New data shows OZ is having an effect, but that areas most in need aren’t benefitting as much as they could. What’s the solution?
Opportunity Zones were designed to direct investment toward the parts of America that need it most. While a great deal of investment has gone to OZs, it has been difficult to figure out how well the initiative is working because of a lack of recent data.
Two recent reports shed some light on how OZs have fared over the first few years of the program. They indicate that some of the promise of the initiative is being fulfilled. However, they also indicate some underserved areas are slipping through the cracks, and provide some insight as to how OZ can be improved.
What new data says about the success of Opportunity Zones
The more information we get about Opportunity Zones, and the more recent the data being analyzed is, the more promising the outlook for the program. Two reports from the last year show why many in the industry are optimistic, but also demonstrate the limitations of OZ as currently structured.
Harrison Wheeler’s “Locally Optimal Place-Based Policies: Evidence from Opportunity Zones,” updated in November 2022, “evaluates the impact of Opportunity Zones on new residential and commercial development, and quantifies how policymakers could have achieved a more efficient response through alternative designations of the investment tax credit.”
Wheeler found that receiving OZ designation increased new development in census tracts by 20.5% and generated “positive spillovers on nearby development.” He cautions, however, that “optimally chosen Opportunity Zones would have substantially increased the investment response” and that “results suggest that there is substantial scope for equity and efficiency improvements in how the program was implemented.”
As far as what those improvements should be, Wheeler points out that “the policy effect is larger in areas with more developable land, with higher local housing supply elasticities, and with lower property values.” Therefore, if OZ tracts were chosen based on what we now know about where they can be most effective, more investment could be directed toward areas that can benefit the most from it.
Wheeler’s paper primarily concerns itself with where development has occurred based on building permits. It cannot provide insight into the effects of OZ investment on community employment, health and well-being, or other metrics related to OZ projects specifically because many projects are still in progress, so it’s too soon to say what effect they will have. But by limiting his analysis to where construction is taking place, he’s able to incorporate more recent data than other reports, and finds that in general, OZ is spurring development in underserved areas as it was intended to.
“The OZ program had strong effects on new residential and commercial development in designated neighborhoods relative to those that were eligible for the tax credit, but ultimately were not selected,” his report reads, stating that those tracts that were not chosen as OZs did not see the uptick in development that happened within OZs. This tells us that without OZ, much of this development wouldn’t have taken place, making the program a win for designated communities.
OZ development is limited insomuch as it only goes toward those tracts that were selected as Opportunity Zones. Tracts that were eligible but not selected cannot benefit. Therefore, by opening up more eligible tracts to OZ investment or selecting new tracts based on areas of greatest need, those census tracts that could have benefitted from OZ investment but didn’t because they weren’t selected would then be able to receive the benefits of OZ.
Another recent report on the success of OZ is “Use of the Opportunity Zone Tax Incentive: What the Data Tell Us,” by David Coyne and Craig Johnson for the Office of Tax Analysis, released in July 2023. Though the authors admit “it is too soon to reach conclusions regarding the effectiveness of the OZ tax incentive” and the report is limited to data from 2019 and 2020, this is a vast improvement over prior reports that largely relied on data from 2018, before fund managers had time to react to the slow rollout of finalized regulations and educate investors on how OZ was to work.
Coyne and Johnson also omit data from Puerto Rico, where some incredible projects are being funded and the majority of the island falls within an Opportunity Zone. Despite these limitations, their data leads to some encouraging conclusions about how OZ investment has evolved over the years and the effect it has had on communities.
The report has some positive things to say about how OZ tracts were selected, stating that in general, “OZs have higher poverty and unemployment, lower income, a larger minority population, less educated households, lower rates of homeownership, higher vacancy rates, and lower house prices than eligible but non-designated tracts, and eligible tracts were similarly different from ineligible tracts.”
As far as where investment was directed, “26 percent of OZs have received qualified investment through 2019, which increased to 48 percent by the end of 2020.” We can only hope that when more numbers come in for 2021 and beyond, we will see similar increases in the number of OZs that have received investment.
The report also found OZs that had received QOZ property investment “experienced stronger increases in educational attainment, income and housing values, and larger decrease in the unemployment from 2012-2017 relative to OZs that did not receive investment.” This indicates that residents of OZ tracts that received investment are benefitting from the program.
However, there were some numbers that highlighted OZ’s limitations. 95% of investment in 2020 went to urban Opportunity Zones, and a large portion of the OZs that received investment were areas that were already improving before the initiative began:
OZs that had a higher median household income, higher measures of educational attainment, higher house prices, and lower unemployment were more likely to receive investment. Moreover, trends prior to OZ designation were an important indicator of which tracts received investment. Tracts that experienced growth in median household income, population, and housing values and reduction in the poverty rate and unemployment rate were more likely to receive qualified investment.
