by Barbara Ray
Are Opportunity Zones a boondoggle for investors or a way to build opportunities in neglected neighborhoods?
Jared Kushner is on board. So is Anthony Scaramucci and the reformed 1980s junk bond king Michael Milken. Opportunity Zones are grabbing headlines and getting investors’ attention with a tax break that could potentially funnel billions of much needed capital into low-income communities.
Ushered in by senators Cory Booker (D-NJ) and Tim Scott (R-SC) on just six pages of the massive 2017 federal tax overhaul, the new legislation allows wealthy investors to defer capital gains taxes—which range from 15 to 20 percent of the profit on investments — if they invest the gains (via a specially designated Opportunity Zone investment fund¹) in low-income census tracts for at least five years. But the big prize comes if they hold the investments for at least ten years, when any appreciation on the new investment becomes tax-free. So if a $5 million investment is worth $9 million after a decade, the investor has a $4 million tax-free gain. Investors can start a new business or build a new property — which is encouraged — or they can “substantially improve” an existing business or property.²
In short, Opportunity Zones could create a market where there currently isn’t one — investing in communities that have otherwise been overlooked. So far, upwards of 250 Opportunity Zone Funds have been created, with approximately $63 billion in potential funding on the sidelines ready to go, according to the Novogradac Opportunity Funds Listing. The US Treasury estimates that at least $1 trillion will be invested in the approximately 8,700 Opportunity Zones over the next 10 years. If true, Opportunity Zones will be the single largest U.S. community development initiative undertaken in the last 30 years.
But there is one aspect of the Opportunity Zone legislation that is giving people pause: there currently are no guardrails. The legislation is open-ended with little guidance on details or regulations in place for transparency. Like with most tax incentives, investors are under no obligation to inform local authorities that a project is using Opportunity Zone tax breaks. There are no restrictions on who can own, manage, or set up an Opportunity Zone Fund. And there currently are no requirements that the IRS ever disclose who has used Opportunity Zone tax breaks. Although the original bill included reporting requirements, they were stripped out for parliamentary reasons during the bill’s passage.³ Bill S-144 introduced in May 2019 by Cory Booker is seeking to add back the reporting requirements, though it has not moved beyond committee hearings. As of November 2019, lawmakers on both sides of the aisle have expressed interest in boosting reporting requirements on any effect on low-income communities.
This lack of oversight opens up the field for projects such as the Springhill Suites by Marriott development in Tempe, Ariz., or student housing near campuses, or in the case of Hall Labs in Provo, Utah, offering investors a chance to buy into a portfolio of start-ups created to commercialize the lab’s innovations. Or hot dog stands. Conceivably, an investor could buy 100 acres of raw land in an up-and-coming neighborhood, put up a hot dog stand to satisfy the requirement that the investment be a “trade or business” and ten years later sell the land and take the profits, tax-free.
Others worry that the investments will fuel gentrification and displacement. If ever there was a specific tool to jumpstart gentrification, experts say, this is it. Investors are unlikely to be interested in seriously struggling communities nor are they likely to aim for those neighborhoods that have already tipped. Instead, like Goldilocks, investors are looking for that just-right neighborhood that has strong upside over the next ten years. “We typically invest in the path of growth,” Origin Investments co-founder Michael Episcope told Bisnow. Origin Investment is an Opportunity Zone Fund that raised $105 million from 425 investors in just 17 hours.
Still others worry that the subsidies will go to projects that would have been built regardless, like the Bryant Street development in Washington, DC, a large mixed-use project along Rhode Island Avenue.
It was well underway, according to the developer, before the Opportunity Zone legislation passed, but now they intend to take advantage of the tax deferrals. Land speculation is also an issue. According to a report by Real Capital Analytics, the number of development site purchases in Opportunity Zones jumped 75 percent from the same time the prior year, and most were speculative purchases, the analysis finds.
“People should be skeptical but not cynical.”
“The fear is that the money would move so quickly into the path of least resistance it will undo the good work underway in communities,” Kresge president Rip Rapson told Money Matters podcast. “Such short-termism obliterates the long-term goals of building healthy, sustainable cities.”
