Red vs. Blue: Opportunities and Risks of Opportunity Zones in an Election Year

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Ever since the Tax Cuts and Jobs Act of 2017 created the Opportunity Zones program to spur economic development in low-income census tracts, there has been an ongoing debate if the program is really working as intended in distressed communities.1

Advocates of the program claim that it is, pointing to property value increases and the billions of dollars contributed to Qualified Opportunity Funds for investment. Critics of the program claim that Opportunity Zones are simply another wealth redistribution scheme to help the rich while doing little for the poor.

Rising income inequality and policy interventions to address it will likely remain at the forefront in the 2020 general election, according to Pew Research Center.2 In this article, we’ll look at some of the opportunities and risks of Opportunity Zones in an election year that investors may want to consider.

Opportunities of Opportunity Zones in 2020

Although the corporate tax rate was once the most controversial part of the Tax Cuts and Jobs Act (TCJA), Opportunity Zones (OZs) have moved to the front and center of the national debate.3 While the program may likely remain controversial after the elections, there are signs of early success as investment in OZs accelerates:

Opportunity Zones program receives bipartisan support

While national politicians may choose to take sides, the Opportunity Zones program is receiving bipartisan support at the local level due to its creative approach to assisting communities that need it most.4 In fact, 69% of Democratic mayors and 65% of Republican mayors believe the OZ tax incentives are targeting the right areas.

Capital invested in OZs exceeds expectations

The federal government originally estimated that during the first two years (2018 and 2019) the Opportunity Zone program would incent between $10 billion to $13 billion in equity capital investment.5

Now, it appears that between two and three times that amount has been invested in Qualified Opportunity Funds (QOFs), and that amount doesn’t include proprietary or private funds. A recent report from the Council of Economic Advisers (CEA) released in August estimates that QOFs have already raised $75 billion in private capital through the end of 2019 alone, most of which would not have entered OZs without the investment incentives.6

OZ program more important than ever in the midst of COVID-19

Emily Laverly is a legislative analyst for Senator Tom Scott (R-SC), one of the original co-sponsors of the Opportunity Zone legislation. In a recent interview, Emily explains why in the midst of the COVID-19 pandemic, Opportunity Zones are more important than ever.7

During economic recessions, low-income communities like those in Opportunity Zones are often the first hit and the last to recover, often lagging well behind the rest of the U.S. in terms of median family income and population growth. The OZ program is an existing tool that can be used to help ensure disadvantaged communities have a new chance as the recovery from the pandemic continues, instead of once again being left behind.

Key component for supply chain development and manufacturing onshoring

The COVID-19 pandemic has also served as a wake-up call for the urgent need for supply chain re-domestication and manufacturing re-onshoring, to reduce the reliance on foreign entities that the U.S. currently has. Opportunity Zones can be a key component to onshore and secure the country’s supply chains by creating additional incentives to onshore manufacturing facilities into OZs to boost economic development, job growth, and national security.

Risks of Opportunity Zones in 2020

Critics of the Opportunity Zone program claim the zones are “all sizzle, fizzle and the abuse of good intentions.”8 While very wealthy investors love the program, others claim Opportunity Zones are nothing more than a bundle of tax breaks masquerading as economic development:

Project returns should be determined by social impact

A recent article from Bloomberg explains why many skeptics had good reason to doubt the policy promises of economic development and job growth from the Opportunity Zone program.9

The main beneficiaries of OZ projects appear to be wealthy investors who expect a market-rate return from their investment, something that is difficult to achieve by investing in a community business. Because of this, a senior fellow at the Urban Institute thinks the program should be revised so that returns are determined by the social impact of each project, rather than market-rate returns.

Opportunity Zones have helped, but not enough

CNBC notes that while Opportunity Zones have helped some low-income community projects and created a new network of investors and social activists, they have fallen short of their original promise of job creation and community-oriented amenities such as grocery stores.10

According to the report, the program’s main flaw is the 10-year investment time horizon needed to receive the most tax benefits from OZ investments. Ten years is too short for long-term community projects such as affordable housing and too long for illiquid investments such as real estate.

Tax breaks may become more limited

Lawmakers continue to be divided about the amount of tax breaks given to Opportunity Zone investors in exchange for the social impact received.11 According The Pew Charitable Trusts, some Democrats have introduced legislation that would repeal the zones or limit the types of projects that qualify for a tax break. On the other hand, Republicans have proposed expanding the zones, such as allowing disaster recovery areas to qualify.

Vast majority of OZ capital flowing into real estate projects

The majority of Opportunity Zone capital is flowing into real estate projects instead of operating businesses that create jobs as the program was intended to do, helping to further the impression that the program is another wealth creation tool for the 1%.

However, while it’s too early to measure how successful the program is for employment growth, the OZ program is helping to elevate the visibility of neighborhoods and deals that investors might not otherwise have considered.12

For example, a long-vacant building in Birmingham, Alabama, is being repositioned as apartments for local residents, while government officials in Erie, Pennsylvania are using the Opportunity Zones program in conjunction with local development strategies.

Conclusion

While it’s likely that the debate about Opportunity Zones will continue well after Election Day in November, the program may yet have promise.

Bloomberg notes that the OZ program could be retooled to better reward investments in low-income area projects by permitting the use of debt instruments instead of equity alone. In the meantime, states such as Wisconsin are leveraging the opportunity the program provides by doubling state tax breaks for investments in Opportunity Zones.

Realty Mogul, Co. and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. See offering documents for additional details, disclosures, and disclaimers.

References

1. https://taxfoundation.org/opportunity-zones-what-we-know-and-what-we-dont

2. https://www.pewresearch.org/fact-tank/2020/02/07/6-facts-about-economic-inequality-in-the-u-s/

3. https://www.forbes.com/sites/sorensonimpact/2019/05/29/opportunity-zones-biggest-myths/

4. https://www.washingtonexaminer.com/opinion/op-eds/bipartisan-success-of-opportunity-zones-gives-trump-an-edge

5. https://www.novoco.com/periodicals/articles/opportunity-zones-incentive-sees-early-success-investment-accelerating

6. https://www.whitehouse.gov/wp-content/uploads/2020/08/The-Impact-of-Opportunity-Zones-An-Initial-Assessment.pdf

7. https://opportunitydb.com/2020/08/emily-lavery-105/

8. https://www.marketwatch.com/story/opportunity-zones-are-all-sizzle-fizzle-and-the-abuse-of-good-intentions-2019-10-08

9. https://www.bloomberg.com/news/articles/2020-06-25/opportunity-zones-don-t-work-can-they-be-fixed

10. https://www.cnbc.com/2020/06/17/opportunity-zones-fall-short-on-helping-low-income-communities-study.html

11. https://www.pewtrusts.org/en/research-and-analysis/blogs/stateline/2020/06/24/black-businesses-largely-miss-out-on-opportunity-zone-money

12. https://www.factcheck.org/2020/06/trumps-unsupported-claim-about-opportunity-zone-investments/

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