9 Early Conclusions of Opportunity Zones for Equitable Development, with Brett Theodos

Brett Theodos

In its early days, how effective has the Opportunity Zone incentive been for equitable development projects?

Brett Theodos is senior fellow at the Urban Institute, where he recently co-authored a research report titled, “An Early Assessment of Opportunity Zones for Equitable Development Projects.” The report aims to comment on how the incentive is working for mission-driven projects.

Click the play button below to listen to my conversation with Brett.

Episode Highlights

  • A definition of equitable development as a combination of community development and economic development, or the nexus of people and place.
  • How mission-oriented actors are using the Opportunity Zone incentive.
  • An in-depth recap of the nine observations from the Urban Institute’s research report.
  • The disconnect that exists between hopeful Opportunity Zone project sponsors and investors.
  • For projects that don’t work, why the Opportunity Zone incentive alone is not usually sufficient to make them work.
  • Why Opportunity Zone capital flow into real estate projects has dwarfed flow into businesses so far.
  • Do real estate projects create jobs?
  • The pros and cons of incentivizing capital appreciation versus impact.
  • The common theme running through mission-driven projects that have been able to successfully use Opportunity Zone capital.
  • What the Opportunity Zone incentive got right, what it got wrong, and suggestions for how to make it better.
  • An assessment of how the federal government has supported the incentive.
  • What may happen with the Opportunity Zone incentive should Democrats win the White House this November.

Featured on This Episode

Industry Spotlight: Urban Institute

Urban Institute

Formed by the LBJ administration in 1968, the Urban Institute is a Washington DC-based nonprofit economic and public policy research institute with a mandate to study the nation’s urban problems. The institute provides insights that inform policy choices about the well-being of people and places.

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About the Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, the Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

Show Transcript

Jimmy: Welcome to the Opportunity Zones Podcast. I’m your host, Jimmy Atkinson. In June, the Urban Institute released a research report on early use of the Opportunity Zones Incentive. The report highlighted 9 takeaways that were drawn from roughly 70 in-depth interviews conducted with different opportunity zone participants. Joining me to discuss this research today is the report’s lead author, Brett Theodos. Brett is senior fellow at Urban Institute, and he joins us today from his home office in Washington, D.C. Brett, thanks for taking the time to join me today. And welcome to the podcast.

Brett: Thanks so much. Happy to be here.

Jimmy: Yeah. Happy to have you here with us today, Brett. The title of your report that you wrote for the Urban Institute is “An Early Assessment of Opportunity Zones for Equitable Development Projects.” So, before we really dive into the report, can you tell us first what do you mean when you use that term “equitable development?” What does that term mean exactly?

Brett: What we mean are projects that really have a dual nature, where they are trying to prioritize both benefits for people and benefits for place. So we’re not simply talking about improving real estate. Even if one group of residents is swapped out for another, we’re really talking about incumbent or original benefits, benefiting in some way from the projects that can be created. And there’s really a large way, a variety of ways, or types of benefits, that could create it, from arts and culture, to housing, to environment. So there’s a lot of things that can still fold into it, but it really is the nexus of people and place.

Jimmy: Or as you define it in the report itself, it’s considered the intersection or union of economic development and community development, which is kind of interesting that you’ve dialed this in so exact. Because I’m guilty of actually using those two terms interchangeably, but they actually mean two different things, and equitable development kind of folds them both in. Is that right?

Brett: Yes. People use the terms in different ways, but I think it is a helpful tension to think of them as separate constructs. And equitable development is really sitting at the intersection of both economic development and community development.

Jimmy: Right, which is more or less the congressional intent of the incentive in the first place. Is that right?

Brett: It is, yes.

Jimmy: Right. So, then, the report highlights a lot of the takeaways that were brought about as a result of all of the interviews that you conducted with different opportunity zone participants, wealth managers, opportunity zone fund managers, different project sponsors, and so on. Those nine key takeaways, essentially, on how mission-oriented actors are using the Opportunity Zones incentive. Can you run us through each of those briefly right now? And, take your time. I kind of wanna just give our listeners a broad overview of the report itself. And then, of course, I’ll link to it in the show notes page as well, if you wanna read it yourself.