But the free-for-all doesn’t have to be inevitable, say others. Several groups are working to ensure that the investments do what they were intended to do: help low-income and overlooked communities. With concerted effort and a watch-dog eye on the prize, Opportunity Zones can still bring opportunity, they say.
“Opportunity Zones can provide the connective tissue to get investors to take a look at places where they haven’t traditionally gone.”
“People should be skeptical but not cynical,” the father of Opportunity Zones, John Lettieri, president and CEO of the Economic Innovation Group, told attendees at the Mastercard Summit for Inclusive Growth in October. “Opportunity Zones can provide the connective tissue to get investors to take a look at places where they haven’t traditionally gone,”Lettieri said.
The Economic Innovation Group is a DC-based public policy organization started by Facebook’s first president Sean Parker, Steve Glickman, and Lettieri. When it launched, Parker was keen to develop a new kind of investment tool to bring money into low-income communities, which ultimately became the Opportunity Zone legislation.
The Build Healthy Places Network talked to more than a dozen experts about the new law, asking about any upside to the legislation and how the community development and health care sectors might use Opportunity Zones to drive new projects to low-income communities to address the social determinants of health that create such stark health disparities between low-and higher income communities.
The interviews point to three ways Opportunity Zones can help:
- By speeding up development in struggling communities and giving wealthy locals a way to keep their money local;
- By focusing investors on social impact and giving them the tools to do well by doing good; and
- By infusing rural communities or declining small cities with much-needed capital. But as of yet, there seems to be little investor interest in using the tax breaks in truly neglected, low-income urban communities.
Speeding Up Needed Development and Giving Local Money a Reason to Stay Local
Erie, Penn., was one of the first mid-sized cities to see the potential of Opportunity Zones to spur development in areas struggling with deindustrialization. It quickly organized a team to petition the governor to name the eight Opportunity Zones the city wanted, and it was also the first in the nation to create a business development prospectus for Opportunity Zone investors, with the help of Accelerator for America. Accelerator for America is an economic development think tank that is helping communities attract Opportunity Zone investments to benefit underserved communities and not just wealthy investors. It has to date partnered with 45 cities, according to its executive director Rick Jacobs.
For Erie, the planning has paid off by bringing fresh capital to much needed projects, said John Persinger, the director of the city’s Downtown Development Corp.
“We needed to shock the system with a significant amount of energy — investment, development, new housing, and commercial activity in Erie.”
Erie’s is a classic tale of Rust Belt deindustrialization. The city has lost more than one-fourth of its population (or roughly 40,000 people) since 1960 and now stands at fewer than 99,000 people. Businesses closed, vacancies spread, and a sense of hopelessness set in. In a four-block radius in downtown, 11 of the 40 storefronts are vacant, said Persinger. A prime stretch of land overlooking a park is practically empty, akin to living in a neighborhood where 40 of 50 homes are vacant. Money wasn’t exactly flocking to Erie in other words.
According to Persinger, the city needed about $150 million to jumpstart Erie’s failing heart. A private firm that conducted a comprehensive plan for Erie said it would take 25 years to rebuild using only public funds like New Market Tax Credits or Low Income Housing Tax Credits. Erie couldn’t wait that long, Persinger said. “We needed to shock the system with a significant amount of energy — investment, development, new housing, and commercial activity.” And that meant private, faster money.
“Opportunity Zones were a good tool for that,” Persinger said. “They could compress the timetable.”
Erie Opportunity Zones
Investors seeking to invest in Opportunity Zones send their capital gains to a designated Opportunity Zone Fund. The Fund, run by money managers ranging from individuals to large investors like JP Morgan Chase or Morgan Stanley, direct the money to the specific project in an Opportunity Zone, whether that be a hotel or a community health clinic.
“Opportunity Zones are why we’re able to do this.”
Erie’s $50 million Opportunity Zone Fund was launched by the city’s main anchor institution, Erie Insurance, a Fortune 500 company, though not all of that amount will necessarily be used in Erie alone. The city’s downtown redevelopment is focused on building a culinary arts district and small business incubator as well as new housing, office and retail space. Beyond downtown, the Erie Innovation District is focused on building infrastructure to cultivate a high-tech economy. The District hopes to form an additional $10 million Opportunity Zone Fund, said Brett Wiler, director of capital formation at the Flagship Opportunity Zone Development Company.
