By Deborah J. Burns
Similar to when the EB-5 program was created, there are high hopes that the Opportunity Zone legislation will lead to investments in distressed communities and neighborhoods throughout the United States. However, the EB-5 program, created to stimulate foreign investment in targeted employment areas throughout the U.S., also saw funds flow into luxury high-rise buildings in Manhattan, Los Angeles and Miami.
Now congress has tried again to stimulate investment in distressed areas by passing The Investing for Opportunity Act of 2017. This law offers significant tax advantages to investors who put capital into distressed areas known as Opportunity Zones. The question now is: Will Opportunity Zone investments have the intended impact on distressed communities or will it succumb to the same forces that have driven other federal economic development programs to be limited to major cities?
Opportunity Zone funding doesn't have to suffer the same fate, and it won't if investors and Opportunity Fund managers add a third metric to assess the return on their investments: Will it provide a positive social impact on those distressed communities? Adding that third metric is called triple bottom line investing, and it might be the only way to ensure that the new law has the effects that congress intended.
A growing wealth gap and media backlash
Opportunity Zone tax incentives were a bipartisan effort in congress to address the widening wealth gap and the unintentional consequence of financial reforms arising from the financial crisis as well as other factors. The poorer half of Americans lost over 55 percent of their wealth over the last decade and control only 1.3 percent of U.S. wealth. Meanwhile, the wealth of the top 1 percent of Americans increased by 29 percent. That 1 percent now controls 38 percent of the nation's wealth.
Opportunity Zone data reveals that 52 million Americans live in these low-income communities and 71 percent of the Opportunity Zones meet the U.S. Treasury Department’s definition of “severely distressed” communities.
U.S. taxpayers can receive significant tax relief by investing in Opportunity Zones to stimulate economic activity, job creation and address socioeconomic needs. There are approximately 8,700 Opportunity Zones across the U.S., and the federal government expects Opportunity Zones to soon attract billions of dollars of investment. With Opportunity Zone tax benefits that can increase after-tax returns by over 50 percent, private investment capital has an incentive to flow into these Opportunity Zones in a big way. The goal in creating these Opportunity Zones is to convert a portion of what the Economic Innovation Group (EIG) estimates is $6.1 trillion in unrealized capital gains to investments in distressed communities.
Similar to the EB-5 program, the first Opportunity Zone investments to be completed are real estate development transactions that would have been completed without the tax incentives. There has been a media outcry over these initial transactions where there appears to be a “rich getting richer” aspect to these investments rather than ways in which these tax incentives can be used to address the needs of distressed communities.
In an apparent effort to address this media backlash and to try to encourage Opportunity Zone investment, congress recently issued a bipartisan “comfort letter” to the U.S. Treasury Department and the Internal Revenue Service clarifying the intent of the tax incentive legislation and encouraging these federal agencies to develop and implement rules to incent large scale investment broadly across the country. But that is easier said than done. The authors of this tax incentive policy, the Economic Innovation Group, summarize that a “network of leaders and stakeholders across public, private, non- profit and philanthropic sectors” are needed for catalytic investment and revitalization of Opportunity Zones. The authors maintain that Opportunity Zone tax incentives are merely a tool and do not assure economic resurgence for Opportunity Zones.
Triple bottom line investing and true Opportunity Fund investment criteria
The idea of triple bottom line investing is to add another metric to assessing an investment: how will it have a positive social impact on distressed communities. That's in addition to the EB-5 double bottom line metrics: financial return and the amount of additional economic activity and new jobs.
Providing a positive social impact could mean converting an obsolete retail space into a multi-use project that includes a medical clinic for community residents. Another could be multi-family housing for a downtown Main Street redevelopment effort. Another would be building senior living facilities in rural communities so that aging parents can remain in their communities instead of having to move somewhere far away. That allows older children to remain in a community instead of shutting down their businesses and moving away to care for their parents. As senior living facilities provide older people the ability to age in place, it helps stabilize communities.
A triple bottom line Opportunity Fund investment strategy builds on the double bottom line metrics but invests in businesses and projects that have a positive social impact on the community by meeting a demonstrated need. To do so, Opportunity Fund managers must be adept at risk-adjusted return analysis, measure economic impact and job creation, and identify community needs, gaps of production for economic development and determine the best Opportunity Zone investments to trigger a series of economic and community development projects.
Effective Opportunity Zone investment projects perform better when they are part of an ongoing revitalization plan. To accurately identify the needs of an Opportunity Zone community requires developing a process for determining the socioeconomic needs of the Opportunity Zone and whether the community has a plan for economic development that meets those needs. Most Opportunity Fund managers have neither the desire, motivation nor the economic development expertise to effectively implement a triple bottom line approach to investing; but investing for positive social impact and community transformation depends upon it.
Avoiding the herd
To make Opportunity Zone funding work, investors will have to look beyond the usual suspects and the usual big cities. If they do that they will be rewarded because there are immense opportunities in under-invested areas.
As an example, New Mexico is one of the poorest states in the union, but there are 63 Opportunity Zones scattered across rural, tribal and urban areas. New Mexico lacks financial intermediaries who are familiar with the opportunities in the state, but there are several investment gems awaiting investors.
A gem is a gem because it’s hard to find. New Mexico has not participated in the rapid rise in valuations fueled by the recovery in major markets. Equity is a scarcer commodity in this state than in others. That’s good news for investors as new, relatively unknown opportunities here can offer better returns relative to more efficient and well-established markets.
It’s good news for the targeted investments as well. Nowhere in the country can you close wealth, education and job-creation gaps such as those that exist in New Mexico. The state with the highest per capita number of PhDs also ranks 49th in education. The state that receives more than $6 billion a year in federal spending on research and development also has the highest rate of children living in poverty. The state that is the birthplace of the many technologies has generations of families living without water, electricity, broadband, and even access to nearby medical facilities, grocery stores, and gas stations. Their need is an opportunity.
And the Opportunity Zone legislation is just the accelerant needed to make it happen. Emerging fund managers with the expertise and knowledge to undertake a triple bottom line approach to investing can generate a solid return on investment; stimulate economic activity and crea