Introduced in 2018 with an expiring benefit already in 2019, Opportunity Zones (OZs) will continue to commandeer more and more cocktail hour discussions in the real estate world through the end of this year and beyond.
Countless articles on the genesis and execution of the incentive (including this fun read from Forbes that chronicles how one of the co-founders of Napster became the philanthropic polymath who championed OZs) help describe the program, which offers tax incentives on capital gains invested in areas of particular economic interest and on the returns that come from successful investments.
The program takes place over the next decade, following this timeline:
Source: JD Supra, LLC
With myriad takes (from Bisnow to the IRS) tackling the particulars of the program, you may be wondering: where does sustainability fit into Opportunity Zones? Upon exploration, it appears that the answer is in making the deal work for developers, city officials and municipalities, and investors alike.
Opportunity Zones for Developers
While the OZ program might make real estate professionals explore different neighborhoods than they would have normally, a project must stand on its own two feet. For developers it is the tax benefit on their new investments that is the primary windfall from the program, rather than the discount on taxes from prior gains.
So, from the developer’s perspective the reason to incorporate sustainability or wellness to create high performance buildings is similar within Opportunity Zones as it is outside of Opportunity Zones: to maximize value in the project. There have been dozens of studies compiled in reports by Stok and the Urban Land Institute demonstrating the financial case for high performance real estate and as more case studies emerge, we expect innovation to continue.
Furthermore, the fact that OZs require investors to hold the asset for at least 10 years to realize the greatest tax benefit means that developers can consider high performance design elements that have a longer payback than the typical 5 to 7 years buildings are commonly held. Increasing daylighting and large-scale lighting overhauls (including bulbs and controls) typically begin providing investors and building owners with returns after year 5 and so can (and should) be considered seriously in the development of projects located within OZs.
At the same time, the incentives from Opportunity Zones can be factors in the decisions made by developers looking to deliver with a uniquely sustainable paradigm in their projects. As equity investors are becoming more accustomed to post-tax considerations in the underwriting of projects, the bump from OZs can ultimately help make a project more attractive to the capital it needs to draw in.
Opportunity Zones for City Officials & Municipalities
For city officials, OZs are a chance to work with developers to help realize an optimized vision for OZ-designated neighborhoods. Municipalities looking to incentivize responsible development can streamline processes (e.g. fast-tracking entitlements, etc.) to promote social and environmental objectives.
In doing so, cities should pursue full spectrum sustainability (social, environmental, and financial) on developments within OZs to avoid cultural discord and to address concerns about the possibility of displacement that could work against the stated objective of the program. Undoubtedly, this issue needs to be at the forefront of the way that municipalities are thinking about executing these zones. If OZs are to be successful, it means achieving buy-in from not just developers and investors, but also the communities within those particular census tracts to avoid gentrification.
There is a chance that municipalities will consider their participation in the Opportunity Zone program as “good enough” for their sustainable development efforts, halting additional progress. With comprehensive plans and building codes driving development, cities in many cases may not engage in any further action to push sustainability goals they may have. The exception could be in the case of variances regarding changes in use or zoning. If there is a request to change use type or zoning, municipalities have historically used this opportunity to integrate additional objectives (like sustainability) into the ensuing development.
Opportunity Zones for Investors
Similar to shifted incentives for developers, the mandated time horizon of 10 years to realize the greatest tax benefits should push projects towards sustainability initiatives that increase longer-term returns for investors. While the baseline of sustainability may be low in conventional development, those contributing capital to projects in OZs are driven to keep an eye on returns on a longer time horizon.
In recent years, EY found that investors are seeing improvements to ROI from considering sustainability in their investments. Private equity firms such as Partners Group use ESG as a guidepost for their investments not just due to a moral imperative, but also because of the desired financial returns they see coming out of those investments.
For Opportunity Zones to be truly successful boons to their communities, they should not be considered in a vacuum. Incorporating sustainability into OZs can and should be paired with other financial incentives (such as C-PACE in certain counties). Creating value for the projects (and communities) with sustainability and wellness can help unlock the greatest potential within Opportunity Zones.
To discuss more about integrating sustainability into OZ developments, drop us a line.