An Illinois CDFI Leader Explains Why Appraisals Reinforce Structural Racism

May 20, 2019; Shelterforce

“What does it mean to have a racial equity lens on capital?” asks Joe Neri in Shelterforce. Neri is CEO of IFF (formerly the Illinois Facility Fund), a large community development financial institution with $347 million in loans outstanding, which lends throughout the Midwest through offices in six states, covering a region extending from Kansas City to Detroit.

One major obstacle to racial equity, Neri mentions, is appraisal-based lending, a process that is so ubiquitous in the buying and selling of both homes and commercial real estate that you may have never considered how the appraisal system reinforces systemic racism. Appraisal-based lending, Neri explains, serves as “an instrument of systemic racism that still has a profound impact on communities, even after the outlaw[ing] of overt redlining more than 50 years ago.”

Neri gives a detailed example of how this works:

Consider the child care center that wants to construct a new center on donated land in a formerly redlined community. When they apply for a loan, the bank orders an appraisal, which requires “comparables.” Due to long-standing lack of formal market investment, the comps (if any) and land values are very low.

Simply put: Old government-sanctioned bank regulations drove down the property/land value for decades, and now current bank regulations prevent investment in those areas where appraised-values are low.”

Neri offers a simple chart to illustrate his point, which we reproduce here:

In other words, to build the exact same building, under appraisal-based lending, a community group could expect to have raise the difference between $625,000 and $1,093,750—which works out to an additional $468,750 in this example.

The result, notes Neri, is that “past practices have been encoded into policies and regulations such as risk-based pricing and appraisals. Legal or not, the outcome is the same—capital is not reaching communities of color as much as it should.”

IFF, Neri notes, “has offered non-appraisal-based lending since its founding in 1988.” But Neri concedes that racial equity wasn’t part of the discussion then. “Instead, we were using a kind of ‘nonprofits equity’ lens that forced us to address the challenge of lending to nonprofits that serve lower-income communities.”

What does Neri mean by nonprofit equity? It means designing loans that work within the logic of the nonprofit’s business model. For many facility-dependent nonprofits, the cost of the alternative—that is, leasing rather than owning—can be high. As Neri explains:

They paid property taxes through their for-profit landlords. And then they were still often forced to move out because of rent increases, or because deferred maintenance threatened their clients and staff. Owning their own property could relieve a lot of the pressure these nonprofits were under to maintain their brand, control their destiny, and save valuable money that could be put toward their missions. The problem was that banks wouldn’t lend to small and mid-sized nonprofits, and/or wouldn’t lend in the low-income communities where they worked.

Neri adds, “We did not use an explicit race equity lens in determining that appraisal-based lending was causing systemic injustice; but in deconstructing the challenges that faced our target market—nonprofits serving lower-income communities—we knew that we had to construct a different underwriting and approval regimen.”

In short, Neri writes, IFF figured out that if it used appraisals to determine how much it would lend, “we would make very few loans in the communities we were founded to serve. You can’t build a CDFI by saying no to clients working in justice and equity.”

What does IFF do instead? The approach they have settled on is an income-based approach. What does this mean? “Instead of asking about the value of the property, IFF asks whether the property is suitable for the nonprofit’s needs and whether the nonprofit can afford the loan payments on our flexible debt.”

Neri does not claim IFF’s approach is perfect. The challenges, Neri concedes, are more profound. Neri quote his colleague Nancy Andrews, who noted sagely that, “We will not invest our way out of racism, or misogyny. We need to put race, gender and justice at the heart of everything we do. That will mean doing more than swimming in our lane, side by side with our civil rights colleagues. It means new partnerships, new priorities, a different lens for understanding our work, and a different kind of focus on public policy than we’ve had in the past.”—Steve Dubb