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'Opportunity Zones' Mean Some Local Communities Could Benefit More Than Others

Special Report: While Designed To Spur Growth in Distressed Areas, Billions May Flow to Markets with Better Economies, Demographics
September 24, 2018
Past plans for this 620-acre site in Painted Prairie, near fast-growing Aurora, Colorado, have included 3,151 residential units and a 20-acre commercial center. The project lies within a proposed opportunity zone.
Image courtesy of PCCP, in a joint venture with Greenfield Partners, Alberta Development and The Fellows Cos.

The new so-called Opportunity Zone program, created as part of the Tax Cuts and Jobs Act signed into law this past December, is designed to help reduce poverty, increase employment and spur growth in forgotten neighborhoods and communities across the United States.

However, billions of dollars for new commercial property investment could end up aiding communities -- and investors -- that do not need the help and it may hurt the neighborhoods and residents it is designed to lift up.

The Department of Treasury has officially designated more than 8,760 areas across the United States as opportunity zones. Households in the zones tend to have lower home ownership rates than the national average and higher rental costs.

But not all the zones were created equally. Under the law, contiguous communities with better economies and demographics could be included as part of the low-income area zones. These areas are also designated by census tracts based on 2011 data and do not take into account subsequent changes in demographics, development or property values.

While state governors clearly emphasized the need to steer money to impoverished areas, they also submitted to the Department of Treasury tracts where the need for development incentives is less, according to the Economic Innovation Group, a bipartisan public policy organization promoting proposals to grow U.S. communities.

As a result, the zones ended up including a variety of developments with backers who aren't in poverty, ranging from an ultra-luxury New York condominium to proposed sites for the second headquarters of Amazon, the online retailer with a stock market value that's reached $1 trillion.

Not all the money piling up to be deployed may be distributed equitably, community organizations contend.

Investors are likely to flock first to shovel-ready projects that can be completed in a short time in communities most ripe for development, whether they are the neediest or not, program participants acknowledge. The law also fails to require that new jobs created from the program go to residents within the community. And there are no written protections to keep new housing developed in the community as affordable.

"The value of the tax subsidy is ultimately dependent on rising property values, rising rents, and higher business profitability," Brookings Institution wrote in an economic study of the tax policy. "That means a state's opportunity zones could also serve as a subsidy for displacing local residents in favor of higher-income professionals and the businesses that cater to them -- a subsidy for gentrification. Indeed, the highest returns to investors, and thus the largest tax subsidies, will flow to those investing in the fastest gentrifying areas."

Fundrise, an online crowdfunding platform that offers direct investment in real estate properties, has launched a $500 million qualified opportunity fund. Fundrise Opportunity Fund is the first of its kind to provide online investment in opportunity-zone projects, making the new tax incentives program available for smaller investors nationwide. Investors will be able to buy shares online for a minimum of $25,000.

"It is incumbent upon us, the private industry, to be responsible stewards of the program," said Ben Miller, co-founder and chief executive of Fundrise. "It's not what you build in the community but how you build it."

He adds that the potential of the opportunity zones leading to gentrification that helps only a few "is the challenge of the program."

Right now, the results of the tax policy, good or bad, cannot be determined because the program has yet to take off, he added.

That is an attitude shared by some in the community development arena.

"There is recognition of that concern," said Chuck Depew, west team leader for the National Development Council, a national nonprofit organization that provides economic and community development assistance to local governments. "Will the program help or hurt communities? I'm not sure we know the answer to that question, but we are being attentive to it."

Gentrification of low-income communities is not necessarily the problem, Depew said, after all, the goal of the incentives is to raise the economies of the community. More of a concern is the displacement of the residents already living in those communities.

For all the attention paid to gentrification since the word was first coined more than 50 years ago, programs designed to lift the urban poor out of poverty have only lessened the concentration of poverty in a very few select urban neighborhoods, according to Next City, a Philadelphia-based nonprofit organization with a mission to inspire social, economic and environmental change in cities.

Since 1970, the number of poor persons living in urban high-poverty neighborhoods has doubled to 4 million, and the number of such neighborhoods has nearly tripled to more than 3,000, according to Next City.

