David is the Founder and CEO of Realized, a firm whose mission is to improve lives through innovative investment property wealth solutions.
Anyone involved in any type of commercial real estate endeavor has by now heard of the qualified opportunity zone program. For those who haven’t, the qualified opportunity zone (QOZ) came out of the bipartisan Investing in Opportunities Act of 2017 as a means for investors to defer paying taxes on capital gains after the sale of assets. Eventually, it found its way into the Tax Cuts and Jobs Act of 2017 and was rolled out soon after. In all the pro-and-con media hype around the program, many forget that its underlying purpose was to funnel financial resources toward in-need lower-income communities.
Though the program is still in its early days – it is, after all, a long-term initiative – the following issues should be considered when discussing QOZs: the program’s impact on lower-income areas, how qualified opportunity funds (QOFs) can boost economic development and how investors can ensure gains are directed to areas in need. With that said, there are still questions as to whether this community revitalization program is actually being utilized to revitalize communities.
QOZs: A Background
The QOZ program’s foundation is found in “Unlocking Private Capital to Facilitate Economic Growth in Distressed Areas,” a 2015 report released by the Economic Innovation Group (EIG).
In that report, authors Jared Bernstein and Kevin Hassett from the American Enterprise Institute and the Center on Budget and Policy Priorities, respectively, suggested that the best way to boost economic development in lower-income areas would be to provide direct capital to businesses. In turn, business owners could use that capital to invest in expansion and equipment for their company. Private investors would provide that capital by investing in funds responsible for funneling proceeds toward in-need areas. The end result would be an increase in employment.
Five years later, the report became real with the qualified opportunity zone program. QOFs are charged with providing capital to those in-need QOZs, and investors are incentivized to put capital gains into QOFs through tax deferrals on those gains.
Is It Working?
In August 2020, the White House Council of Economic Advisers released “The Impact of Opportunity Zones: An Initial Assessment,” which claimed that investors had put $75 billion into QOFs, proof that the program was working. Yet, within days of the report’s release, experts debunked that figure.
Accounting Today claimed that the $75 billion was based on an extrapolation from Securities and Exchange Commission filings, with additional self-reported surveys from accounting and consulting firm Novogradac. Novogradac’s findings on opportunity funds indicated more than $12 billion had been invested into 811 QOFs as of September 2020.
Confusion over the exact amount invested in QOFs is one issue. How those monies are deployed is another. There are no reporting mechanisms in place as to how or where those funds are deployed. To monitor the program, Sen. Tim Scott introduced S.2994, “Improving and Reinstating the Monitoring, Prevention, Accountability, Certification and Transparency Provisions of Opportunity Zones” (IMPACT) in late 2019. As of September 2020, Scott indicated he was still working on the bill, but the Covid-19 pandemic had put it on the back burner.
Meanwhile, an Urban Institute report offered another balanced view, pointing out that the QOZ program is creating “an ecosystem of community development efforts,” consisting of government agencies, community leaders, philanthropists and fund managers.
Yet QOFs are currently struggling to attract investors due to below-market returns and long-term illiquidity. This has prompted funds to focus on projects with better return rates, which has raised questions about whether the funds are being allocated effectively toward places that need it most.
Understandably, the coronavirus pandemic has slowed both QOZ improvements and QOF investments. According to a June 2020 survey, 52% of respondents indicated that current market conditions – including Covid-19 – hurt QOZ activities.
Ensuring Benefits To Low-Income Communities
Even as the actual answers to the QOZ program’s efficacy are few and far between, QOFs and investors can take steps to ensure resources are directed toward the right projects for communities in need.
Qualified opportunity funds should focus on:
1. Stronger community outreach. QOF managers should carefully listen to community leaders and stakeholders to determine the community’s needs, rather than making assumptions about what projects or investments will make sense for a community.
2. Local and state government incentives. While the QOZ program is a federal mandate, it should be a highly localized endeavor. QOF investments are just the beginning. To ensure significant economic development, QOF managers must understand available local government incentives and tools to ensure the best rate of revitalization.
3. Better transparency. QOZ reporting mechanisms aren’t yet mandated by law, but that time won’t be too far off. It’s a good idea for QOF managers to create a system now, which details where monies are coming from and how they are being deployed to provide more conclusive data for both investors and political entities.
Investors should focus on:
1. QOF due diligence. Responsible QOFs will provide specific urban revitalization plans, versus vague statements and promises. While finding specific track records on funds might be difficult because of the program’s relative youth, studying previous activities of fund managers and stakeholders can provide insight on past performance.
2. Realistic benefits. Investors should understand that the main QOZ incentives are tax deferral and urban renewal instead of high rates of return. The goal here isn’t profits, but rather, a focus on lower-income community improvement.
When all is said and done, the qualified opportunity zone program is not in place to benefit investors or fatten qualified opportunity funds, but rather, to support community revitalization. Understanding the goal of QOZs can help ensure its purpose is fulfilled.
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