Brett: Great. So, we did interviews with project sponsors and investors, intermediaries, local government actors, and the like, to try to understand how Opportunity Zones were working in financing mission-driven projects, or equitable development projects. So this really wasn’t meant to be a comment on everything the program is accomplishing. It really is zeroing in on how is this incentive working for mission-driven projects?

And we heard a fair amount of uniformity, a fair amount of consensus, from the folks that we interviewed about what the key early lessons or takeaways were from the life of the incentive to date. And we bracketed those into nine observations. And they were as follows. First, that OZs are reaching actors that haven’t been engaging in the traditional community development field, that they are drawing new actors and new energy and excitement into that space. Second, that that attention is catalyzing, in some communities, a new ecosystem of community development, the nexus of local government, possibly state government, philanthropy, private market developers, mission-driven developers and investors.

Jimmy: And just, sorry to interrupt you there, Brett. But those top two points, I think those are the two big positive takeaways that your report highlighted, of the nine. And then, the next several highlight some of the shortcomings of Opportunity Zones. So both the good and the bad, your report highlights. So continue on with number three, and onward, some of the shortcomings that result from the Opportunity Zone incentive.

Brett: Sure. And the third, I don’t know if it’s a shortcoming or a missed opportunity. But the third was that the OZ structure lacks encouragement for resident or intermediary engagement. That said, in the report, we described that that’s true for other federal community and economic development programs, too. So, when we spoke to actors, we didn’t necessarily hear that there was more resident or less resident engagement in Opportunity Zones projects than there was in new market tax credit projects or community development block grant projects or the like.

So OZs don’t really stand out as better or worse in that regard. I’d say, to the extent there’s a distinction for OZs, it’s that these other programs have intermediaries, which are intended, and hopefully actually do act in place of resident input, whether that’s a city, you know, the elected officials, or whether that’s a nonprofit, mission-driven actor, or whether that’s a state housing finance agency. So it’s in some sense the intermediary function that’s more saliently different than it is the resident function.

And from there, other findings of interest that emerge, I think the most core or fundamental challenge that we heard, and we heard it a few different ways, but, was that many mission-driven project sponsors are struggling to find investors. And that happens for a few reasons, and it happens in a few different ways. But the end result is that there’s a disconnect between many mission-driven sponsors, hopeful project sponsors, and investors. And part of the reason is that OZ investors are demanding higher returns than impact projects can support. And that partially reflects that the Opportunity Zone incentive is, in some ways, a rather shallow form of subsidy, in terms of the amount of return that’s added from the temporary deferral and the step up in basis. You know, we’re talking about a couple hundred points of return, and that is not enough to get a project from 8% to 15%, if that’s what a project can otherwise offer, and what an investor otherwise demands or expects.

And so there certainly were examples we found of highly mission-driven investors who are willing to accept much lower than market rates of return. But most of even the impact investing field is looking for rates of return that mean that Opportunity Zones are not sufficient in helping most mission-driven projects on their own get across the finish line, and become funded projects.

Jimmy: Right. And I’ve heard a lot of the same. You know, one of the most, one of the more common questions I get, is just that, “Hey, how do I find capital? Where’s the money?” And then I also hear, you know, people with experience, namely project sponsors, fund managers, say essentially what you just said, but in slightly different terms. They’ll say, “The Opportunity Zone incentive doesn’t make a bad project good, but it has the potential, in some cases, to make a good project great, or maybe a very good project great.”

Brett: I’ve heard very similar wording. And when I hear that, what that says to me is the project doesn’t work. You know, a project that doesn’t work, Opportunity Zones aren’t sufficient to make it work. That they can give a little bit of extra return, they can help out, but the investors are not willing to get projects across the finish line, even with the addition of OZs that they wouldn’t have been otherwise. And so, it’s worth acknowledging that that’s very different from our other tax tools to support community
development. Low-income housing tax credit projects would not be happening but for the tax credit. Most, though not all, new market tax credit projects wouldn’t be happening but for that tax credit.

