While a billion people watched the Academy Awards this year, few thought about the celebrity-filled Kodak Theatre and the strip of Hollywood real estate it sits on. This strip of real estate is part of an urban revitalization movement sweeping America. Savvy investors are putting money to work in inner cities, and the results are paying off. At the forefront of this trend are some of America's largest pension funds.
The Hollywood and Highland Center is just one such landmark; think Times Square, Harlem's 125th Street, Brooklyn's waterfront development, San Francisco's piers, downtown Los Angeles with its impressive Frank Gehry-designed Walt Disney Concert Hall and Boston's Chinatown. All received pension fund investment and all made money for their investors.
Back in the early 1990s, basketball legend Earvin Magic Johnson was one of the first to recognize the value inherent in the inner city. Teaming up with Sony Corp. of America and TGI Friday's Inc., Mr. Johnson saw the untapped potential of serving the urban market. On the heels of the South Central L.A. riots in 1992, Mr. Johnson and then-partner Victor MacFarlane raised $50 million from the California Public Employees' Retirement System for mixed-use retail developments in underserved but densely populated areas in California, starting in South Central L.A. CalPERS' instructions were explicit: Just don't lose any money. With 20% return on investment, Messrs. Johnson and MacFarlane delivered. Today, Canyon-Johnson Urban Funds LLC with $2 billion of assets under management and MacFarlane Partners with $20 billion reflect the growing trend toward urban investing in America.
Urban investment through property, real estate and development projects has long been an important component of many institutional investors' portfolios. After equities and bonds, property has played an integral role in balancing the asset allocation and providing a longer-term element in investment strategies that are otherwise sensitive to the highs and lows of market sentiment. Given the shrinking equity premium of the public securities market, pension funds are seeking new kinds of investments where there is reward for expertise and knowledge consistent with the long-term objectives of such institutions.
Michael E. Porter, professor at Harvard Business School and director of its Institute for Strategy and Competitiveness, suggested in the Harvard Business Review issue of May/June 1995 that America's inner cities have valuable but often unrecognized attributes for private investors. Mr. Porter's insight was based upon a thorough analysis of the competitive advantages of inner cities, including their strategic locations, underserved local demand, their links with larger, regional clusters of innovation, and human resources. Importantly, he argued that past development strategies had been misplaced: The social investment model had failed to capitalize on these desirable attributes of inner cities. The way forward, Mr. Porter wrote, was to capitalize on private, for-profit initiatives and investment based on economic self-interest and genuine competitive advantage.
Nearly 15 years since Michael Porter's article first appeared, our research finds evidence that this radical approach to urban development is reaping dividends for both investors and communities. Pension funds using specialized investment vehicles with the requisite knowledge required in urban development are able to generate both risk-adjusted rates of return and significant community impacts in terms of revitalized neighborhoods, employment and income growth. Today's investment track records provide the evidence that backs this claim. As a result, pension fund investment in U.S. underserved capital markets has doubled in the last four years.
Pension funds are increasingly interested in the value embedded in America's urban infrastructure, including roads, bridges, airports and seaports, recognizing the growing shortfall in federal, state and local governments' tax-raising capacities. Whereas the favored investment vehicle in this space used to be government-guaranteed bonds, there is increasing interest in urban investment products that are held by favored investors through special-purpose vehicles that build, operate and ultimately sell out to the public market. Here, the scale of investment is larger in dollar terms, as well as larger in the geographical scope and significance of these projects typically being intertwined with whole regional economies. But the principle is the same: Instead of urban infrastructure being seen solely as a social commitment leading to urban development, it can be seen as a private financial asset for a public purpose.
Some commentators have raised doubts regarding the capacity of pension funds to realize the benefits of targeted investment programs. They worry that political interference will influence investment decision-making. One of the most important lessons from our research confirms that the governance of the investment process is a key ingredient in the success of such targeted investment.
Pension fund investment in America's cities has been able to set in motion the insights about private-sector urban development offered by Michael Porter nearly 15 years ago. Savvy financial institutions are formulating investment procedures and protocols that realize the comparative advantages of inner cities while integrating communities with the goals and objectives of investors. This model for urban development offers a roadmap for many other kinds of businesses seeking ways to develop their presence in these growing markets.
The coming decade might well be witness to a new commitment to America's cities, one that realizes the promise of the Porter model through businesses and institutions that hitherto have been seen as the enemy of community development.
Gordon L. Clark is a professor and head of the school of geography at the University of Oxford, Oxford, England, and director of its Centre for the Environment. Tessa Hebb is a senior research associate and postdoctoral fellow at the school. Lisa Hagerman is a research associate and postdoctoral fellow at the school. Along with other individuals, and with the support of Oxford and other institutions, the authors have collaborated on The Public Sector Pension Funds and Urban Revitalization Initiative http://urban.ouce.ox.ac.uk/ index.php a research project aimed at investigating and promoting the best practices in urban economic development by U.S. public sector pension funds.
The authors will be among the speakers featured at a conference the initiative is sponsoring titled Pensions Funds: Investing to Build Strong and Sustainable Communities. It is June 10 at Harvard Law School, Cambridge, Mass. The agenda for the conference is available on the initiative's website. Anyone interested in attending should contact Ms. Hagerman at [email protected] for registration information.