Opportunity Zones is a tax incentive available in 2019 as part of the Tax Cuts and Jobs Act. Investors who roll-over capital gains for a period of time, can earn a tax cut that equates to 1%-3% of the return on
The goal of the program is twofold: to increase equity investment in small cities across the U.S., and to help decrease wealth inequality within those reasons.
The tax incentive is the brainchild of early Facebook investor Sean Parker. Its very “Silicon Valley” in its approach. There are valid concerns to the tax cuts ability to accomplish its goals. Writing in CityLab, Timothy Weaver, questions whether the tax incentive will exacerbate wealth inequality and gentrification.
The flexibility of the tax incentive, however, puts the responsibility for ensuring equitable and healthy development on the back of local communities. Communities can, theoretically, ensure that an increase in capital finds the best partners and projects, and increases opportunities for underserved communities.
Demand-side vs. Supply-side
In many small cities a debate rages. The debate revolves around how best to stimulate economic develop. Some advocates believe the problem is demand-side. In other words, there is not enough good businesses being started. Yet businesses started in these cities lack the human and financial capital to succeed regionally or nationally.
Economic developers who feel the problem is demand-side, encourage that we need community building – in other words – the informal exchange of knowledge to stimulate the capabilities of entrepreneurs. This type of community extends to placemaking. Through training, events, and concentrating investments, we are able to build a critical mass of activity in certain sectors. The critical mass attracts investments at the right volume leading to sustained growth.
Supply-side arguments relate to capital. The lack of capital is well-acknowledged. Small cities might have $5-$10 dollars per capita of venture capital investment while major metros can have $1000’s of per capita investment.
Succeeding in Supporting Opportunity Zones
For Opportunity Zones to succeed in both of its intentions, to increase capital access in small to mid-size cities and decrease wealth inequality by creating jobs and other forms of economic opportunity, local regions must manufacture demand.
Initially, investors have a limited time to take advantage of the Opportunity Zones incentive. The incentive could be extended in the future, but the initial authorization allows for a one to two year window. There is talk that the window will be extended.
As of writing, and two months before final rules are released, there are 39 funds established for Opportunity Zones capitalized at a low estimate of 7.5 Billion. 5-10 funds will invest nationally. The rest will invest in targeted footprints.
There is estimated to be a trillion-dollar market for capital gains eligible for OZ investment.
The role of deal-making is a little recognized missing gap in small to mid-size cities. The investment capital that we have available is by and large in the form of debt capital. The equity capital that we do have available is almost in all cases subsidized through grants.
The market for equity capital is not existent in small cities. In fact, there is virtually no discussion about what a market for equity capital even looks like. The types of organizations that can derive a profit from equity investment are firms like venture capitalists, private equity, and investment bankers. The key functions of these organizations are assigning a level of risk and subsequently an estimated return to a particular investment.
This process includes providing financial management of irregular or risky deals.
While the intention of Opportunity Zones is noble, if we don’t have a local financial infrastructure to package and analyze and mitigate the risk of deals, the policy will not encourage new or social impact investment.
Building an Equity Market with Demand Side Deal-making
It will be up to the economic development community to decide to rapidly add the capacity to make deals that can attract Opportunity Zone capital. This should be the community’s choice, with the caveat that deals should be made in accordance with the spirit of the OZ legislation. For example, if communities choose to support attracting funds that support high growth tech startups, they should also figure out how to use equity capital to increase home ownership and access to working capital for under-served neighborhoods and entrepreneurs.
If communities choose to invest in manufacturing, they should also make risk capital available to small businesses such as retailers, restaurants, small agencies that allows us to maximize some of the patient capital already deployed.
Make no mistake, there will be a lot of risk associated with this type of investment. The risk is both at the level of the deal, but also at the level of the community.
In fact, one community’s City Council petitioned to remove themselves as an Opportunity Zone. This could be a great decision of OZ capital creates gentrification and supports unsustainable businesses. However, the decision could prove to be a blunder if local organizations figure out how to implement OZ capital in a way that supports the spirit of the legislation.