Will Opportunity Zones Accelerate Gentrification or Spur Critical Investment in Distressed Areas?

Since the enactment of the Tax Cuts and Jobs Act of 2017, the real estate development community has been abuzz about the potential boost provided by the opportunity zone tax benefits introduced in the act. Put simply, opportunity zones are a tax benefit permitting investors to defer (and partially eliminate) capital gains tax by investing gains realized from the sale of property into a qualified opportunity fund (QOF), which in turn must contribute those investments into businesses or development projects located in qualified opportunity zones. Opportunity zones are designated by each state, and the majority must be in low-income communities as that term is defined in the tax code.

Opportunity zones inevitably will spur some increased investment in distressed communities. More than 100 QOFs have been created—with many more on the way—and a recent study estimated a potential $6 trillion available for investment in opportunity zones. That being said, at this early stage it’s difficult to project the true scale of investment and the resulting impact on the opportunity zone neighborhoods.

With so much capital being assembled to invest, will opportunity zone investment truly be a game changer for distressed communities or accelerate gentrification? The focused nature of opportunity zones, coupled with somewhat dated census information and the inclusion of a minority of tracts that do not qualify as low-income communities, could result in more early QOF investments in areas already on the upswing, since those tracts will feature the most attractive projects. Professionals are seeing this impact in the first wave of opportunity zone investments, but are hopeful that more funds will be directed toward truly distressed areas as the program matures. Thomas Bruce, Production Manager at PGIM Real Estate Finance, put it this way:

“In the short term, opportunity zone investors will continue to seek out projects that will drive the highest rents and the most favorable returns. Once these high-performing projects are picked off, investment dollars should begin to flow to projects in areas of need that investors traditionally would not look to invest in. While the first wave of opportunity zone capital may be concentrated in areas that are already undergoing transformation, much of the capital that follows is likely to be invested in low-income communities and lead to greater equality.”

Anytime someone tries to incentivize private investment, investors will seek out the “best projects,” which could mean most early opportunity zone investments will occur in areas which are already recovering. However, with so much money being placed in funds that are looking for projects, once the early wave of investments is over, it is likely projects will occur in those distressed communities the program was designed to assist.

Furthermore, because many experts believe the benefits associated with the opportunity zone incentive are not sufficient by themselves to allow for projects to move forward, state and local officials will be asked to layer on additional incentives. Requests for additional incentives provides state and local officials the ability to try and direct opportunity zone investment to the distressed communities most in need.

Another concern is that opportunity zone projects will most likely result in real estate redevelopment without emphasis on job creation, infrastructure and home ownership opportunities that are needed in these distressed communities. For these opportunity zone investments to truly be a “game changer,” state and local officials will need to play a critical role in layering incentives to direct opportunity zone investment in those projects with the greatest long-term benefits to local communities.