Guest article written for AllAboutAlpha.com – the official publication of the Chartered Alternative Investment Analyst (CAIA) Association
Originally posted at: http://allaboutalpha.com/blog/2012/06/18/alpha-hunters-investing-in-urban-communities/
In 1800 only 2% of the world population (which was just 970 million in total) was urbanised. By 1950 that figure had grown to 30%, and by 2030 it is estimated that more than 60% of the world’s population (around 5 billion people) will live in towns and cities. Already over 193,000 people are being added to the urban population every day, more than 2 each second.
While much attention is given to the urbanisation of the developing world, similar trends have been occurring in the developed countries which have profound economic and social effects. The 2010 US Census showed that America’s urban population increased 12.1% from 2000-2010 (against a national population growth rate of around 9.7%). Almost 80% of the US population now live in urban areas.
In the developed and developing world, urban communities are synonymous with contrast, they contain some of the densest pockets of wealth and poverty together with huge diversities in ethnic groups, languages, cultures, economies and more. They are seething masses of humanity with a mix of social issues and opportunities, and we are only just beginning to understand them.
To learn more about urban communities and the investment case they present, I spoke to K. Robert “Bobby” Turner (Chairman, CEO and Co-Founding Partner of Canyon Capital Realty Advisors and a Partner in Canyon Partners) who has overseen more than $12 billion of investment into urban communities.
Canyon Partners and its affiliates, including Canyon Capital Advisors, Canyon Capital Realty Advisors and ICE Canyon, are investment management firms and registered investment advisors headquartered in Los Angeles, California.
Mr. Turner has been a pioneer over the past decade in the area of “triple bottom line” investing ; an investment philosophy of providing sound financial returns for investors, fostering opportunities for residents of the communities in which it invests, and embracing environmental responsibility. These funds include the Canyon-Johnson Urban Funds, a series of closed-end real estate funds and joint venture with Earvin “Magic” Johnson, focusing on inner-city and urban real estate development, and the Canyon-Agassi Charter School Facilities Fund, a joint venture with Andre Agassi focusing on the development of learning-friendly, environmentally responsible charter school facilities for best-in-class charter school operators
Mr. Turner serves on the Advisory Board of the Virginia Avenue Project, a Los Angeles based not-for-profit organization providing after school services for inner-city and at-risk youths, and on the Board of Directors of the Pacific Charter School Development Corporation, a Los Angeles based not-for-profit organization focused on providing underserved California students with high-quality charter school facilities. Mr. Turner also serves on the board of the Initiative for a Competitive Inner City (ICIC), a national not-for-profit organization founded in 1994 to promote a market-based approach and cutting-edge solutions for inner-city revitalization. Mr. Turner is an active member of the International Council of Shopping Centers (ICSC), the Pension Real Estate Association (PREA), and the Urban Land Institute (ULI). He is a graduate of the Wharton School at the University of Pennsylvania (B.S., Finance) where he and his wife have endowed a curriculum development fund and speaker series for social impact studies, and where he serves on the University’s Undergraduate Executive Board of Advisors.
Q: What is the rationale behind urban development and urban investing?
[K. Robert “Bobby” Turner] Investing in urban communities, education and infrastructure are essential for the future of our culture and society. They are also incredibly smart investments. Often people view them as social or impact investments- I hate that moniker because it assumes or implies a reduction in yield. I typically think impact investing, on the whole, can generate better risk-adjusted yields than the alternatives.
If one wants to treat societal problems, then philanthropy and government spending are fine. If one wants to cure societal problems, one has got to come up with sustainable solutions- and that means attracting for-profit capital.
Q: What is the economic role and impact of urban communities?
[K. Robert “Bobby” Turner] America’s urban markets represent 75% of our population, 68% of jobs but only 12% of the nation’s land mass.
Some people think of urban as only the inner-core impoverished, others include the first ring suburbs. Urban can be poor… urban can be rich! To me, urban is defined by density and diversity. Urban is an opportunity! I have not been an urban investor in re-gentrification, which tries to change the character of a community and, candidly, is very speculative. Instead I look at revitalisation, which constitutes investing in existing densely populated and ethnically diverse communities and delivering the goods and services that are sought after but not provided. You are not trying to create demand, but rather aim to fulfill unmet demand.
Q: What is your investment mandate?
[K. Robert “Bobby” Turner] It’s very easy to invest money; all you have to do is hit send on your wire instructions. In our business you are held accountable on getting your money back with a return thereon. The primary job of a good investor is to do three things. Identify, Quantify and Mitigate Risks. In most investment theses one of the risks you always identify and quantify but struggle to mitigate is the risk of demand. If you build something… if you create a product… if you have a service… is there a consumer base out there? In most cases, entrepreneurs take the risk to create demand, or hope that demand will come to them.
