Gino Borges:

Welcome Steve Glickman.  I met Steve at the Nexus Conference in Washington, DC. Steve was on two different panels discussing Opportunity Zones, and on both panels, it was clearly evident that Steve was head and shoulders above the rest in terms of knowing what was happening in the Opportunity Zone space. He really understood it from an angle that I really appreciate because you really made people feel really comfortable about the topic.

More importantly, he stays close to the hope and the intention of the program. As people spoke about potential problems of the program, Steve really had a strong sense of what the intentionality was. That’s a byproduct of also being a creator of the program of which we’ll be able to hear a little bit more about here.

Steve is the founder and CEO of Develop LLC, an advisory firm focused on building and supporting opportunity funds and broader opportunity zone marketplace. He was the founder cofounder and former CEO of the Economic Innovation Group, which was the bipartisan organization that was the chief architect of the $6 trillion OZ program. Also, Steve previously served in the Obama administration as a senior economic advisor at the national security and economic councils.

He has been featured in Bloomberg, LA Times, New York Times, NPR, Washington Postand Wall Street Journaland about 14 other publications as well. The point being is that Steve really knows his stuff about Opportunity Zones and is really passionate about the topic, too. Not only is it a policy walk, but he’s really passionate about it.

Steve Glickman:

Excited to be here with you. As you mentioned, this is all I think about, these things. So, that either makes me very useful or very boring. Hopefully you’ll find it more useful than boring.

Gino Borges:

To begin with, at a high level, what was the opportunity zones designed to do?

Steve Glickman:

It’s fundamentally a program meant to change the way, or at least some part of how the capital markets work. It’s both the commentary on what capitalism and investment looks like these days and also the capacity of government to address what are now long-standing issues that relate to the inequality. The Economic Innovation Group that I launched and ran from 2013 to 2018, along with Sean Parker who was our chairman and chief patron, was really an attempt to bring a bipartisan approach to one specific type of inequality, which is geographic inequality. At the time we were looking at it, it was not something that was very well understood or mattered to people in a time when we’re very focused on income inequality. We thought, and I still do think, that income inequality is a byproduct that only a relatively small chunk of the country these days can benefit from economic growth. Particularly after we had the huge recession in 2008, it became clear that the federal government, state governments and large companies weren’t able to be stewards of redevelopment that we needed in many places.

The private capital had to step up, but wasn’t. There was an enormous amount of wealth that had been generated in that part of the economy, in part because of how successful the stock market was. Also, the tax code changed over the last 30 years to keep much more wealth with individuals. This is a way to catalyze the long-term private equity investments in what should be relatively distressed, low-income communities around the country with a federal subsidy, which is what the Opportunity Zone incentives provide. With the skin in the game from state and local players, governors were largely tasked with picking the Opportunity Zones in their states. What we have now is a map of 8,760 places that make up about 12% of the country, covering 35 million Americans that make up the downtowns of many cities. In the middle of the country there are about 75% urban, 25% rural and they’re a big experiment to see if we can crowd fund a Marshall Plan for places that have fallen behind through a private capital channels and use that to do everything from building real estate development to infrastructure and energy projects, to investing in businesses, and doing venture capital investments.

We’re really in the first inning of it, although it’s a good time to have this call because we just got a number of answers to open questions from the Treasury and the IRS through a large amount of regulations. There are now 250 pages of regulations around this program that provide a blueprint for what you can invest in. You have a fairly flexible program that should be useful for lots of different types of investors.

Gino Borges:

Take me through that journey in terms of the innovation group. How did this all sort of come about?

Steve Glickman:

Sean Parker was an early instigator of this for sure. He’s someone who’s very smart and sees ahead of the curve on things that are happening in the country and he was moving from the private sector phase of his journey to the philanthropic phase. He was very interested in how you do development, not just in the U.S. but around the world, through a private sector lens in a way that’s more sustainable. We had some early conversations in 2012 that really led to the creation of this experimental group, a bipartisan group in D.C. that was supposed to be a combination, given an advocacy group to bring together investors, depressed communities and mostly at that point federal policy makers and Congress. It started under the Obama Administration and became law under the Trump administration.

