An Introduction to Financial Development of Communities
Although this article was initially written for cohousers intending to interact with mainstream financial institutions,1 it has been revised so that much of the information applies across the board to any intentional community group seeking loan money. Nonetheless, if many long-standing intentional communities had to depend on commercial lending institutions, there might be fewer communities today with substantially less sustainability features. But until the intentional communities movement has developed its own financial institutions (and what are we waiting for, folks), communities need to be prepared to access conventional bank and lending institution dollars.
What is exciting about sharing this information with communitarians at this time is that some folks within mainstream financial institutions are beginning “to get it” about communities. That does not mean they are any less prudent in deciding whom to make loans to. But it does mean that there are increasing numbers of financial “insiders” who are potential advocates for lending to intentional communities of all kinds. (And if any of you “insiders” are reading this, please let the Foundation for Intentional Community (FIC) know who you are.)
The quality of social entrepreneurship in many community founders generally leads them to develop, or find people with, the financial skills to get built what is needed in a way that is significantly sustainable. It’s a direction that many communities strive for. With respect to finances, this means that it’s not oriented toward debt or the “buy up” culture promoted by the home building and real estate industries. Each community has to critically evaluate what the most effective financial direction is for its members at any given time. In some cases, conventional financing could deplete financial resources that might otherwise enable people to focus more on their relationships with one another, the broader society, and the Earth—what are called quality of life issues—rather than simply making a living, the primary purpose of which is to pay on a mortgage. Having explored a full range of options can help a group make a more informed decision.
The fact that intentional communities are even dealing with mainstream financial institutions says a lot about the broader culture, and the way in which social change is moving into the mainstream. What communitarians have and continue to achieve as a movement—including the cohousing and ecovillage movements—is increasingly attractive and desirable to many in the mainstream. Perhaps the ultimate institutional challenge for “communitizing” is the banking industry.
Sirius founders Gordon Davidson and Corinne Mc-Laughlin in their classic book, Builders of the Dawn, said that today’s communities can be seen as “blueprints for humanity’s journey into the future É pioneering positive responses to global problems.” Connections in which there are shared values between lenders and borrowers can give certain communities the freedom to more confidently carry on that research and development. But many times, the timing and resources are such that a group needs to just go get a bank loan! The information that follows can help.
The First Steps (Regardless of How You Are Going to Finance the Big Project)
As you define your community dreams, you will need to investigate forms of ownership, and the financial requirements, for what you want to do. For example, if you want to buy an apartment building, you will need to know how much capital you can raise, what the lending options and requirements are, and how the ownership of the assets will be established. If you are creating a housing project from scratch, such as a cohousing development, you will find that banks generally do not loan money until a certain amount of development work has been done. You will find that long before you submit a loan application to a bank, you will need to spend money developing your project. Sometimes, lots of it, depending on the size of the project. You will be able to apply the money spent by members toward future down payments on mortgages, so keep track of every dime.
Funds for start-up costs can be generated in several ways. One is to charge a monthly assessment. Someone who is interested but not committed may not mind putting up 10 dollars a month for awhile. In almost every start-up group, the really committed people will put in large amounts of unsecured cash to cover the expenses. This may add up to thousands of dollars, especially when you start hiring architects, attorneys, and such. Once you get into it this far, you have enough capital commitment from members that they have enormous interest in seeing it through. The people with little investment are generally the ones that are most likely to leave the group.
Another way to generate money is to have a committed person or persons loan money to the group with payment based on future assessments of future members. Be sure to document any such agreements well. Misunderstandings about loans can cause problems later. Some forms of legal agreements allow for silent partners, who can contribute cash into the project but are not actually members. This is handy for borrowing money from relatives and friends of members, for example. But be sure you understand the securities laws in your state.
If you are creating a community as one large capital project that will be funded by future mortgages, such as a cohousing project, the development group will have to come up with enough money to:
- incorporate as a group and recruit a core group of members;
- provide group process training, parties, etc.;
- provide a down payment to secure the site;
- do feasibility studies on the site;
- provide costs related to any zoning changes;
- provide architectural and legal fees;
- provide permit fees; and
- provide a consultant fee to coordinate all of this in the event the group chooses not to take on this function itself.
