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ImpactAlpha, February 12 – Of all the factors stifling America’s underserved communities, a dearth of economic investment is among the most pernicious. For decades, institutional capital has largely bypassed disadvantaged urban and rural areas due to the perceived risk of investing there – whether those concerns are justified or not.
As a longtime investor in underserved communities, I have witnessed firsthand the transformative power of private sector capital to create jobs, energize schools, revitalize neighborhoods, and ignite hope. I have also faced rejection from institutional investors who are fearful of any number of real or perceived hazards, from lack of market opportunity and narrow customer base to high crime and poor governance.
Overcoming this barrier of perceived risk is critical to incentivize the flow of institutional capital into the places that need it most. In the 1980s and 1990s, smart initiatives such as federal empowerment zones, state enterprise zones and Low-Income Housing Tax Credits successfully attracted billions of dollars of private capital into high-need areas. They provided tangible incentives – credit enhancements, tax credits, and subsidies – that reduced economic risks and helped real estate developers and businesses invest in these areas, and make a profit doing so.
The new federal Opportunity Zone investment program currently taking shape fails to deliver the same incentives, particularly for institutional investors. Without them, the program will not achieve its intended goal of revitalizing economically challenged communities. At its core, the legislation aims to attract investors by deferring capital gains on existing investments and eliminating capital gains on new appreciation if an investment is held for more than a decade. In the minds of supporters, this will unleash a torrent of long-term investment.
However, the Opportunity Zone program does nothing to help an uncertain investment become profitable in the first place. For this reason alone, the program fails to address the fundamental reason institutional capital has historically avoided disadvantaged communities – because the risks are perceived to be too great compared to other investment opportunities. It will leave many investors wondering: what good is a capital gains tax break on an investment that is likely to lose money?
The weaknesses of the Opportunity Zone program don’t end there. Many of the world’s largest real estate investors are tax-exempt institutions such as pension funds, university endowments and sovereign wealth funds. These institutions command enormous capital, yet due to their tax-exempt status they will receive no benefit from Opportunity Zones, eliminating any incentive to invest.
And finally, the legislation’s requirement that taxes on deferred gains be paid by 2026 will create intense pressure for some investors to sell assets prematurely to satisfy their tax liability. Not only does this preclude those investors from benefiting from the program’s much touted tax break on new appreciation on investments held for ten years, it also undermines the prospects for stable, long-term investments in high-need communities.
Pulling people up
Even if these concerns are addressed, institutions may find there’s more than meets the eye to succeed in Opportunity Zones. It’s tempting for investors to think that an MBA or well-capitalized spreadsheet is all it takes to thrive in high-need communities. They should think again. If I’ve learned anything in 25 years of investing in underserved communities, it’s that a top-down, “we know best” attitude in working with communities is the surest path to failure.
What is required are skills not always taught in business school: humility and empathy chief among them. My business partner in the early days of urban investing was Earvin “Magic” Johnson. He taught me and some of the most influential institutional investors that successful investments are made not in parcels of land, but in people and communities. Meeting those needs requires listening, and learning, on the part of the investor.
The priorities of our residents have directly shaped the business model of our multifamily housing fund, for example, which operates more than 7,000 units of affordable workforce housing in urban areas around the country. Community members have repeatedly told us that education, safety and healthcare are top priorities for themselves and their families.
As a result, our properties offer resident-focused services to directly address these issues: free after-school tutoring is available for students; police officers and other law enforcement organize neighborhood watch programs; and nurses and other medical professionals offer health and wellness services on-site. Professionals who live at our properties provide these services to fellow residents in exchange for discounted rent. The program has been extremely successful, leading to improved quality of life, higher tenant satisfaction rates, and longer lease terms – a winning model for everyone.
Many Opportunity Zone investors may not be so responsive to their communities, and will instead seek to change the character of a neighborhood by building luxury apartments or destination retail. Fulfilling the spirit of the Opportunity Zone ideal means pulling people up, not pushing people out. Only a program that creates true incentives to invest for the long term and meet the needs of current residents is one that can live up to the promise of its name and create lasting opportunity for all.
Bobby Turner is the chairman and CEO of Turner Impact Capital.