We have a “6-D’s” approach:
- D1 – Density of Population. There has to be at least 250,000 of a reasonable radius
- D2 – Diversity. That’s where the opportunity is! The emerging, overlooked, misunderstood minority communities. Traditional capital does not come from those communities and hence does not have comfort investing in those communities.
- D3 – Demand. I’m not looking to try and create demand. I need to empirically prove to myself that there is a tremendous wait-list for the goods and services I’m looking to provide.
- D4 – Developer. Real estate is a cottage industry, a local industry. You may have gone to the best business in the world and learned that the three most important things in real estate are location, location, location- but it’s just not true! It’s relationship, relationship, relationship.
- D5 – De-Leadership. I know it’s not proper English but you simply don’t want to invest in communities that aren’t characterised by strong, supportive leadership that embrace partners. We actively shop marketplaces for opportunities with strong city, mayoral and community support.
- D6 – Doing Good! We believe that by being open, honest and transparent with communities- they are more likely to protect, respect and patronise our projects. We work as a double bottom-line investor. Our primary responsibility and obligation to make money for our investors. That however, is not mutually exclusive to making positive change. In fact, they are synergistic and by being socially impactful, you can reduce the risk.
We don’t have a specific mandate in terms of what we invest in. Our aim is broad reaching, what does the community need? One community may need job creation, another may need worker housing, another may need for-sale housing, some may need for-rent housing and of course retail.
Q: What are the fundamentals supporting urban investment?
[K. Robert “Bobby” Turner] The US population is going to grow by over 120 million in the next 30 years. The vast majority, perhaps more than 90%, will be minority groups who will move to what are called gateway cities where there already exists a density and diversity of those populations.
Q: What do you see as the key macro-problems in urban markets?
[K. Robert “Bobby” Turner] As a society, we are in real trouble- particularly in America. We are a society of consumers not investors. In my generation… the baby-boomers… we have believed that success is defined by materialism. As Americans, we spend more than 51% of our disposable income on housing and transportation. That is ludicrous when compared against the vast majority of the world who spend significantly less. France spends just 32% on income and housing, Japan 27%, United Kingdom 21%, India 14% and China 10%. Americans love big homes! The average home in America is 2,300 sq. ft. Compare that with France and Japan where the average is 1,200sq.ft, the United Kingdom where it’s around 818 sq. ft, India where it’s 504 sq. ft and India at 350 sq. ft. Our homes are almost 9 times the size of a typical Chinese home! Also… only 4.5% of the US population uses public transportation. That’s unbelievable! The US household carbon footprint is more than 5 times the global average. We are consuming.
Think of the impact on the economy when we spend all that money on consumption rather than where we could be spending- healthcare, education and so on. It translates very easily. Today, America ranks 5th in the world on per-capita education spending. We test nearly 35th in the world in relation to STEM (Science, Technology, Engineering and Mathematics). Why is that? If we look at how and where we spend money as a society… We as Americans rely on K-12 education to be paid entirely by the government. We don’t subsidise or supplement it. The average American family spends less than 1% of their disposable income on education. The country that ranks 1st in the world for STEM is South Korea. This is a country that also relies on their government to pay for K-12 education. Notwithstanding, the average Korean family spends over 10% of their disposable income to supplement education in the form of tutors, after-school programmes, summer programmes and so on.
If you ask an American where the DJIA or Facebook is trading today, everybody knows. Ask the same person how many kids dropped out of high-school last year and nobody knows. That to me is very short sighted, after all what is the better barometer of the future of America? You now have a number of new generations. Generation X (around 40 million large, kids born between 1965-1980) who are fairly pessimistic. They’ve seen the market crash and see that home ownership, 401-K’s and pension plans- which their parents told them would allow them to retire at 62- simply don’t work now. 12 million homes are worth less than their debt in the USA, pension funds are down, services and amenities are down and the reality is that Gen-X have to adapt to new rules. They are downsizing and de-leveraging. Then you have Generation Y (75 million in size born from 1980 to 1995). This group is raised on technology! My kids live on Facebook and their lives are about consensus and community building. It’s not about living in an isolated mansion. They see parent’s failure to retire and see that home ownership is no longer interesting. For them, the new American Dream is about the experience of products, and they are very concerned about the environment.
Q: Do underlying trends in Generation X and Y impact your urban investment strategy?
[K. Robert “Bobby” Turner] The preferences and sentiments of the next generation of Americans will be driven toward transit oriented urban living. Part of this is emotional and part is economic. If the average household that spends 25% of their budget on transportation moves to a transit rich neighborhood, they could take this spend down to just 9%. We’re talking 14% of income that could now be spent on something else just by moving to a transit rich neighborhood. We haven’t done that yet in America- we haven’t invested in the infrastructure- and as a result only 4.5% of the population use public transportation.