Once you have an approved project, with engineered drawings more or less ready to go, and have a builder lined up, then the banks will talk about giving you a project loan. If your group is simply acquiring an already built property—a large house or apartment building or farm with structures on it—your prefinancing preparation work may be simpler.
Underwriting and Timelines
“Underwriting” is what lending institutions call the evaluation work they do on a loan application. The loan application can be two pages or 10 pages, but either number of pages might require backup data comprising hundreds more pages. The loan officer doing the underwriting checks it all out in a process that takes anywhere from one month to three or more months. If you have a tight timeline where time equals money, you may want to submit more than one loan application at the same time. This way if a lender ultimately rejects the loan at a critical time, you have another option. When you apply for a loan, you pay a loan fee that covers the cost of this underwriting. Often this loan fee is not refundable, even if you are turned down for a loan. Ask your potential lender about this. Some lenders do return some or all of the loan fees if you are not approved. This can sometimes be negotiated.
Lines of Credit
Some lenders will provide a line of credit to certain qualifying groups. A line of credit can cover many predevelopment expenses, also called soft expenses, such as architects, engineering, and legal and process training. There are a variety of methods for paying back the line of credit, depending on the lender. However, lines of credit may carry substantially higher interest rates than a long-term mortgage.
Cooperatives and Condominiums
The two most common types of legal entities for communities with respect to lending institutions are co-ops and condos. Banks first look at your legal ownership model (see the article on legal structures, earlier in this section). In general, cooperatives have a harder time finding bank loans than condominiums do, although this varies around the country so be sure to check your local banks. Banks understand and deal with condominiums on a regular basis, and the advantage to the bank is that each condominium has a single owner. Cooperatives hold a blanket mortgage on the whole project, but some cooperatives find that share loans, described below, are a handy thing to have once the community is settled in.
If condominiums are overbuilt in your area, or if there is a large vacancy rate in local condominium projects, you may have extra problems finding a lender.
When you approach banks, go to the main office first. Each bank usually has specialty people who have expertise in certain areas. Ask for the specialist who does condominium loans, or business venture loans, or construction loans.
Accessing Public Monies
Local, state, and federal housing programs and finance agencies can also provide financing for communities. In many cases, public monies can be used for alternative forms of ownership such as land trusts, limited equity co-ops, mutual housing associations, and certain types of nonprofit organizations serving persons with special needs or providing other public educational services.
As a rule of thumb, accessing public monies will require a significant percentage of the housing population served to have incomes under 80 percent of median household income for the area, according to the US Department of Housing and Urban Affairs standards. Many communitarians seeking to live more environmentally sensitive and less complex lives might qualify, even if their lower incomes are voluntary.
Programs using public monies are apt to have many strings attached. These strings are not very much of a barrier, but they can require considerably more paperwork and time, in some cases a year or more. Often, there are annual reporting requirements.
If you want your group to be considered for such financing, it is important to make an effort to get to know your elected officials, and local, state, or federal agency officials in the jurisdiction that has control of the money. They need to know and trust you. Also, since the legislation that makes the public monies available changes all the time, you need to keep track of that legislation. In some cases, you can help advocate for the legislation. In many areas, there are affordable housing advocacy groups that keep interested persons informed.
You may also want to hook up with an existing nonprofit housing developer with expertise in working with public agencies. Such an organization can act as your fiscal agent, package your loan documents, and provide the many services you will need whether you are creating a new development or acquiring an existing house, apartment building, ghost town, or farm. These organizations are prominent in both urban and rural areas, and often might be members of coalitions such as the Southern California Association of Non-Profit Housing. Check with your city or county’s local community development or housing director to identify such organizations.
Because many communities live better for less, they are important to affordable housing officials. Qualifying groups can provide an important service by working with the public sector to demonstrate how higher quality community living can actually save taxpayer dollars.