So I realize this is not a tax credit. But the question still exists of how many projects are getting done that wouldn’t have gotten done anyway. And that was one of our findings is that there were indeed some projects that investors and project sponsors said the OZs really were very helpful in helping it come together. But a much more prevalent experience that we heard was that the OZs provided a little boost, provided a little extra return, but the project would have happened anyways. And sometimes we heard the project was identical in terms of pricing, at least for the business. You know, this form of equity swapped out for that form of equity, but no real benefit was driven to the business. So that might have helped the investor some, but not necessarily generated any new benefit or project in the community that wouldn’t have happened otherwise.

Jimmy: Right. So that takes us through the first, I think that takes us through the first five points. You’ve got four more. I’ll let you kind of go through each one of those now.

Brett: Great. So, the next finding won’t surprise the listeners of the podcast. And that is we heard that even though OZs were designed to spur job creation and business growth, most of the capital is flowing to real estate uses. And there’s a few different reasons for that that we heard at multiple points related to exit, related to compliance, so that you can make sure that this thing is still able to get the tax benefit after the time period. So, but it does mean, and we do cite data from Novogradac, that under 4% of capital so far has gone towards operating businesses. So it is a very small share. There’s some interesting examples that we highlight, including some financing for operating businesses that are becoming owner-occupants of real estate. So there is an intersection between operating business and real estate that is an intriguing use case for this incentive. But that was a smaller proportion of the interviews that we spoke with. Most often, it’s commercial, and it’s multifamily real estate.

Jimmy: Right. Yeah, that’s been one of the biggest disappointments of the program so far is that it hasn’t been used to catalyze more business investment. You know, I think, a couple of reasons for that are one, the real estate rules were just a little bit clearer from the outset. And I think that’s a function of just how the statute is structured, just this being a place-based policy. But it’s also a function of the timing of how the regulations rolled out. You know, large amount of any questions that we had on what qualifies as an eligible real estate investment for Opportunity Zone capital flow into it, those questions were clarified pretty early on after the first tranche of regulations, for the most part. Whereas a lot of questions surrounding business investment weren’t really cleared up until the final regs were issued toward the end of last year. Do you have any other thoughts to add on that, Brett?

Brett: I think that’s right. And I think that timing does matter. That said, there are just some basic and structural elements to the incentive that make business investing more difficult, and that relate to the fact that real estate doesn’t move, and businesses can. Certainly, business investment is more risky. Fifty percent of small businesses fail within five years. But also, in terms of exit, and this is actually something that’s relevant for real estate too, but especially for business, is investors wanna sell at the point the asset has, in their view, really reached a peak. And if that doesn’t align well with the tax incentive, then the incentive, you know, the permanent exclusion in new gains, is not necessarily adding that much value to the project. In the end, it may or it may not, but the question is, up front, how certain investors can be about that as it affects their underwriting processes.

Jimmy: Right, right. Yeah, at the same time, you are critical that OZs were designated to spur job creation. Most capital is flowing into real estate. That’s fact. You know, and like you say, Novogradac has a lot of good if not incomplete data on that. I’ve heard some people argue though, that don’t real estate investments spur job creation on their own, though, in two ways? One, there are construction jobs being developed. And then, the real estate is built for a purpose, oftentimes for businesses to later move into. What are your thoughts on that? That point?

Brett: It’s really tricky, actually. In some sense, the question we’re asking is not just about first-order effects, but second-order effects. And so, yeah, and it’s also confounded somewhat by the question of would the projects have happened anyway? So, if these are good deals that just got a little better through OZs, and they would have happened anyway, then arguably, the OZ resulted in no new net benefit of the project being created. Now, if the projects wouldn’t have been done but for OZs, then certainly there could be benefits that could be attributed to the incentive. But beyond that, I think it’s helpful to think of a scenario where, at some equilibrium point, there’s enough office space for enough business. And if you think about it, if we build three more big office buildings, will we automatically have businesses to fill those buildings? You know, if we build three more grocery stores, do we have the purchasing power and interest in buying groceries to support that? Or does that mean that three other grocery stores go out of business because we no longer need those grocery stores?

