What You Need to Know About Opportunity Zones

(Forbes)

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By Morgan Simon, Contributor

March 30, 2018

The Tax Cuts and Jobs Act (TCJA,) known for creating Opportunity Zones, is often celebrated for its potential to move billions of dollars into low-income communities. However, there remains an open question as to whether this program will ultimately serve to add value, or extract values, from these communities.

Opportunity Zones (OZs) are defined as “economically-distressed communities where new investments, under certain conditions, may be eligible for preferential tax treatment.” First conceived in April of 2018, OZ plans are now in place for communities in all 50 states this year. How it works is that each state nominates blocks of low-income areas by census tract, which are then certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service. Through the IRS, investors can file a Form 8896 to create a Qualified Opportunity Fund — vehicles structured as either a partnership or corporation for the purpose of investing in an OZ census track, whether in real estate or directly in businesses through equity. The fund is required to hold at least 90% of its assets in that qualifying OZ area.

Simply understanding the mechanisms of OZs creates a major barrier to entry for more socially-minded investors. This interview aims to unpack some of the mystery. Markeze Bryant works at Acumen America; a seed stage investment fund focused on helping low-income families generate better access to health care, education, and financial services — taking a start up approach and working with early stage companies. He was born in a now-designated OZ, went to college in an OZ, and most recently was married in an OZ. He has been working diligently to identify, and maximize, the impact opportunity of opportunity zones — and shared his insight on how communities across America can best benefit from the program.

According to the IRS’s website, over the next few months “the Treasury Department will be providing further details, including additional legal guidance, on this new tax benefit.” At this point, can you break down how OZs will work mechanically?

OZs are places in the U.S. where over 30 million people live and work across our country. They cover downtown, industrial, suburban, and rural areas. They’re part of daily life for a lot of people.

To make a profit, essentially a taxpayer must sell an asset and generate a capital gain. The taxpayer then puts the capital gain into a Qualified OZ fund. There is ultimately delay and reduction of taxes owed to the government — if held for 10 years, that taxpayer can pay zero capital gains tax on the new investment in the fund. I think that’s the real prize: if you hold your investment in some of these opportunity zones from funds, you essentially pay no tax on your returns, which could lead to a 30-40% increase in your annualized return. That’s what I want people to really understand: this isn’t a small tax benefit, it’s pretty massive.

The problem in our country is that capital has moved in a predictable fashion, to serve certain regions and populations, the last hundred years or so. That’s why certain groups and places continue to be left behind. OZs are simply an incentive to move capital across America in a more inclusive fashion; more quickly and to more places where it just naturally wouldn’t end up.

Are OZs going to be universally extractive or additive? In other words, who tends to benefit more with projects like these — the investors holding the wealth, or the communities getting new businesses and real estate built?  

I think they’re both. They are extractive because investors with wealth from across the country are investing in low-income places and expect to generate a return on their investment. That capital will not be owned by the people that need "opportunity." However, OZs are also additive because entrepreneurs can open businesses and develop real estate using "Other People's Money” as a catalyst. That’s how people have generated wealth since the 1600s. Additionally, money is just one form of capital. Investments in human capital can remain even after an investment is exited — like investing in an entrepreneur who still has that experience, that context, the contacts, and the ability to move onto something bigger and better.

One of my mentors told me that you really need to follow policy, because policy is how capital moves. If you think about mortgage interest tax deduction, that’s why we have such a huge single family home real estate economy. You look at 401ks, that's why we have this huge retirement market. It’s all because of government incentives. So I see opportunity zones as very structural incentives that can have sweeping effects around impact investing.

We’re hearing more and more the use of the term “impact washing” across the sector. Are you seeing this happen in OZ projects?

Impact washing is definitely a thing. I cringe when I hear of investments in self-storage centers or luxury condos in OZs. And I think the reason is that these investments just have pretty low multiplier effects. Who is really going to benefit from this — that needs to and can’t benefit otherwise — in these low income communities? I don’t see a need for condos that are going to be priced three, four, five times what the average person can afford to pay there. It’s just a low, unproductive use of capital in my mind.

To be fair, those investors are just taking advantage of a tax tool, most are not claiming to have any social impact. What matters most is that these investments don’t absorb too much capital that will prevent or delay high-impact investments. The ones that do generate impact need to be 80, 90% plus of the deals done, and they need to be highlighted. We need the brightest minds from the impact investing world to be working on OZ investments.

What would a non-extractive OZ look like, and what are best practices for these projects?

