The Tax Cuts and Jobs Act of 2017 included a provision for Opportunity Zones, which are a new community development program to encourage long-term private investments in select low income census tracts. Taxpayers who invest capital gains into “Opportunity Funds” can receive a federal tax incentive. These Opportunity Funds can then invest into projects in census tracts designated as Opportunity Zones with the stated goal of boosting economically-distressed communities.
In Greenville County, SC, nine census tracts have been designated as Opportunity Zones (click here for map). The selection was made through nomination by Governor McMaster and subsequent certification by the Secretary of the U.S. Treasury.
Some of these census tracts, such as the one located south of I-185 in the central southeastern part of Greenville County, could certainly benefit from private capital to add housing and jobs. But others, such as West Greenville, are already seeing significant investment, and some fear that gentrification will be accelerated with this added incentive.
Regardless of the risk and opportunity in Opportunity Zones, they are now part of the tax code, so it’s worth understanding them and how to put them to use. As Senator Tim Scott of SC – one of the main sponsors of the legislation – said in a recent article in Forbes, “You can paint all types of possible scenarios, but I have 50 years’ worth of evidence showing the risk of doing nothing.”
Will Lambe with Enterprise Community Investments presented an overview of Opportunity Zones to the November 2018 Greenville Partnership for Philanthropy meeting, held in partnership with the Ten at the Top Alternative Capital Providers group. The meeting was also attended by members of the Nonprofit Alliance, representatives from local and state government, developers, and economic development professionals. (Click for slide deck)
Will explained some of the details around Opportunity Funds. The tax code creates special treatment of capital gains through Opportunity Zones. There are $6 trillion in gains in the U.S., and the provision incents investors to realize the gain and move the capital into an Opportunity Fund which will invest in an Opportunity Zone. In exchange for the investment, the investor receives a deferral on the gain and gets a write down in the eventual taxes on the gain (based on how long those funds are invested and to a low of 85%). In addition, whatever gains are made on the Opportunity Fund investment can be tax free if held for 10 years.
Will described the current Opportunity Fund landscape as a garden hose with a big bubble of water just before the nozzle, representing gains that have been realized since the passage of the tax bill in December 2017. Investors who realize a gain have six months to invest in a Fund. Once capitalized, Funds have time constraints that compel them to invest quickly into shovel-ready projects. Over time, the supply of capital and the demand for it should even out. Will suggested that we have two to three years from now to develop projects and prepare them for investments from Opportunity Funds.
What projects are in our zones, and how do we tee them up?
Communities interested in attracting and deploying Opportunity Fund capital for projects in their Opportunity Zones need to bear a few things in mind. First, this investment capital is equity – it can’t be deployed as debt. Second, the design of the Opportunity Zone regulations encourage investors to hold fund investments for ten years (with an assumption of profit at that point). So, when looking at potential projects to invest in, Will suggested that fund managers will ask “Can this project take on equity and produce a market rate return, and what is the ten-year exit strategy?”
Regulations regarding the reporting on and evaluation of the community impact of the investments are under development, and according to many writers and experts, the rigor of these requirements will do much to determine whether the community outcomes will match the success of outcomes for investors (see the Wall Street Journal, Forbes, and City Lab).
Enterprise Community Partners aims to maximize the benefits of Opportunity Zones for both the communities and capital providers. Will said that since 1982, Enterprise has invested $3 billion in what are now Opportunity Zone tracts. The Enterprise Opportunity Fund is developing a national pipeline and looking for projects that have been blessed by local governments. They are particularly interested in public-private partnerships (which he noted Greenville is well-known for), workforce housing, job production, and product innovation. Furthermore, regardless of federal evaluation requirements, Enterprise is developing its own proprietary impact measurement system for Opportunity Fund projects.
Will said there are several things that local leadership can do to create an ecosystem that encourages investment. Examples he provided:
- Inform the marketplace
- Develop an online portal on projects
- Give site tours and education
- Write letters of interest
- Incent certain types of activity
- Leverage add-on incentives, gap financing, risk mitigation
- Create public funds
- Pair investments with other sources of financing
- Ease certain development requirements
The best thing local government and interested community members can do is control sites in Opportunity Zones. Will pointed out that people own land, and in distressed communities the manifestation of good things on the land is often a long time away. With Opportunity Funds, investors just want to know, “What will this project look like in 10 years when I exit? Who’s going to buy it from me? What is my exit strategy?” If the community can put forth projects with good answers to those questions, investors will be interested.
As for philanthropy, there are several unique roles in making the most of Opportunity Funds for the good of community. Doing development in distressed markets is hard. Philanthropy has access to resources that can write down the costs of getting a piece of land to the point where it can be developed for the good of the community. Funders can ask, “What is it that we can do to make sites that are of interest to developers more likely to be in service for the community?” Examples are to buy the land, negotiate with the owner of the land, support the process of working out heirs property, and support local government in implementing the aforementioned ideas.
Will was asked about how Opportunity Funds can help with rural development, for in the state there are Opportunity Zones in very rural and impoverished areas, many with predominantly African American communities who are far from capital resources. Unfortunately, Will said he “hasn’t cracked the nut on how to create economic activity where there isn’t any.” The idea behind Opportunity Zones is to unleash economic activity where there is a little. In the end, most investors will be looking for the greatest return on their investment, and very rural areas aren’t typically the environment for this.
Will offered a few final thoughts for attendees. First, investors can invest only in projects, not “areas.” Will has had local governments pitch their Zone areas to Enterprise, but the geography is almost irrelevant. Enterprise and other Fund managers need to know that there are macroeconomic principles present in projects to produce returns. So, local communities need a pipeline of deals in their zones, and you might need 100 project ideas to produce a few that result in investments.
Second, some investors are in the Opportunity Zone work only to make money, but Enterprise and other mission-oriented investors intend to do capacity building along with it so that when their ten-year investment is up, there’s capacity in the community to carry that investment forward under new ownership. Local communities can also be mindful of the post-OF investment landscape in their areas.
Third, individual investors can also roll their own capital into their own qualified investment. They don’t need to participate in an Opportunity Fund to benefit from the tax incentive. The blessing of this is a community can keep both the investment and project local. The curse is that there’s very little transparency regarding where the capital came from, where the capital is going, and what it’s doing.
In the end, Will emphasized that the power is in the pipeline of projects. There is capital all over the place. If you have projects, you have power – you can seize on the capital. This is where local communities can come together with a vision of what they specifically want to happen in their Opportunity Zones. As soon as the project is signed with a particular investor, the community’s power is gone. So local stakeholders can make the most of the opportunity by controlling the land, controlling the decision and the conversation.