So it is to say there could be jobs that move across the street, potentially, from this grocery store to that grocery store. But historically, economists and other researchers don’t think about real estate as generating net jobs in the same way as operating businesses, for those reasons. Which, again, is not to say that there are no new jobs at the address where the project is. But it is to say when we incorporate this kind of second-order thinking, that that’s where the conclusions get challenged.

Jimmy: Right, what is the end net effect? That’s a valid point. Well, I think you’ve got two or three more takeaways here that your report highlights. I’ll let you get through those, and then I’ll throw some more questions your way Brett, go ahead.

Brett: Right. So, another finding or conclusion related to the business conclusion, and again, this is more particular for mission projects, which was our focus, was that even for real estate, the exit strategy’s around your 10 raise challenges for project founders. And that’s because in the most immediate, the OZ incentive doesn’t incentivize impact. It incentivizes appreciation. And so, there is more benefit for investors with more appreciation. That could be a really good thing for certain kind of projects, and it might motivate certain investors to get involved. But for community assets, mission-driven projects, like affordable housing or health care facilities, or charter schools or any number of those types of projects, they don’t necessarily wanna buy back the property in 10 years at 2x the price they could have gotten financing for today.

And in some of those spaces, there’s a disconnect, because 10 years sounds like a really long time to some investors, but to an affordable housing provider, to a charter school, to an arts facility that’s really geared and built out just for that entity, 10 years is a very short time, and they’re looking for leases that are appreciably longer than that. And so, there’s a tension and a disconnect that’s, both in terms of the appreciation and also in terms of the length of time, that means that, even for real estate projects, mission-driven real estate projects, that there are disconnects, and it can be hard to do those projects as well.

Jimmy: And then your final two points, they raise some questions about the incentive and how much of a difference it’s actually making, and the need for, and maybe you can just briefly run through those last two points, takeaways number eight and nine.

Brett: Sure. So, we found examples of OZ projects, or, put differently, we found examples of projects that were using OZ capital that did fit our definition of mission-driven equitable development projects. A common theme running through those projects is that they had other subsidy sources in them. And those ranged. They included things like low-income housing tax credits and new market tax credits. They certainly included state money and local money, whether in the form of tax abatements or other credits or incentives or grants, philanthropy as well, other HUD programs in addition. So there really was a full range of state, federal, local and philanthropic supports provided to projects. And so, to the extent that we did see OZ projects produced in a mission-driven equitable way, it really did depend on other subsidies being brought to bear.

And that fits with our earlier findings that the OZ subsidy, on its own, is largely not sufficient in helping mission-driven projects cross from here to there, to get across the finish line. Again, this isn’t true for every project and every investor. So it’s important that we acknowledge that there are some investors that are willing to take projects across that finish line and accept a 1% return or 2% expected return. We highlight some of those examples in the report. We have some case studies of some compelling projects that did see that, but if we step back and look across the set of projects that we spoke with, it really was the case that OZs needed other support, other subsidy, to be able to produce mission-driven projects. And that relates to our last conclusion, which was the need for OZ financing was mixed. And in many cases, the OZ capital itself was not the mission-critical element to the project moving ahead.

Jimmy: Good, and that just about does it. Those are your nine key takeaways or conclusions that you uncovered through your dozens of interviews with different Opportunity Zone participants. I enjoyed reading the report very much. You know, it was critical of the incentive in some regards, and I’m very pro Opportunity Zones, of course, being the host of the “Opportunity Zones Podcast.” But yeah, there are some shortcomings or some missed opportunities with Opportunity Zones with the incentive. And you did a very nice job highlighting those. Let’s turn to some of the positives for a minute, if we can revisit. I wanna hear from you, in your own words now, Brett, some of what the Opportunity Zone Incentive got right. What did it get right, primarily, and maybe you have one or two other examples that you could highlight.

Brett: It’s a very flexible tool. And when you think about what communities need, communities are very different. And so, what one community needs is not the same thing as what another community needs. And so, from that perspective, that’s an attractive feature of the OZ. Now, there’s risks that come with that, because then the question is who’s deciding what communities need? But on its face, I think there is attractive elements to the flexibility that OZs convey. The other attractive element to it is that it’s looking to access a class of capital and investors who are different. These are not the same bank, CRA-motivated set that we have seen as the foundation and conventional practice around community development in this country.