A non-extractive OZ project is one where the value created is shared. I’d like to see a good blend of broad-based ownership for employees and contractors, training and apprenticeships, and general acknowledgement of existing community efforts. A lot of people are doing these things, but they are on the margins.

We need to ask… if a project generates $100M in profits, where does this money flow? How much of it is left in the community?  I just wanted to call out that a $100M dollar investment with a little bit of philanthropy wrapped around it and some kind of job fair, that doesn’t really cut it.

Paying living wage jobs is very important, but I think we need to go beyond just job creation and more about jobs that allow people to build enough wealth that they can in turn invest. And then it’s the natural question of “well, how do you make sure that people who live in opportunity zones can get hired in some of these roles?” So a specific budget for training and helping people fulfill those skills as a part of the opportunity zone investment I see as being very interesting, and need to be a focus of the board and the fund manager and the LP.

Tax benefits under OZs specifically exclude the development of some private or commercial entities, like golf courses or country clubs, to avoid the creation of businesses that wouldn’t be of use to these communities. Still, under the law, luxury hotels are just as likely to be built as affordable housing units in these areas. Regardless of the type of property being constructed, what are some more key questions impact investors should ask when looking at an OZ project, to make sure the impact for the community is going to be real?

The question is: how inclusive is this investment? To what extent? Remember why this program was created in the first place. It’s about helping those left behind in our economy. Period. So each investment should do something meaningful to help disadvantaged people get ahead. Ask “who participates from the upside, who gets hired, who holds the power?” So for example, if you’re going to invest in a fund that is saying “hey we only want to build commercial real estate" or "we just want to fund start ups,”  the second level thinking there is “what kind of startups?” “What happens if the startups are successful — then who benefits?”

I think my biggest fear is that in 30, 50 years, there will be “OZ Part 2” because the first one never made any impact — tons of smart people running around trying to figure out a new community development tool. So I think it’s important that we get it right this time and make sure this wave of capital really attaches itself to people that live in low income communities — in or outside of an opportunity zone actually. Because the goal is to really help people get ahead.

Are you feeling hopeful about this iteration of OZ development?

I do feel hopeful because I’ve studied a lot of these other programs, and there’s really two things that are very interesting about this one in particular. Number one is that it’s equity. Now, general finance dictates you need debt and equity to make really anything work in this economy. And for the last 50 years, it has all been about lending. Lending to minority business owners. Lending to get affordable housing. Student loans. All lead people to try and bootstrap and pay back these loans and navigate out… with no cushion, no rich uncle that’s going to say “here’s a year to figure this out, and you don’t need to pay interest.” So the fact that it’s equity is a game changer in my mind.

And then number two is that this program compared to others really reaches broadly. Most folks live within miles of opportunity zones. It kind of touches everyone in a lot of ways and I think that’s good because even in impact investing we have a small number of people and capital working on the biggest problem in the country. So thats my perspective on why I’m hopeful.

What should communities and investors be doing to hold cities accountable, and get the most value out of the program?

Impact investors and cities should simply highlight and make great investments with the OZ funds. I don’t think impact accountability can be achieved unless it’s mandated by the government. Even then, people will find a way to abuse the program the way we see tax inversions and other esoteric strategies. I do think it’s important to maintain a market driven approach so that this program does not become a niche area where lawyers and tax attorneys are the only ones making money.

For people who are in the community, who may not have capital gains, it’s about getting involved with entrepreneurs and developers that could benefit from having access to expertise. Helping an entrepreneur figure out his business plan or figure out a plot of land to build a real estate project on, really gets capital ready to compete in the market.

Besides investing in Qualified Opportunity Funds, can readers get involved in creating better OZs without becoming expert investors? What’s the first step?

Yes of course. Get involved in OZs near your community and figure out what is needed to help attract investment. People outside of the OZs can shop at some of the businesses, talk to the entrepreneurs, ask them “have you heard this program?” I think education and adding some sort of value to someone who can take advantage of it is really the most important thing.

Support might range from legal services, financial modeling, or marketing. Use your skills to help entrepreneurs raise money. The great thing about Opportunity Zones is that most of the inner-workings are the responsibility of the fund managers. Entrepreneurs simple need to do what they do best, and that is to create great companies.  

There will be layers to creating impactful OZs. There will be a national, institutional layer, where you have the megafunds working on large venture or real estate projects. But you also have the local mom and pop bakery that needs to raise $10,000. Both are very important. So just get involved where you have the skills and can take action.