There are many nonprofit community lending institutions across the United States. They are part of the socially responsible community lending movement. Many such lenders are networked through the National Asso-ciation of Community Development Loan Funds based in Philadelphia. They have an annual conference and a newsletter.
The underwriting criteria for some of these lenders can be more stringent than that of for-profit banks. Often, however, such lenders will provide a good deal of technical assistance not available from banks. The loans can be more flexible than banks, and community lenders always have socially and often environmentally responsible goals incorporated into their lending criteria.
Keeping Track of Unequal Monetary Contributions
The individual members of the core group do not necessarily have to contribute like amounts of money. However, be careful about documenting the disproportionate contributions of cash to the group. The group’s partnership agreement, shareholder agreement, or other organizational documents should clearly provide that excess contributions be treated in one of the following ways:
- As a loan to the group, which accrues interest at some agreed upon rate, and which is payable to the contributor either on a certain date, upon the happening of a stated event (such as upon getting a bank loan), or upon demand;
- As a capital contribution to the group, which increases the contributor’s capital account (or number of shares) in the venture, and providing that the capital be returned to the contributor in some manner out of proceeds from capital transactions (such as sale or refinancing of the assets/land owned by the group); or
- As a gift, in whole or in part, to the group.
Failure to address expressly these excess contributions in one of these ways is a formula for misunderstanding and conflict at a later date. At least one cohousing community failed to expressly address this issue and did not even realize until a few years after construction that the excess contributors had essentially made a gift to the community that they would never recover. That’s fine, except it was not what the contributors intended and led to some upset on the part of these unwitting “donors.”
Appealing to Secondary Loan Market
One key to finding bank support is to have a legal structure that is supported by the secondary loan market, Federal National Mortgage Association, fondly called Fannie Mae (FNMA). It is to your advantage to be as competitive as possible so you can shop around for the best deal. It makes resale much harder if you only have one bank you can get financing from. Banks, especially after all the savings and loan problems, are very reluctant to give loans that are not backed by FNMA. One major way banks make money is to sell batches of similar sizes and types of loans, usually in denominations of $500,000 to $1,000,000, to FNMA to free up capital to loan again. Small, unique loans, that are not underwritten by the secondary loan market, have to be held by the individual bank. Under federal regulations, banks are allowed to hold only a certain percentage of their total worth in these types of loans, and commercial banks do not want to be left holding loans they cannot sell. Banks or mortgage brokers can help you apply for FNMA approval.
Co-op Share Loans
If you can be defined as a cooperative, you may also want to be approved for FNMA share loans. This can be an important advantage for the co-op as well as for incoming and departing members. With share loans, a departing member can take out what they have paid into the co-op, the co-op does not have to come up with the money to pay out to the departing member, and a qualifying incoming member can get a share loan for their unit. Contact the National Cooper-ative Bank in Washington, DC, to determine what your group needs to do to be eligible for share loans.
If you can show a large number of the projected units in your development as being presold, it is a real bonus to your loan application. Having membership agreements, financial plans, and down payments already drawn up and ready to go can be a big help. The more you do to show that people are committed to carrying through the project financially, the better you look as a loan risk. Banks typically favor loans to projects that have presold 75 percent of the units.
Another factor in getting loan approval is the kind of protection offered to the lender, often called mortgagee protection. Lenders will examine your legal agreements for details on insurance, resale, condemnation of units, approvals of unit division, or anything that could devalue or make a mortgaged home hard to sell. Your loan application is evaluated with the assumption you will default on a mortgage and the lender will have to sell the property to get their loan money back. Anything you can do to make the resale of units simple and attractive makes your project a better risk to the bank.
Be sure any rules you put into your legal documents that define ownership will pass the scrutiny of the lenders. A good attorney usually passes such things for review by one or more financial institutions the attorney has a relationship with. Be sure to ask your attorney about this. It’s really a problem to get this far into the process, and then have to redo everything because the lender won’t approve the loan.
Some of the flags for lenders may include: restrictions on resale of units, building materials that are not standard, parking and vehicle access, sweat equity that is required prior to occupancy permits, garages, size of unit, and cost relative to cost of the lot.