A common criticism of OZs has been that too much investment has gone to areas that were already improving economically. As the report states, “These results so far suggest that OZs that have received qualified investment have generally been economically better off than OZs that have not yet received investment, with notably higher educational attainment, median household income and housing values.”
So we have areas that received OZ investment that weren’t those in the greatest need, and other tracts that were in need, but either weren’t designated as OZs or didn’t receive investment. How do we get investment to those areas? One solution is to change how we designate an Opportunity Zone.
Solutions for OZ: redrawing the map
In 2022, the Opportunity Zones Transparency, Extension, and Improvement Act was proposed in Congress. Aiming to improve Opportunity Zones, the bill would have instituted needed elements like impact reporting requirements, but also proposed a system for redrawing the OZ map.
The bill suggested removing OZ designation for tracts with a median family income of 130% of the national median family income or greater, giving states the ability to replace those tracts with other low-income communities of highest need.
In theory, this process could be repeated if OZ is renewed long-term. Every few years, OZ tracts could be analyzed and the designation removed from areas that are no longer deemed suitable. That way, communities that need investment can get it through the assignment of new tracts and the elimination of OZ incentives for areas that don’t need it.
Unfortunately, the bill failed to pass before the end of the legislative session. Similar legislation could pass in the future, and would greatly help OZ’s chances of renewal by setting up a system for continual analysis and improvement. Other legislation has also been proposed that would help bring investment to areas that haven’t benefited from OZ as much as hoped.
Efforts to help rural communities through Opportunity Zones
In 2023, provisions related to Opportunity Zones were added to the Small Business Jobs Act in the House of Representatives. In addition to new reporting requirements, these proposals would create new OZ tracts in rural areas using criteria different from the original OZ bill, with the goal of targeting areas of “persistent poverty.”
Rural communities have had trouble attracting OZ investment for a variety of reasons. While expanding the number of tracts may help, there are limitations to what this legislation can accomplish. That’s why it’s important that private-sector solutions like the Sorenson Impact Center’s Rural Opportunity Zone and Recovery Playbook and OPAL’s Community Growth Accelerator are so vital.
Creating more tracts among areas of greatest need, whether through the creation of new rural OZs or a redrawing of the OZ map, can help combat some of the imbalance that has occurred with OZ investment. But some think this imbalance toward urban OZs is due to deals that were already planned before the bill’s passage, something that will be corrected with time.
In an interview with JTC, Ellavoz’s Robert Hutchins had this to say about the influx of urban OZ investment in already-gentrifying areas at the initiative’s outset:
The institutional investor space is where the big OZ money was raised early on through mega-deals that weren’t impact-focused but happened to fall within Opportunity Zones. They essentially got tax breaks for projects that penciled out regardless of the tax exclusion, but I’m quite confident the best cherry-picked deals are over, and good deals will be harder to find for the big players. I expect fewer non-impact deals in the future, and that the space will be cleared out for those with an understanding of impact investing.
One can hope that as data continues to come in, we’ll see OZ investment has indeed become more impact-focused and spread out among different tracts. But no matter how investors care about impact, these projects still need to make economic sense. Part of the issue with investment in some of the most impoverished OZ tracts is that even with OZ tax incentives, there is a perception of too much risk.
As stated by Coyne and Johnson, “The incentive structure for OZ investments is not primarily to make a negative-return investment profitable, but rather to make a good return greater.”
The impact potential in OZ tracts of greatest need will surely entice investors who want to make a difference. But funds still need to generate returns and minimize the risk involved in an OZ investment. To do that, they need to be efficient and reduce unnecessary costs and operational risk. That’s where we come in.
OZ tax incentives, though attractive to investors, will not rescue a fund from poor performance. You need to maximize efficiency, reduce overhead, minimize operational risk, and meet all OZ tax reporting requirements for yourself and your investors in a streamlined, cost-effective manner, all while delivering on the impact you promised.
JTC’s fund administration solution for Opportunity Zones was purpose-built for the sector, utilizing our experience as a leader in OZ fund administration since the program’s inception. We can provide institutional-grade fund administration based on industry-leading technology designed to reduce overhead and increase efficiency while minimizing operational risk. We also provide in-depth impact reporting and full transparency through a secure online portal that offers investors 24/7 access to the information and documents they need for their tax returns.
Opportunity Funds don’t exist just to deliver returns, and they don’t exist just to deliver impact. They have to do both, and with the right help, QOFs can impact communities that need investment most while providing investors with peace of mind that projects with which they may be less familiar can deliver the returns they desire.
JTC works to help our clients ensure their projects accomplish what they intend to through a set of OZ best practices we’ve developed to ensure security, transparency, and compliance for the continued success of the OZ sector. We believe in the future of this initiative both for the good it can do for our clients and for the impact it can have on communities in need.