nico wants to prioritize for wealth creation. The minimum investment is $100 for 10 shares in the REIT.
But it’s also about market dynamics.
The prices for rent-stabilized buildings in Echo Park are at a point where buyers interested in maximizing returns have been looking to mine profits from the gap between where they can buy a rent-stabilized building and where they can sell it after using the state’s eviction laws to pull units one-by-one out of rent-stabilization. Echo Park has been the epicenter of such activity — last year Curbed LA reported that in the zip code that includes Echo Park, in one three-month stretch there were seven units a day pulled out of rent-stabilization.
At the same time, those same prices are also low enough that Nico can acquire them, finance any rehab or repairs, and still offer a reasonable return to institutional investors as well as local investors even without the additional profit from kicking out rent-stabilized tenants and bringing units up to market rates.
”It would be harder for us in a market with no tenant protection in place,” Levine says. “The fact that this program is priced into how assets are valued here means you can earn an acceptable rate of return by owning.”
Investors get two potential forms of returns from the Nico Echo Park REIT — quarterly dividend payments per share, and the ability to sell their shares at an appreciated price based on the value of the buildings in the REIT’s portfolio.
Nico offers to buy back shares from investors on a quarterly basis, though the share price only gets updated once a year after an annual appraisal of its properties. Theoretically, Nico shareholders could also sell their shares to other investors, but likely would have to sell them at a price lower than what Nico would offer.
But Nico Echo Park REIT shares won’t be bought and sold on the stock market. Instead, Nico is using one of the newer regulatory mechanisms for selling and exchanging ownership shares that came out of the Jumpstart Our Business Startups Act, passed by Congress in 2012.
Levine says Nico’s Echo Park REIT has hundreds of shareholders right now, including institutional investors as well as local shareholders. He declined to disclose any more specific information about the shareholders at this point, citing U.S. Securities and Exchange Commission regulations.
As another safeguard, the Nico Echo Park REIT itself is incorporated as a benefit corporation, meaning it has a legal obligation to its shareholders to maximize its positive social returns in addition to financial returns. Thirty-seven states have passed legislation to recognize benefit corporations alongside traditional LLCs, other corporate entities and nonprofit entities.
Being a benefit corporation means shareholders would have legal rights to sue the entity if it doesn’t sufficiently meet its social goals, for example by providing enough rental assistance to tenants of its buildings during a pandemic. (Nico has in fact offered tenants multiple layers of rental relief during COVID-19, including grants out of its own operating reserves.)
Nico plans to create other REITs for other neighborhoods and in other cities.
“The first one was a lot of work, a lot of time, and pretty painful to set up, but we think we can do this more efficiently going forward,” says Levine. “We’re looking at markets all over the country right now.”
Levine is upfront about how enabling existing working class Latino, Black and other tenants of color to benefit financially from the gentrification of their neighborhoods isn’t the same as preventing huge capital flows from utterly transforming their neighborhoods into spaces that may no longer meet their needs or feel like a place where they still belong.
But if there’s financial value in these neighborhoods because those who have been living in them as renters make them unique and vibrant, Levine wants to prove there’s a model for everyone and not just homeowners to have access to that, or take it with them if and when they go, and even pass it down to future generations.
“I don’t think any of these models will work at preventing displacement,” Theodos says. “These are about sharing in the wealth of development as it happens. It’s important to know what they can do and what they can’t do. I think these could be used in gentrifying neighborhoods, in some sense you want people who are long-term residents to benefit from appreciation in the neighborhood.”
This article is part of The Bottom Line, a series exploring scalable solutions for problems related to affordability, inclusive economic growth and access to capital. Click here to subscribe to our Bottom Line newsletter. The Bottom Line is made possible with support from Citi.
Oscar is Next City's senior economics correspondent. He previously served as Next City’s editor from 2018-2019, and was a Next City Equitable Cities Fellow from 2015-2016. Since 2011, Oscar has covered community development finance, community banking, impact investing, economic development, housing and more for media outlets such as Shelterforce, B Magazine, Impact Alpha, and Fast Company.