The 2017 Tax Cuts and Jobs Act established Opportunity Zones, designated census tracts in which capital gains on investment are not taxed under certain conditions. The zones were sold as a means to spur economic development and job creation in distressed communities, yet as we enter 2020 the zones are a point of contention among policymakers. Critics argue that they are simply tax cuts for the rich masquerading as entrepreneurial efforts to help the poor. Supporters preach patience, arguing that the observed investments in high-priced luxury real estate will, in time, help the people that the policy claims to prioritize.
The basic impulse to direct capital to low-income areas through tax breaks is the correct one but, to bring about long-term prosperity, Opportunity Zone rules must strike a balance between maintaining investment incentives and ensuring that investments are aligned with sustainability standards.
The 1939 classic film, The Wizard of Oz, might help explain why sustainability considerations, or ESG criteria, are necessary. Sure, “OZ” is common shorthand for Opportunity Zones and that is certainly a fun coincidence, but there are several genuinely important lessons we can draw from this fictional story that should be applied to the newly chartered zones.
In the movie, a girl from rural Kansas is transported to a magical place called Oz. She learns of a powerful wizard who can help her return home. To earn his assistance, the girl teams up with a brainless Scarecrow, a heartless Tin Man, and a cowardly Lion to deliver a valuable witch’s broom to the wizard. Upon completion of their quest, they discover that the mighty wizard exaggerated his abilities and is, infamously, just a man behind a curtain.
Here, we see a geographic area full of wonder, promise, and a variety of problems. Usefully, this is exactly how Opportunity Zones are framed. We also see a lost, unsuspecting main character (read: the residents of Opportunity Zones) surrounded by supporting characters (aka policymakers and investors) who lack either intelligence, empathy, courage, or transparency. All ends happily largely because the influential supporting cast addresses their shortcomings along the way. For real life Opportunity Zones to script their own satisfying endings, we must approach these census tracts in a manner that is similarly knowledgeable, compassionate, bold, and inclusive.
First, consider the Scarecrow. Investors are wisely beginning to put their capital in cities that have already demonstrated environmental resilience because the threat of strengthening and increasingly frequent extreme weather events heightens the risk associated with infrastructure and real estate. Putting money into areas at significant risk for environmental hazard is simply not good business. Therefore, if resilient cities are attractive investments, the next logical step would involve building more of them.
Troublingly, banks are noticing the financial toxicity of climate change, and are shifting mortgages on climate-vulnerable homes to Fannie Mae and Freddie Mac. These are dangerous mortgages because properties at risk of climate damages are currently significantly overvalued. Due to a lack of proper investment into resilience, banks are behaving eerily similar to how they were leading up to the 2008 financial crisis. So, while investors certainly must navigate local issues, they must also invest with long-term strategic foresight in these zones for the sake of national economic well-being. Knowledge is money and, as evidence of climate continues to amass, this should incentivize Opportunity Zone investors to embrace sustainability.
Second, consider the Tin Man. Tracts qualify to be Opportunity Zones because they face some combination of high unemployment, blight, resource scarcity, inadequate infrastructure, and economic immobility. Yes, Opportunity Zones very well may be a boon for capital investors, but the interests of OZ neighborhood residents must be prioritized, and economic activity absolutely cannot come at the expense of these vulnerable communities. These census tracts are not playgrounds for millionaires to just visit, wreck, and then depart from. Leading with the heart means investing with sustainability in mind.
Say, for instance, the advocates for these zones are ultimately correct and an influx of capital does create meaningful and inclusive benefits to the zones. If those housing, commercial, and transportation infrastructure projects do not take social and environmental impact into account, any prosperity low-income households might enjoy will be short-lived.
Extensive literature exists on how poor environmental quality is associated with spikes in crime, greater risk of developing psychiatric disorders, increased diabetes rates, more frequent injury deaths, and an average life expectancy decrease of approximately three years. Pollution is often more highly concentrated in low-income areas that qualify to be Opportunity Zones as well. The last thing they need is more pollution in the air brought in by out-of-town investors.
