A tax break to hasten gentrification? Housing market’s Opportunity Zones may miss their target

In mid-November, a Chicago-based private equity firm with an eye on underserved neighborhoods raised $105 million from 425 investors — in just 17 hours.

Around the same time and about a hundred miles away, Milwaukee officials were meeting to discuss what they hope is an influx of money from a fresh wave of investors for badly needed city improvement projects.

https://on.mktw.net/2E6wtRE | by Andrea Riquier | MarketWatch | @ARiquier

The two parties’ paths might never have crossed. But now, a productive match is a real possibility thanks to a new tax scheme known as Opportunity Zones. The program was tucked into the federal tax legislation passed late last year. It offers big tax shelter incentives to investors in qualified Opportunity Zones, officially designated areas in low-income communities that would otherwise struggle to attract capital.

While the opportunities the program represents are clear to some participants, analysts and advocates around the country say there are very real questions about how effective it may be as a tool to broaden housing access and spur economic development, or whether it may, in fact, be detrimental to the needy communities it sets out to serve.

“I tend to be fairly skeptical about tax incentives that are targeted to really specific locations,” said Jenny Schuetz, an economist and fellow in the Metropolitan Policy Program at the Brookings Institution.

“We have a fair amount of evidence from past programs like enterprise zones and the Neighborhood Stabilization Program that when you outline a specific geography, you tend to shift activity but you don’t necessarily increase net overall activity,” Schuetz said. “It just relocates capital.”

Even more critically, according to many observers, is that it’s really hard to find communities that are stable enough to make investors happy, but needy enough to qualify for the program’s infusions of cash and other resources.

“You don’t want to pick an area that’s already gentrifying,” Schuetz told MarketWatch. “It’s unfortunately also true that if you give incentives to a really distressed location, like [parts of] Detroit or Cleveland, it doesn’t seem to help much. The trick is to find a place that’s on the cusp.”

Many housing-watchers also think that the idea of targeting resources to a place, rather than the people in it, may sound good, but isn’t likely to be effective.

Julia Gordon is executive vice president of the National Community Stabilization Trust, an organization founded in the wake of the housing crisis to eliminate blight and mitigate the effects of vacant homes on municipalities. She thinks that investors tapping Opportunity Zone funds are more likely to gravitate toward real estate plays in distressed communities, simply because they’re a more straightforward way of investing than, say, education. “But if what you’re trying to do is get broad economic development happening in these areas, housing is critical but so are other things, whether jobs or infrastructure,” Gordon said.

As Schuetz puts it, “people-based investments” are usually more successful because they’re more targeted. Poor people in a particular area may need jobs, or job-training skills, or they may need better housing programs. But giving money — or tax breaks — to intermediaries with the hope that some benefits will trickle down rarely works, she thinks.

‘You don’t want to pick an area that’s already gentrifying… [T]he trick is to find a place that’s on the cusp.’ Jenny Schuetz of the Brookings Institution

Some city officials may think otherwise. In Milwaukee, any investment is good investment, according to Martha Brown, the city’s deputy development director. Like many Rust Belt communities, Milwaukee struggles with an overhang of vacant properties — both commercial and residential — at the same time that it’s trying to counter an affordable housing crisis.

Brown ticked off a long list of projects that had been designated as Opportunity Zone-ready: a large shopping mall on the far northwest side of town that’s now “largely vacant,” an industrial corridor and multiple abandoned factory properties, undeveloped tracts near the airport and vacant former public schools that might be re-purposed for housing.

It’s going to require city resources both to publicize the investment opportunities and to make conditions suitable for investors, by offering re-zoning or other rule tweaks, Brown said, but Milwaukee city officials are excited about the possibility of increased investment funds. “We think there’s a lot of opportunity,” she said.

It’s worth noting that not all government officials see development as necessarily positive. Local leaders and incoming members of Congress have slammed the decision to bring another Amazon AMZN, +0.08% headquarters to New York’s Long Island City, an area already on the gentrification upswing.

But generally, a sense of excitement is palpable, according to Don Hinkle-Brown, president and CEO of Reinvestment Fund, a community development financial institution that lends to affordable housing developers, among other projects.

“This is arriving at a moment when impact investing and a different way of managing money is catching on. I’m hoping that is harnessable,” he said.

To be sure, Hinkle-Brown also has concerns, particularly about patchy development efforts and gentrification. “This is an unplanned firehose of money that could be connected to a community. There may be speculation. That’s some of the worst stuff that can happen — nothing changes hands because everyone’s waiting. Prices go up in anticipation of development that hasn’t happened yet.”

(To quantify that “firehose,” the Economic Innovation Group, a think tank whose work was influential in helping develop the policy that made it into the legislation, estimates that there is $6 trillion in unrealized capital gains that could be fodder for Opportunity Zone funds.)

But Hinkle-Brown thinks there’s potential for a mismatch between the eager money and the projects that need to be done. They likely have different time horizons, risk tolerances and financial profiles, and probably aren’t used to working together. IRS rules are still being finalized. And more critically, incoming funds will be equity, and most infrastructure-like assets are generally financed with debt.

Yet another criticism of the program is that it has no provision for monitoring work that’s being done under the Opportunity Zone name, nor outcomes that emerge. As that “firehose” of money deluges local communities, it may create more work for local advocacy groups and the news media to document and analyze what’s going on, at a moment when both types of institutions are themselves resource-starved. And even if it’s possible to offer a lens on some individual communities, that won’t provide systematic data, Schuetz noted.

“There’s a good chance we will have no data on effectiveness,” Schuetz said.

‘This is arriving at a moment when impact investing and a different way of managing money is catching on. I’m hoping that is harnessable.’ Don Hinkle-Brown, president and CEO of Reinvestment Fund

There are probably already unintended consequences trickling through the economy, a variation of the speculation wave Hinkle-Brown expects, Julia Gordon said. She has heard from one legal aid lawyer about a surge in the number of tax foreclosures being suddenly rushed through court to free up available investment properties in a designated Opportunity Zone, for example.

And while many advocates say Opportunity Zones could line the pockets of rent-seekers in distressed communities while doing little to solve local problems, Gordon sees something even more ominous for the housing market.

“My concern is that Opportunity Zones turbo-charge the wave of properties transitioning to rental,” Gordon said. That would crystallize two big post-crisis trends: massive numbers of owner-occupied homes becoming rentals, and the surge of institutional investors into what was traditionally a mom-and-pop business, with a mixed track record.

“If you’re really going to develop healthy neighborhoods, broad-based homeownership is a critical part of that,” Gordon told MarketWatch. “It’s possible that as this program develops, new regulations or changes to the statutes will enable it to support homeownership, but now it’s hard to see how that works.”

While many funds are already soliciting money, some are waiting for more guidance. And given Hinkle-Brown’s concerns about money matching up to needs, it may be no surprise that he believes “this will not be a credit that will see the most meaningful mission stuff immediately.”

For more background, the economists at BuildZoom did an Opportunity Zone analysis in October, available here. Another, from the Rutgers Center for Real Estate, is here.