Two philosophical aspects related to Opportunity Zones must be considered. The first is the nature of corporate tax incentives. Amazon’s recent tax incentives could obliterate the political will for corporate tax incentives in the future.
The nature of the corporate tax incentive changes in a global economy as work becomes digitized. Public tax incentives for business attraction may be slightly easier to justify in an era when public funding supported physical infrastructure for the manufacturing of tangible goods, and when venture funding wasn’t available. Legitimize cases of public support could occur when a manufacturing firm couldn’t otherwise finance water, sewer, and electrical infrastructure for a brand-new location. In today’s economy, when the ability to support a gentrifying tech workforce with amenities, is a much tougher sell.
Society should reevaluate corporate tax incentives. However, Opportunity Zones are written into tax law and funds formed. It is necessary to ensure that funding goes to projects that generate social impact and don’t exacerbate gentrification.Funding should support the intention behind the legislation and not line the pockets of an already wealthy capitalist class.
The types of projects that funds support is critical. One can imagine projects and vehicles that prevent gentrification, encourage underrepresented entrepreneurship and business ownership, and create meaningful jobs. If Opportunity Zone funds support this type of activity, the policy is filling a major hole in the economies of smaller cities.
The second, and broader philosophical aspect of Opportunity Zones, is the nature of venture financing in small to mid-size economies. Opportunity Zones encourage equity financing as opposed to debt financing. Equity financing ultimately requires the investor to be a partner in the venture. The type of equity partnerships can vary from hedge funds to real estate investment trusts. The business models of these partnerships can vary substantially from one another.
For example, hedge funds are designed to icentivize
Other equity partnerships are much less risky. The return to investors in real estate investment trusts operate in part like a loan. Investors receive a fixed return over time, for example, 10% annually for 10 years. Unlike a loan, investors can benefit from the property’s appreciation,realized during an exit event. This type of risk could be healthy in commercial and residential real estate markets that might be distressed.
For example, investing in distressed communities might only allow for investors to utilize equity base partnerships such as a Real Estate Investment Trust. In distressed communities, markets are often broken. Let’s say a property requires 10 million dollars to bring back to life, but after the renovation only is valued at 5 million dollars. This happens a lot in distressed communities because a property is heavily dependent on the value of others located nearby. Debt funds managed by commercial banks will not invest in these opportunities because the property is underwater. When this happens, the market is broken.
There are other examples of equity-based partnerships. Early stage companies without tangible collateral (equipment, machines, etc.) also cannot obtain loan financing. Equity financing steps in to fund basic operations until the company can become profitable. The return can be deferred until the exit event. However, most venture capital is available only in major metros, so startups outside these areas seeking to create the jobs of tomorrow don’t have access.
Opportunity Zone funds should take on an appropriate amount of risk. It is hard to imagine a scenario where funds should operate like hedge funds with carried interest. However, we should support funds that seek to build community owned land trusts as a hedge against gentrification, or who seek to fund under-served entrepreneurs. Other use cases of OZ funding might be investment trusts that fix broken commercial real estate markets, and innovation-based capital for small manufacturers.
As more equity capital becomes available in local economies it will be important to understand what sectors benefit from equity investment and what sectors do not benefit. In any case, we must keep a close eye on the types of projects being funded through Opportunity Zones.