“Opportunity Zones are why we’re able to do this,” said Persinger, referring to the scale of redevelopment in downtown Erie. He sees Opportunity Zone funds filling a gap of about $25-$75 million of the $150 million needed to do everything he and the city envision.
Across town on the east side of the city is a long-neglected neighborhood that is also in an Opportunity Zone. The neighborhood is the focus of Hamot Health Foundation, which works in close collaboration with the local health system, the University of Pittsburgh Medical Center (UPMC) to support community health initiatives. The neighborhood has significant health disparities and residents leaned heavily on the ER because few had a designated medical provider.
The Foundation and UPMC Hamot had begun investing in the neighborhood prior to Opportunity Zone legislation to address the social determinants of health, but they see Opportunity Zones as an “important tool in our toolbox,” said Hamot Health Foundation president Charles (Boo) Hagerty. Affordable, high-quality housing is a big part of that effort to address the social determinants of health, Hagerty said, as is green space, housing repairs for deteriorating homes, and other neighborhood infrastructure, including a physician’s office in the heart of the neighborhood.
Opportunity Zone money, he thinks, may be the last in, but can be an important source of money for the neighborhood. “Because everything is lining up now, I think we’ll find developers who will want to build the affordable housing, and I think the Opportunity Zone money will then come in as icing on the cake.”
Opportunity Zones are “an important tool in our toolbox” for addressing social determinants of health.
Erie is a model for others, said Accelerator for America’s Rick Jacobs. “Not every place has a Fortune 500 headquarters like Erie does, but many have other large companies.” Opportunity Zones, he thinks, could be the beginning of local wealth discovering a way to invest at home instead of sending their money to Wall Street.
“There’s a lot of wealth in communities across the country,” Jacobs said. “Those wealthy individuals can do what everyone does — give their money to a money manager and see the money invested elsewhere. We’re saying, invest some of it at home.”
Opportunity Zones, he thinks, could be the beginning of local wealth discovering a way to invest at home.
Persinger would agree and he’d add another source of local money — the tsunami of retiring small manufacturers in the region. “There’s many cases where ownership is about to retire without succession plans. When they sell, he said, the money from the sale “goes to money managers in New York and the owners retire to Florida.” Although these owners often prefer to keep their money local, Persinger said, it hasn’t made financial sense given the risk. But Opportunity Zones could change that. “What we’re trying to do is when they sell, let’s capture those capital gains and invest them into projects in Opportunity Zones.”
Nudging Private Equity Investors to Do Well by Doing Good
The intent of Opportunity Zones is to get new forms of capital into communities most in need. And while some investors will no doubt use this tool to make as much money as they can, other investors may find there is now a way to more easily have a social impact as well — to do good while doing well.
The recently released OZFramework is designed to be the guide dog for these investors. Created by the U.S. Impact Investing Alliance, the Beeck Center for Social Impact + Innovation at Georgetown University, and the Federal Reserve Bank of New York, the Framework gives investors an overarching set of principles to follow for social impact.
“It tries to lay out practices in community development more broadly,” said John Cochrane, manager at the U.S. Impact Investing Alliance and who had a hand in developing the guidelines. Geared to the Fund managers, the framework offers guidelines on community engagement, equity, transparency, measurement, and outcomes.
The framework “helps investors get their head around how they actually are impact investors,” he said. “We’ve been really encouraged by the breadth of folks willing to have the conversation with us.”
“It’s so critical that the investors don’t rip the asset out of the community after ten years and leave nothing behind.”
The framework pays special attention to exit strategies, he said. “It’s so critical that the investors don’t rip the asset out of the community after ten years and leave nothing behind” — something they could easily do given that the real financial benefit comes from the sale of the investment after ten years when its appreciation in value goes untaxed. It’s here, he thinks, that a role for CDFIs and philanthropy could emerge. A local CDFI, for example, could help a nonprofit fund the purchase of the health care center when the investor is set to leave.