The fact that some lenders will view these things as flags rather than the important public service that they often are can be very disappointing for many community groups. These groups have demonstrated commitments or plans to heal themselves and the planet by, among other things, caring about their neighbors, using alternative building materials, preserving land and open space, having fewer cars, reducing automobile dependency, and living in smaller, more compact spaces than the conventional consumerist American household.
There is an important public service that communitarians can provide by getting these mainstream loans, so make friends and build trust with the assorted lenders. If enough of us across the country get mainstream loans and prove our worth to lenders, local communities, and the public interest, over time the lending criteria will change.
The Loan Process for Capital Projects
Once the developer has the approval of local government for the project, the lender gives an Acquisition and Development (A&D) loan which typically covers the cost of buying the land and development costs to date. This covers option money or a down payment on the land, feasibility study, architects fees, and permit fees. The A&D loan may also cover the costs of the commons, such as the common house.
In order to secure this first loan, the group must have a realistic budget, a high number of presold units (with owners prequalified for mortgages), and someone with recognized development expertise. In many cases, the group will have to come up with a percentage of the expected development costs, which may run several hundred thousand dollars. In most cases, the future owners have paid all the predevelopment costs and that money is credited toward the developer’s portion of the A&D loan. It is crucial to keep accurate records and receipts of all money that goes into the project in order for it to be credited.
For the next step, the developer gets construction loans to cover the materials and labor of building the project. Often a substantial amount of infrastructure work is expected to be done before the construction loan is given. Usually each building gets a separate construction loan. Once the individual units are constructed and completely finished, the bank loans each prequalified owner a mortgage, based on a percentage of the appraised value, such as 90 percent of the appraised value. The funds generated by the mortgage pay off the construction loan and any other debts owed to contractors. In each step of the process, the banks will require lots and lots of different documents and often will ask for one set, then ask for something else, then yet another thing.
Loan Process for Build-As-You-Go Approach
If you are not doing a large capital project, but a gradual build-as-you-go approach, bank loans for intentional community projects can be more difficult than other sorts of similar developments. This is mainly due to the problems of clear title ownership of the mortgageable assets. As previously mentioned, banks evaluate your loan application with the assumption you will default on a mortgage and they will have to sell the property to make their loan money back. A single owner is much easier for the bank to deal with than a partnership or corporation, although this varies among lenders. Ask questions of local banks regarding their lending criteria. You can often find a local consultant or mortgage broker who knows the criteria for all the local lenders. One thing that makes it easier is if the group can show a substantial portion of investment, like 30Ð40 percent of the total costs.
Once the bank has tentatively accepted your project, they will do an appraisal of the project to determine how much money to loan. How much the lender will actually loan is called a loan-to-value ratio and is determined by the difference between the amount that the bank appraises units for and what they really cost. That difference has to be made up by the owner in terms of a down payment. For example, if a bank loans 90 percent (90 percent loan-to-value ratio) of the appraised value and they appraise a unit at $100,000 but the unit actually costs $125,000 to build, the bank will actually only give you a mortgage for $90,000 and the buyer will have to make up the extra $35,000.
Low appraisals can cause big problems, especially because they often come very late in the process. If an appraisal comes in unreasonably low, ask for a reappraisal. Having information about similar projects (condominium or co-op unit values) can help boost an appraisal. Be sure common elements are fairly evaluated in the appraisal.
If you are making an offer on a property, it is important to either get your own appraisal prior to making the offer or make the price you are offering subject to an appraisal that you will get before closing.
Getting Real About Financing: Screening Members for Financing
As the plans for the project are developed, the estimates for the costs begin to take shape. This is the place where many groups find that people drop out. The group needs to evaluate its individual and collective ability to qualify for bank loans. Depending on how you set up your loan, either the group or each individual will be responsible for coming up with a particular amount of money each month. This is a good time to closely evaluate personal finances. Check that each member has the ability to qualify for a loan. Banks typically look at some percentage of the individual’s annual or monthly income as the amount they will loan. A common rule of thumb is that banks will loan 2.5 times your total annual income. In affordable housing circles, the rule of thumb is that the household pay no more than one-third of its monthly income toward its housing costs. Lenders also look for stable work history (two years at the same job). Independent business owners get a very critical and close scrutiny.
