Source: Chronicle of Philanthropy
We are in an exciting and uncharted era of philanthropy because of increased interest in impact investing, new tools like “pay for success” (also known as social-impact bonds), and new IRS rules that enable broader use of program-related investments, such as low-interest loans that foundations can make to nonprofits.
However, in the midst of all of this change and innovation, American philanthropy is missing an opportunity by not using more of its investment tools to aid capital projects. Physical facilities and the underlying systems that run them are more important than ever in allowing nonprofits to deliver new programs and services.
The creativity under way is amazing. Take for example, Meals on Wheels of Tarrant County, Tex., which delivers over a million meals a year to 5,000 vulnerable people. It has extended its traditional mission to also assess the health needs of those it serves and then connects them with local services. Its ability to grow and reach more people is enabled by its new 63,000-square-foot food-production and distribution facility.
Physical projects also play an important role in rebuilding communities. Take, for instance, the redevelopment of Washington Park in Cincinnati — spearheaded by the community-development group 3CDC. This $48 million project revitalized and expanded a rundown park into a vibrant, eight-acre centerpiece for the renewal of the Over-the-Rhine neighborhood. The new park includes amenities like performance spaces, playgrounds, a dog park, and water features, as well as a 450-space underground parking garage. The park’s revitalization has led to stunning amount of commercial and residential development.
But groups seeking to build such projects are finding it harder than ever to get foundation money as philanthropies channel more funds into financing nonprofit programs and projects and advancing public policy.
While old-style capital campaigns may seem passé, foundations should continue to provide capital grants so they can seize the opportunity provided by the federal New Markets Tax Credits program. Established by Congress in 2000, this program creates a powerful subsidy for projects in low-income neighborhoods that create jobs and provide important goods and services. To date, the program has generated over $70 billion in private investment for over 4,700 projects that serve low-income people and communities. And Congress recently extended the program for an additional five years.
Both the Meals on Wheels and Washington Park projects used New Markets and foundation grants as part of their financing. Foundations often say they want to see grantees “leverage” their funding — use their grant to attract other dollars. New Markets are complicated (a reason some foundations shy away from them), but at its most basic level, a grant made to a project with New Markets will receive 20 to 30 cents for every dollar a foundation invests. However, without philanthropic grants, nonprofits find it extremely difficult to participate in the New Markets program, because they must provide the remaining 70 to 80 percent of the cost of a project up front, and that usually means they must take loans out. Such loans are a problem: Nonprofits end up saddled with unsustainable debt. The only way to make New Markets truly work for nonprofits is to replace some or all of this debt (called the “leverage loan” in New Markets-speak) with money from foundation grants or program-related investments.
Meals on Wheels received $5.4 million of philanthropic grants — roughly half of the leverage loan and one third of the total $16 million in financing. Washington Square received $4.5 million in philanthropic grants (in addition to $14 million of grants from the Cincinnati city government) toward the $48 million project. This is not your old-style capital campaign with foundations being asked to fund the entire project. With New Markets, a grant goes a long way in terms of leveraging the federal subsidy and whatever private dollars are in the project. These projects are successful examples spearheaded by high-functioning nonprofits. However, many nonprofits are not as skilled, sophisticated, or lucky. For every successful project like Meals on Wheels or Washington Park, many other efforts to build important facilities to extend nonprofit services never get off the ground.
While philanthropic dollars are essential to making it possible for nonprofits to take advantage of New Market Tax Credits, surprisingly few national philanthropies take advantage of this tool or participate in capital projects at all.
It’s time for that to change. A main reason philanthropies say they don’t support capital projects is that they are expensive and risky and have a confined impact on a single geographic market. Some foundations are willing to support capital projects in their hometowns or will occasionally support projects that can be copied broadly elsewhere or that serve as a catalyst to other goals, say improving education.
But that logic is problematic, as I learned when I asked a high-ranking official of one of the largest U.S. philanthropies who would pick up the tab to duplicate a capital project that his fund had proven made a difference. If everyone is looking to create a model, who pays for the model to be put to work in communities across America or around the world? He said he figured that community foundations would pick it up.
However, many of us know that community foundations vary greatly in their focus and capacity. Many of them are mainly managing donor-advised funds that rarely are channeled to capital projects.
Just as important, capital projects often need more subsidies than local grant makers can bear. The tax credits, along with money from national philanthropies, can bridge this gap, especially for projects that aren’t in America’s biggest cities.
To be sure, the New Markets Tax Credit program is far from perfect. One foundation executive I talked to cited the high transaction costs to compensate the accountants and lawyers necessary to structure these deals. The program is complicated, and the financial institutions that receive credits from the federal government have to compete for them annually, creating a rushed funding cycle to complete the approval of each year’s projects.
In an ideal world, New Markets would provide a higher level of subsidy for nonprofits (like another federal tax credit program for affordable housing), but that is not currently the case. Grant makers could provide a useful advocacy voice in pushing for change. But until policy makers refashion the credits, it’s still better to use them than ignore them.
While the biggest reason for foundations to finance projects using the credits is to better advance their philanthropic missions, they should also realize the credits can be useful as an investment tool. Foundations could combine grants and program-related investments in a single project, providing the bulk — or even all — of the leverage loan, thus enabling New Markets-financed projects to move forward quickly while making a return on investment for the philanthropy at the same time. What’s more, these deals are very low risk compared with other investments.
Grant makers may find that the wisest way to get involved in using the credits is to join a collaborative, where multiple philanthropies commit resources to create a large enough pot of grants and program-related investments to fully support capital projects. This collaborative could assess the strength of capital deals, pledge money to help projects get off the ground, and then commit financing to deals that are ready to go.
But whether they go solo or together, it’s vital that foundations drop their reluctance to pay for real-estate projects that could advance their missions. They should work side by side with governments, banks, community-development financial institutions, and other organizations on critical projects that have the potential to transform our communities.