We spent two years in stealth mode trying to figure out what we wanted to do. I look at previous place-based incentive programs. These types of incentives have a long bipartisan history that date back to Jack Kemp in the 70s and 80s, and into Bill Clinton. The last program in this space was almost 20 years ago and a lot of those programs hadn’t been very successful. That commentary is very much alive today. We designed a program that was meant to function very differently from previous programs and being much more flexible and scalable so that they could deploy capital into lots of different asset classes. But we took a long time to study it – two years, which being in a stall mode for two years in DC, you might as well be dead.

People do not want to talk to you at events. We launched in 2015 along with a group of cosponsors or champions – I became a cosponsor in the legislation. Cory Booker and Tim Scott were very involved in the political side. We also worked with Jared Bernstein, who is Vice President Biden’s Chief Economist and Kevin Hassett, who became Donald Trump’s Chief Economist, which is very interesting because they’re likely to be favored to be the two opponents for the president in 2020. We’ll see what happens. But, it just goes to show that there are ideas that work across the aisle and that aren’t even that controversial if you structure it the right way and frame it the right way and go to the right group of champions. But at that point, we were still a long shot for passing legislation.

We developed a white paper that became a piece of legislation that was introduced in 2016 and eventually reintroduced in 2017. Then, because of a sequence of events that I think involve Donald Trump’s election and the recognition that place mattered to people politically.  People in different places were experiencing the economy differently. In part because we had a very strong champion, Tim Scott, who’s the Republican senator from South Carolina. He was a lieutenant in passing the tax reform bill that happened at the end of 2017. We had a shot, and we had a life raft to jump on to get this idea across the finish line. All of a sudden, it became law at the end of 2017, and we were off to the races when no one really knew about this. But, we needed governors, mayors, the administration, and Congress to act. It was very much so seeing the organic growth of a new market.

Gino Borges:

Obviously, a lot of people are attracted to this from a policy angle, but there’s also a lot of investors that are interested in this topic from a lot of angles. Can you talk about, what are the benefits of Opportunity Zones to investors compared to traditional investments?

Steve Glickman:           

As I mentioned earlier the Opportunities Zone incentive is different than a lot of other programs. It’s not an upfront tax credit. What it’s designed to do is to subsidize the risk of growth investing and real estate development projects in what are economically struggling markets. The way it subsidizes that risk is in two ways. It provides you an incentive that relates to capital gains, at the front and in the back end. In the front end, you have to start with capital gains and you have to take inactive capital gains, sell that asset and create a tax event for yourself which you can then redeploy into what are called Opportunity Funds, basically specialty private equity vehicles that can be structured in lots of different ways, but are investing for a long-term period of time in these zones.

To get the full incentive, you really need to be invested in these funds for 10 years or more. This is patient capital. As you go along and you stay invested, you get to defer that original tax bill, the original capital gains until 2027. That’s when you have to pay that tax. And in the meantime, you get a discount on the capital gains tax up to 15%. That’s the front end benefit, but the back end benefit is much bigger. That’s whatever you invest in, if you’ve held that fund for 10 years or more when you sell those investments, whatever profits you made in those investments are now tax free. What’s really interesting is that you can hold it for that investment for decades and make as much money as you can make in that program.

It’s all tax free now. That presumes you’re making profitable investments in areas that are harder places to invest in. That’s the trade off here, and it’s meant to create a large market of investment for ideally every investor. They’ve got a small part of their portfolio that’s similar to emerging markets investments in a regular portfolio, but think of these as domestic emerging markets investments having incentive and the incentive is big for, depending on your yield, your return, up to 40% or more in added returns. So if you’re getting a return that’s 10% now, maybe earning 14 or 15%, which can change the game in terms of the things that become investible and how competitive this is for other asset classes. It’s a fairly big incentive, but with an acknowledgement that you’re taking risks because not only do you have to hold for 10 years, but you have to improve your investment for the most part. You have to build something brand new. We have to improve something that’s already in there. Those rules are pretty strict. Run the program. That’s the art of investing through this incentive.

Gino Borges:

What do you see right now as a narrative that’s constantly being perpetuated that just isn’t really what either the policy was intended to do or what it’s actually going to do?