It is to your advantage to do this type of survey and evaluation as a group before the bank does. Having several people in the group not qualify for a loan is a major setback and this typically comes very late in the development process.
The “We Can Afford” Trap
Keep in mind that there are differences between what the bank will loan an individual and what the individual can really afford. In addition to the monthly mortgage payment, there are also taxes and insurance and perhaps monthly assessments for the community costs. It is common for people with a passion for community living to initially commit to making personal financial sacrifices in order to live in the community. These can be unrealistic commitments that they later are unable or don’t want to keep, and this can put a financial strain on themselves and others. Encourage an honest appraisal of peoples’ financial abilities before the loans are signed.
Setting Up a Community With No Banks Involved
If you are going to create a community with no mortgages or other encumbrances then you need: significant start-up capital to buy the land and other things you want; and a process for returning a person’s investment when they leave or for returning loan monies to nonresident lenders.
One way communities often handle investments by members is to organize as a share co-op, with the clear understanding that the owner of shares is solely responsible for their purchase and sale, subject to approval and regulation by the group. For example, the group can set the share price at $5,000, restrict the transfer of the shares only to people approved by the group, and restrict the number of shares held by any individual. You can also tie share ownership to governance by allowing share holders one vote per share on particular matters such as financial decisions. Some groups designate different types of shares, and restrict voting shares to one per household in order to ensure that their democracy is not tied to financial investment.
You should also have very clear written agreements about the assets a member brings and keeps. Do members retain personal ownership of their assets or do they assign them to the group? Certain assets, such as houses, property, or automobiles require title changes to document changes in ownership. If a member gives all their assets to the group, what exactly do they get, if anything, when they decide to leave the group? Document this clearly.
Many intentional communities have started, purchased land, and then gone broke and been forced to part with the land and buildings due to lack of funds. As you create your legal papers to define your community, be sure to put in a clause about dissolution of the community. Define who gets what and when they get it.
One way to avoid going broke is to not purchase land until you have a solid membership commitment. Define a minimum core group size that is elastic enough so that if a couple of people left, you would not go bankrupt right away. For example, if your core group is eight committed families, this gives you enough leeway so that if one leaves you can still make your payments while you recruit to fill their space. If you only have four families, and one leaves, this places a much larger financial strain on the remaining families to cover the payments.
Revolving Loan Fund
Revolving loan funds (RLFs) are generally associated with nonprofit community development activities, including many kinds of innovative affordable housing projects. RLFs bring together lenders, borrowers, and technical assistance providers for the purpose of providing access to development money that is not normally available through conventional channels, particularly for low income persons and groups. RLFs try to attract sufficiently large amounts of capital (from both loans and gifts) at low enough interest rates, in the case of loans, that the monies can be loaned or re-loaned out to development projects at high enough interest rates to support the administrative tasks of the funding organization. As monies are paid back to the fund, they can, in turn, be loaned out again for other projects, which is what gives the fund its “revolving” nature.
People interested in making socially and environmentally responsible investments are increasingly drawn to the good work being done by RLFs. In many cases, an RLF will pay a higher interest rate than can be obtained in conventional interest bearing accounts. But then, loans to RLFs are unsecured. Nonetheless, the RLF usually requires the monies it lends out to be secured. RLFs have excellent track records on both ends—paying back loans to their lenders, and having their borrowers make good on loans from the RLFs. Details on the performance of RLFs can be obtained from the National Association of Community Development Loan Funds in Phil-adelphia.
An RLF can be created as an arm of a nonprofit housing development organization or a local community development organization. More and more local government organizations and foundations committed to affordable housing are creating revolving loan funds.
