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A D L A I W E R T M A N

B E N J A M I N R O S T O K E R

SoLa Impact and The Billion Dollar Social Impact Fund

Martin Muoto, the CEO and Founder of SoLa Impact, stepped into his car to return to his office in the heart of South Los Angeles. At that moment, he was likely the only investment fund manager who was raising a $1B fund and driving to an office next to boarded up

buildings. SoLa Impact was founded as a for-profit social-enterprise real estate developer and rental management company. Its mission was to increase the amount of high-quality affordable housing in low-income communities. Muoto had just finished reviewing progress on SoLa Impact’s newest project, a 92,000 square foot commercial space, called the Beehive. This latest project was made possible by the creation of the new Opportunity Zone tax-incentive program. Despite early success finding investors and commercial tenants, Muoto’s efforts to scale this real estate development model was off to a slow start and prospective tenants were harder to recruit. As he drove across town, it was easy to spot SoLa Impact’s residential properties amidst a sea of boarded-up and vacant buildings. SoLa’s buildings were like a breadth of fresh air. Their modern aesthetic and high-quality construction showed the care and dedication that the SoLa team had invested to fulfill the company’s mission. As he drove, Muoto considered what elements of his new fund he would have to adjust to attract institutional investors. He knew raising a $1B real estate fund would not be easy, especially when he had chosen to name the fund the “Black Impact Fund.” However, he felt with SoLa’s track record and the right pitch, success was just around the corner.

Laying the Foundation: Discovering an Opportunity Muoto grew up in Northern Nigeria. His father had instilled in him and his siblings an aspiration to

attend college abroad. During the Cold-War, his father had left Nigeria to study medicine in Poland as part of a good-will initiative by the Soviet Union and Eastern-Bloc countries. This educational opportunity enabled Muoto’s father to elevate his family’s standard of living and he had encouraged his children to follow a similar path. While in high school, Muoto set his sights on universities in the United States. “I knew that American schools would highly value standardized tests, so I bought a used SAT study guide. It may have been the only one in the whole country!”, he laughed. When he applied, for most schools, he could not afford to pay their application fees, so he had his high school principal write

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a letter asking colleges to consider his application without their required $50 application fee. His first acceptance letter was from the University of Southern California. “My brother had received a full scholarship, but I did not. So, I thought: ‘Okay, I guess, they can’t afford both of us… I understand,’” he shared. Fortunately, the undergraduate program at the Wharton School of Business at University of Pennsylvania (UPenn) offered him a full scholarship and admitted Muoto to Penn’s elite Benjamin Franklin Scholar’s program, representing the top 5% of the incoming class. Muoto was the only student in Nigeria that year to receive a full scholarship to an Ivy League University. “I felt like I was 1 out of the 80 million Nigerians that had just won the lottery!,” he extolled.

In 1989 he flew to Philadelphia, Pennsylvania to attend UPenn with a round trip ticket and $440. “I really cannot thank my parents enough for making great sacrifices to set me up for success,” he offered. On the rare occasions Muoto could afford to call his parents, he would sometimes complain to his father about the challenges of studying at an elite academic institution in a foreign country. He reminisced:

I would tell my dad: “I'm working 20 hours a week washing dishes in the school cafeteria and I'm getting my ass kicked academically by these very smart students”. My father would say: ‘Wait…hold on for a second, I was a black Nigerian man in the 60’s in Poland, going to Medical School…in Polish…and I graduated top of my class.’ … I would hang up the phone and think “I guess I have nothing to complain about. Time to get back to work!”

Muoto would not see his parents for the next seven years as they could not afford to come to the US to visit, and he could not afford a flight back to Nigeria.

A Career in Venture Capital At UPenn, Muoto majored in industrial sociology and multinational management at the Wharton

School. After graduating in 1993, he remained in the United States and set his sights on a career in venture capital (VC). “While my classmates sought jobs in investment banking or consulting, I saw technology as the great equalizer and venture capital as the top of the technology food chain,” he explained. He first worked as an analyst at the Gartner Group and, three years later, he secured a position at General Atlantic Partners (GA). GA has been one of the largest private equity firms in the country and based in one of the wealthiest cities in the United States, Greenwich, Connecticut. In contrast at the time, UPenn was located in a low-income, predominantly African American area of West Philadelphia. “In hindsight, working in Greenwich, Connecticut and being exposed to partners that flew first class, sometimes even on private jets, was a bigger cultural shock than moving to West Philadelphia and going to UPenn. It was just completely out of my world,” he admitted.

