February 19, 2019 - From the February, 2019 issue

VX2019 Tackles The Promise & Uncertainties of Opportunity Zones and Value Creation

The Opportunity Zones program, passed by Congress as part of the Tax Cuts and Jobs Act in 2017, provides tax incentives for investment in low- and moderate-income communities in an effort to build wealth in areas that need it most. But what will implementation of this new policy look like, and will it be sensitive to local needs? At the VerdeXchange 2019 Conference, an esteemed panel of developers, financiers, and civic leaders gathered to talk about the intriguing potential surrounding Opportunity Zones, the risks of gentrification and displacement, and the regulatory uncertainties that are delaying investment. Moderated by Ian Ross (Co-Founder and CEO, OppSites), the panel featured: Fiona Ma, California State Treasurer; Lew Horne, Divisional President, CBRE; Con Howe, Los Angeles Fund Managing Director, CityView; Greg Ames, Managing Director, Trammell Crow Company; Jon Bonanno, CXO, California Clean Energy Fund; and Aaron Thomas, Director, Economic Initiatives & Opportunity Zones, Accelerator for America. 


Fiona Ma

“There are currently 1,000 projects in California's Opportunity Zones that have either started or are in the planning process. The State Treasurer's Office has a lot of money that we could infuse into these projects.” —California State Treasurer Fiona Ma

Ian Ross: The Tax Cuts and Jobs Act of 2017 created a provision for Opportunity Zones. The goal is to encourage deal flow, and to direct the $6 trillion in pent up capital gains that are looking for shelters and places to go, into real estate and business opportunities in 8,700 of the nation’s low-income census tracts, which were selected by each governor in every state.

Three distinct tax advantages for Opportunity Zones. One, an initial deferral of taxes on gains. If you have gains from the sale of a stock or asset, you can put them into a Qualified Opportunity Fund (QOF). Then you have about 180 days for that fund to make investments.

Then, as you hold the investment over time, you’ll incur a step-up in the basis of your initial investment up to 15 percent. In other words, only 15 percent of your initial investment is subject to taxes; you’ve managed to shelter 15 percent. This isn’t a quick turnaround; the goal is long-term, value-generating investment in low-income census tracts. 

Ultimately, if your fund holds the investment for 10 years, the entire appreciation of the new investment can be excluded from capital gains taxes. That’s the big play; that’s what all the excitement about. This is an opportunity to make a long-term investment, to create cool new projects in areas that haven’t necessarily been on the radar of the capital markets. This is essentially a community and economic development program structured as a private-sector capital gain incentive.

One of the most exciting aspects is the opportunity to invest in new and expanding business, so it’s a business development program as well.

This is all about the timing. The incentives for the investment community increase over time. Timing and the ability to execute—whether it’s a real-estate project or a business project—is what matters.

In California, there are 879 of the nation’s 8,700 Opportunity Zones. That’s 10 percent of the national marketplace in the continental U.S. (For what it’s worth, basically all of Puerto Rico is an Opportunity Zone.)

OppSites, our company, is working with the state of California to host an online marketplace where you can gain access to deal flow and create a profile and search around for what you’re looking for.

A big part of the excitement is the pressure of getting the clock started on your investment. You want to start that clock early because the value increases with time. Being able to execute, get money into a fund, and get that fund to invest in projects sooner rather than later is why everybody is buzzing around this discussion today.

Fiona, is it just the investment funds and capital markets that are the winners here? How do we get value down to the actual people of California? 

Fiona Ma: Even though I am only in Week Four as your state treasurer, I’ve spent the last four years as your friendly tax collector on the State Board of Equalization. I spent six years in the State Assembly in leadership roles and four years on the San Francisco Board of Supervisors. I am a CPA by training; I started in public practice and now have found my calling in the public sector. 

The good news is that Governor Gavin Newsom wants to completely conform California taxes with the federal tax advantages in the Opportunity Zone legislation. That means California is open for business. We are going on the roadshow to say, “Come or stay in California and invest in us.” 

There are currently 1,000 projects that have either started or are in the planning process in California’s Opportunity Zones. We are trying to be the convener of some of these dealflows. I’d like to try to match investors with shovel-ready, sustainable, holistic projects here in California where we can leverage more of the dollars. The Treasurer’s Office oversees the 9 and 4 percent affordable housing tax credits, but we also have a lot more money that we could infuse into these projects.

Ian Ross: Lew, who stands to benefit from this program and who is most worried about it?

Lew Horne: CBRE is very excited about this new program. Every community needs an inflection point to change to demonstrate to investors and the local community that there is momentum in that area to attract other investors. 

We saw this in Downtown LA with the Staples Center. It was an inflection point; it changed everything. Then there was the Adaptive Reuse Ordinance, which also changed everything; all of a sudden, we had residential in Downtown LA. We see the same thing happening now in Inglewood with Hollywood Park: There’s a momentum that’s changing the value across the board for the entire community.

The Southern California marketplace is one of the top marketplaces in the world for private capital. If we can redirect that capital into areas that heretofore have not had the growth that they need, that is going to change those communities, create momentum, and spur other private equity investment.

Right now in the Southern California marketplace, industrial is 1 percent vacant. We have a 2-3 percent vacancy in residential, and plenty of office. We’re seeing values that are literally putting people out of their homes. We need more residential development without question. The big winner here is going to be the local community, which is what this whole program is designed for.

Ian Ross: Aaron, how do we make sure that the 31 million Americans living in Opportunity Zones get to participate in the upside?

Aaron Thomas: It comes down to ownership and participation. The challenge is whether they know about it, first of all; there’s a sales portion, because they can’t take advantage of it if they don’t know about it. 

