Community Financing to Solve the Landlord/Tenant Agency Problem

By Sachin Desai

In the discussion around the Rockville case, we determined that a key barrier to implementing energy efficiency projects is the landlord/tenant agency problem.  Namely, the landlord pays for the project, but the tenants, who pay for the electricity, get all the benefit.  Tenants don’t treat electricity costs the same as rent.  Ironically, to pay for the improvements the landlord would have to raise rent, scaring away tenants.  About 100M Americans live in rentals[1], and the global movement to cities will only generate more rentals.  We can’t afford to ignore renter-occupied spaces from the energy efficiency/clean energy movement.

I believe the best way to solve this problem is to bring the renters into the deal financially – through “community financing.”  The debt or equity capital usually paid by the landlord for a sustainability improvement can be supplied by pooling small investments from rentees instead.  Rentees can be incentivized to fund green improvements if they can share in the financial benefit, not through reduced energy bills tempered by increased rent (boring), but by making a profit on an investment (fun!).  Through an investment model, rent does not need to be raised initially.  Rentees can also continue to receive investment returns even after they leave a place (or they can sell their investment to other rentees in a restricted secondary market).  This helps them to think long term even if they are living in a rental short-term.  The landlord can participate as well, or some value could be kicked back to the landlord just for going along.  The landlord benefits anyway through increased property values upon resale, although we saw in class that isn’t always appreciated.

Community financing (aka peer-to-peer financing, or crowdfunding) is just starting to become popular.  There are dozens of donation-based crowdfunding sites, from IOBY to Kickstarter to Donors Choose to Project Green Campus (my own creation –  It’s less common, but there are multiple for-profit community financing platforms active as well, from Lending Club to Wefunder to Circleup, Rock the Post, Fundrise, and more.  Fundrise and Realtymogul are focused solely on the Real Estate sector.  Although most of these platforms are failing or will fail, the sheer amount of interest in this new industry leads me to believe there is potential.  I have not found anyone tackling the problem exactly described above, but community finance seems to fit the challenge pretty well.

There are (at least) two big challenges with running a for-profit community finance platform.  The first is legal.  Any group that directs people to investment opportunities has to register as a broker-dealer with the SEC, which is tough.  Lending Club, a community financing platform for consumer loans, gets around this by becoming the issuer of the loans instead of the broker.  It engages in a complex set of transactions whereby it purchases the loan from the initial borrower and issues it to the lenders (which are crowdfunded) on its own behalf.  However, the note issued to the lenders only pays out the amount of the loan the borrower actually pays back (in other words, Lending Club issues borrower-payment-dependent loans).  This isn’t a perfect solution.  Any company issuing securities to the public in large numbers has to register to “go public” with the SEC and other agencies – a process that requires a couple million dollars (although I believe it’s possible to do it for much less).  Some of the other for-profit community finance platforms out there instead are waiting on the now-infamous JOBS Act to make the process of issuing securities to the public cheaper.  However, the SEC has been dawdling on writing the enabling rules for this legislation, and many believe the SEC will make the JOBS Act rules onerous and unusable.  I believe the best route legally to establishing a for-profit community finance platform is to just register with the SEC in full, and instead find a way to do so cheaply.

The second challenge is more fundamental – you have to get tenants to participate as a community to purchase something, when before they’ve never acted as a community.  You have to build a community in essence.  A website platform alone won’t do this – it takes lots of manual work make a community.  This isn’t impossible – a non-profit called Groundswell has gotten a lot of press for helping communities group-purchase renewable energy and energy efficiency improvements.  And the rise of social networking has shown us that it is possible to make the process of community-building more efficient and scalable.

Any company that can address these two above challenges and create the right transaction structure I believe can do well in this space and make an impact in the battle against climate change.  What does the class think?


One thought on “Community Financing to Solve the Landlord/Tenant Agency Problem

  1. By Anonymous

    The author above proposes a financial tool that would allow renters to benefit from the investment in energy efficiency or sustainability upgrades. Although this is an innovative solution, probably the author overestimates the median renter’s ability to make such an investment. The author’s solution could address one execution hurdle of sustainability projects by designing a product that would allow the benefits of such an investment to accrue to the investor. However, an investor requires disposable income to make an investment in order to finance such an investment and renters are less likely to meet this criteria.

    In the United States renting a home is an indicator of having less household income. As of 2012, household median income in the United States was $67,367. The same figure for rental households is estimated to be $33,363, less that 50% of the national median.[i] These renters will not likely have disposable income available to make investments in sustainability projects. Even conceptually, given the numerous tax advantages provided to homeowners in the US, generally residents rent homes to avoid the high capital expenditure of buying or building a house due to liquidity constraints. Although the author’s solution solves some of the execution barriers to sustainability investments, renters’ scarcity of disposal income will prevent the author’s solution from providing an adequate incentive for this population to invest in sustainability investments.

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