After two years at GA, he moved to New York City to become a founding member and principal at Accretive Partners. Accretive was a private equity firm founded by a former GA partner, Michael Cline. At Accretive, Muoto participated in the founding of Fandango (a leading movie ticket website purchased by Comcast in 2009) and led investments in several other technology and outsourcing companies. In 2004, he moved to Los Angeles to help turnaround a troubled logistics and distribution company that had been acquired by Accretive. “I was sent out to a tough area of the San Fernando Valley to turn a

Adlai Wertman, David C. Bohnett Professor of Social Entrepreneurship, and Senior Case Fellow Benjamin Rostoker prepared this case. This case was developed from field research and published sources. Cases are developed solely as the basis for class discussion and are not intended to serve as endorsements, sources of primary data or illustrations of effective or ineffective management. Copyright © 2021 Lloyd Greif Center for Entrepreneurial Studies, Marshall School of Business, University of Southern California. For information about Greif Center cases, please contact us at [email protected]. This publication may not be digitized, photocopied, or otherwise reproduced, posted or transmitted without the permission of The Lloyd Greif Center for Entrepreneurial Studies.

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distribution company around. That was the hardest job I ever had!” he shared. His hard work at the distribution firm was rewarded when it was acquired by eBay (a large e-commerce company). Although he had found the financial success that he aspired to, he often felt out-of-place. “Although ‘being a VC’ was stimulating and financially rewarding, I was never entirely comfortable as a venture capitalist. My soul just wasn’t in it.”

Finding Real Estate Seeking to diversify his personal investments, Muoto began to invest in real estate on nights and

weekends. He first purchased rental properties in gentrifying and trendy neighborhoods in Los Angeles: Venice and Echo Park. “My Cash-on-Cash yields in Venice and Echo Park started out very low, 2-5% during the hold period but, with appreciation, they turned out to be great deals for those areas (over a 20% IRR),” Muoto offered.

Rental investments are primarily analyzed on four metrics: Gross Yield (Yield) and Capitalization Rate (Cap Rate), Cash-on-Cash Return, and Internal Rate of Return (IRR).

• Gross Yield (Yield): Annual rental income divided by the property’s value, expressed as a percentage.

• Capitalization Rate (Cap Rate): Annual rental income minus operating expenses divided by the property’s value, expressed as a percentage. Operating expenses can include: legal fees, loan fees, building inspections, repairs and maintenance, management fees, vacancy costs, insurance costs, and other charges. Cap Rate assumes the properties Gross Yield without using any debt or leverage.

• Cash-on-Cash Return: A return-on-investment measure that includes any debt used in the purchase of the property. Cash-on-Cash represents the actual cash an investor receives annually after he or she has paid the properties mortgage, taxes, and other operating expenses.

• Internal Rate of Return (IRR): Measures the annualized rate of return given an expected future cash flow or eventual sale of the property.

Muoto was surprised at how tangible the work of real estate development and management felt and how quickly he took to it. “It was very unlike what I did in my corporate life which was write emails, analyze financials, and put together PowerPoint presentations. In real estate, when you say put a wall here, a few days later there was a wall! It was so gratifying because it was such an immediate manifestation of one’s decisions.” Excited by this new investment avenue, he applied some of the skills he gained as a VC. “I had gained an appreciation through private equity investing to analyze opportunities from a quantitative standpoint. The first thing I did was download the entire MLS and I developed a bunch of algorithms to help me analyze the data. I looked at every metric that could be indictive of value: price per square foot, rent per square foot, gross yield, current CAP rate, pro forma cap rate, etc.,” he stated. The results of his analysis surprised him:

In South Los Angeles, I found incredibly undervalued real estate assets relative to their potential rent. CAP Rates of 7-9%, which didn’t exist anywhere else in Los Angeles. And I asked myself: why are people not investing in this area?

Muoto began to explore investing in South Los Angeles. South Los Angeles generally referred to the area immediately south of downtown Los Angeles. Historically, this area was commonly referred to as “South Central”, and included parts of Watts and Compton. In South Los Angeles, 68% of the 1,000,000 residents identified as Latino and 27% as African American. Additionally, 37% had income below the federal poverty level, unemployment was 17%, and 42% of adults had an education less than a high school level. (See Exhibit 1: South Los Angeles Demographics and Geography).