I believe that legislation will also come in- meaning that smart-growth and global warming policies will drive demand. We as a society are finally recognising that something must be done. We’ve just experienced the warmest 12 months in the history of record keeping of America; there was no winter here this year! If people still believe that global warming is a myth? My goodness we’re in a whole heap of trouble.
Q: Is the investment methodology for urban different from other forms of investment?
[K. Robert “Bobby” Turner] The skills required to be successful in urban development are very different than those required in non-urban development. You are dealing with a very different consumer. You are dealing with minorities, language issues, immigrants, crime, gang membership and so on. In the goal of identifying, quantifying and mitigating risks (which have typically been the realm of government spending and philanthropy), you’ve got to recognise the conditional skills and tools you need are different- you have to think out of the box. Grabbing your HP 12-C and doing combinations, simulations and permutations on cash-flow models simply won’t cut it.
When we talk about urban, the vast majority of people think, “my goodness, these are poor communities… risky communities… communities that are characterised by ethnic communities with low income and high poverty rates… high crime rates, drug issues, gang issues etc etc…” The reality is that while many of the communities we invest in may be poor per-capita, they are significantly richer when you assess spending and disposable income per square mile, than some non-urban marketplaces. I remember back in 1994, I was developing a big-box retail project in Harlem, New York. I met the folks from Home Depot and we suggested they developed their first Manhattan based Home Depot in Harlem. The response was that they thought it was safer to build their next store in Greenwich, Connecticut. Why? Because they felt the per-capita household income in Greenwich was say $100,000 and in Harlem it was $25,000. We had to educate that retailer about the fact that population density in Harlem was over 10 times that in Connecticut! The average house in Greenwich sits on around 1 acre while in Harlem you have 50 apartments in the same space. In reality you have to multiply the density of population by per capita income to figure out what the true spending power is – and that requires education.
When Magic and I got together, we defined intelligence in two ways. We started with IQ (your intellectual quotient- how good you are at linear thought processes) and then realised that you also have EQ (your emotional quotient- how good you are at understanding and working with people). You want to focus on marketplaces where you can collaborate with communities and partners to identify, quantify and mitigate risk.
Our investment methodology is driven around what consumers needs are. If you go into a community to build retail, don’t be arrogant enough to assume that you know what retail that community wants. You have to work with community leaders to find out what kind of restaurants, dry-goods, soft-goods, banking and other items they want. Who are the dominant ethnic grocers in the area to anchor the market with? How are you going to deal with crime and gang membership? In this case, there are great opportunities with public-private partnerships that work with local law enforcement agencies. There’s also great ways to work with technology! Things as simple as changing the wattage of bulbs in a parking field so that you light it up like a soccer field! That’s very disruptive to criminals. CCTV, 24/7 local police presences…. These are things you have experience of – but which most investors simply do not understand.
Magic and I brought together a dream-team of people to help us run this fund- a member of our team is a recovering law enforcement agent! He goes into a neighborhood with us, sits down with the local police precinct and watch-managers and helps us to understand how, as a partnership, we can mitigate risks.
Q: What risks are you not prepared to take on?
[K. Robert “Bobby” Turner] Things like zoning and entitlement- those are political risks. I will only take on risks I can control, things like construction risk, financial risk, lease-up risk and even the risk that I may not find patrons. What I’m not going to do is buy land or a building and hope that I can convince politicians and policy-makers to support my ideas for re-use or development. We work in partnership and I do not need to invest in marketplaces that are not supportive of urban development.
Q: What is the role of education in urban development?
[K. Robert “Bobby” Turner] Our urban fund and our education fund are so co-dependent on each other. The biggest social issue facing communities is education- the fact that we’re failing to educate the backbone of tomorrow’s society. With all of our developments, we aim to complement them with education projects.
We’re no longer competitive in the global economy with regards our GDP when compared to other countries who are actually educating! We’ve gone from number 1 to number 35 in education in 20 years. Over that same period, US GDP has grown 150%. South Korea has grown over 250%, China 1700%, India 472%. A lot of that is due to education.
Outside my main job over the last 7 years, I’ve built 38 charter schools in Los Angeles using Melinda Gates’ money- creating 16,000 school seats. I’ve found that by using philanthropy I was only moderately impactful. In LA alone, there are over 38,000 children on the wait-list, there’s a lot of work yet to be done.
This is generational. The Chinese, the South Koreans… the vast majority of these emerging nations are doing now what we did in the west hundreds of years ago. They’re investing generationally. North America and the EU have lost that- we’re consumers and we don’t think of anything other than ourselves.
What does this mean for Investors & Risk Managers?
Many of the greatest investment opportunities in history have come from major macro trends in society be they industrialisation, globalisation, conflicts or otherwise. Urbanisation is no less profound than any of these- potentially being the single biggest migration in human history.
Urbanisation presents exceptional short and long term opportunities for investors with the right skills, appetite and- perhaps most importantly- attitude.