Not everyone believes in the magnamity of private capital, however. Sometimes it will take more explicit oversight. The Kresge Foundation, for example, is experimenting with quid pro quo (the good kind). The foundation committed $22 million to an Opportunity Fund with two partners. In exchange for Kresge’s risk mitigation against future losses, the Fund (with an $800 million target) has committed to tracking the social impact of their work in communities and other related covenants.
“You can spend a lot of time and energy telling markets what the social responsible thing to do is, said Kresge president Rip Rapson during the Money Matters podcast, “but in the end, it’s real investors seeking real returns.”
This approach, they hope, will signal to the market that there is a third way — capital can be deployed responsibly and still make money. “If we can demonstrate early on that this has value,” Rapson said, “we can get more of our philanthropic partners on board. This covenant could be a model for others.”
Enticing Opportunity Zone investors to do the right thing is also on the mind of Dr. Suzet McKinney. As CEO of the Illinois Medical District (IMD) in Chicago, McKinney is using an Opportunity Zone to bring in capital to the District’s ambitious plans to build a life science district in a struggling part of the city.
McKinney draws a direct line from jobs to better health.
The District consists of 560 acres on the city’s West Side, a stretch with high poverty rates and large health disparities. Anchored by four major hospitals and two medical universities, the IMD will knit together several major health systems in the area. When completed, it will include the existing medical research facilities, labs, a biotechnology business incubator, and more than 40 health related facilities along with new retail, a hotel, and new residential buildings to support the life sciences hub.
The goal is to revitalize the area and, most important, bring jobs to the community. With an unemployment rate of 25 percent in the Opportunity Zone in the IMD, it is work that cannot wait. McKinney draws a direct line from jobs to better health. The stability and income that a steady job provides steadies lives and reduces stress. Jobs also mean the larger community benefits as well. And in the case of the IMD, 40 percent of life sciences jobs, she notes, require only a high school degree or GED.
The IMD has an advantage in steering Opportunity Zone money to do the right thing: As a unit of local government, it has oversight to regulate zoning, permits, and other inducements to development. The IMD can also wield influence through its role in selling land.
“Since we know Opportunity Zones are going to be advantageous to developers, the question is, how can government and health care institutions ensure that they benefit the community?” she said. “That’s something we take seriously here.”
“Opportunity Zone investments will always require some entity to lead and entice it to do what we want it to do.”
In other words, developers can’t just come in and put up a hotel, she said. She regularly engages nonprofits, CDFIs, developers, and others with vested interest in the area to keep the projects in line with community needs.
“Dr. McKinney might become a poster example of that confluence between health care and community development,” said Accelerator for America’s Rick Jacobs. “Opportunity Zone investments will always require some entity to lead and entice it to do what we want it to do,” he said.
Driving Money to Overlooked Areas in Rural Communities
Opportunity Zones are not only in urban areas. In Colorado, for example, 60 percent of its Opportunity Zones are in rural areas. “There,” said Jana Persky, Opportunity Zone program director for the state of Colorado, “the tenor of the debate is different. Any investment is considered good investment.”
Opportunity Zones, she said, are a way to thread a difficult needle. “It’s an imperfect policy that has the potential to do really cool things,” she said. With intentional policies, they’re hoping to help the tax program realize its full potential while mitigating the negative impacts.
“It’s an imperfect policy that has the potential to do really cool things.”
In Montrose, Colo., in the high mountain desert on the western side of the state, Chelsea Rosty, director of business innovation for the city government, is excited about the potential of Opportunity Zones. Montrose is a neighbor to popular Telluride and has long been a trading hub for the mining and agriculture industry that once dominated the region. Today it’s growing like gangbusters, slated to have the fastest population growth in the western half of the state. That population growth has led to rental occupancy rates of zero, said Rosty. The town needs to build to stay ahead of the curve, and to do that, it needs money.
Rosty spent months reading everything she could get her hands on about Opportunity Zones before she began putting Montrose on investors’ radar. “The state’s economic development office told us that Opportunity Zones will be the biggest economic development tool in our lifetime. We wanted to be on the front of that and not let the development happen to us,” she said.
She and her team created an in-depth prospectus for investors and soon began to see the results. A group of former hedge fund owners loved the area and wanted to invest. The investors came armed with a $500 million Opportunity Zone Fund
In rural areas “the tenor of the debate is different. Any investment is considered good investment.”
