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Big Changes Could Happen To Opportunity Zones Post-Election, But More Will Be Needed To Address Disinvestment

Whether Donald Trump or Joe Biden wins the presidential election next week, commercial real estate can expect the opportunity zone program will remain intact but receive some tweaks, experts say. That will likely include some reforms and new reporting requirements no matter what, but which man holds the office could determine if the program grows or shrinks in scope.

President-elect Joe Biden at a community event on the campaign trail in Iowa

Polls show the Democratic Party stands a good chance of picking up a trifecta in the elections next Tuesday and assuming control of the White House and both congressional chambers. That could kick off momentous changes in tax policy, including a big boost to the taxes on capital gains. But even though the two major contending parties present starkly different visions for the country, both agree investors should get tax breaks on capital gains if their dollars are put to work in historically neglected communities.

A 2017 tax reform package pushed by the Trump administration led to nearly 9,000 census tracts across the U.S. being labeled opportunity zones, and investors who fund projects there can eliminate capital gains taxes if they help improve or develop a property and hold it for 10 years. But instead of fulfilling its stated goal of helping blighted areas, critics charge the program attracts investment to already-affluent areas, sometimes even funding luxury residences and hotels.  

Stories like that led Democratic rising star and U.S. Rep. Alexandria Ocasio-Cortez to propose defunding administration of the program. A White House led by Joe Biden wouldn’t embrace such radical change, though it would likely push a few modest changes, experts say, including more stringent oversight of the program to ensure it benefits low-income communities.

“The Biden campaign views opportunity zones as one of the pillars of their economic strategy, especially as it relates to racial equity,” according to Develop CEO Steve Glickman, a former Obama administration official and an architect of the program.

But that doesn’t mean no big changes lie in store. In addition to pushing for higher capital gains taxes, the Biden campaign advocates rolling back tax breaks for real estate investors such as 1031 exchanges, which allow the deferral of capital gains taxes if proceeds from an investment sale are ploughed back into another property.

“That would almost certainly lead to more capital being invested in the OZ program because it would be the only alternative,” Glickman said.

And a Democratic landslide and takeover may bring more radical change. U.S. Sen. Ron Wyden, the top Democrat on the Senate Committee on Finance, proposed legislation that would add reporting requirements, strip the OZ designation from affluent census tracts and prohibit investments in luxury rental properties and similar assets. Tenant advocates also say they will push a Democratic majority for even deeper reforms that would bolster job creation and small-business development in economically disadvantaged communities.   

U.S. senators and representatives from both parties want opportunity zone funds to start collecting and reporting data on how many jobs OZ investments create in low-income communities, and for the U.S Treasury to provide granular data on the program’s other real-life impacts. Glickman called these bipartisan legislative reforms “low-hanging fruit,” and the broad support each enjoys should mean easy wins for sponsors including U.S. Sen. Tim Scott, a Republican from South Carolina, and U.S. Rep. Ron Kind, a Democrat from Wisconsin.

The Illinois Medical District and its OZ sites.

A Trump victory could bring about more substantive changes, according to John Sciarretti, a partner in the Dover, Ohio, office of Novogradac, a firm that helps investors and developers structure, finance and syndicate tax credits, including OZ incentives and New Markets Tax Credits.

The company held a virtual OZ conference last week, and Ja'Ron Smith, a deputy assistant to Trump, was a featured speaker. He was generally supportive of the reforms proposed by Scott but also said the administration would be open to allowing state governors, who had a lot of leeway in choosing which tracts became OZs, to radically expand the zones, perhaps even doubling the number, Sciarretti said.

“He mentioned that they wanted to give governors another bite at the apple,” he said.

The announcement was a bit of a surprise, Sciarretti added.

“No one else has proposed expanding the number of zones.”

With all the talk about reforming OZs going around, Sciarretti said it is important to remember what the program has already achieved. The primary objective was to get dollars into distressed communities. The original estimate was that $100B would flow into the zones over 10 years, and after less than two years, investors had already committed $75B, according to an August progress report by the White House Council of Economic Advisers.

“Clearly, it’s met that primary objective, at least in terms of volume,” he said.  

But what impact all that capital will have in the years ahead is difficult to forecast.  

