Economics

Navigating the Land of OZ: Understanding Opportunity Zones and Opportunity Funds

Flying under the radar in the 2017 tax reform package was a sleeper provision that authorized the designation of “opportunity zones” and the creation of “opportunity funds.” This versatile program has the potential to stabilize and revitalize distressed neighborhoods and surrounding communities by unlocking private investment capital through a series of tax benefits.

The provision allows individual and corporate investors to defer capital gains tax until 2026 if those gains are reinvested into new construction or major rehabilitation of projects in economically depressed areas via designated opportunity funds. If held for five years, the original amount of capital gains tax due is reduced by 10%; if held for seven years it is reduced by an additional 5%.  If the investment is held for at least ten years, gains on the invested amount accrue tax-free. 

Estimates suggest that $6.1 trillion of unrealized capital gains is held by American households ($3.8 trillion) and American corporations ($2.3 trillion). Getting to that capital will be a bit trickier. Much of the money is disaggregated across individual accounts managed across myriad institutions and platforms. 

At least 90 percent of the assets in such funds must be invested in government-designated low-income zones. The governor of each state was able to designate up to 25 percent of the state’s low-income communities (LIC) as opportunity zones. Up to 5 percent of the designated zones could be contiguous to LIC tracts. The zones are designed to be in areas that have a poverty rate of at least 20 percent or that have a median income that does not exceed 80 percent of the metropolitan area’s median income. The final designations were made in spring 2018. In total, 8,700 opportunity zones were chosen by state governors and approved by the U.S. Department of the Treasury. These zones range from a few blocks in large metro areas to entire municipalities in some rural states. The Treasury Department has indicated that no additional opportunity zones will be added. 

The expectation is that the added tax incentives will make investment in these disadvantaged areas just a little more enticing and add another option to the capital stack. Concerns exist that the investment capital that may come flooding in also has the potential to push out residents and achieve value primarily for investors. It is expected that states and local communities will provide guidelines to ensure that the objectives of affordable housing, strong neighborhoods, and vibrant, diverse, and sustainable communities are met. 

As of the third week in August 2018, final rules from the Treasury Department were still pending.

The Messy Complexity of Life

I’ve found  that buildings and communities are deceptively complex.  In their simplest form, buildings provide us with shelter and enable us to work productively. Communities link us together and provide the necessities of a civilized society - roads and schools, safety and security, systems of communication and infrastructure - energy, water and waste disposal,. But, beyond that they are also an eco-system that reflects the culture and values of the people that live, work and play within them. A unique matrix of individual parts that when put together in a thoughtful and intentional way create harmony and enable each of us to bring our best selves to the mix. Buildings play an important role in how easily and effectively we can do that. And the recognition of how people interact with each other is key to creating a resilient and vibrant community.

The best projects are ones in which we make the conscious choice to be mindful and think holistically and systemically about the solutions. The trans-disciplinary nature of the team and partnering with the community brings forth solutions that may not be obvious or expected, but in the end are more meaningful and durable. By sharing roles and crossing disciplines we learn from and challenge each other, ultimately pooling and integrating a wealth of expertise. Today’s world requires a vastly different analysis - one that looks at the total value of resiliency, sustainability and high performance. It includes the full range of economic, social and environmental impacts. Decisions around sustainability need to quickly move beyond neat rows of check boxes (and simple payback) to the messy complexity of real life.

There exists a quantifiable and integrated suite of payoffs at the property level that accrue to the owner and occupants, as well as at enterprise and community levels. Successful adaptation and change happens when we are able to articulate the benefits in the context of this complexity and make this the primary source of inspiration and the lever for action versus falling into the trap of easy black and white answers."

The best offense is a good defense. 

 

re·sil·ience (rəˈzilyəns)

  1. the ability to become strong, healthy, or successful again after something bad happens.
  2. the ability of something to return to its original shape after it has been pulled, stretched, pressed, bent: elasticity

     

    I'm about to head off to huddle with a group of colleagues to frame "10 Principles of Resilience" based on our work in more than a dozen communities.  This gave me the chance to look at some of the projects I've worked on, and think about lessons learned.  

    Resiliency can be divided into four basic dimensions of urban resilience[1]:

    • health and well being,
    • economy and society,
    • infrastructure and environment, and
    • leadership, strategy and community engagement. 

    The cost of preparing for a hard to see, long-range event can play second fiddle to immediate, day-to-day operational challenges particularly when there are competing capital needs.  However, resiliency is not merely a protective Band Aid, it is also an economic driver.  Economics is a combination of avoided risk and the capitalization of opportunities.

    The objective is to proactively make cities and communities increasingly capable of overcoming both the day to day and catastrophic stresses placed upon them.    This is measured in terms of economic value- increased revenue, avoided cost, community cohesion, environmental health and resident physical and social well-being.  Each of which contributes to a desirable, future ready city.

    Developing a plan for a resilient community involves a large and diverse number of stakeholders spanning the domains of economic development, industry, social equity, urban planning, design, and engineering.  Some of the focal points include establishing leadership structures, finding launching points to gain traction, and engaging business and residential community to help drive appropriate investments.   

    Costs associated with resiliency measures must be viewed in conjunction with the avoided impacts – loss of property, business and economic exposure and critical life/safety mitigations.  At the same time, value associated with a stronger, more resilient neighborhood and quality of life must also be incorporated.  Communities rely heavily on linked networks.  The loss of one critical component of infrastructure can have cascading effects throughout a myriad of systems.    

    For example, our work showed that in the event of a climate related event in the Duwamish River area in Seattle (such as a sea level with a King tide or prolonged precipitation) significant economic losses would be incurred.   Lost wages, property damage and business interruption would reverberate throughout the local, regional and national economy.  

    While the actual amount is difficult to assess, a comprehensive commercial level assessment in the Green River Valley (GRV) shows total property value exposure between $30-50 billion.  Given, the Duwamish area accounts for about 30% of total sales/property tax and 10-20% of total employment in the overall GRV region, we estimated about a $10 billion exposure in property value in this area.  Business interruption, for days or weeks, would add exponentially to this cost.  Food insurance is generally an exclusion in most policies.  Even though many companies carry property damage and business interruption insurance, the downtime and inability to deliver a product or service in a timely manner has long term ramifications – for the firm, their employees and their clients.  

    Research shows resilient people, possess three characteristics: a staunch acceptance of reality; a deep belief, often buttressed by strongly held values, that life is meaningful; and an uncanny ability to improvise.  Communities, made up of people, are the same.  

    Resiliency strategies play a huge role in long term viability and economic value both for public entities as well as individual businesses and residents.   The objective is to future-proof against potential downside while priming to take advantage of opportunities. What region or business would, in their right mind, leave their long term fate to the vagaries of the environment, when reasonable, prudent and proactive measures can be taken to avoid property and profit losses? 

     

    [1] Rockefeller Foundation 100 Resilient Cities Program