Second of all, it’s about focusing, from a development perspective, on the community itself. How do we foster minority entrepreneurship, female entrepreneurship, and low-income entrepreneurship? How do we foster businesses that serve the communities themselves moving into those neighborhoods?

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When we think about how Opportunity Zones actually affect the people living them, I think it’s about making sure that people can participate—which means that they own it. If they get people moving into their neighborhoods and kicking their rent up and kicking them out, I don’t think that helps the people this was supposed to help. 

We’re thinking about how to make sure that people own these things, whether that’s through a community asset corporation using funds from Opportunity Zone development to finance debt on things for the community to foster those things, or any other kind of way.

Ian Ross: Con Howe is currently working on an Opportunity Zone project. Is the incentive enough to move the needle to make projects in areas that weren’t necessarily market-ready—to turn a project that wasn’t a project into a fundable project?

Con Howe: No matter what, the project has to make sense in terms of the market direction. But what this program does do is attract capital to these locations. These are communities that haven’t seen an infusion of capital. The best part, frankly, is that it’s not even checks out of taxpayers’ pocket here—it’s national. The United States Treasury Department is in effect losing money from capital gains in order to put that money into neighborhoods and communities that need an infusion of capital. 

On the first question about who will be the winners: Frankly, the immediate winners will be those firms or individuals who are already doing this kind of work. I’m lucky in that CityView only does urban infill, multifamily development, and we already, for 15 years, have been working in many of these neighborhoods. We looked through our current assets and found that almost a third of the sites that we done over those 15 years are in Opportunity Zones. We looked at our pipeline, and it’s about a quarter to a third. We feel that we are well placed. 

As an example, we have a project south of Downtown at Adams and Grand. It’s ready to go and we’re attracting investors quite enthusiastically to move ahead on this 290-unit project two blocks from the Metro. Those who are ready to go will maximize the benefits, because you’ve got to get started, since it is a 10-year hold to maximize the benefits. That’s a good thing, because we want long-term investment.

Fiona Ma: What’s great is that so many projects in these areas sometimes don’t pencil out because the cost of building and construction keeps increasing. This is the perfect opportunity to get going on so many of those projects that have been waiting for that capital or waiting for the state to give them that 9 percent tax credit, which is oversold. It’s a way to jumpstart and get these projects going. I look forward to working with folks like Con who have been in the planning stage and are waiting for that gap funding.

Lew Horne: One challenge I think this program faces is that you need not only the ready-to-go-developer, but also the ready-to-go site. There’s a 30-month period where, if you’re not showing material progress—and I’m not sure that’s been defined—then you’re in trouble on the overall investment. (Fiona, maybe you can help us and the community work out what “material improvement” mean.) There are very few projects that can go to a complete change of use—which is typically what you’re going to be dealing with in these kinds of communities—in that timeframe, with CEQA and all the other issues that generally get tacked on to development projects. A 30-month period may not be enough time to “show material progress.”

Ian Ross: This is a compliance issue: For these funds to remain in compliance, they have to show significant improvement. There are a variety of guidelines, and for the real-estate side, there’s one that’s very exciting: that the cost of land is coming out of the initial basis assessment. That brings the coast into play, and makes it so that the cost of land in California doesn’t make this cost-prohibitive. On the business side, it’s about showing a certain amount of expansion and growth over time.

We’ve been focused primarily on real estate. Let’s switch gears to other types of opportunities that Opportunity Zones may create additional capital for. 

Jon, speak to how the Clean Energy Fund is looking at energy and infrastructure projects for the Opportunity Zones program.

Jon Bonnano: We are a non-profit organization focused on supporting diverse clean energy entrepreneurs—women, people of color, and regions that are typically overlooked by private equity. We focus on helping them build better businesses and capitalizing those businesses through a variety of financing mechanisms. 

We believe that assets such as solar arrays, electric vehicle charging stations, and energy storage are all appropriate for Opportunity Zone finance. Because of that, we can now work with partners like CBRE to upcycle their energy costs and liabilities and create assets. We can make these projects interactive partners with the electrical grid, potentially selling services back to the grid. 

We are not pooling capital. Our role as a non-profit is to facilitate the compliance of Qualified Opportunity Funds. Investors or developers would come to us, and we would help them set up their fund and stay compliant. We are trying to get out of the way of the transaction, and add the value of clean energy infrastructure into projects. Or we could inject capital from a Qualified Opportunity Fund into corporate equity. 

Ian Ross: Let’s talk about the timing side of the equation. Many time-dependent, and either live or die depending on how fast the CEQA approval process goes. 

Greg, as a developer, how are you looking at the timing side of Opportunity Zones to ensure Trammell Crow projects can survive and attract capital?  

Greg Ames: Governor Gavin Newsom has proposed building 3.5 million homes, and we at Trammell Crow are going to do everything in our power to help him achieve that. The CEQA process does pose a threat to the challenge of taking advantage of Opportunity Zones here in California. 

Just in here in Los Angeles, Trammell Crow has about 1,800 multi-family units in process within Opportunity Zones. But the clock is ticking on the Opportunity Zone program benefits. Our projects have to be on the ground and underway by December 2020 in order to take advantage of the tax deferral. That is because the tax bill on the first investment becomes due on January 1, 2026. If you fail to get your project going within 23 months, you will leave benefits on the table. 

To take advantage of Opportunity Zones, investors are looking for permit-ready and shovel-ready sites, without any CEQA appeals or any objections. We need to be able to provide the benefits within 30 months. 

The big takeaway is that some investors are weighing whether or not to put their money into California because of the uncertainties of the land-use challenges. Other states that can accelerate the project approval process—and do not have to worry about CEQA—are attractive. What we are promoting is for everyone to get into alignment, and show investors that we can accelerate projects in those communities.

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© 2019 The Planning Report | David Abel, Publisher, ABL, Inc.