“Everything is anecdotal right now because we don’t have reporting,” Sciarretti said.

“It may not have lived up to exactly what we hoped it would do, but it’s a start,” Origin Investments co-founder Michael Episcope said.  

His Chicago-based private equity firm launched an opportunity zone fund in 2018 and amassed $105M in commitments from 425 investors in just 17 hours. It now has six residential projects with OZ funding, including a multifamily project in Charlotte, North Carolina’s NoDa district; Elan at Pike's Peak in downtown Colorado Springs; and Pilsen Gateway, a $64.5M, 202-unit development in Chicago’s Pilsen neighborhood.

OZs have already changed the investment climate for some portions of Colorado, according to Mike Landes, the opportunity zone program and special projects director for the state’s Office of Economic Development & International Trade. 

Pilsen Gateway

The additional shot of funds from these investors helped complete deals that otherwise may not have happened, Landes added. Wedge Brands, an outdoor industry holdings company, got $1M from a group of OZ investors, enabling it to begin construction on a $14M, 76K SF distribution center in Montrose, a rural community in the western part of the state.

It’s one of about 65 Colorado projects backed by OZ investors that are in the process of development, he said.

“Ultimately, we’re seeing communities with strong, long-term development strategies be able to incorporate the OZ program into their plans,” he said.   

Landes would like to see legislators include more technical assistance for community leaders still struggling to understand the program’s scope and capabilities. But overall, he’s not worried about what will happen next year in Washington, D.C.

“If there are no changes, we would muddle through, because this is an investment tool already taken up by so many investors,” he said. “But it sure would be great to know more about the impact of the program.”

Others call that insufficient.

“It’s not enough for this program to provide details on what they’re doing unless there is another mechanism in place to ensure they’re doing what the program originally intended,” Illinois Medical District CEO Suzet McKinney said.   

She said she believes the program’s designers were overly optimistic, and they thought that simply creating tax shelters for new OZ developments would create jobs and reduce disparities.

“I don’t think much thought was put into how to actually do it,” she said.  

Development sites totaling 40 acres of the 560-acre medical district on Chicago’s West Side lie within an opportunity zone, and McKinney is fielding development proposals. She supports new reporting requirements, but she also wants to see the federal government require state and local governments, which designated the tracts chosen as OZs, ensure new development brings the number and kind of jobs that will reduce economic disparities, as well as encourage developers to bring local community organizations and nonprofits on board as partners.

Elan at Pike's Peak

As an independent agency empowered to make zoning decisions, the IMD is essentially a local government, and McKinney wants to set an example for others as they pick and choose OZ development projects. The district requires that any developer reserve 30% of the work for minority-owned businesses, along with 10% for women-owned firms, with a significant portion going to West Side contractors and suppliers. Developers will also need to sponsor apprenticeships, hold local job fairs, work with local community groups and reserve at least 50% of the jobs for Chicago residents.          

The IMD aims to foster mixed-use projects with a focus on the life sciences sector, including labs and conference centers. Roughly 40% of the jobs in life sciences only require a high school diploma, a perfect fit for Chicago’s West Side.

“These are the types of jobs many people living in the community will need,” McKinney said. “The district is also surrounded by low-income communities where the vast majority of the residents are Black or Latino, so it’s very important to us that any new projects that we consider are beneficial to the residents.”

Episcope supports the proposals for more detailed reporting on OZ impacts, as long as the requirements don’t get too burdensome. But getting developers to break ground on projects that will truly change the trajectory of low-income communities will take far more than making adjustments to opportunity zones.

Episcope said the company can secure OZ investors the program’s tax breaks, but only after identifying projects that will turn a profit. An OZ designation doesn’t cut the costs of construction materials or labor, so workable deals tend to be on the fringes of the impoverished neighborhoods selected as OZs, most likely near downtowns or other rising areas, such as Pilsen, Charlotte’s NoDa or the IMD.  

“Of the 8,700 or so opportunity zones, only 5% to 10% meet our investment criteria,” he said.

Bringing new capital and investment to places that need it the most may require subsidies that cut the cost of construction, Episcope added. Turning a $60M project into a $50M one means the owners would have less risk and could charge cheaper rents.

“That’s what would allow developers to move farther into low-income communities.”