Steve Glickman:           

I view this program through a pretty macro lens. Again, we’re in the first inning and all the rules weren’t in place about this program until a few weeks ago. The industry is just building and that means that the type of people that are investing, how much money’s being invested in, what kind of projects people are investing in, and where they’re investing is going to develop and evolve over time and what would be natural to market.  What’s happening here is that the early movers and the early pioneers who are taking a lot of risks are offsetting that risk by investing in places that feel more economically stable, that are closer to home, closer to the capital markets, and in projects that would work regardless. That’s the reality of what’s happening in the near term but while a lot of people use that as an indictment of the program is not value-added to me, it’s just recognition that the industry is brand new and that’s what you would expect to happen earlier.

Over time what’s going to happen, as we’re waiting for the rules for this to happen, is you’re going to see more and more capital flow into the market that will be looking for more and more deals that will push people to find projects outside of those geographies. I see it now in real time. It’s not hypothetical as far as I’m concerned, into different asset classes. From commercial real estate, which is the marines of community development investment because there’s so much muscle memory, it’s so obvious to things like energy and infrastructure and business investments, all of which are deals that I’m working on in real-time and to markets that are beyond places like Oakland and San Jose and Seattle and to places in the middle of the country where I’m also starting to see more and more deals.

The natural equilibrium should be (in a program that can tap into $6 trillion of unrealized capital gains and is going to do, I believe, $100 billion of deals a year) for there to be more capital than there are deals and for there to be an increasing spread of the types of deals they’re in. But there’s a lot of “gotcha” stories now that weren’t deserving in Brooklyn, which I agree was not deserving, but it’s a very small part of the ultimate puzzle. The program obviously won’t have a shelf life beyond its initial period of time to invest, which is essentially over the next 10 years. I think you’ll see this be tremendously important to a lot of communities and a go-to part of the portfolio for investors.

There are already probably about 300 opportunities, known funds, all of whom are raising capital. You can’t go to any major wealth manager these days and not have them at least have heard about this program and hear the demand from their LPs. The market is getting more sophisticated around that. That’s probably the single biggest thing. The advantages if you see what I see is to be an early mover in a lot of these other markets, whether the geographies or asset classes are fund strategies they’re not seeing the flip side, the philanthropic and impact community. I think they come at this from the perspective that these are impact funds and they’re not really impact funds in the traditional sense. They can be, but this is impact-based investing, which for whatever reason impact investing has never embraced as a form of impact investing. It really makes it its own generous class of investment, which is going to be brand new from both the market perspective and the impact perspective. It makes sense that everyone’s a little uncomfortable, but I think both sides of the market are pretty interested in it.

Gino Borges:

What’s the most frequently asked question that you get?

Steve Glickman:           

I get lots of different questions. I probably talk equally to community stakeholders as I do to big investors and fund managers stakeholders, but they tend to have different questions. To be honest, right now the two sides of the market aren’t doing a good job talking to each other, which is part of the problem that the program is meant to address. I think that’s a good macro point to make. This program is just about facilitating capital and that’s not going to be a silver bullet for hardly any community, but it is creating a different conversation between the investors and communities, which we really need because I can’t see a way we solve a lot of these large economic development problems unless the private investor community is engaged. Once they’re investing, they have much more skin in the game to see other things happen that makes sense in communities. Whether that’s crime prevention or building of affordable housing or whether it’s energy or property taxes, good local government and the places that are going to do the best at this early on are your nontraditional markets. We’ll have good local government, good mayors who are really engaged. We talked about one of them – Nan Whaley, the mayor of Dayton, Ohio, people to judge, obviously a candidate for president that was very aggressive about this. As the mayor of South Bend, the mayor of Stockton, California or Columbia, South Carolina, Birmingham, Alabama, who had been many of these cities. Those mayors, typically come out of communities that had been cut off from capital markets.

They see this as a once in a generational way to change the conversation where they’re from and to start planning in a different way, long-term about what can happen to their communities. In the community, it’s very much what will attract capital on the fund managers. It’s very much a sustained kind of conversation. The communities want to find the fund manager they should be talking to. For the most part, what it boils down to is the fund managers want to find out who the investors are they should be talking to. The investors want to find out who the good fund managers and where the good places are. It’s much of the same core question, which is who should my partners be in this journey? But of course, there are a lot of technical details people don’t understand as well.

Gino Borges:

Do you have current examples of what that multistakeholder communication looks like around the country? Have you seen of where people are actually considering investor fund manager and community?