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Muoto spoke with real estate agents and developers to hear their experiences in South Los Angeles. “Every broker I spoke to said: I wouldn't invest there if I were you; you're going to lose your shirt; you're going to deal with bad tenants, drug dealers, and prostitutes; you're going to deal with delinquencies; and they are going to trash the place,” he described. But Muoto wanted to see for himself. He shared:

I found dozens of properties that ‘on paper’ looked like good investments. I would drive down during the weekends, often at night, to see first-hand if these stereotypes were true. Ultimately, I walked over 100 properties before I made my first investment. And I didn’t just ‘drive by.’ I stopped, I knocked on doors, and I talked with the tenants and residents. The brokers were only about 5% right. But it was on the margins. South LA lives with the stigma of the 80s and 90s crack cocaine epidemic, gang violence, and race riots. Few other communities are judged by the way they looked 30-40 years ago. Most people here are honest, hard-working people who just want a safe place to raise their kids.

In 2009, he made his first purchase in South Los Angeles: a triplex multifamily building at 94th Street and Vermont for $215,000. Over the next three years, he purchased ten more buildings.

Learning the Business “I learned the business, the honest way–but also the hard way–which is you use your own money

before you use somebody else's money,” Muoto stated. He would personally host open houses, screen tenants, sign leases, oversee the property renovation projects, and collect rents. Often, at the beginning of each month, he would collect much of rent in cash. He recounted one particularly eventful Sunday after collecting rent:

One Sunday, I was driving back from South LA and I was pulled over by LAPD [Los Angeles Police Department] for speeding on the highway, one of the only two times in my life. I opened the glove compartment to get my registration and $9,000 in cash fell out, rents that I had just collected. The cop looked suspiciously at me and asked, ‘Do you always carry that much cash?!’ As a black man, I thought, I’m going to jail! Fortunately, I have a spotless record and the police officer let me go saying: ‘Sir, I have advice for you: Don’t drive around with so much dough!!’

Despite the many challenges, Muoto embraced real estate and property management. “It started as a hobby, and I found a real passion for it. I never really felt that I was ‘working.” Real estate investing selected me as much as I selected it,” he confided. Muoto had developed a personal framework for evaluating new life opportunities. He termed them the Four P’s: Profit, Passion, Pragmatism, and Purpose. “I think if you balance all four P’s in your professional life, then you really get into the flow and can make real impact.” In 2012, Muoto decided to follow his Four P’s and pursue real estate full time.

Drafting the Architecture of SoLa Impact As Muoto began networking with other property managers, he found a kindship with Gray Lusk.

Lusk was running a portfolio of around 300 units in North Hollywood—another low-income community in Los Angeles—for a family office. Lusk and Muoto would compare notes on struggling to find good contractors for rehabs or negotiating with difficult tenants. Muoto recalled, “There was this white guy from South Carolina who was managing buildings in minority communities with just as much compassion and nimbleness as I was. I thought we could do great things together.” In 2013, they began their first joint business idea: a third-party property management business for rentals in South Los Angeles. They planned to charge a fee to manage South LA properties for absentee landlords, most of whom live in upscale areas or out of state, and rarely if ever visit their properties. “We quickly learned

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that most of the landlords in South LA technically speaking, suck, and didn't want anything to do with their tenants. They had this unwritten rule of: if you don't bother us, we won't bother you,” Muoto shared sadly. “I was spending $15-$20,000 to renovate apartments and I couldn’t convince our clients to spend $2,000.” It was clear to Muoto and Lusk that they would have to own their real estate assets to ensure the quality apartments that they wanted to provide.

Finding an Investment Thesis Over the next year, Muoto and Lusk contemplated the idea of raising a real estate fund “The simple

thesis was: if we give tenants an incredibly good product, we will attract the best tenants and they will treat and care for the property as if it was their own home,” Muoto stated proudly. As an example: instead of installing $49 sinks and $12 faucets from Home Depot, they would select $275 stainless steel apron sinks and $79 industrial faucets; instead of pre-molded backsplashes, they would install tile backsplashes in the bathrooms and in the kitchens; instead of laminate, they would install engineered hardwood floors. “We wanted our tenants to feel a sense of ‘accessible luxury’ and give them things they had seen on TV, but never felt they would have,” Muoto summarized (see Exhibit 2: Example of SoLa Rehab). This thesis generally attracted higher quality tenants who became invested in maintaining their units being considerate of their neighbors.

Social Impact Mission “I have a motto: go to where you are celebrated, not where you are tolerated,” Muoto declared. Even

from the beginning Muoto saw his work as part of a personal social mission. He saw parallels between the poverty in South Los Angeles and the poverty in Northern Nigeria. Muoto had grown up in the impoverished and predominantly minority-Muslim northern part of Nigeria. He expounded on this parallel:

If you put people in an environment where they feel they have no opportunity, no outlet, and with poor education, they become disenfranchised and hopeless and often resort to desperate measures. In Nigeria, this led to the rise of Boko Haram [a militant extremist group]. Boko Harm, ironically, translates to “Western education is bad”. In South LA it was very clear to me, that the combination of disenfranchisement due to systemic racism, the lack of opportunity, and the rising level of income inequality created a hotbed for discouragement and despondency. It leads to potentially very bad outcomes.