Co-op Resources and Services Project (CRSP), the nonprofit umbrella organization of the Los Angeles Eco-Village, owns 48 units of housing in two adjacent central city apartment buildings (as of this writing) in one of the world’s richest cities, and yet the organization has no bank loans. CRSP created its ecological revolving loan fund (ELF) in the mid 1980’s, contributed about $20,000 of its money to it, and, over a period of four years in the 1990s, used money to leverage nearly $1 million for its acquisitions. People and organizations who know and trust CRSP’s work over the years have loaned money to the ELF in sufficient quantities to enable them to purchase the properties without using banks or mortgages. Most of CRSP’s loans are unsecured at both ends. It is one way they have been working toward demonstrating a sustainable economics system.
CRSP-ELF works exclusively in the Los Angeles Eco-Village neighborhood at this point, but most RLFs have a larger geographic area of service. The big challenge for a small RLF, such as CRSP-ELF with its single neighborhood focus, is to keep paying money back faster than it is borrowing. In this way the nonprofit sponsor is building equity in its buildings.
Although all groups would not necessarily qualify as state or federally exempt organizations, an RLF could be established by any group that collectively has the connections and the trust to generate a portfolio of loans sufficient to do its development. The National Association of Community Development Loan Funds holds an annual conference where people can learn more.
More Advice About Qualifying for a Bank Loan
Learn from rejection. If the first bank turns you down, ask why. Then apply that knowledge on the next loan attempt.
Don’t be afraid to ask a loan officer about tips or help for getting loans. They can offer some valuable insights on how to go about getting your loan. They want your money, so don’t hesitate to ask lots of questions.
If you’re involved in a development project, it helps to have a contractor who has a good track record. Banks will require the financial statements of your contractor.
Figure out early what financial resources your group really has. When applying for bank loans, do a pre-screening of the group to check qualifications for loans. Banks charge a loan application fee and making sure that everyone on the loan qualifies, especially if you need presales in order to qualify for loans, can be crucial.
Keep handy all your receipts and documents of money members have contributed. The bank will ask for them, perhaps several times, especially when you are signing off the mortgage. Don’t pack your receipts away until you have signed your mortgage paperwork and own your home.
Before you turn in your loan paperwork, make a copy of it and keep a copy of any paper you give the bank. Assume the bank is going to lose the most critical paperwork, so keep backups.
Put someone in charge of keeping track of the loan paperwork. This person should collect all receipts and other proof of collections. Organize the paperwork into files, with one file for each unit or household.
Banks will often look closely at the financial condition of your developer. Be sure the developer can stand that kind of scrutiny. Lenders look for a borrower who has enough financial reserve to cover the unknown.
One Last Word About the Funding Puzzle
Whether a group is purchasing an existing home or building, or developing a new community, the most important thing to remember about financing is that it is like a jigsaw puzzle. It rarely comes from one source. Often you don’t know how all the pieces are going to fit together. Initial financial commitments will leverage other financial commitments, and sometimes they won’t. A group has to learn to live with that uncertainty. Commitments can be all lined up, then interest rates may plunge and a group may find itself wanting to start all over again. No matter how carefully developed the plans, a group should always be ready for a roller coaster ride. If it turns out that it was all easy—though there will always be much more paperwork than anyone wants to deal with—that will be frosting on the community cake.
Center for Community Change, 100 Wisconsin Ave NW, Washington DC 20007, USA. Tel: 202-342-0567, fax: 202-333-5462. Email: [email protected]http://www.communitychange.org/
Provides a range of technical assistance on affordable housing finance issues and sources.
US Department of Housing and Urban Development (HUD), Customer Service Center, Room B-100, 451 Seventh St SW, Washington DC 20410, USA. Tel: 800-767-7468
Rob Sandelin lives at Sharingwood Community and is one of the founders of the Northwest Intentional Communities Association (NICA). Lois Arkin is the founder of CRSP, a nonprofit resource center for small ecological cooperative communities, founded in 1998. CRSP is the sponsor of the Los Angeles Eco-Village where Lois lives and works doing public advocacy work for more sustainable urban neighborhoods.