Steve Glickman:           

Some of this has been happening through the philanthropic lens, the Kresge Foundation, or the Rockefeller Foundation that have intentionally tried to bring together diverse communities. There’s a group called Accelerator for America, chaired by Eric Garcetti that has brought together a number of mayors with investors to help figure out how to build prospectuses and strategies around this. In terms of specific places, there’s been some interesting stuff in Birmingham, Alabama where the city is developing a type of a public-private fund around this space where the city prioritizes projects and the private sector will bring in the capital. They’ll sort of co-manage some of that money together or co-prioritize where that money goes. It’s starting to take place. But again we’re early, so what funds are really trying to do now is structure themselves in a way that makes sense with the program and raise money.

What communities are really trying to do is get a hold of their assets and figure out what’s in them and how to build, make themselves relevant, or put themselves on the radar screen of the broader community. I’ve seen a lot of examples of marketplaces and data platforms trying to bridge that gap. I think there’s a big opportunity there still, but nothing has really scratched that itch totally yet. So again, I think you’re seeing this start to form as we get through this year and into the next year when funds go from raising capital to deploying it, you’re going to see many more conversations around communities and the capital side figuring out how to make this work. To some extent that already happens, right? You can’t really do, whether it’s real estate or infrastructure, development without having a strong role with the communities and a good conversation there.

We’re going to see more of this coming from where capital coming outside of communities who aren’t familiar with a lot of those stakeholders. Trying to find out how to partner with them will be the challenge. That’s the big change here. If you’re a city in the middle of the country, we may have lots of local capital, but if you really wanted to tap into New York or San Francisco or LA capital and funds, this is going to be your opportunity to do that. You’re going to have to make some new relationships there.

Gino Borges:

There’s the policy and then all of a sudden the IRS is responsible for clarifying the rules in regards to how the program will evolve for funds and investors and so forth. A lot of those rules have become clear over the past couple of weeks. Can you touch on what’s clear and what’s still murky?

Steve Glickman:           

By now we have a lot of answers to most of the fundamental questions. The rough timeline is the legislation. The statute passed in December, which is the architecture of this program. There’s no one who was selected in June of last year. So the market’s only really been around since then. There was a first round of rules in October released by the Treasury and IRS and in a second round that just was released two weeks ago by the Treasury and IRS.

That accounts for about 250 pages of regulations, which is a lot to wade through. It basically provides a lot of the threshold, where capital comes from, how funds should be structured, how they have to be deploy, the types of tactics you can use in making investments, such as how to use debt and how do you treat new financing, how do you deal with depreciation and a lot of fundamental nuts and bolts questions. We have a lot of the answers and a lot of the opening questions are really in the margins of some of those regs. I think the hardest part of assets to invest in are going to be businesses already in zones as opposed to new businesses or those moving into zones. There’s a little bit of murkiness or maybe organic complication there.

Of course, the Treasury and IRS rules are thinking about this in an academic exercise as tax lawyers and in the practice of actually deploying this gap on the ground raise all sorts of questions that require interpretation. The reality is we’re not likely to get a lot more big chunks of answers from the administration. A lot of the additional questions are going to come out through just the process of people with reasonable interpretations, working with advisers, dealing with tax examiners and trying to get tax rulings on stuff as you go and just starting to deploy in the marketplace. The good news is the rules make clear that almost without exception you can rely on whatever’s already in the regulations and take that to the bank. You don’t have to worry about waiting for final clarity. This is still a new entrepreneurial market. I expect it to drop over the course of a few years, but there’s enough rules to deploy capital in just about any asset class now if you work with folks that are familiar enough with the rules.

Gino Borges:

Can you make that distinction? It seems like the real estate conversation dominates the Opportunity Zone funds, but there’s also an opportunity for qualified businesses. Maybe you can just talk about how some of those are running in parallel with each other and then how funds are being set up distinctly for real estate. Some are being set up distinctly for qualified businesses.

Steve Glickman:           

Most of the market has been in commercial real estate. Across all asset classes, multifamily, mixed-use, commercial, senior living, industrial, everything you can think of. There’s an equal number of assets of those in terms of projects available across asset classes.

That’s most of the market. But, keep in mind it’s very familiar with community investment programs and it’s also tangible and unlikely to move out of these zones. It makes it an easy task for the class to figure out. It’s also a class of investment. It’s very sensitive to taxes and has all sorts of tax treatments that people have been using for a long time to feel that asset class business investments tend to work differently and they come with more complications organically because businesses can grow out of zones and move out of zones. It’s really only been around now for a couple of weeks but I expect it to be as big of an asset class as real estate, both in private equity business investments and in venture capital form because this is a program that provides an incentive on returns, on your multiples on investments.