And so, OZs have held out the potential of accessing new actors and new capital. And that has generated a lot of buzz, a lot of excitement. And it’s resulted in cities creating czars in order to coordinate efforts. It’s resulted in a whole lot of conferences, and consulting opportunities, and just, a new energy around economic development, principally, but to some extent community development, in places. And so, in that sense, OZs have succeeded in gaining a lot of attention. I think we’re still working through, and in some ways, you know, not seeing a commensurate scale of investment in actual projects. But I think those design elements, both tapping new investors, and being so flexible, is what has generated so much excitement about OZ.

Jimmy: Right. Yeah, definitely a lot of excitement. And, as you point out in the title of your paper, it’s an early assessment. So I’d be interested in seeing what may change over the next couple of years here. Obviously, there’s a lot of shortcomings, or potentially missed opportunities with Opportunity Zones. Could you state briefly, you know, some of the big missed opportunities there? And what would you recommend, and what does your paper specifically recommend, that policymakers do to address some of those missed opportunities going forward?

Brett: I think the biggest failing of OZs is that it’s not being used, largely, for operating businesses. And when I think about what is needed across the U.S., and what the federal tax code already supports, we already have a lot of federal incentives to produce real estate with certain social benefits. We don’t have so many federal resources to produce job growth in communities that really need it. And so, from the outset, that was the element and the potential with OZs that I felt had the greatest justification, that was the most compelling in terms of need. Because there are plenty of other ways that real estate can be built in this country, and existing tools as well.

So I would lift that up as probably the biggest deficit. There are other elements, too, that make it hard. In some ways, Opportunity Zones are both too lucrative for projects that don’t need them, and not lucrative enough for projects that do. And so it’s this odd middle place of both being not a very deep subsidy, and yet, for the projects that are happening, being too deep a subsidy, i.e., being a source of subsidy that they didn’t need at all. And so in some sense, I think OZs need to be made stronger, and more, a deeper subsidy, whether that’s adding to the capital gains, step up in basis, or through another approach. And I would also like to see that graded by community need.

So, if you’re in Brooklyn, the thought that you have the same need in a community, a zone, that has homes worth a million dollars on average, as the zone in Youngstown, where the average home is worth $14,000. Those are very different capital market inducing places. And so I would like to see an incentive that is better targeted to need, and that perhaps has a scaled or graduated element to it. And I would also like to see an incentive for which there is a stronger certification process. So, the certification process right now really isn’t a certification process. It’s a self-certification process. And so, I think if we have a stronger emphasis on mission actors, which can include for-profits, then we can more easily justify why additional subsidy is needed, because we can more easily justify that the program is producing things that wouldn’t have happened otherwise, and is producing things that really will be benefiting the residents of these low and moderate income communities.

And so, there’s a number of other changes that could be built in, in some fundamental sense. I think that we need to size the incentive to impact, rather than just to appreciation, which might mean some targeting around either AMIs, or units produced, or targeting around job production. I would also be interested, and this is a bigger change, but in the spirit of our current moment, I would be interested in thinking through how to broaden who can invest in the program. So, limiting it to those who have capital gain is definitionally the top 1% to 5% of people in this country, that have that many gains that they can part with for 10 years. You know, corporations, obviously, as well, can participate.

And so, something that was more in the form of a refundable tax credit as a way to allow people who live in neighborhoods to make investments into their own communities, and have an ownership stake in the commercial stores they shop at seems like a compelling thing for our time to be able to show and reflect. And then lastly, I would say that there are ways that mission-driven funds could be supported more clearly. And that could include some adjustments to, for example, allow investments into CDFIs to count as eligible, which they then could deploy in a variety of forms. So, there’s other elements at place. I think we probably got some of the zones wrong, and should consider removing some of them. They don’t stand out as especially needy. But all of these things could be pursued, or some of them could. And either way, I think we would result in some improvements in terms of mission outcomes from the program.

