Community development entities

What Is Community Development Entities?

Community Development Entities (CDEs) are specialized financial institutions certified by the U.S. Department of the Treasury's Community Development Financial Institutions (CDFI) Fund. Their primary mission is to serve as intermediaries, channeling private investment into low-income communities to stimulate economic development and create positive social impact. CDEs operate within the broader context of impact investing, focusing on areas that traditionally lack access to conventional capital markets. Through programs like the New Markets Tax Credit (NMTC) program, Community Development Entities play a crucial role in revitalizing distressed urban and rural areas by facilitating financing for businesses, community facilities, and real estate projects.

History and Origin

Community Development Entities emerged as part of the New Markets Tax Credit (NMTC) Program, which was established by Congress in December 2000 through the Community Renewal Tax Relief Act. The program's objective was to incentivize private capital investment in distressed communities by offering investors a federal tax credit in exchange for making equity investments in certified CDEs. The U.S. Department of the Treasury's CDFI Fund oversees the allocation of tax credit authority to Community Development Entities through a competitive application process. The NMTC program was designed to address the historical lack of investment in low-income areas, providing a mechanism for private capital to flow into underserved markets. Since its inception, the program has aimed to breathe new life into communities suffering from dormant facilities, inadequate amenities, and lower property values. The initiative has been cited as a significant driver of economic revitalization, generating substantial private investment for every dollar of federal funding¹⁰.

Key Takeaways

Community Development Entities (CDEs) are Treasury-certified financial intermediaries.
Their core mission is to attract private capital to low-income and underserved communities.
CDEs primarily operate through the New Markets Tax Credit (NMTC) program, offering tax credits to investors.
The capital raised by CDEs is used for debt financing and equity investments in qualifying businesses and projects.
These entities play a vital role in stimulating economic growth, creating jobs, and providing essential goods and services in distressed areas.

Interpreting Community Development Entities

Community Development Entities are interpreted as conduits for capital that bridge the gap between private investors seeking tax incentives and projects in communities that struggle to access traditional financing. When evaluating a CDE, stakeholders often look at its track record of deploying capital into qualified low-income community investments, its impact on job creation, and its contribution to local economic growth. The effectiveness of Community Development Entities is measured not just by financial returns, but also by the social impact and revitalization they bring to distressed areas. They are a critical component of public-private partnerships aimed at addressing systemic economic disparities.

Hypothetical Example

Imagine "GreenLight Solutions," a certified Community Development Entity that has received an allocation of New Markets Tax Credits. An investor, "Global Fund LLC," makes a $10 million equity investment into GreenLight Solutions. In return, Global Fund LLC receives a federal tax credit, which is claimed over seven years.

GreenLight Solutions, now capitalized with Global Fund LLC's investment, identifies a manufacturing plant in a severely distressed urban neighborhood that needs capital for expansion. The plant plans to create 150 new jobs, primarily for local residents. GreenLight Solutions provides a combination of debt financing and a small grant to the plant at below-market rates and with flexible terms. This capital infusion allows the plant to purchase new machinery, hire additional workers, and increase production, contributing directly to the revitalization of the low-income community.

Practical Applications

Community Development Entities are instrumental in a variety of real-world scenarios designed to foster economic revitalization:

Small Business Expansion: CDEs provide crucial capital to small businesses in underserved areas, enabling them to expand operations, purchase equipment, and hire local talent. This can include anything from local grocery stores to manufacturing facilities.
Community Facilities Development: They finance the construction or rehabilitation of essential community infrastructure, such as healthcare clinics, schools, and daycare centers, improving the quality of life for residents.
Affordable Housing Initiatives: While the NMTC program primarily targets commercial and industrial projects, CDEs can sometimes play a role in mixed-use developments that include affordable housing components, especially when integrated with other economic development goals.
Job Creation: By providing accessible financing, CDEs directly contribute to job creation and retention in areas where unemployment rates are high. The NMTC program has been credited with creating or retaining over 888,200 jobs since 2003⁹.
Catalyzing Private Capital: CDEs attract private capital that might otherwise not flow into these areas, leveraging federal tax credits to encourage socially responsible investment. For example, the program has generated $8 of private investment for every $1 of federal funding⁸.

