Do opportunity zones work? Erie is beginning to find out

By Liz Farmer

From the get-go, the concept and execution of opportunity zones, which are defined by the Internal Revenue Service as “an economic development tool that allows people to invest in distressed areas in the United States,” generated controversy in public policy circles. Some proponents lauded the idea as an innovative way to quickly drive investment into distressed communities, while critics warned that the incentive would lead to gentrification. 

Compounding matters was the designation process for opportunity zones, which was handled by states. Thanks to a few quirks in the way the law was written, some high-income areas were designated for the tax benefit. The New York City borough of Brooklyn, for example, has several low-poverty/high-income census tracts designated as opportunity zones.

But controversy aside, the key question – as with any tax incentive program – is: Does the benefit change investor behavior? Thanks to a slew of research that has been published over the last 18 months, it appears that it does.

Opportunity zones work by helping investors reduce the capital gains taxes they owe on previous investments by investing those gains in OZ communities for at least seven years. If investors keep their investment in OZs for a decade, they can eliminate their tax bill entirely.

Research by a University of California, Berkeley economist tracked eligible communities and those chosen as opportunity zones before and after the program destination. While the communities performed similarly prior to 2018, commercial and residential development jumped in the OZ communities after being selected for the tax incentive. 

“With this finding and its magnitude, we can be confident that the change in behavior was enormous, a 20% jump in likelihood of development in a community as a result of OZ designation,” said John Lettieri, president and CEO of the Economic Innovation Group, which helped get the policy passed in 2017.

But whether these investments will ultimately improve economic opportunities for residents is not something that can be answered definitively with a few years’ data. But the data does appear to dispel some of the concerns.

The Gentrification Question

The opportunity zone program has already outperformed other tax credit predecessors. In its first three years, investment has flowed to approximately 3,800 communities, a mark that took 18 years for the New Markets Tax Credit program to reach.

So far, however, investment has been fairly targeted. According to a U.S. Treasury Department analysis, roughly 48% of zones have some kind of investment, but the bulk of that money has been spread across a small portion of communities. Even so, Lettieri points out, that investment – at least $48 billion by the end of 2020 – is going to communities that are substantially more economically distressed than the rest of the country. These jurisdictions average in the 87th percentile for poverty, 81st for median household income and 80th for unemployment.

For Lettieri, one of the biggest affirmations of the policy is that the new investments in housing and mixed-used developments are not pricing out renters – a hallmark of gentrification. The UC Berkeley study found that as housing supply increased in OZ communities, housing values also rose but rents stayed the same. The study also found positive spillover from designated communities into surrounding communities.

Lettieri said the early concerns that OZs – most of which have been distressed for decades – would become gentrified was “a luxury belief” that hasn’t panned out.

“The thing to be concerned about was that it wouldn't move the needle, not that it would move the needle too much,” he said. “I don’t think we’re going to look back at OZs and say, ‘They did too much.’”

Luring Investors

The ultimate success of opportunity zones in any given area will depend to a large degree on local efforts. 

For example, the Erie Downtown Development Corporation in Pennsylvania is working with local and philanthropic organizations to leverage opportunity zone investment. It has lured more than $200 million in direct investment and more than twice that figure in related investments for projects ranging from housing to retail like Erie’s first downtown grocery store in decades.

EDDC officials told the publication Go Erie in 2020 that it took two years and dozens of meetings and conversations to build a relationship with the Arctaris Impact Fund, one of its first investors.

“How do you get them to invest in a community with a median income of $10,800?” Matt Wachter, vice president of finance and development for the EDDC, told the news outlet. “It isn’t easy.”

In fact, it’s even harder for rural areas, which account for 40% of the designated opportunity zones. Many were concerned at the outset that rural communities would get passed over by investors, and so far those fears are proving valid. Nearly all of the opportunity zone investments have been in urban areas, according to Treasury data.

There are a host of barriers: The deals are too small, the risk is too high, the real estate doesn’t appreciate as much so as to produce capital gains, and investors don’t know rural places and players. 

There are a few exceptions, of course. In Harvey, North Dakota, a local couple used the OZ incentive to rehabilitate a downtown property into a mental health and wellness center. Responding to the region’s lack of mental health care, the center is the only place to offer counseling services within a 60-mile radius.

But in most places, rural investment needs more than just the opportunity zone nudge. In addition to Pennsylvania, a number of states are testing strategies. For example, Kansas offers student loan repayment assistance and/or a full state income tax credit to non-residents who move to a rural opportunity zone. Washington state offers tax credits for contributing to a rural development and opportunity zone fund. And the nonprofit Opportunity Alabama is creating “ecosystems” that include local benefactors, investors and impact funds to benefit communities across the state. 

“A lot of folks really expected that having an opportunity zone – just being designated one – would be enough to really bring investors and capital to them,” said Megan Brewster of the Sorenson Impact Center, in an interview with The Daily Yonder last year.

“(It’s) a competitive market in the sense that there’s more than 8,000 nationwide,” she added, “and that really having a conscious, intentional strategy around what they would do with that capital, why they needed it, what their brand is as a community would really help give investors the confidence to then actually make some of those deals penciled through.”

Liz Farmer is a reporter for Route Fifty, where this story originally appeared.