This research does not send warnings of potential future harm, it signals the real present-day consequences of failing to interact responsibly with our environment. These outcomes harm intergenerational health, labor force participation rates, public safety, and community cohesiveness in Opportunity Zones. To ignore these red flags is to concede that these zones are deceitful, ill-intentioned ploys designed to profit off of economic hardship. If investors truly intend to make win-win investments, they must use their capital to address underlying environmental issues.
Next, consider the Lion. Climate change will disrupt the status quo, and what worked in the past will very likely not work in the future. Investors cannot fall back on familiar assets. They will need to be brave enough to invest in nascent and emerging industries such as clean energy. Opportunity Zone rules ought to be amended in order to make it more difficult for investors to pull capital out of a zone after only a few years. Therefore, policymakers need to brave enough to compel such long-term engagement.
Furthermore, part of building a resilient and sustainable place means designing with an expectation of change and putting an emphasis on flexibility and adaptability. Nascent and unforeseen industries, services, and products will change the labor market in the next few decades. The projects that are funded now must be nimble and responsive enough to handle this inevitability. For instance, are new buildings designed to eventually be repurposed or merely for immediate convenience? Preparing for change might make some feel uncomfortable, but we need to learn from the Lion because such change is necessary.
Finally, consider the Wizard. Opportunity Zone policy structure lends itself to a top-down development process. However, quality planning welcomes bottom-up decision making as well. Locals are experts in their neighborhoods. Residents experience firsthand the unique daily challenges and inefficiencies of their communities. They also have a more intimate understanding of their human capital and the skill sets of their neighbors.
But it is more than a mere matter of the doing right by these populations. Projects that are successful generally meet three thresholds: feasibility, viability, and, too often overlooked in top-down processes, desirability. In fact, giving people things they did not ask for can even be detrimental to poverty alleviation efforts, as was the case with TOMS Shoes and PlayPumps.
The Wizard of Oz illustrates the virtues of personal growth and self-reliance, but the Wizard himself reminds us to remain cognizant of our limitations. Outsider investors are limited in their knowledge of what makes targeted communities thrive. Therefore, it is in the best interest of all parties for investors to be humble, transparent, and attentive to the needs of the residents in zones they are engaging with financially.
Take transportation infrastructure projects, for instance. It is easy to view highways and car-centric roads as platforms for regional connectivity, secondary economic benefits, and investor profit. But there is a reason why real estate in walkable, pedestrian-safe, resource-dense places appreciates much faster than in car-dependent areas. People generally value close proximity to food, schooling, health care, civic institutions, parks, cultural amenities, and jobs so highly because it affords them the luxuries of time, convenience, and reliable accessibility. Rather than longer but faster commutes, people consistently want shorter but slower routes around their communities. In order to get the most bang for their buck, investors must be sensitive to local desires such as these.
For all the problems with Opportunity Zones, the core premise remains a good one, and it is salvageable. Planners, policymakers, and investors simply must adhere to sustainability guidelines and invest in resilient, low-impact, net-zero emissions projects that put people first. To do this effectively, they ought to leverage all available tools to engage with residents of Opportunity Zones. It is worth re-emphasizing that walkable streets, clean renewable energy, and ecosystem services are not only desirable and beneficial to residents, they are also profitable to investors. Therefore, adapting to these requirements is more than reasonable, it is financially prudent.
However, guaranteeing the property rights of residents as well as introducing carbon, developer-bearing congestion, and commercial land-value taxes are justifiable enforcement recourses should investors not voluntarily opt to finance zones responsibly. These mechanisms, put in place while maintaining tax-free status for capital gains, would nudge investors to make more sustainable decisions.
All told, Opportunity Zones are aptly named. Under these tax rules, underserved communities can see real benefits. Investors ought to see these zones as blank slates that possess the framework necessary to support healthy and strategic growth. They are brimming with potential to become productive, vibrant, human-centered neighborhoods. But their prospective investors must embrace sustainability principles to truly capitalize on the opportunity. A tax-free trickle-down haven that lifts entire cities out of poverty is a dreamy concept, but it is time to wake up and live in reality… because there is no place like home. And the best homes are built with stewardship and sustainability at the foundation.