Limitations and Criticisms

Despite their intended positive impact, Community Development Entities and the New Markets Tax Credit program have faced certain limitations and criticisms:

Complexity and Transaction Costs: The structure of NMTC transactions, involving multiple layers of financing and entities, can be complex, leading to high transaction costs that can dilute the overall impact of the investment. Some critics argue for consolidating CDEs with private investors to simplify the program and reduce these costs⁷.
Difficulty in Measuring True Impact: While job creation and square footage of development are reported, it can be challenging to definitively prove that all economic activity generated by NMTC projects would not have occurred without the subsidy. Some research suggests that a portion of projects might have proceeded even without NMTC financing⁶.
Oversight and Accountability: Concerns have been raised regarding the U.S. Treasury Department's oversight capacity to track project failures or ensure that funds consistently reach the most severely distressed communities. Reports have highlighted incomplete reporting on various aspects of the program⁵.
Potential for "Crowd Out": There is an ongoing debate about whether the program "crowds out" private unsubsidized investment or merely redirects existing capital rather than generating entirely new investment into low-income areas⁴.
Geographic Scope Concerns: While intended for low-income areas, the broad eligibility criteria for census tracts under the NMTC program have led to some criticism that the subsidies are spread too widely, potentially benefiting areas that are not the most in need or even projects that could be privately funded³. The Tax Policy Center has analyzed such concerns, noting the debate over whether the program's benefits justify its costs².

Community Development Entities vs. Community Development Financial Institutions

While closely related and often operating in similar spaces, Community Development Entities (CDEs) and Community Development Financial Institutions (CDFIs) serve distinct functions, though a single organization can sometimes be both.

Community Development Financial Institutions (CDFIs): These are financial institutions (e.g., banks, credit unions, loan funds, venture capital funds) that primarily serve low-income communities and individuals who lack access to conventional financing. CDFIs exist to provide affordable financial products and services, such as loans, investments, and financial counseling. They are certified by the CDFI Fund based on their mission, target market, and accountability to the communities they serve. CDFIs use a variety of funding sources, including private capital, federal grants, and their own earned income.
Community Development Entities (CDEs): CDEs are specific entities certified by the CDFI Fund for the purpose of participating in the New Markets Tax Credit (NMTC) program. Their primary role is to attract private investment by offering federal tax credits to investors. CDEs then deploy this capital into qualified businesses and real estate projects within low-income communities. While many CDFIs are certified as CDEs to leverage the NMTC program, not all CDEs are CDFIs, and not all CDFIs are CDEs. A CDE's certification is tied specifically to its function within the NMTC program framework to provide specific types of investment capital, often as a conduit for capital gains tax credit benefits.

FAQs

What is the main purpose of Community Development Entities?

The main purpose of Community Development Entities is to act as financial intermediaries that channel private investment into low-income communities through programs like the New Markets Tax Credit, stimulating economic development and job creation.

How do investors benefit from Community Development Entities?

Investors benefit by receiving federal tax credits (specifically the New Markets Tax Credit) in exchange for making equity investments in certified CDEs. This credit offsets a portion of their federal income tax liability.

Are all Community Development Entities non-profit organizations?

No, Community Development Entities can be either for-profit or non-profit organizations. However, for-profit CDEs are typically the ones that can issue the New Markets Tax Credits to investors¹. Non-profit CDEs may operate by transferring their allocation to a for-profit subsidiary CDE.

What kinds of projects do Community Development Entities fund?

CDEs fund a wide range of projects, including small business expansions, manufacturing facilities, commercial real estate developments, healthcare facilities, schools, and community centers, all located within eligible underserved communities.