There is no way to assure upfront that this initiative, the first new federal community incentive of this century, will have any better result.

"Sellers whose land is in an opportunity zone are getting excited as they believe this can lead to more interest," said Rick Egitto, a principal in capital markets for Avison Young in Denver.

Egitto is marketing land for sale in Aurora, Colorado, in a federally qualified zone.

"Interestingly, like this parcel, not all of the opportunity zones are in bad areas that need redevelopment," he said.

His site is in a submarket of Aurora already undergoing serious development. Just west of the land, the $800 million Gaylord Rockies Resort and Convention Center is under construction and will be completed before the end of this year. The 85-acre development will include 1,501 guest rooms and more than 485,000 square feet of convention space. Over 600,000 room nights are already booked at the hotel and Egitto's site is primed to accommodate overflow hotel room booking and restaurant and retail demand.

The site is equidistant, eight miles, or two stops on the light rail, between the two largest job generators in the Denver area: Denver International Airport with 35,000 employees and the Anschutz Medical Center with 24,000 workers. Both of these job drivers are expected to grow significantly over the next decade with a major terminal expansion approved for the airport and consistent development occurring at the medical center.

This month, Pacific Coast Capital Partners LLC, in a joint venture with Greenfield Partners, Alberta Development and The Fellows Cos., acquired an abutting 620-acre, fully entitled residential and commercial development site. The property is currently entitled for 3,151 residential units and a 20-acre commercial town center. Shortly after closing, the first phase of 600 lots was sold to five homebuilders.

"The Denver region has experienced strong and steady job and population growth but has not produced enough homes to keep up with demand. Those factors combined with a focus on entry-level product made this an attractive investment opportunity for PCCP," said PCCP partner Jim Galovan.

In New York City, a portion of the Hell's Kitchen area between 50th and 58th Street and 10th Avenue and the West Side Highway was designated an opportunity zone. The designation surprised some because the zone is a few blocks from Central Park, just north of the burgeoning Hudson Yards, and a few steps away from some of the most expensive properties in Manhattan.

In the spring of 2017, Silverstein Properties paid $166 million for a 327,000-square-foot office building in that zone. Since then, the building has undergone significant capital improvements and expanded its amenities including a bike room and common area upgrades. It is now home to media, fashion, tech, and luxury brands, including a Volvo showroom on the ground floor.

A year ago, New York developer Sumaida + Khurana acquired two adjacent buildings in the zone for $65.18 million. There are approvals in place for a full demolition. Sumaida + Khurana have commissioned world renowned, Pritzker Prize-winning Portuguese architect Álvaro Siza, to design 611 West 56th Street, an ultra-luxury condominium that will be Siza's first building in the United States.

One Manhattan broker lamented that the opportunity zone designation has brought out investors who are getting on her nerves. They are wasting her time low-balling every offer in hopes of talking local owners out of their properties before word of the program gets too widespread.

Compound Asset Management, a New York City-based real estate asset management and technology company, is launching a series of real estate funds to invest in individual markets across the country, including Manhattan and Brooklyn. "We’re watching the opportunity zone program take shape," the company said in a statement on its website. "The IRS has still not yet formalized how opportunity funds will be certified. We’re skeptical that this legislation will create dramatically positive changes in blighted areas. But, we firmly believe that it will spur investment activity and pricing, and so we’re watching the space closely and expect a flurry of activity in the very near future."

Investment was already rising in some Opportunity Zones even before the designation of the tax benefits. Such was the case for opportunity zones surrounding downtown Los Angeles (shaded blue in the map) from 2016 to 2017. So far in 2018 however, investors have held back from buying in opportunity zones (bottom, left) while awaiting final guidelines from the Internal Revenue Service.

Meanwhile, sales of properties in the Los Angeles area that are not in opportunity zones (shaded orange) have consistently been stronger (bottom, right).



On the West Coast, downtown Los Angeles is another notable example of where investment disparity could occur.