“Some investors are looking at the bottom dollar, and rural communities don’t have the numbers,” Rosty said, meaning the returns just aren’t there. “This group, though, wants to invest in rural Colorado. We’re lucky they found us.” The Fund — Rosty could not divulge the investors pending finalization — joins Rural COZ, another Fund focused specifically on rural areas in Colorado.
Given the population boom and lack of housing, Montrose was already working on a 168-acre mixed-use housing and retail development along the river, but the Opportunity Zone investments sweetened the deal, Rosty said. She sees Opportunity Zone funding as an important source among the many funding sources needed for housing developments in rural areas. Without these kinds of tax incentives, she thinks, rural areas will see only “passion projects.” Opportunity Zones “make it so they can be both money-making and passion projects, but also happen much quicker than they would have without the Opportunity Zone investment.”
What Role for Affordable Housing?
One of the key social determinants of health is housing — a safe, affordable home reduces parental stress, which benefits children’s social and emotional development; a home free of lead and mold helps reduce asthma flare-ups and brain health. Healthy housing also supports neighborhood health through tax revenue and home values. Improving the neighborhood and improving health leads to higher real estate values, walkability, new jobs, and more. It might be tempting to see Opportunity Zone Funds as a much-needed infusion of cash to build this affordable, healthy housing. But don’t hold your breath, say some experts. The main source of funding for building affordable housing, the Low Income Tax Credit (LIHTC), doesn’t play well with the Opportunity Zone tax breaks.
In the past year, only about five deals have closed in which investors used their capital gains in a LIHTC deal in an Opportunity Zone.
“I don’t think anyone has cracked the code yet on how to attract capital gains into the LIHTC investment space,” Brett Macleod of JPMorgan Chase told the audience at an affordable housing summit.
In the past year, only about five deals have closed in which investors used their capital gains in a LIHTC deal in an Opportunity Zone, said an executive at a low-income housing tax credit syndicator. The handful of deals accounted for less than 1 percent of the $6 billion LIHTC market, the executive said — and the first year is the most opportune year to invest due to program regulations. The lack of interest is because banking institutions — the biggest investors in LIHTCs, accounting for approximately 98 percent of the investor market — rarely have capital gains. Because they are such big players in the LIHTC market, this limits the pool of potential investors to just a handful of banks that might have a one-off capital gain event in a year, such as the purchase of a small regional bank.
Community Development Financial Institutions (CDFIs) are also not typically equity investors, like most of the Opportunity Zone investors will be. Equity is a much riskier and expensive form of financing and therefore the equity investor wants greater control of the project than a lender does, according to a report by Charles Tansey and Michael Swack, and there are also differences in how the two groups approach due diligence, underwriting, and other elements of the deal. There is a reason that, with but few exceptions “nobody ever provides both debt and equity to a project,” Tansey and Swack write, “because the interests of the two are in opposition.”
Nor is rehabbing or otherwise preserving affordable housing a good fit, experts say, because those projects don’t add significant improvements to the properties as the Opportunity Zone legislation requires, and therefore are not eligible for Opportunity Zone capital. (A “substantial improvement” must equal the original investment (basis) plus $1, according to the legislation.⁴) An exception is if the building has been vacant for at least five years, in which case the “significant improvement” stipulation is waived. That could create an incentive to oust tenants and keep a property vacant for five years before selling them to a Fund, or to raze the building and create a parking lot, which would meet the stipulation that a business can replace a vacant property and avoid the “substantially improve” requirement.
That could create an incentive to oust tenants and keep a property vacant for five years before selling them to a Fund.
Some developers have nonetheless dived in. SoLa Impact Capital — a $100 million Opportunity Zone Fund in Los Angeles — is working on affordable housing projects in Opportunity Zones there. Mostly funded by high net worth social impact investors, SoLa Capital has opened Beehive, a coworking space and entrepreneurial hub for small businesses operating in Opportunity Zones in south LA. It also plans to build between 1,500 to 2,5000 units of affordable housing, according to Forbes
Commercial spaces in affordable housing developments might also be a possibility for Opportunity Zone investments. While LIHTC investors typically shun commercial spaces because of the added risk, Opportunity Zone investors are looking for just those kinds of profit-generating investments. A health center or a grocery store on the ground floor of a housing development might be a good fit for such an investor or the Opportunity Zone investor could provide the capital to a nonprofit to buy and operate the business. CDFIs could also direct their efforts to small businesses in Opportunity Zones.
