While economic disparities between regions began to disappear in the 20th century, they have begun to resurface, according to a report on “left-behind places” by the Brookings Institution.
The report credits “a fortunate tier of big, dense metropolitan areas” with jump-starting the new divide. Cities in the top 2% of income and growth began to outpace moderately and marginally prosperous areas alike in the 1980s, when digital technology started having an effect on the economy.
Impact investors have long used place-based investing strategies to channel development money to projects in areas of the country that are currently underserved by traditional commercial development. Adding momentum to this trend, Congress has introduced tax incentives for investing in what are known as Opportunity Zones.
New Incentives for Place-Based Investing
As outlined in the 2017 Tax Cuts and Jobs Act, investors may receive tax-free capital gains treatment if they invest in areas of each state designated for economic improvement. These areas are known as Qualified Opportunity Zones. While investors have to put their investments in a Qualified Opportunity Fund, there are three possible tax benefits associated with this type of investment.
Two of these benefits are connected to the investor’s original capital gains. First, by investing in a Qualified Opportunity Fund, investors can defer tax on their capital gains until December 31, 2026, or the time when they dispose of the Fund—at which point the taxes become payable. Second, up to 15% of that gain can be excluded if the investor meets certain holding period requirements. The third benefit relates to the investment in the Qualified Opportunity Fund itself. If it is held for 10 years, 100% of the gain from the Qualified Opportunity Zone investment may be excluded from federal income tax.
According to Glenmede’s In the Zone: A Primer on Opportunity Zones, these investments are likely to appeal primarily to two kinds of institutional investors. Property investors could find Opportunity Zone investments attractive, particularly if they have experience managing distressed assets or if they can take the risk of erecting new buildings in distressed areas that might have more vacancy or turnover. Early-stage venture capital investors who have the means to rehabilitate properties are also likely to see the appeal of these funds. This is because they’ll be best prepared to meet the requirement that investors make “substantial improvement” to the acquired asset within 30 months of acquisition. Some venture capitalists may find that the 10-year hold period for the tax benefits is longer than their normal investment window, though.
In late October 2018, the US Treasury published proposed rules implementing the Opportunity Zone tax incentives and has scheduled hearings later this year to get public comment. Many investors are waiting for the final rules to be issued before proceeding with an investment.
The Wider Context of Place-Based Investing
Opportunity Zones are the latest iteration of local place-based impact investing, a concept that has been around for several decades. Place-based investing strategies channel capital to specific local communities to achieve a range of goals, from building affordable housing and providing access to healthy food to aiding business development and accelerating job creation. Place-based investing can unfold in varied ways, as evidenced by these three examples.
- Philadelphia. A 33-year-old community development financial institution, Reinvestment Fund helps finance diverse initiatives in communities across the country. In 2018, it announced the PhilaImpact Fund, a collaboration with the Philadelphia Foundation aimed at raising $30 million for projects specific to the Philadelphia region related to “housing stability for low-income families, better health outcomes, higher educational attainment, greater access to fresh, healthy food, and more.”
Jacksonville. The Jessie Ball duPont Fund is providing $3 million to be leveraged to build $50 million in assets through Self-Help, a group of nonprofits that facilitates access to savings, loans, and financial transactions to people who are unbanked or otherwise financially unstable.
Louisville. Kentucky’s largest charitable foundation, the Community Foundation of Louisville gave a $200,000 loan to transform a former restaurant into what calls itself the city’s first kitchen incubator. Chef Space is designed to provide young caterers, bakers, and food truck operators with accessible commercial kitchen space, as well as mentoring and connections to potential customers.
Place-based impact investing has demonstrated its ability to change communities that have been neglected by economic development. The generous tax breaks offered under the Opportunity Zone legislation mean there could be much more capital available soon. This offers the possibility of positioning place-based investing as a key tool in funneling crucial development dollars into the most vulnerable regions.