Opportunity Zones: The Dire Risks For Investors And The Communities

Real Estate

Many have heralded opportunity zones as having the potential to be America’s largest economic development program. Over the last several months, the commercial real estate industry has been obsessed with the potential of opportunity zones, and with the recent release of additional regulations from U.S. Department of the Treasury, you can expect enthusiasm around the program to continue to grow. The questions that will measure all of our future investment in opportunity zones are: Do the fundamentals of OZ investments ensure a return of capital? And will they empower or displace the residents living inside the lines of designated opportunity zones?

What is an opportunity zone?

The opportunity zone program created by the 2017 Tax Cuts and Jobs Act offers favorable capital gains treatment for taxpayers who invest in economically “distressed” areas. Much has been written about the prospects of the program and amount of opportunity zone funding becoming available.

One estimate suggests opportunity zone funding is already pushing past $20 billion. A Pittsburgh-based financial services company is reported to have raised $486 million for opportunity zone investments. The Kresge Foundation and Rockefeller Foundation have partnered to offer incentives to managers of qualifying opportunity funds, while major New York City real estate players are working together to try to raise $1.8 billion in opportunity zone funding.

It seems that many sources of capital are entering the space.

The primary incentive to invest in opportunity zones is tempting. If one were to invest a capital gain in an opportunity zone and hold it for 10 years, they would be permitted to forgo paying taxes on the entirety of the original investment amount — an enticing prospect, to be sure.

But investing in distressed, under-resourced and blighted communities is not as simple as A, B, C or buy, build and hold. Cities across the United States have histories that affect which areas thrive and which areas lag behind.

Those considering opportunity zones should bear a risk in mind: Your tax incentivized investment does not guarantee you a return on your investment, or even the return of your principal.

Be cautious as you invest in an opportunity zone.

It stands to reason that there are many individuals and institutions that will make opportunity zone investments this year. The incentive to do so is just too attractive to pass up.

It also stands to reason that billions could be lost through investments made in communities and areas that opportunity zone fund managers don’t fully understand. The program is enticing, but presents a field of questions for investors.

Is the area ready to absorb the asset? Will users move to your apartment building? Will they shop at your retail? Will organizations see your new office space as a viable option for their employees? How does it feel to walk that street at 7 a.m.? How about at 7 p.m.?

Opportunity zones could become one of the greatest takings from urban communities.

Beyond the investments themselves, opportunity zones may be destined to exacerbate rather than improve the problems of delayed redevelopment in urban and economically distressed communities. Proponents of OZ investments promise the program will spur growth, increase employment and reduce poverty. However, the program was stripped of the reporting requirements originally conceived as part of oversight of the program.

Consider lessons from the Federal Empowerment Zones program of the 1990s. By subsidizing wages through tax credits, empowerment zones incentivized companies to invest and hire locally. A study of the first six years of the Federal Enterprise Zone program concluded that though it “substantially improved local labor and housing market conditions in EZ neighborhoods,” more consideration needed to be given to the long-term impact of those gains on existing residents of the area. The report stated:

“While [enterprise zone designated] communities appear to have avoided large scale gentrification over the period examined in this study, policymakers should consider carefully the potential impact of demand side interventions on the local cost of living…. If authorities wish to use EZs as anti-poverty programs they may wish to consider combining housing assistance or incentives for the development of mixed income housing as complements to demand side subsidies.”

Communities with low median incomes experience a lack of investment through vacant commercial properties, outdated manufacturing facilities, inadequate access to high-quality education and a lack of healthcare service providers.

While some estimates have the potential investment in opportunity zones at over $23 billion, little has been discussed about the risks massive unplanned investment could have on communities that have gone without the foundational basics of healthy neighborhoods. Urban policy analysts have weighed in on the program’s blind spots. A Brookings report by Hilary Gelfond and Adam Looney argues that, as currently constructed, there is no guarantee that opportunity zones will actually benefit residents of economically distressed communities.

Without pairing master planned community building requirements with the investments, opportunity zones might go even further than gentrification. If the benefits of the investment only accrue to the capital providers as owners, we may end up with new displaced economically disadvantaged populations. Without massive investment in education and affordable housing, we will start a new game of musical chairs where we rebuild one community without housing the existing residents, effectively displacing them for resettlement until we do it again.

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