Ways to Still Make This Work
Contrary to many assumptions, it’s not too late to get ahead of Opportunity Zone investments and ensure that they do benefit low-income communities. While investors are circling, not much money is moving yet. A recent Novogradac survey finds that Opportunity Zone Funds have raised less than 15 percent of their goals and even less has gone out the door. “Every manager I talk to is saying gaining traction is slower than expected,” said John Lettieri of the Economic Innovation Group.
Regulations such as housing trust funds, renter protections, anti-displacement protections, inclusionary zoning restrictions, or zoning overlays with equity impact requirements are all ways to check Opportunity Zone abuses.
It will take concerted effort to prevent Opportunity Zones from descending into a boondoggle for the rich. State, county, local and federal oversight will be needed if the tax incentive is to truly benefit low-income communities, experts say. Regulations such as anti-displacement protections, renter protections, housing trust funds, inclusionary zoning restrictions, or zoning overlays with equity impact requirements are all possibilities. Congress appears to be taking note after several negative articles pointed to favoritism in designating Opportunity Zones, the most egregious case involving Michael Milken in Nevada. Key Democrats have also requested that the Government Accountability Office (GAO) monitor the legislation’s implementation and outcomes, including on economic development, job creation, housing and other factors.
In the meantime, local governments may have to take it upon themselves to steer Opportunity Zone investments. City officials in Boulder, Colo., for example, hit the pause button on rapid development in Opportunity Zones while it updated its zoning and land use regulations. The City Council is now researching the legality of requiring investors to provide a larger threshold of community benefits, such as affordable housing.
“I don’t think that Boulder has yet settled on a model to direct Opportunity Zone investments,” said Jana Persky, from the state’s economic development office. “But no city has.”
Philanthropic models like the Kresge Foundation’s covenant with Fund investors are also options. But as EIG’s Lettieri noted at a recent summit, philanthropy overall “has been strangely quiet” on Opportunity Zones. If this law is to live up to its potential, he said, we need the buy-in of all institutional leaders, including philanthropy. Philanthropy, he said, should be taking the lead in shaping the landscape and supporting community organizations as they figure out how to respond to Opportunity Zone investments. It could be building capacity and financing deals, he said, to make projects like grocery stores or affordable housing easier to “pencil out.”
“Opportunity Zones are a perfect example. Everything needed for wealthy investor to make money is baked into the law but the community benefits are not.”
Without more oversight, without more structure, Opportunity Zones run the risk of being just another example of the government’s dismal history of doling out public money to private business with the hope that it will trickle down to those most in need. “Wealth is structured. Poverty is structured,” said Asali DeVan Ecclesiastes of the New Orleans Business Alliance at a recent Mastercard Center for Inclusive Growth summit. “Opportunity Zones are a perfect example. Everything needed for wealthy investor to make money is baked into the law but the community benefits are not.”
 At least 90 percent of the assets of a qualified Opportunity Zone Fund must be invested in an Opportunity Zone property and the Fund is checked every six months. To qualify as substantially improved, the improvement must at least match the original cost of the investment.
 Land that has been vacant for at least five years is an exception to this rule. In addition, a Fund can lease a business that has long existed without the need to substantially improve it. The mind reels at the prospects for loopholes and workarounds.
 Specifically, the Byrd Rule — named for former Senator Robert Byrd –prevents policy provisions with no impact on revenue from being included in a reconciliation bill.
 The requirement is to “substantially improve” any assets located in an Opportunity Zone, but as the Center for Budget and Policy Priorities notes, proposed regulations essentially and inexplicably eliminated this requirement for new business activity in several important circumstances: Opportunity Zone Funds can buy undeveloped land (that is, land without a building or other structure on it) without investing new capital to improve the land (see hot dog stand above). Also if a building has been vacant for five years, the Fund is not required to substantially improve it. It could run a low-investment business on the property, such as leasing the building to a storage facility operator, and sell the building 10 years later tax free.