With Reforms On The Horizon, OZ Players Optimistic About The Program's Future
As a candidate during last year's presidential election, Joe Biden promised reforms to the opportunity zone program to prevent "billionaires [from exploiting] opportunity zones tax breaks to pad their wealth."
The promise of the U.S. government’s opportunity zone program to direct long-term investments to low-income communities has been criticized as a tax loophole that largely benefits investors who have steered the money to more affluent areas. In 2019, U.S. Sen. Tim Scott, the Republican from South Carolina who co-sponsored the bill that created the program, issued a program-ending warning to developers and investors targeting OZs.
The Biden administration has yet to tinker with the program, but real estate executives in California told Bisnow last week that Biden's adjustments will likely be welcomed, and many hope that the program will become more transparent.
“Biden is likely going to look to mend, not end, opportunity zones and try to find a way to respond to the legitimate criticisms,” CalOZ President Kunal Merchant said. “I think that gives investors a sense of comfort and stability that the program is going to return to its bipartisan roots.”
The onset of the coronavirus pandemic in 2020 boosted the program on a national scale as investors looked for places to park capital sidelined from the stock market.
In April 2020, professional services firm Novogradac & Co. reported that the 406 opportunity zone funds nationwide listed on its site had raised more than $10B in equity before March 13, the day President Donald Trump declared a national emergency due to the coronavirus. Four months later, 580 qualified opportunity zone funds had raised $12.05B.
At the time, California was the top state for OZ investments, with over $1.19B raised, or 15.9% of total equity raised nationwide, by Novogradac’s count. Though that is the most recent information available from the firm, anecdotally, fund managers and OZ experts told Bisnow they hadn't seen evidence that the arrival of a new presidential administration has had an effect on the program to date.
For Joan Kramer, principal and co-founder at Mountain Pacific Opportunity Partners, the last couple of quarters brought a notable increase in the number of people interested in working in opportunity zones with MPOP, which mainly works in California and the western U.S.
“We have seen a rise in investors engaged in and putting funds into OZ deals each quarter in 2020,” Kramer said. That trend continued for MPOP in 2021 to date.
In Kramer’s view, one reason why it had taken the OZ program awhile to gain traction was that there wasn't immediate clarity about the program and its regulations. The reforms that the Biden campaign outlined would work toward adding greater transparency to the program and where the money goes and into what kind of projects, or whether the program is achieving the goals lawmakers intended.
As it stands, the amount invested in opportunity zone funds is likely much higher than independent sites that track their progress indicate. Databases created by firms like Novogradac and organizations like the National Council of State Housing Agencies include information about OZ funds that elected to share information about their fund. There is no reporting requirement for that information attached to opportunity zone investments.
"One of the frustrations across the marketplace, no matter where you stand on the program, is that there’s not enough transparent data about how capital flows are going to the funds and to projects and to which parts of the country geographically," said Develop LLC founder Steve Glickman, who helped shape the program during his time at the helm of the Economic Innovation Group, speaking at a Bisnow webinar.
The reforms that were already laid out in Biden’s campaign work toward addressing another criticism of the program: that it is not delivering on its goal of enriching the economically distressed and historically disinvested communities that hold OZ projects.
A study published by the Urban Institute last year found that the opportunity zones program was providing neither the economic development nor community development benefits that the program aims for, in part because investors don’t really have an enticement to make community-oriented or social impact investments in distressed neighborhoods.
California holds 879 OZs, but critics of the program note pockets of already-trendy neighborhoods like LA’s Arts District and Hollywood are among them. For investors looking to make a solid return on their investment, not all zones are created equal.
"It's the same incentive in hot marketplaces and truly weak marketplaces. Capital is not going to search very hard or very far," Urban Institute senior fellow Brett Theodos, who co-authored the institute’s 2020 report, told Bisnow in July.
A number of activists working on anti-gentrification issues have criticized the program for a different reason, claiming that the program will continue to exacerbate gentrification and create displacement of residents who live in these distressed areas and are likely to be economically struggling themselves. In 2019, South LA-based community advocacy group Strategic Actions For A Just Economy released a report titled “Displacement Zones: How Opportunity Zones Turn Communities Into Tax Shelters For The Rich” that suggested a repeal of the program. Two U.S. senators have advocated for removing key funding from the program or repealing it altogether.
But OZ experts indicated they didn't think the end of the program was on the horizon.
Many of the activists and organizers who voice these concerns are focusing on the few instances of poorly chosen zones instead of the good that the program could achieve, Merchant said. CalOZ aims to maximize opportunity zones’ potential in the state and advocates for California to offer the capital gains tax incentive.
“If there were zones that were selected for this program that, for these gentrification concerns, were not the right zones for these projects, that’s a legitimate conversation,” Merchant said. “Let’s have that.”
