Two significant reports on Opportunity Zones were issued within hours of each other by two important organizations, the White House Opportunity and Revitalization Council and the Urban Institute, on June 17. These reports examine the implementation of the OZ legislation to date. Code Section 1400Z-2 (OZ act), and the efforts so far to turn the OZ act into tangible and successful business projects located in economically challenged communities.
The two reports address different aspects of the OZ efforts and draw significantly different conclusions about how successful the legislation has been in achieving its policy goals of promoting long-term equity investments in low-income communities.
THE COUNCIL REPORT
The first report, titled “Opportunity Zones Best Practices Report to the president,” was issued by White House Opportunity and Revitalization Council (the “council”). The council was formed by the president to support the administration’s pledge to encourage public and private investment in economically distressed areas, including OZs.
The Council is comprised of 17 federal agencies and federal-state partnerships representing relevant departments of the federal government and is tasked with coordinating their efforts to help complement the OZ tax incentive and with helping taxpayers and investors as they try to spur economic development in economically distressed areas.
The report looks into best practices sections of local governments and states, foundations and other nonprofits, qualified opportunity funds, and how to leverage federal resources for OZs. There is also a detailed section on case studies that discusses the important efforts to collect and track data.
The council report is perhaps the most comprehensive compilation of data on OZs and the accomplishments thus far in implementing the OZ incentive. When the report was issued, Alfonso Costa, Jr., Deputy Chief of Staff of Housing and Urban Development, in a presentation emphasized that there are evolving and continuing best practices at the various levels of government. He provided the City of Erie, Pennsylvania as a strong example with its OZ efforts. The report discusses the Erie Downtown Development Corporation (EDDC) and its early efforts to bring together leaders in the business, philanthropy and government sectors, and their work to move quickly to take advantage of the OZ legislation.
Costa pointed to their mission to “transform the City of Erie and revitalize its downtown areas.”
He also cited that Erie played a helpful role in interacting with the efforts of the city of Birmingham, AL. It was striking that a city from the NW corner of Pennsylvania and a city in the heart of Alabama were coordinating efforts and exchanging ideas and experiences on how best to take advantage of resources from the federal government and incentives under the OZ program.
Costa noted that the residents of Alabama, in particular, have benefitted from the efforts to coordinate the OZ work in the state under the umbrella of an organization called Opportunity Alabama (OPAL). OPAL has provided resources to cities and towns throughout the state to help them understand how to best to promote and utilize the incentives under the OZ program and take advantage of the resources available through the federal government.
The best practice report contains 12 pages of relevant examples of projects that have been created and many even funded thus far in OZs, spanning a range of activities from real estate and clean energy to technology and agricultural projects, and spanning geographic regions from small rural communities in Maine to Stockton, CA, and beyond.
The listing of projects that are already funded and under construction (and in some cases nearing completion or already completed) gives a sense that there is a lot of success that has already been achieved in providing significant benefits to residents of economically distressed areas, including OZs. This report identifies these successes, looks at the common factors and strategies that helped make the projects successful, and provides best practices with guidance on how to take the lore and the learning from these communities and share it throughout the country.
For leaders or residents in a city or town that has OZs and is seeking to take maximum advantage of these incentives, this Best Practices Report offers an advanced education on how to go about doing it the right way and is a must read.
THE URBAN INSTITUTE REPORT
By contrast, the Urban Institute (UI), in its report entitled “An Early Assessment of Opportunity Zones for Equitable Development Projects, used a very different methodological approach and reached a variety of initial conclusions on the early implementation of the OZ program. Some of these conclusions are positive, other are critical, some are accurate and realistic and some seem either gratuitously negative or simply naïve.
Importantly, the UI report creates a new metric called equitable development and judges the success of the OZ tax incentive against this self-styled standard -- which was not the policy intent of the legislation.[1] Moreover, it is very difficult to determine the outcome (even under this new standard) of the OZ tax incentive just two and one half years after the legislation passed and just six months after the issuance of the Final Regulations, three months of which were spent in a COVID-induced economic shutdown. Tellingly, the positive outcomes as described and documented in the council report do not receive in the UI report either the credit or attention that arguably is warranted.
The UI report was based on approximately 70 “in depth interviews” with project sponsors, fund managers, investors and other parties actively involved in OZs. The methodology was presumably selected in an effort to dig deeply into the practical realities of developing an OZ project during the initial period since the passage of the OZ incentive, and to address in useful detail the specifics of how OZ projects have been progressing (or not progressing) to date.
UI acknowledges that at least $10 billion – and likely far more – has been raised thus far and invested prior to the COVID pandemic. On the positive side, the UI report found that OZs “are helping spur the evolution of a new community development eco-system, engaging both project developers and investors who have limited historical engagement in community development work.”
On the negative side, the UI report found, “despite this catalytic effect, however, we also see that many mission-oriented actors are struggling to access capital. Many project sponsors are struggling to access the class of investors …for whom the OZ incentives are tailored. Additionally, many mission-critical projects yield below-market returns that most OZ investors appear unwilling to accept. As OZ incentives are not structured to encourage resident or community engagement, mission-oriented projects struggle to compete for attention with higher-return projects -- for which OZs provide much larger subsidies because of the design of the incentives.”
The information identified by the UI in its report, including some of its criticisms which can be taken as constructive, the UI’s comments probably require some leavening with pragmatic observations based on practical realities.