In addition to the risks, Muoto also saw a possibility for positive changes. “It became apparent to me that working on four pillars could reverse the trajectory of disenfranchisement: affordable housing; access to education; business ownership; and access to capital.” Muoto admitted, “I would like to say I had an incredible vision of how the social and financial mission would come together, but in reality, it was a Darwinian process.” Finding a model to fulfill this social mission would evolve over the next few years. He first developed partnerships with over 15 non-profits to provide referrals for at-risk residents. These partners included: Gettlove, PATH, Good Shepherd Center, FirstFive, HOPICS, the Veterans Administration, and Housing and Urban Development Administration.

Fund I: First Outside Investors In late 2014, a year after joining forces, Muoto and Lusk raised their first fund from outside

investors. Muoto led the fundraising and the fund management, and Lusk led the real estate development and property management. “My personal capital was starting to run out, and we wanted to demonstrate that, if we owned the assets and implemented our investment strategy, that we could produce demonstrable market rate financial results alongside true social impact,” Muoto stated.

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One of the first prospective investors Muoto contacted was an accomplished mentor when he worked in venture capital. Muoto reached out after losing touch for 10 years. The mentor agreed to meet and Muoto shared, “As I was talking to him about what I was doing, I could tell he was thinking: how did you go from Greenwich, Connecticut to South Central Los Angeles…what the hell happened to your career!?” The mentor was at first skeptical that Martin could perform true social impact and get market rate returns. Martin recalled him saying, “You have to pick one–either you are a for-profit, maximizing returns, or you’re a non-profit focused on fixing social problems.” But Muoto persisted and eventually convinced him. “At one point, I said, ‘It's incredibly important to me that you invest. If I lose you a penny, I will come and work for you until I make up the money.’ He said, ‘Well, that’s a win-win!’ and committed to the fund.”

Even with his personal connections, Muoto also needed to demonstrate the expected financial returns. Fortunately, he had several years of operating history based on his own properties. From 2010- 2014, he had purchased, rehabbed, and managed eight properties. Collectively they had earned a 10.4% cap rate and 21.5% cash-on-cash return. He further estimated that with a data driven approach and outsized value to renters he could provide higher returns to investors. In six months, Muoto had reached his goal of $10 M (see Exhibit 3: Overview of SoLa Funds).

The success of this first fund was notable. From 2015-2016, SoLa purchased 33 properties and expanded the number of units to 265 (see Exhibit 4: Locations of SoLa Properties). The average purchase price per unit was $84k. Fund I invested over $5.5M in Capex (capital expenditures) to renovate 158 units (~61% of the portfolio). Half of the tenants received rent assistance from the government, which was paid directly to SoLa and provided a stable revenue stream. Financially, SoLa achieved 7% cash-on-cash return in 2015 and 8.5% cash-on-cash return by the end of 2016. These returns were expected to improve as the properties stabilized and required less capital investment. SoLa had determined stabilization would require 12-24 months from acquisition. Based on third-party appraisals, the properties’ assessed market values increased an average of 15-18%. Muoto further discovered additional advantages to the SoLa’s model as he scaled the business. SoLa developed proprietary access to a pipeline of properties from repeat sellers and landlords. SoLa could also establish favorable lending terms with banks, as the investments fulfilled the banking regulatory requirements of the Community Reinvestment Act.

Delivering on the Social Mission To support this growth, SoLa increased the team from four professionals and eight contractors to

seven professional and 50+ contractors. (See Exhibit 5: Number of SoLa employees by year). Muoto was especially proud to announce that SoLa had housed 19 veterans, 36 formerly homeless, 5 women from domestic violence programs, 2 from gang violence protection programs, and 3 youths aging out of foster care.