But he said that many of these activists come from the Bay Area or LA. Merchant said that outside those areas — in rural or exurban areas of the state — he has encountered less concern from residents about gentrification and more interest about how investment could improve their cities and towns.
“Somebody in a part of the country that hasn’t seen any kind of upward mobility or economic dynamism in literally decades sees this tool as a way to level the playing field,” Merchant said.
Compared to more rural parts of the state, the Bay Area has experienced decades of intense gentrification and displacement in the region’s core. Pockets of affluence are often in proximity to poverty, complicating the efficacy of the program, as some areas designated as opportunity zones have a greater need for affordable housing and economic development than others.
Of the region’s 107 zones, the bulk are in Alameda, Contra Costa, Santa Clara, San Francisco and Solano counties, with a few in San Mateo, Sonoma, Napa and Marin. With development overall stymied by the coronavirus pandemic, some opportunity zone activity currently lies in West Oakland and downtown San Jose, both areas with long histories of gentrification.
Oakland, the most populous city in Alameda County, currently has several projects at varying stages of development within a zone in its West Oakland neighborhood. While developers of these projects may or may not seek opportunity zone funding channels, one project at 500 Kirkham St. by Panoramic Interests is being funded through the initiative despite being put on pause early last year due to the pandemic.
The plan involves building 1,032 housing units, 35K SF of retail and two new pedestrian streets on a parking lot formerly used by Caltrans. Panoramic owner Patrick Kennedy said initial plans to break ground last July were thwarted. The project has been granted a three-year extension, and he is seeking a large equity partner.
“San Francisco and East Bay are going to come back with a vengeance,” Kennedy said. “People tend to forget that the tech firms and biotech firms that are here now and that are somewhat dormant are doing extremely well, and as soon as they get the green light to repopulate, I think that they will.”
One of the Bay Area’s developers most active in utilizing opportunity zone funding is Urban Catalyst, which has seven projects underway in downtown San Jose, having raised $131M in the first round of fundraising for the projects, according to a press release. They represent various product types with two mixed-use office/retail projects, a senior housing facility, a multifamily apartment building, a residential high-rise with office and ground-floor retail, a hotel and a student housing building next to San Jose State University.
Urban Catalyst is JTC’s biggest client in the Bay Area, according to JTC Americas General Manager Reid Thomas, whose office is based in Silicon Valley. He explained that JTC has a technology platform designed to administer highly complex financial transactions by ensuring that money goes where it’s intended and that regulations and compliance reporting are followed.
Since adding opportunity zones to its repertoire in 2018, Thomas said that JTC has over 100 opportunity zones under contract nationally, but because California doesn’t conform to the federal tax rules in terms of providing capital gains incentives, it poses a challenge for the initiative in the state.
“It makes the investments less attractive,” Thomas said. “The whole idea is to get capital to flow into these areas that it traditionally hasn’t flowed into. That makes doing the deal harder because it’s harder to get returns, and it’s riskier for investors to go into these areas. The smart thing would be to provide incentives for capital to flow, not disincentives. Paying capital gains at the state level are less attractive. California is still quite hot in terms of opportunity zone activity. There’s still a lot of good stuff going on, but they just haven’t conformed like other states have.”
Merchant said that one of the reasons California doesn’t conform is because it has one of the highest capital gains tax rates in the country and doesn’t want to forgo the revenue, operating under the assumption that the state is so attractive for business that the added benefit is unnecessary.
“There’s a tremendous amount of potential opportunity zone capital here in California, and because there’s no conformity, it creates a competitive disadvantage,” Merchant said. “Every deal that’s happening in California is less attractive than in places that do have conformity.”
Thomas and Merchant agreed that the OZ program needs more transparency and reporting requirements to measure whether it has the intended impact. Thomas said he is hopeful that the Biden administration will pass rules mandating reporting on the impact of opportunity zone investments.
The lack of reporting requirements is part of a broader criticism directed at the program.
Because it targets economically distressed areas, it carries the risk of causing gentrification and displacement of existing low-income residents. Merchant said that is why CalOZ is working to codify best practices for community engagement with the reasoning that community members living in OZs know best about what kinds of development will be of the greatest benefit.
"We’re giving people these tax credits, and we’re not asking them for anything in return,” University of California Berkeley Professor of City & Regional Planning Karen Chapple said.
Chapple, who is one of the leaders of the Urban Displacement Project, said that the opportunity zone legislation not only lacks strict criteria for designating areas based on poverty and unemployment levels but also doesn’t include standards for creating and preserving affordable housing such as requiring payments to the Housing Trust Fund, leaving such benefits up to the discretion of developers. She said it should also secure other benefits like commitments to hire locally for construction apprenticeship programs.
"Anytime you’re using taxpayer money, you want to make sure that you’re receiving something for the public good,” Chapple said. "So here you have a program designed to solely benefit the private sector. If we’re using that public money, let’s figure out what folks need in that area.”