Jimmy: Yeah, agreed. A lot of good ideas there to have a better mission-driven approach to Opportunity Zone Incentive. And to expand the field of potential investors, as well. I like that idea quite a bit. And then, making the incentive deeper, I like that idea of increasing the basis step-up, especially, I mean, the seven year 15% basis step-up on the original deferred gain has gone out the window already, so we’re down to 10%, and maybe even 15% was enough. Maybe something like 25% or, more even, would make the incentive that much deeper. That’s an interesting idea as well. Brett, what are your thoughts on how the federal government has done supporting the program so far to date, with the creation of the White House Opportunity and Revitalization Council, and all of the work that the Treasury Department, and IRS in particular, have done in regulating the incentive? What are your thoughts on how they’ve done so far?

Brett: I think they’ve thrown everything they have at it. The White House has made this a top priority. I feel like almost every agency, at least all the relevant agencies, have produced their own efforts to try to double down or support the incentive. So I really can’t think of things the administration has left undone that would make the incentive more attractive to investors. Let me modify that a little bit to say that they’re working within the confines of the legislation. And so I think some people want them to change things or write rules differently. But as I read the legislation, I think there are some clear lines there that are challenging to move forward with. That said, this is a market-driven tool. This is a market-driven incentive. It is open to a lot of different investors for a lot of different uses in a lot of different places. And so, regardless of what the federal government has done, and the White House Council, that doesn’t fundamentally, you know, adding a preference point here, or an accommodation there, that doesn’t fundamentally change the program as it’s most typically used and understood and accessed.

So I think there’s been a lot of signaling of the program as important, but I don’t think that is fundamentally why OZs are getting a lot of attention. I think the fundamental reason is because of the OZs themselves, and the structure and the incentives that they provide.

Jimmy: Right. Yeah, I think that’s a fair point. You know, at the end of the day, it’s a private capital incentive, designed to operate within private markets. By design, the government really shouldn’t be dictating too much of the success of the program one way or another, after the statute has been written, anyway, within the confines of the law itself. It’s very private market-driven. We’re in an election year. Got a presidential election coming up here in a few short months. If we are to see an administration change, if Trump gets voted out, Biden gets voted in, Brett, what do you anticipate might happen with regards to the Opportunity Zones Incentive, if anything?

Brett: So, just first to acknowledge that I have not spoken with the Biden team in any capacity on this, so I don’t have any…this is not reflective of any firsthand insight into their thinking. That said, as I have discussions around this tool, there are critics who want it to change or even go away, and we’ve seen legislation introduced that would result in some pretty significant changes to it. But I also see a fair amount of enthusiasm still for the tool, even among Democrats, certainly among Republicans. And so, if I had to guess, a Biden presidency means that OZs continue. I think a lot will depend on if Congress acts, we might see differences in some regards, for example, on reporting. Certainly it will depend who gets in place at the agency leadership levels, and what their agendas are. But I have yet to hear anything about a clearly articulated difficulty with or opposition to Opportunity Zones emerging from the Biden campaign.

Jimmy: Very good. Well, Brett, I really appreciate your time today. Thank you so much for joining me. Before we go, where can our listeners go to learn more about you and the Urban Institute?

Brett: So, we have all of our publications on www.urban.org. We have a landing page for Opportunity Zones that has this report and the other fact sheets, briefs, and reports that we’ve produced. It has a link to testimony that I gave before Congress on the program, and a couple of public comment letters that we’ve put in about reporting issues. It has data about the program, as well as some event summaries, and it also has a tool. We designed a tool for Opportunity Zone projects, where they can, project sponsors can self assess how much impact or benefit they expect to create from the program, as a means of helping us understand better what communities need. So, all of that at urban.org.

Jimmy: Perfect. That’s urban.org, and for our listeners out there today, I will have show notes on the Opportunity Zones database website for this episode. You can find those show notes at opportunitydb.com/podcast, and there you’ll find links to all of the resources that Brett and I discussed on today’s show. I’ll be sure to link to urban.org’s OZ landing page, as well as to the full report as well. All right, thank you, Brett. Really appreciate your time today.

Brett: Thanks so much. Appreciate it.


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