Opportunity knocks in the US for rundown areas — and investors

Senator Cory Booker cited the Torah and deployed his limited Hebrew as he pleaded with a group of New Jersey real estate executives — many of them Jewish — to join his investment crusade for poor neighbourhoods. Doing so, Mr Booker declared, would be a chance to “do the greatest mitzvah” — or good deed — “of all.” 

Not that the executives needed much convincing at the meeting in October: many were already salivating at what could be the biggest tax break of their lifetimes.

Known as Opportunity Zones, Mr Booker’s initiative was a little-noticed element of President Donald Trump’s 2017 tax bill. In simplest terms, it allows investors to reduce their capital gains by investing in deprived areas.

At a time of extreme political polarisation, the proposed Opportunity Zones have brought together some unlikely bedfellows, with the backers including Obama progressives such as Mr Booker, Manhattan allies of Mr Trump and Silicon Valley pioneers. 

There is less consensus, however, on their likely impact. Proponents argue that Opportunity Zones may one day come to be seen as the boldest economic development plan for poor areas in a generation. But they could also end up presenting the most generous tax deal to the rich in decades.

The revelation that the new Amazon headquarters in Long Island City is located in one of these Opportunity Zones has only increased the interest in — and scrutiny of — the proposal. 

“When Opportunity Zone legislation came out last December, in some ways we thought it was almost too good to be true,” said Sherry Wang, managing director at Goldman Sachs’ urban investment group, which focuses on disadvantaged communities. She was speaking last month at a conference organised by the real estate programme at Rutgers University Business School. “I think it’s a once-in-a-decade — maybe once-in-a-lifetime — opportunity,” Ms Wang added.

James Nelson, who heads the New York-area practice at Avison Young, a real estate broker, expresses similar enthusiasm. “I’ve been doing this for 20 years and I’ve never seen anything as close to exciting as we think this can be,” Mr Nelson says, predicting Opportunity Zones would become the method of choice for high net-worth individuals and family offices to make “intergenerational” transfers of wealth. 

When he gave a talk on Opportunity Zones in Manhattan in October, the room was bulging with attendees. “Every other investor you’re speaking to is talking about this because the implications are massive,” Mr Nelson says.

There is a long history of trying to bend the tax code to lift up impoverished areas. It is a matter of wonkish debate whether Opportunity Zones will fare any better than previous efforts. Some worry they may actually worsen gentrification. 

Still, even before the final rules are written, opportunistic money managers are scrambling for a piece of the business. Among them is SkyBridge Capital, the alternative asset manager founded by Anthony Scaramucci, Mr Trump’s shortlived communications director. His firm is trying to raise a $3bn fund to invest in Opportunity Zones. Daniel Barile, a managing director at the firm, says it is targeting the “mass affluent” sitting on inflated stock portfolios after a long bull market and facing big capital gains taxes if they sell.

“It will benefit the billionaire, but for this programme to be a success it will [also] be the doctor, the lawyer, the dentist with some Netflix stock,” he says.

John Lettieri, one of the architects of Opportunity Zones, says the aim is to shift some of the estimated $6.1tn of capital gains built up in the US — particularly in the easy-money years that followed the financial crisis — to deprived communities.

The authors of the plan settled on a simple incentive: allow investors to defer capital gains — from the sale of property, stocks, a business, anything — as long as they reinvest the profits in one of 8,700 Opportunity Zones around the country. These are deprived areas chosen by each of the states where the average income is less than 80 per cent of the surrounding area or poverty levels are above 20 per cent.

For those who qualify, their original capital gains tax will be reduced by 10 per cent if they hold the new investment for at least five years. It will be cut by 15 per cent after seven years. After 10 years, there is an added bonus: any profits generated from the Opportunity Zone investment become tax-free.

“This is by no means in our view a silver bullet but it’s one very powerful tool to deploy on behalf of communities that have been left behind,” says Mr Lettieri, president of the Economic Innovation Group, a Washington think-tank founded by Sean Parker, the technology entrepreneur who upended the music industry with the creation of the Napster file-sharing service and was an early investor in Facebook. 

When details first trickled out, some viewed Opportunity Zones as another handout to billionaires in a Trump tax bill already tilted toward the wealthy. That perception was not helped by the discovery that one of Mr Trump’s golf courses is located in an Opportunity Zone. (It is not eligible for any benefits.)

Opportunity Zones: investment incentives

There is also the fact that real estate developers — renowned for their determination to avoid taxes — are expected to be big users of the funds. At present, their favoured tax vehicle is a “1031 exchange”, which allows a developer to defer capital gains by ploughing the proceeds from one property sale into another property investment. Opportunity Zones have been described as a 1031 exchange on steroids.

Even some real estate investors have their suspicions. “There’s got to be a pony here somewhere,” says one.

While Opportunity Zones may benefit Mr Trump and his inner circle, they came to life during President Barack Obama’s administration. A 2015 white paper published by the EIG served as a blueprint for a bill co-sponsored by two African-American senators from opposite ends of the political spectrum: Mr Booker, a progressive Democrat who grappled with poverty as mayor of Newark, New Jersey, and Tim Scott, a free-market Republican who grew up poor in Charleston, South Carolina.

The legislation attracted bipartisan support. Mr Scott was instrumental in tucking it into the larger Trump tax bill that Congress passed late last year.

Mr Booker, who many expect to run for president in 2020, describes it as a way to use capitalism to address the inequality that has become one of the left’s most urgent concerns. “I want to create a business case for low-income areas in America,” he says, predicting Opportunity Zones “will probably be the biggest economic development thing to come out of Washington in this generation.”

