As will come as a surprise to no one, small businesses in America’s inner cities are heavily undercapitalized. They often don’t have the financing they need to expand product lines or payrolls, to step into new ventures or neighborhoods. Research from the Initiative for a Competitive Inner City estimates that 71 percent of urban businesses have this problem, with on average only a quarter of the capital they need to compete in their industries. And of these businesses, half are likely to be owned by minorities.
The problem, though, gets even more complicated: To the extent that small urban businesses are able to access capital, lenders have been most willing to give them money for something they don’t need – real estate.
“This is a 15 to 20-year problem, it’s a problem that was pronounced but not really caused by the recent credit cycle,” says Gloria Lee, a partner at Next Street Capital, a for-profit community development financial institution that works with exactly these types of businesses along the Northeast corridor from Boston to Washington, D.C. “A lot of people think during the credit cycle, in ‘06-‘07, that all the banks pulled back, they stopped lending to small businesses. That’s true. But the real reality is that capital has really not flowed for non-collateralized deals, non-real estate deals, in our urban markets for a very, very long time.”
This sounds familiar. The American economy has for years been pouring money into real estate, at the expense of under-investing in human capital, business operations, education – you name it. It’s particularly striking, though, that as officials in Washington tout the importance of small businesses to the American economy, federal programs designed to help them have been a big part of skewing their available resources toward buildings, not business operations.
The ICIC looked at two such programs, New Market Tax Credits and Community Development Financial Institutions, both of which were designed to help funnel resources into some of the country’s most distressed neighborhoods. They found, however, that both programs have primarily served as a source of real-estate lending. Of the $6.5 billion awarded in needy urban areas from 2006 to 2008 by the CDFI program, less than a fifth went to business transactions.
And most banks are unwilling to lend capital to small businesses unless the loan has the government backing of programs like these.
“The quote that we hear all the time,” Lee says of her firm’s clients, “is ‘my bank wants to give me a loan for something I don’t need, and they’re not willing to give me the loan for what I really do need.’”
More office space or an expanded factory floor doesn’t do these companies much good if they can’t also fill that real estate with equipment, raw materials and new hires.
So how did we get here? Lee points to the New Market Tax Credits, a program that was first conceived in 1999 as a way to help businesses operate, not invest in real estate.
“Between the genesis of what the vision of the program was supposed to be, and by the time it actually went through the tax dept, the Treasury, the lobbyists and Congress,” Lee says, “what actually got legislated into law was fundamentally a program that made it very, very difficult to do non-real estate deals.”
These federal programs are now trying to shift gears. But they’re also clawing out of a mindset that’s been pervasive throughout the American economy for years.
“And the problems were not created recently,” Lee says. “The fixes to them on the policy level require a willingness and ability to think more flexibly about the existing programs that are currently in place, that were actually originally once envisioned to meet this unmet need. But somehow we drifted again back into our safe real estate zone.”
Photo credit: Lucas Jackson/Reuters