About one-eighth of all neighborhoods in America have been designated as opportunity zones. However, according to Fundrise's Miller, some have more immediate investment potential than others. Neighborhoods such as downtown Los Angeles and its neighboring Arts District community are undergoing a revival, driven by the synergies between relatively affordable housing, the extension of commuter rail lines, and new employers coming into the area.

Between May 2013 and May 2018, downtown Los Angeles home prices kept pace with Los Angeles levels overall with a nearly 32 percent increase in prices, according to a Fundrise report. A 125,000-square-foot shopping center and office complex, At Mateo, opened this year in the Arts District of Downtown Los Angeles.

Fundrise has previously invested or committed about $100 million in neighborhoods in and along the areas now designated as opportunity zones in Los Angeles. Fundrise kept its initial Los Angeles opportunity zone investment in a needier area of the market.

In the Culver City market of Los Angeles north of the Los Angeles International Airport, Fundrise Opportunity Fund this summer purchased a 6,874-square-foot, Class C office building for redevelopment. About 22 percent of the people in that opportunity zone live below the poverty level; household incomes are 20 percent lower than the average for the city, according to Census data.

A separate joint venture between Realm Estate of Newport Beach, California, and The Bascom Group, of Irvine, California, this summer acquired a 1.7-acre parcel of land in the Fashion District of downtown Los Angeles for $24.25 million. The site is entitled and planned for the development of a 33-story, 452-unit high-rise multifamily community, and the first tower to be built in the emerging Fashion District.

The project was worth undertaking even without the tax benefit, according to the buyer.

"The location not only is located in the highly desirable and emerging Fashion District but will offer panoramic views of the downtown Los Angeles skyline," said Todd Caldwell, development manager of Realm Group. "The opportunity fund qualification is an added bonus."

Realm Group has another high-rise development in the works in downtown Los Angeles that will consist of a 36-story, 422-unit multifamily tower. That project is located in the rapidly developing downtown Los Angeles area west of the 110 Freeway known as City West.

The inclusion of highly sought-after areas in California was an initial problem for the state. The Department of Treasury overturned one-fifth of the initial recommendations of areas to be designated opportunity zones. California's initial recommendations included such areas as Stanford University's campus in Palo Alto, San Diego State University's campus in College Heights, and in Berkeley in Alameda County. All have high poverty rates, but thanks only to large student populations. None of them received the designation.

In a report on its website, Fundrise identified the top 10 metropolitan areas that it said have the most immediate growth potential. Along with Los Angeles, three others are in California -- Oakland, San Jose, and San Diego.

Notable also is that of Fundrise's top 10 opportunity zones, four are among the top 20 contenders for Amazon's second headquarters, which will probably greatly speed the growth of the chosen city, adding about 50,000 jobs and creating new demand for residential and commercial real estate.

Fundrise's only other opportunity zone purchase so far is in the resurging LeDroit Park neighborhood of Washington, D.C., home base for Miller and Fundrise but not one of its Top 10 metropolitan areas. Still, Washington, D.C., is widely considered one of the top landing spots for Amazon's second headquarters, a project known as HQ2. The neighborhood around LeDroit Park is one of four of the areas the nation's capital is pitching as a site for Amazon. In fact, three of the sites in Washington, D.C., being pitched to the online retailer align with zones in Washington, D.C.

Overall, however, community organizations estimate that less than 4 percent of the entire nation's designated opportunity zones have recently experienced high levels of socioeconomic change, a proxy for gentrification and displacement risk.

The average opportunity zone's housing stock has a median age of 50 years, more than 10 years older than the U.S. median, a sign that many of these neighborhoods urgently need reinvestment.

For community development organizations such as the National Development Council the opportunity zone provision opens the door for the possibility of preservation and development of affordable housing, businesses and jobs. As the initiative gets underway, they say they are working with local governments and organizations to raise the visibility of investment-ready projects to shape how and where more of the money could flow.



Editor's Note: This is the fourth of five parts on new so-called Opportunity Zone tax benefits designed to boost investment in economically distressed communities.

Part I: The Coming Cash Wave

Part II: Awaiting the Rules

Part III: Investor Interest

Part IV: Boon or Boondoggle?

Part V: The Case for Help

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