The business investments are just going to be much higher multiple in real estate investment. Also, they are more prone to failure where there’s some downside protection as well in this program. It was really designed to be the first community investment program to facilitate business investment at scale. The rules make that fairly easy. If you’re a brand new business in the zone, any investment you get where your investors are using capital gains through a fund, and it could be their own fund, is going to receive this tax treatment. If you’re a business that relocates into a zone in almost all cases, your properties and your operations are just fortunately in the zone. Any further and future investment you get is going to be receiving this tax treatment as long as the investment comes from capital gains.

If you’re an existing business, it’s more complicated because the program is designed to bring new assets in the zone or improve the existing assets. It’s a little bit harder to do that in business and the piece of real estate because your assets as a business are more likely to be personal property like desks and computers and chairs and other space and that may be an easy or a hard test to meet. If you’re leasing real estate, it doesn’t count for the program, which is good. So you won’t be dinged for leasing real estate. You won’t have to improve that asset. It just depends. If you’ve got a big physical infrastructure right in the zone, it will be tough to meet the test, if you’re like a tech company and you’ve got a small one and you’re already in the zone, I think those would be relatively easy tests to me.

I do think this will create a whole new market. Now the challenge for investors in businesses is real estate. You’re less likely to have full control over the asset and its exit events and you don’t want an exit before 10 years without creating some complication. It’s more likely your businesses may move out of the zone, let’s say. You know, as it’s typical to get a further round of capital in San Francisco, New York, hopefully this provides incentives for a business to stay and grow in place, which is the single biggest way you create transformational development in places. You think of examples like Exact Target in Indianapolis that got bought by Salesforce for $2 billion and created a bunch of local wealth and local investors that have started to redevelop Indianapolis. Or if you think of Shipped, which is like an Instacart competitor in Birmingham, Alabama, that got sold for a million dollars to Target. Same kind of story there, those unicorns have a huge impact on both investors, appetite to invest in different places and in terms of the creation of local wealth. I hope this will generate a lot of it. But it is more complicated. There’s a pro and a con to being in the business market. I do think it will end up being quite large. It will take probably a few more years to develop.

Gino Borges:

When you look at the asset classes on the commercial real estate side, how do you see it shaping up in terms of retail, multifamily, industrial? How’s it currently taken shape and what do you envision there?

Steve Glickman:           

If you look at the flow of deals in Opportunity Zones before they were zones, the same geographies in 2017, there are about $50 billion a year in deals in those 8,760 zones. The sales volume has gone up 10, 20, 30%, and they’re pretty evenly divided among asset classes. Industrial is a very interesting asset class because there’s a big industrial footprint because a lot of the places that are struggling are struggling because they never fully diversified from being an industrial economy. It’s the single biggest class, like 15% of those assets. So it’s a plurality, but it’s almost the same amount of multifamily and commercial and senior and retail and affordable living being smaller groups of assets.

But, you can do just about anything in these zones. I’ve not seen an asset class that necessarily works better than another. This all goes down to the underlying projects and how well they pencil and how well they work in their market. That’s the thing about this program. Every market’s going to be different, totally different types of projects. I was just in Puerto Rico, which is a really interesting market because 95% of the island is an Opportunity Zone. It has the second most Opportunity Zones in the country after California, about 10% of the total market. It’s all on this island and you can do big infrastructure projects because you’ve got all these continuous zones in Puerto Rico, they need tourism stuff and they also need multifamily. There are lots of local incentives and Puerto Rico is on top of it. You can do lots of different things there. In other markets, they really need housing. That’s really what makes sense – you need the housing before you can do the commercial. Every market’s going to be different and you really have to understand that local approach to invest in this in a savvy way.

Gino Borges:

Can you talk about, from an investor angle, how long and how does it work? If somebody sells their Apple stock and has $250,000 of capital gains, walk us through that process, the timeframe that they have to allocate to an OZ fund and perhaps just walk us through a simple example.

