Digitization Creates Financeability

Reality is analog, but money is digital – and digital reckoning is the lifeblood of efficient commerce. Ever since people began counting on their fingers, converting subjective assessments into quantitative proxies enabled trade between parties who saw the world differently, valued things differently and spoke no language in common. 

On this foundation of digitally expressed self-interest rose the 19^th-century Industrial Revolution and its robber-baronial fortunes, and then a century later the Information Revolution with its burgeoning panoply of digitized instruments: securitization, mobile money and cryptocurrency.  More than efficiency, digital trading is addictive: each transaction, no matter if it wins or loses, is a dopamine hit, and the hunger for these has driven state lottery jackpots, fantasy sports betting, day traders and other behaviors that need not be profitable so long as they are compulsive.  Regardless of profitability, however, money is a value system, even if its users are unaware of it, and money’s value system is dogmatic: What cannot be quantified is not valued, and what is not valued cannot be financed.

There lies the rub for social-impact investing.

Impact is the ultimate analog occurrence. Impact goes beyond ‘decent, safe and sanitary’ (the 1949 definition), beyond the enumeration of amenities available (used or left idle), and into the quality of life and opportunities for moving people to independence, households to economic uplift, and the inclusion (both real and perceived) of those excluded by circumstance, legacy system or intention. Impact also lies either in the unknown future or the unknowable human soul, and neither is remotely digital. In pursuit of impact, therefore, sponsors and financiers seek observable binary or quantitative proxies – a high school diploma as a predictor of future self-sufficiency, and a grade point average as an indicator of future economic success. 

These proxies, being both internally personal to the individual and externally delivered via entities, are presumed to be objective and consistent (though in reality, neither is), but what about improvements to the property? Paints low in Volatile Organic Compounds (VOCs) may improve air quality and help children’s future health; photovoltaic windows may reduce energy consumption; and solar panels will reduce dependency on fossil fuels, but none of these incontrovertibly pay for themselves in basic underwriting. To make the numbers work, all of them need some concessionary capital, up through and including grants, and that capital is concessionary only in pursuit of impact.

The Low Income Housing Tax Credit (LIHTC) system solves the analog-to-digital problem via Qualified Allocation Plans (QAPs). As its ultimate prize is the ultimate soft capital—LIHTC equity, monetizable into anywhere between 70 and 95 percent of total development cost (TDC)—a state housing finance agency is able to impose its own value judgments on the LIHTC marketplace by making these impact proxies administrative minima or awarding them additional QAP points. Either way, the digitally responsive development community figures out how to supply them.

Moving beyond LIHTC and its governing impact on soft equity, debt pricing offers a further realm for converting analog into digital, via green and sustainability standards, where currently there is burgeoning competition to be the quantitative referee of virtuous housing:

• The global market leader is Leadership in Energy and Environmental Design (LEED), pioneered by the United States Green Building Council (USGBC) and continuously evolving, with the additional feature of asset-class specialization, tiering of standards and a scoring menu; and
• Beyond LEED, the British and European competition (BREEAM), WELL ( a holistic approach to health in the built environment) and Fitwel (boost your 2025 ESG Performance with Fitwel!) have offered their variants.

All of them, and more that are being spawned, are now maneuvering to be seen as surfing-edge of both analysis and virtue. As one example, WELL prescribes and evaluates multiple elements in the air (VOC levels, ventilation, non-smoking buildings, filtration), water (including handwashing and sink size), nourishment (points for fruits/vegetables in the lobby, eating spaces and education) and movement (ergonomics, furniture adjustability, bike racks, lockers and showers). All of these earn points and contribute to the overall rating. And WELL, like the other standards, periodically adds categories, and then objects with the categories. There is currently no check on the standards employed by the standard-makers, and instead an arms race to capture market share.

Although each standard implicitly promises that the rated entity or building will be perceived as virtuous and artfully avoids any mention of costs or payback, most implicitly tout hard economic benefits. This leaves the economics of the business case up to the capital markets—by how they dial the knobs of financial products. When an analog concept (e.g., ‘sustainability’) is converted into a digital metric (score points or rating tiers), preferably by an entity perceived to be both technically qualified and financially independent, that score can boost financeability to the extent the capital provider wishes. (This is the market lesson of QAPs.) The capital provider’s perception of impact can be directly converted into access to friendly grants (e.g., Enterprise Green Communities) or more favorable loan terms (e.g., Fannie Mae green mortgages), including savings on the interest rate. Financial institutions seeking either regulatory or public-relations kudos for their virtue will pay more for loans adjudged as worthy, the perception of impact as adjusted by ratings or standards proxies can also be converted indirectly, for instance by qualifying for a preferred financing instrument (e.g., the ‘innovative financing’ CRA test, established in 2019), which in turn is evaluated by another impact-judging entity, such as the Office of the Comptroller of the Currency (OCC).

The financial ecosystemic scaffolding of digitizing impact now taking place in the Information Revolution echoes the Industrial-Revolution capital markets’ pioneering a little more than a century ago by the bond credit rating agencies (Moody’s founded 1909; Standard & Poor’s established its credit ratings in 1914; Fitch in 1913). All of them got their start around the time of the Wild West era of structured credit offerings, whose Roaring 20s brought us the 1929 stock market crash, the credit-crunch-induced Depression and the 1933 and 1934 enactment of securities legislation and the launching of the Securities and Exchange Commission (SEC), whose registration requirements and disclosure standards became the new and long-lasting sheriff in town.

Today, we are in our own Roaring 20s of digitizing green and sustainability impact quantification proxies. For affordable housing developers, and very soon for any housing developer, achievement of green/sustainability accreditation is rapidly becoming not a luxury but a necessity. 

Before seeking a green blessing, however, a sponsor should be very, very careful in choosing one to pursue. Just as money is a value system, a third-party’s rating algorithm is a value system, and it’s not the market’s, it’s theirs. Already the capital markets are reverse-engineering their products to match green or sustainability standards in the same way that bond pricing has been for decades reverse-engineered to credit ratings.

Money, the most enduringly useful of human inventions, brings volume and order to capital markets. Digitization accelerates the production and exchange of value for money and spawns new financial product innovation.

In short, digitization doesn’t just create financeability; digitization creates financing.