Tim Weaver, an urban policy professor at the State University of New York at Albany, is sceptical. “This approach is nothing new,” he wrote in a scathing review. Whether they were Thatcher-era “enterprise zones” in Britain or Clinton-era “empowerment zones” in US inner cities, such policies tended to deliver little for the money, he argued: “Sadly these policies almost inevitably result in tax giveaways for investment that would have occurred anyway.”

Adam Looney, a fellow at the Brookings Institution, says the benefits of a variety of “place-based” policies was “inconclusive”.

Mr Lettieri is reluctant to over-promise but insists that in designing Opportunity Zones, he and his colleagues examined a slew of predecessors to understand where they had gone awry. 

Some, they decided, were too complex or too narrowly defined to be of much use to investors. They took a dim view of tax credits because they were often directed at specific companies to entice them to relocate — such as Amazon — or doled out by a distant bureaucracy. Even when subsidies and tax credits helped, their effectiveness was inevitably limited because they were capped at a certain level.

The great appeal of Opportunity Zones, Mr Lettieri argues, is their flexibility — and the fact that investors can steer as much, or as little, of their capital into worthy projects as they see fit.

“It doesn’t bother me that people are initially sceptical,” he says. “This is a tool — not a guarantee.”

Ms Yang believes the mere discussion surrounding the policy may yield some benefits for poorer neighbourhoods. “There could be real estate developers who never looked at these areas who will now,” she says.

There is at least one feature intended to ensure that Opportunity Zones amount to more than a tax dodge. Investors cannot simply park their money in a vacant lot and reap the benefits. They must increase the value of a business or property by 100 per cent before the investment can be sold on. That would be far easier to accomplish in a poor neighbourhood than, for example, an up-and-coming part of Brooklyn.

State and local officials have been given leeway to choose their Opportunity Zones, based on underlying census data. While some may wish to promote dilapidated downtowns, others might focus on rural areas. 

Remarkably, the life expectancy of those living in selected zones is four years lower than it is for those outside them, according to an EIG review. Yet there are some strange outliers. Even proponents of the plan are scratching their heads at the nomination of Long Island City, the fast-growing Queens neighbourhood where Amazon just announced plans to build a new headquarters. The area is too wealthy to qualify as an Opportunity Zone, but New York appears to have used a special exemption to make it one. “It’s at least puzzling,” Mr Lettieri concedes.

In Tucson, an Arizona city with lots of low-income areas, mayor Jonathan Rothschild is hopeful about the scheme. “The investors are excited about it. We picked really good projects, and if it works, great,” he says. The mayor is uncertain about how Opportunity Zones would interact with existing tax incentives and other details that will not be clarified until early next year. “Whether it’s really adding more to the pot? We’ll see,” he adds. 

There is the risk that Opportunity Zones might succeed too well. Some worry that investment suddenly pouring into poor neighbourhoods might push up property values and displace longtime residents. That is a particular concern in a city like Newark, which is already undergoing a renaissance and where 78 per cent of residents are renters.

Jason Grove, chief policy adviser to Newark’s current mayor, Ras Baraka, suggests the city might counter the threat to local businesses by instituting rent controls — something sure to be unpopular with developers and investors. “The city of Newark isn’t a financial product — it’s home,” says an undeterred Mr Grove.

For now, fund managers are more focused on the possibilities of Opportunity Zones than the potential pitfalls. 

Derek Uldricks, president of Virtua Capital, is talking to technology executives who have company share options and would like to diversify their holdings but cannot do so without taking a big tax hit. Virtua specialises in 1031 exchanges and already has 60 or so projects in the works — mostly in the hospitality sector in the south-east and south-west — which would qualify as Opportunity Zones and thus for capital gains breaks. “It, in effect, just fell into our laps,” says Mr Uldricks.

Virtua is marketing two funds — one geared toward investors with $1m to $5m to invest and another for the “ultra high-net worth” crowd. Mr Uldricks lamented the fact that Opportunity Zone funds may not benefit the middle class — although that probably won’t worry his hyper-wealthy clients.

“From the investor standpoint, the tax benefits are tremendous,” says Mr Uldricks. “We’ve never seen anything like it — certainly not in our lifetime.”

History: Distressed areas need more than tax breaks

The new Opportunity Zone policy creating a stir in America was born nearly 40 years ago in Thatcherite Britain.

In 1980, prime minister Margaret Thatcher created 11 Enterprise Zones intended to reverse the decline of derelict neighbourhoods. One was the docklands in east London that became the Canary Wharf financial district.

While Thatcher remains a hero of the right, the idea for Enterprise Zones has largely been credited to an urban studies professor who hailed from the political left: Peter Hall of University College London. Throughout the 1970s, Mr Hall refined his theories about sweeping away regulations and lowering taxes in particular locales in order to encourage investment and alleviate poverty.

Enterprise Zones quickly crossed the Atlantic, where they found an enthusiastic champion in Jack Kemp, a Republican who was searching for ways to revive his rusting congressional district in upstate New York. Mr Kemp won support from President Ronald Reagan and several states tinkered with the idea. Yet it was under a Democratic president, Bill Clinton, that the renamed Empowerment Zones became law in 1993.

Their record has been mixed — and sometimes difficult to assess because of a lack of data. Some analysts have questioned their overall employment benefits, arguing that many of the jobs created in such zones have simply migrated from elsewhere. 

Others argue that the most blighted areas require public investment in infrastructure and services before they can attract private capital — regardless of tax and other incentives.

Mr Kemp’s acolytes still complain that Mr Clinton’s Empowerment Zones were a weak and overly bureaucratic imitation of their policy. 

With Opportunity Zones, which were included in President Donald Trump’s sweeping tax plan last year, they may at last have a chance to test a new version of an old idea.