During Q3 of 2015, Muoto was approached by an entrepreneurial hair salon manager. She had been renting a booth at a salon in Beverly Hills but was interested in creating a high-end salon in South Los Angeles. She explained that African American women in South Los Angeles were regularly traveling to more affluent neighborhoods to have their hair styled and she saw an opportunity to bring service to a more convenient location. Muoto embraced an opportunity to advance the SoLa’s double-bottom line. “Beauty shops are one of the few entrepreneurial opportunities available to women of color who do not possess extensive formal education. They can earn a livable wage, control their own hours, and reduce childcare costs by bringing their children to work,” he explained. He continued, “What many entrepreneurs in South LA lack is access to capital. And that is something we are fortunate enough to be able to help with!” SoLa invested around $30,000 in capital improvements to design, develop, and market the new salon. SoLa retained formal ownership of the brand (Studio Soul™) and entered into a profit-sharing arrangement with the entrepreneur on products sold (hair extensions, beauty products,

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etc.). The project exceeded expectations earning $2,500/month in combined rent and profit sharing, well above the projected $1,400/month. “Two guys with no beauty experience had built the most stylish hair salon in all of South LA,” Muoto chuckled. (See Exhibit 6: Construction of Studio Soul)

Fund II: Scaling the Model By 2017, SoLa began raising a $50M fund based on the returns of the first fund. The second fund

targeted a highly competitive IRR in the mid-teens over the 7-year life of the Fund (see Exhibit 3: Overview of SoLa Funds).

While raising this second fund, Muoto began reaching out beyond his professional network. He was proud to have recruited investors who worked at top-tier investment firms for Fund I, and he could now tout having existing investors from General Atlantic, Goldman Sachs, Oaktree, Colony Capital, and the founders of Riot Games. He explained his approach:

Our LPs [limited partner investors], while private individuals, were regarded as very disciplined and tough-minded investors. When you have happy investors, they're always happy to refer you to other high net worth investors. We were very fortunate to set realistic expectations of returns, which we've exceeded every year.

Working with insightful investors also enhanced SoLa’s financial model. Muoto credits these investors input for setting a high bar and providing valuable advice. “Having these deeply experienced investors has always pushed us to raise our intellectual rigor, financial discipline, and reporting to meet their expectations,” he acknowledged.

Addressing investor concerns While on the road fundraising, Muoto would regularly receive two types of questions: Is your

primary focus on making money or performing a social good? And Is SoLa’s model scalable?

In response to the question regarding the dual social and financial mission, Muoto would reply: “We certainly believe in ‘Doing Well by ‘Doing Good’, but we are unapologetic about the fact that we have to make very good returns. We cannot attract and sustain intelligent and institutional capital unless we deliver superior returns.” He would then add to this answer: “We not only want capital, but we seek investment partners that are aligned with our long-term mission and vision to transform tough, neglected urban areas into viable economic centers.”

In response to the question regarding scalability, Muoto would reply: “There are so many great deals in areas that others think are ‘tough’ to manage because no one is investing there. I mean there are about a million people that live just in South LA, we were buying ten buildings a month and not even making a dent in available inventory.” He would follow up on this statement by explaining his strategic approach:

We are not focused on: if we can eventually sell a billion-dollar business. Rather we are focused on: building a business and a real estate portfolio brick-by-brick. In this sense, we are incredibly pragmatic. I’ve found that if are too focused on where you will be in 5 or 10 years, you don’t get anything done today...

By June 2017, SoLa had closed a $55M Fund II, which they had oversubscribed. Over the next 18 months (June 2017 – Dec. 2018), SoLa purchased 135 properties with 1,166 units. They renovated 38% of the units. By 2018, Fund II’s market rate double digit IRR.

A key expense as SoLa grew was the increasing number of employees. They had tripled the number of full-time professional employees from Fund I to Fund II. Muoto explained his thinking:

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The opportunity is too great and the responsibility is too important for the operating company to be profitable right now. So, we plow every single penny back into scaling the team. It's not quite the business model I envisioned, because it's very people intensive, but we're not asset allocators, we're operators … and we're control freaks. So, for all those reasons, we end up doing critical functions in house more than most other firms. For example, we don't want to explain our design model to every new architect, so we even brought a couple of architects and engineers in house.

Muoto found an unexpected ability to recruit talented employees based on SoLa’s social mission. “The rising desire by African American, Hispanic, and Latinx executives to do more for their community has given us an opportunity to recruit talent who we would not have normally appealed to…or been able to afford. But successful professionals are increasingly looking for purpose in their career and many minority executives want to find a way to ‘give back’ while they are still in their prime,” Muoto shared.

Measuring and Reporting Impact One of these key early SoLa recruits was Sherri Francois as Director of Social Impact. “Sherri came

to us after a successful career in New York. She was looking for something meaningful and started out by volunteering. After a week, we saw her incredible value and offered her a job. She has done incredible things for us and taken the impact side to the next level,” Muoto extolled.

