By now, you’ve probably heard something about Opportunity Zones. The latest buzzword in the economic development community has already generated dozens of articles from national publications, and tens of billions of dollars’ worth of “qualified Opportunity Funds” have already been announced. What’s behind the hype? Why is this incentive so popular – and how can it impact a city like yours? This article gives you the back story on Opportunity Zones, how they work and what you can do to leverage them for community growth.
Opportunity Zones – The Background.
The Problem. Though the Great Recession officially ended in 2009, there are parts of the United States that have never recovered. In fact, the most distressed portions of the US have lost jobs and economic productivity every year since 2007. These communities are far more likely to experience issues with business formation, economic mobility and even educational attainment. While talent is evenly distributed across all parts of America, economic opportunity – and, as a result, access to capital – is not.
The Solution. Opportunity Zones are a place-based economic development response to this issue. A concept that started as a white paper by a D.C. think tank (called the Economic Innovation Group) found its way into the tax reform package that passed in December 2017.
Selecting the Zones. The law required every state governor to select their Opportunity Zones by March of 2018. The criteria were simple: pick up to 25% of certain designated “low-income communities” (Census tracts with high poverty rates, high unemployment, or low median family incomes) in your state, with no other limitations.
Setting the Map in Alabama. Governor Ivey made sure that every county had at least one Opportunity Zone. She then allocated the remainder across the state, focusing on places where there were already core assets to justify investment, such as downtowns, interstate exits, airports or industrial parks. Her designations were approved in April, and by May 2018, the map was set. Any changes to the map will, at this point, require a formal act of Congress. See www.opportunityalabama.com for an interactive map of the Opportunity Zones.
How Opportunity Zones Work – the Investor Perspective
Opportunity Zones were created to attract patient, at-risk capital to low-income communities. The longer an investor stays committed, the greater their incentives become.
How It Works – A Practical Example
Assume Jane has $200,000 in stock she acquired in 1990. It is now worth $1.2 million. Jane sells the stock, realizing a $1 million gain. Within six months, she forms her own “qualified Opportunity Fund” (or finds a national one already in existence) and deposits $1 million. Immediately upon doing so, she gets Benefit 1 – deferral of the capital gains tax she would have otherwise owed on the $1 million. She’ll have to pay her tax bill on her original $1 million investment December 31, 2026 – but because she invested this year (2019), she will get Benefit 2 – a 15% discount when she pays her bill in 2026.
Once she forms her Opportunity Fund and makes her deposit, Jane will have another 6 to 12 months to identify one or more investment opportunities. Assume she invests in revitalizing some commercial buildings at the core of a blighted neighborhood. As that neighborhood redevelops, her investment will become more and more valuable until, 10 years later, the $1 million she put in is worth $3 million. When she sells the property to a new owner in Year 10, all her $2 million in gain is tax free.
The key here is that the vast majority of investors expect cash flow out of these investments (rents, dividends, etc.) during the 10-year holding period. As a result, this is not necessarily the program for starting a new nonprofit or a risky business likely to fail within the next decade.
How Opportunity Zones Work – the Community Perspective
As you can see, the Opportunity Zone incentive is not a grant. There is no “central administrator” of who gets the money that comes in. Private market forces decide how much capital goes to the Opportunity Zone in your community versus the one in North Miami Beach or across from downtown Nashville. And private capital always follows the path of least resistance – which may not be into your backyard. Your role as a community is to help make the path the funds must take to your community as easy as possible. Here are the five things you can start doing now to accomplish that objective.
1.) Education and Awareness. Activate all the potential members of your local funding ecosystem that can contribute in some way to the long-term success or failure of your local OZ organizing effort. Those members include: project sponsors (developers, landowners, business owners, entrepreneurs and others with investable projects); potential investors (high net worth individuals, “prodigal sons,” financial advisors, accountants and others who know where the money is buried); community members (e.g., elected officials, economic developers and the chamber of commerce); and third party supporters such as bankers, attorneys, local anchor institutions and others who could have a vested stake in seeing an ecosystem thrive. (see chart above) The best way to do that is via one or more educational events – and Opportunity Alabama is happy to help you provide that education.
2.) Building an Investment Pipeline. Find the projects in your Opportunity Zone that have the potential to produce returns for investors over a 10-year period.
3.) Marketing Your Community. Think about what someone from Seattle or the Bronx would see from the basic demographic information about your community – then tell them the story behind the numbers. This step helps investors fill critical gaps in their knowledge base around why your community is a phenomenal place today and why it will be far more phenomenal 10 years from now.
4.) Developing a Local Investor Network. Opportunity Zone investments present residents and “prodigal sons” alike with the ability to own a piece of their future or leave a legacy behind. Either way, they will need someone to help prove to them that these investments will produce returns, and they will need an investment vehicle to get their dollars into projects. Who creates that diligence structure and that investment vehicle will vary substantially from community to community, and Opportunity Alabama can help you think through the options.
5.) Closing Deals and Last Dollars In. Revenue sharing agreements, land control, purchase guarantees and other local incentives can make or break an OZ project. Opportunity Alabama can help you think through what structures will work best to incentivize the particular deals you believe have the highest community impact potential.
Where to Go from Here
When Congress created Opportunity Zones, they conveniently forgot the community instruction manual. Fortunately for Alabama, there is a nonprofit that works on a statewide basis to help communities fill their Opportunity Zone knowledge gaps and develop strategies for implementing the action steps described above. Opportunity Alabama is here to help you do everything on the list above – from educating your local ecosystem to developing a pipeline of local projects. During 2019, Opportunity Alabama is working to build short marketing documents for every Census tract in Alabama. We have already worked with the City of Birmingham to complete its Opportunity Zone Prospectus (available at birminghamoz.org) and are continuing to work with dozens of other communities across the state to build out short-form marketing documents and long-form investment prospectuses like Birmingham’s. At the same time, we are in the process of introducing over $300 million in projects to potential investors. We are creating a statewide Opportunity Zones ecosystem with equity at its foundation, and your community is invited to be a part of that ecosystem.