The fact that small, inexperienced sponsors with limited track records have difficulty raising capital – however well-intentioned their projects – is hardly surprising. Inexperienced sponsors without a solid track record will inevitably struggle to raise capital regardless of the incentives being offered, if investors do not fundamentally believe in the economic prospects of a particular project. This reality is not unique to the OZ tax incentive.
Fundamentally, OZ capital is tax-incentivized equity requiring a return since the incentive is based on investing in appreciating assets. To the extent projects yield “below market returns,” other capital (i.e. foundations, grants, tax credits) can bridge that gap or project sponsors can identify impact capital that allows for lower returns. Also, if projects have significantly “low to no” returns, then sponsors should look to other tools in the economic development tool kit, including philanthropy, to move these worthwhile projects forward. It is also true that the OZ incentive was designed to attract capital to low- and moderate-income communities and bring successful, profitable activities into these OZs. By doing so, the OZ incentive can assist in breaking the investment cycle where already successful communities continue to attract further investments, leaving moderate- and low-income communities behind. Thus, OZ tax incentives serve as an exogenous factor designed to benefit the residents in these low- and moderate-income communities.
The OZ act was never intended to promote non-economic or below-market business activities based on a policy notion of what is “better” for the community. Instead, it is designed to bring in strong, solid businesses -- and even outstanding businesses – to areas that otherwise had no expectation of attracting these kinds of businesses, and indeed may struggle to attract any new businesses at all.
To its credit, the UI report acknowledges that there are a variety of federal, state and local incentives, from credits to developer loans, that in fact can be layered in with the OZ tax incentive to make a decisive difference.
The UI report concludes that the OZ incentive “has mixed effects in terms of making projects work that would not otherwise happen” and acknowledges that “some developers reported that the incentives did make a decisive difference in allowing projects to go forward, while others were clear that their projects would have proceeded without the OZ equity.” The UI report adds this telling comment “most observers appear to agree that a primary benefit of the program is that it elevates the visibility of neighborhoods in deals that the investors might not have considered otherwise.”
However, the UI report makes a rather significant issue that “OZs were designed to spread job creation, the vast majority of OZ capital appears to be going into real estate, not into operating businesses…” In fact, it was always logical that real estate development would lead the way in taking advantage of the OZ tax incentives. First comes the infrastructure, then comes the businesses. The newly created commercial and residential real estate anticipates that businesses will move in to occupy the commercial real estate space, and employees will seek housing locally. Almost everyone in 2018, who was interested in the OZ tax incentives was in the real estate business; by 2020 it can be estimated based on actual experience that a much higher proportion of investors and project sponsors are now looking to start and invest in OZ-based businesses.
It is worth pointing out that the real estate industry has been utilizing federal, state and local incentives and subsidies for decades, and are used taking advantage of myriad of incentives. Venture capitalists and private equity funds, by contrast, are not used to seeking, never mind taking full advantage of, tax incentives, and so it likely took a period of time for these investors to become aware of and comfortable with the incentives. Note that it took almost two years for the IRS to issue Final Regulations with enough specificity to provide adequate guidance. It can be argued that these incentives did in fact catch the attention of business creators near the end of 2019, and that in early 2020 things were headed in an extremely positive direction, until the COVID pandemic.
In this context, the best practices report by the council provides not only ample evidence of early successes, but also a practical education in how communities can learn from each other to promote, advance, and execute OZ projects and businesses.
The UI report is predominantly optimistic and positive as it acknowledges many of the good things that in fact have been achieved. Its most prominent criticisms – such as a lack of capital going to inexperienced sponsors or to projects offering “below-market returns” -- are so inevitable that it hardly bears mention, never mind emphasis.
The UI report, best of all, acknowledges that at least some projects have been created that would not have occurred but for the OZ tax incentive. Those are precisely the projects that the OZ act was designed to promote. The implied criticism that some projects would have gone forward anyways misses the point: it is the incremental combination of the things that might have happened anyways (one never knows) coupled with the things that never would have happened otherwise, that make the OZ an exciting place with huge potential going forward. Success is not merely additive, it compounds. The OZ Act seems clearly to be helping many economically distressed communities reach what we all hope will be a critical mass of successful real estate and business development projects.
Notes:
The Urban Institute Report states: “Despite being viewed primarily as an economic development tool in low-income communities—that is, positioning the local economy on a higher growth trajectory—many proponents have suggested that OZs also have a community development purpose of helping people in poverty to improve their local context and lead healthy, productive lives. We refer to development that blends economic development and community development goals, and that seeks to engage residents and local leaders in decision making about development in their communities, as equitable development. This report examines how actors driven primarily by a community development mission have sought to use OZs to fulfill an equitable development mission.”
Just as a counterpoint for describing how the metric of the Council may be different, the White House Executive Order on Establishing the White House Opportunity and Revitalization Council (EO 13853):
“Fifty-two million Americans live in economically distressed communities. Despite the growing national economy, these communities are plagued by high poverty levels, failing schools, and a scarcity of jobs. In December 2017, I signed into law a bill originally introduced as the Tax Cuts and Jobs Act (Act), which established a historic new Federal tax incentive that promotes long-term equity investments in low-income communities designated as “qualified opportunity zones” by the Governors of States or territories.”
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