During the deployment of Fund II, SoLa began allocating a portion of their profits to formalize the delivery, measurement, and reporting of their impact. This investment quickly rose to over a $1M a year on the social impact team and its programs. To expand the social mission, SoLa established a non-profit entity: the SoLa I CAN! Foundation. The impact team identified four key areas to focus their efforts: affordable housing, education, community development, and job creation. To deliver on these areas they would conduct an assessment during tenant onboarding to help connect tenants with, as of 2019, over 40 partner non-profits, government agencies, and local organizations. They also created and directly offered their tenants career development programs, financial literacy education, credit repair workshops, and financial stability mentorships. Through the I CAN! Foundation they provided the tenants’ children scholarship opportunities, financial literacy programs, and career awareness field trips. Finally, for the community they offered wellness and food distribution programs.

They reported in 2019:

• Affordable housing: o 30% previously unsheltered homeless o 90% of the formerly homeless remained housed o 33% Survivors of domestic violence o 80% Single Mothers

• Job Creation: o Created over 300 construction jobs o 80% Local contractors o 70% Local suppliers o 47% of employees identified as female and 77% identified as minorities

• Access to Education: o $100,000 in college scholarships to 31 recipients o 30% had experienced homelessness o 60% were first in their family to attend college

• Community Development: o Organized quarterly meetings among the 40 partner organizations to foster

collaboration and coordination

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Fund III: Opportunity Zones In 2019, SoLa began planning its third fund. Originally the fund followed the same business model

as the previous funds and raised the target to $100M. However, this model shifted after Jeremy Keele, one of the early thought leaders on Opportunity Zone legislation visited SoLa. Opportunity Zones (OZs) referred to a tax incentive intended to encourage development in low-income areas. Muoto recalled, “Jeremy said to us, ‘OZs are tailor made for what you do.’ But at SoLa we had this knee jerk reaction that was: we generally find that government programs are too complicated and bureaucratic for us.” Keele returned several months later and pitched SoLa again on OZs. “We took a closer look and then realized that half of our buildings were already in opportunity zones and two-thirds would qualify for the Substantial Improvement Test.”

The Investing in Opportunity Act, which created the OZs, was made law as part of a package of tax cuts passed in 2017. The legislation was sponsored by a bi-partisan group including, Senator Tim Scott (Republican-South Carolina), Cory Booker (Democrat-New Jersey), Representative Pat Tiberi (Republican-Ohio), and Representative Ron Kind (Democrat-Wisconsin). It intended to reallocate a portion of the $2.3T in unrealized capital gains to economic development projects in low-income areas. Unrealized capital gains refer to profits (or capital gains) from an investment is held but not-yet sold. In the United States, when investments are sold, capital gains can be taxed as high as 40%, which has incentivized investors to delay selling profitable investments. To incentivize economic development in low-income areas, the Investing in Opportunity Act offered investors the chance to defer and reduce their capital gains in exchange for investing in an Opportunity Zone Business or Fund based in a designated Opportunity Zone area (see Exhibit 7: Explanation of Opportunity Zone Incentives). Details of this program include:

• Opportunity Zones (OZ): Over 8,700 areas across the country were designated as Opportunity Zones. These areas were required to have at least a 20 percent poverty rate or a median income no greater than 80 percent of the median income in their metropolitan area.

• Opportunity Zone Business: Businesses with 70% of their tangible property used to conduct trade based within an OZ.

• Qualified Opportunity Fund (QOF): A fund which:

1. Invests 90% of its capital in property or businesses in opportunity zones

2. Makes a substantial improvement on these assets by doubling the adjusted basis after purchase

• Investors Tax Benefit: Upon receiving a capital gain, if an investor re-invests 100% of the capital gains into a QOF and holds this asset for 10 years:

1. Capital gains taxes are deferred for seven years

2. After seven years, the tax basis is reduced by 15%

3. After 10 years, any additional capital gains earned on the OZ investment is tax free

Strategic Opportunities and Risks for SoLa Upon reassessing the OZ legislation, the team at SoLa evaluated the opportunities and risks of

making Fund III a Qualified Opportunity Zone Fund (QOF). Muoto explained the advantages they identified:

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What the opportunity zones could do for us was make the investors more patient and more supportive of ground up construction. We considered that we had acquired and improved 1500 units in Funds I and II, but we had not added a single unit to the housing stock of California. We were simply not going really address the affordable housing crisis without building new units. The timing of the OZ legislation made it possible for us to expand our mission and vision of impacting the affordable housing crisis and the needs of low-income communities.

In addition, a QOF could expand the pool of investors who would be attracted to SoLa’s Funds. Muoto continued, “It would lead us to a whole bunch of investors that might be less interested in our social mission, but excited to participate for the tax incentive. Regardless of their personal motivation, it allowed us to “Do Good” by leveraging their capital”

The SoLa team also identified strategic risks in aligning themselves with the OZ legislation. Despite its bi-partisan sponsors, traditional affordable housing organizations and foundations were skeptical that the program would actually provide aid to those in need. Criticism centered on three issues: selection of the areas, accountability of the investments, and cost of the program. Of the 8,700 areas designated as OZs, 24% were in areas with relatively low poverty rates (below 20%).1 The definition of low-income also enabled areas that were not in distress to be selected, for example, next to elite colleges.2 This selection risk was of particular concern to critics because the legislation did not stipulate any reporting requirement for QOFs. As a result, there was no way to determine the extent of participation or the exact use of investment funds. Critics expressed concern that the estimated $1.6B in lost federal revenue would not result in greater number of affordable houses or increased job creation than traditional economic development programs.3 This fear that the OZ program would be used for tax avoidance and gentrification was reinforced by the announcement that Amazon would build a headquarters in an opportunity zone in Long Island City, New York City (Amazon later agreed to not take the tax benefit and ultimately canceled the headquarters project on Long Island).

The SoLA team decided that the importance of investing in historically neglected communities outweighed the risks of being associated with OZs and to reframe their third fund around a QOF. “Up to this point, many OZ projects followed the letter of the law, but not the spirit of the law. We were determined to embody both. And, in some respects many in the industry were very happy for us to be among the visible poster children of the legislation because they could say: don't look at what we're doing, look at what SoLa is doing,” Muoto admitted.

The SoLa QOF Muoto began the processes of raising capital for this third fund by reaching out to the same investor

network as the previous funds. With the advantages of the opportunity zone, SoLa projected they could add 1,500 units to SoLa’s portfolio in which 75% of the units would be part of ground-up construction and 25% would be rehabbed properties. The target IRR would continue to be competitive with other real estate funds. (See Exhibit 3: Overview of SoLa Funds and Exhibit 4: Locations of Properties).

Six weeks after opening the fund, they had raised $50M. At the same time, they came across a new opportunity to expand into commercial real estate in an OZ. “We found these incredible red brick warehouses in South LA for $175 per square foot that would be worth $800 per square foot anywhere else,” Muoto shared. The SoLa team calculated that this space could be transformed into the ‘nations first OZ business campus’ and bring a new dimension to their economic revitalization. They called this project the Beehive (see Exhibit 8: Beehive Designs). The property would total 92k square feet on 3.5 acres and would appeal to a mix of entrepreneurs and established businesses. Muoto noted, “A big part of entrepreneurship is trusting your instinct…backed by 10 different spreadsheets to test the assumptions. With the Beehive, the instinct side and the data side were there!”

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With half the fund committed, they announced the Beehive and received a fair amount of push back from some of the committed investors. The push back surprised the SoLa team since the Beehive would only represent 10% of the fund. “We had proven ourselves as residential developers, but we hadn't proven ourselves as commercial developers. Investors told us: you are in way over our skis, you may be drunk on capital. The criticism was real!” Gray Lusk recalled. Despite the criticism, they oversubscribed the fund and raised $115M in a total of 12 weeks.

Challenges of the Beehive By 2020, 40% of Beehive was leased. The SoLa team was pleased to announce that the majority of

the tenants were businesses owned or managed by women and minority entrepreneurs. The largest tenant at the time was a new social enterprise, the South Los Angeles Beverage Company. This craft brewery was founded by two African American men with roots in South LA and they had committed to drawing 75% of their employees from the local area. “Sola is investing $750,000 to build out space and the brewery is going to raise $3 million.” said Muoto.

Despite this progress, by this point in time, SoLa had hoped to have leased 75% of the Beehive. “Impacted by COVID-19 and companies allowing employees to work from home, the progress of attracting major corporations and high-growth tenants to any office had been challenging, and the Beehive has been no different,” Muoto shared. Still, the Beehive, generated a tremendous amount of media and local attention. Some of this media attention came in the form of a visit from Ben Carson, Secretary of Housing and Urban Development. 2020 was a presidential election year and Muoto was initially hesitant to get pulled into the politics of the OZ legislation. However, Muoto explained, “I believe liberals and conservatives, rich and poor, Republicans and Democrats can agree on the a few things: Every community wants more opportunity and control of their destiny.”

Fund IV: Black Impact Fund During the Summer of 2020, thousands of Americans took to the streets to protest the

disproportionate killing of black and brown individuals by police officers. The demonstrations quickly grew in size, particularly after the murder of George Floyd in Minnesota. These protests coalesced under the slogan ‘Black Lives Matter.’ “During the summer of George Floyd, I think we all asked ourselves are we doing enough?” Muoto recalls. While it had always been a part of their strategy, the SoLa team began to consider a new fund that would place economic opportunities for brown and Black communities explicitly at the forefront of their mission.

This fourth fund would be called the Black Impact Fund (BIF) and aimed to eventually become the largest minority managed fund in the country at $1B. In addition, 13% of the asset’s appreciation, fees, and ‘carry’ would return to the community via a Community Fund that distributed grants. The number 13 represented 13% of the US population who were African American in 2020. Half of the BIF would be invested in OZs and half outside OZs. SoLa identified major cities across the country where the BIF could be deployed. Net IRR was projected to be double digit returns. (See Exhibit 9: BIF Fund Details)

In the Fall of 2020, Muoto stepped away from daily operations for a few days while his son was born “I was sleeping on a cot in the hospital and it became clear to me that my responsibility to my child and the next generation was to look for solutions to the broader racial and income equality issues through the Black Impact Fund,” Muoto shared. They prepared to open the fund to investment in early 2021. “We had tested the pitch with a couple of investors and it seemed to land,” Muoto admitted.

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Unexpected launch and resistance In addition to the high net-worth individuals and family funds, SoLa decided to target larger

institutional investors for the BIF. In December 2020, the Wall Street Journal published a feature story announcing the Black Impact Fund. “Suddenly it felt like everybody was taking our calls: the Rockefeller Foundation, the Ford Foundation, University of Southern California, Yale University, Stanford University, and many more …,” Muoto stated.

Despite this auspicious start, Muoto encountered resistance closing the new prospective LPs. Months into his road show, he was still working to persuade these larger institutional investors to commit. After some honest conversations with prospective investors, three types of concerns emerged:

1. For social first investors, OZs had gained a negative reputation for gentrifying neighborhoods and enabling tax avoidance. OZs had also become associated with the Trump administration, which caused a knee-jerk rejection by some “progressive” investors.

2. For financial investors, the 13% allocation for social impact was a dealbreaker. They supported the social mission as long as it was paid for from a portion of SoLa’s management fees rather than the fund’s appreciation.

3. Both social and financial investors were concerned that the pace of geographic expansion was too risky. Investors thought that the housing challenges on the east and the west coasts of United States were too different to simply replicate the SoLa model.

Adjusting the Pitch Muoto packed his laptop and prepared to drive home from his office. In the midst of the Covid-19

pandemic, traffic was fortunately not going to be an issue. He was however deeply contemplating how best to modify the Black Impact Fund to accelerate investment. What trade-offs should he make between the financial and social goals of the fund? It seemed there were three options to begin thinking about:

1. Re-allocate the fund’s thesis to be outside OZs. This would appeal to skeptical social-first investors but alienate financial-first investors.

2. Remove the stipulation that 13% of the fund’s appreciation be allocated to social impact. Muoto estimated a majority of the financial investors would then come on board, but this change would upset the 10% most committed socially aligned investors and reduce the social impact he was looking to achieve.

3. Reduce the geographic scale and size of the fund. This would appease risk-averse investors. However, it could limit the impact for those in need of affordable, high quality housing across the county.

Muoto revved his engine. Like many decisions he had faced on this journey, he knew it would require a combination of intuition and calculations to find the best path forward.

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Exhibit 1: South Los Angeles Demographics and Geography

Source: SoLa Impact

Exhibit 2: Example of SoLa Rehab

Source: SoLa Impact

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Exhibit 3: Overview of SoLa Funds

Source: SoLa Impact

Exhibit 4: Locations of Properties

Fund I Fund III

Source: SoLa Impact

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Exhibit 5: Number of SoLa employees by year

Source: SoLa Impact

Exhibit 6: Construction of Studio Soul

Source: SoLa Impact

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Source: SoLa Impact

Exhibit 7: Explanation of Opportunity Zone Incentives

Source: SoLa Impact

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Exhibit 8: Beehive Designs

Source: SoLa Impact

Source: SoLa Impact

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Exhibit 9: BIF Fund Details

Source: SoLa Impact

Source: SoLa Impact

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Source: SoLa Impact

Source: SoLa Impact

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Source: SoLa Impact

Endnotes

1 Hilary Gelfond and Adam Looney, “Learning from Opportunity Zones: How to improve place-based policies,” Brookings Institute, October 2018. 2 Samantha Jacoby, “Potential Flaws of Opportunity Zones Loom, as Do Risks of Large-Scale Tax Avoidance,” Center on Budget and Policy Priorities, January 11, 2019. 3 Joint Committee on Taxation, “Estimated Budget Effects of the Conference Agreement for H.R. 1, The ‘Tax Cuts and Jobs Act,’” JCX- 67-17, Dec. 18, 2017