Steve Glickman:           

Unfortunately, because of the regulations, simple examples have gotten a bit more complicated. The base rule is you have 180 days from the day you sell an asset to roll over the capital gains. We’re just talking about the gains into an Opportunity Fund. But, it matters where you’re getting your capital gains from because it impacts how your clock works. If you’re invested in public or private companies, that clock is 180 days from the sale. If you’re invested in real estate, typically what are called 1231 gains, you have 180 days from the end of your tax year and all the way from your tax year. If you get your gains from a partnership, you would pay one. You either have 180 days from the date the partnership sells the asset or 180 days from the end of the year.

What that means is public or private companies will have longer to invest and investors, new partnerships or real estate will usually have the first six months of the next year to invest. Which means if you are ready, you may have thought you sold a real estate asset last February, you may have thought your clock expired, but actually you have until the end of June to deploy your capital; the same thing in a partnership. I don’t think that’s fully translated out in the marketplace yet. Over time people will obviously understand that. The obligations to the investors is to put it in a fund and then really the obligation shifts to the fund, which operates under a different clock to deploy that capital in certain ways.

I’ll talk to you about that clock real quickly because finders now have more flexibility to invest as well after these rules. They have 6 to 12 months to deploy capital, at least six months to deploy that cash and up to a year. Those strategies extend that time clock even further. We can basically put it in a subsidiary that now has 31 months to deploy capital so you can have up to three and a half years to really deploy that cash, as long as you have a strategy that works according to how the program is designed. There is more flexibility than I think people thought. But there are very specific types of assets. They have to be obviously in the zones, they have to be brand new, or you’d have to substantially improve them, which means if it’s a piece of real estate, you’ve got to put as much money into it as you acquired the asset for, minus the value of the land.

You can also invest in land, but that’s a different path. Then there’s a different process if you’re talking about companies, so there are slight differences in how the fund will deploy that capital. But the strategy for a lot of funds where you need to have a single asset or a set of single asset funds or multi-asset funds. Where they’re looking at a pipeline of many, many deals so that they have in the field of that to read whenever they get capital into their funds. The funds are going to want to be pretty flexible to the capital gains clocks of their investors.

Gino Borges:

We have one question from Jim that talks about coming out of a 1031 exchange versus selling a stock. He also gets six months, but that starts at the beginning of the fiscal year and not necessarily when selling a stock, right?

Steve Glickman:           

Yeah. So if it’s a real estate sale, you have six months from the end of your tax year, which for most will be from December 31st. That’s because the Treasury wants you to offset your gains from your losses and just vet your net earnings from your real estate sales. That’s why it’s structured that way. The partnership flexibility is structured because a lot of partners in partnerships, you won’t know when the sale is. They won’t get their K-1s until March or April. So they provided a cost, not have to guess at what those games look like. It’s actually meant to be flexible. But that means if you have a sale this year, you’re probably not going to deploy your capital until next year, which gives you a lot of time to evaluate, but limits your flexibility in how quickly you can move as an investor.

Gino Borges:

Also, how does one establish the basis if they’re coming out of a real estate gain into a fund?

Steve Glickman:

Their existing basis? It should be clear on the documentation you get depending on how you get that gain, right? Be the same gain you would the IRS. Whatever is essentially taxable by the IRS is not being deferred and you can take back your basis, unlike a 1031 where you guys are deploying the whole thing, the basis, and again into a new project. In this program, you can take back the basis. You just deploy the gain. What that really means is you’re just deploying what the IRS is going to tax you on.

Gino Borges:

We have a question from Ted. “Can Steve discuss Opportunity Zones and sustainable agriculture? I’m interested in OZ real estate investments that convert raw land into organic farms.”

Steve Glickman:           

I hear that a lot. There’s a lot particularly around vertical agriculture. I hear there’s a lot of interest in this program. I just talked to one of the larger agricultural investments in the program. They are trying to figure out how they use this in investing in crops. If it’s a vertical agriculture where they are, you’re building the infrastructure on the land. That’s pretty easy. If it’s, crops, and you’re investing in farm land, just keep in mind you’ve got to improve the land in some way and that’s pretty typical. The test is lower. The improvement test is lower on land than on a building. But you can’t just have the status quo land. He doesn’t want you to landbank. They don’t want you to just buy existing farm land and write it off after 10 years. They want you to somehow create some kind of improvements into that land.

Gino Borges:

It sounds like the bulk of the zones are designed for urban renewal opportunities. I know that in Nevada there are some rural areas that are being viewed for geothermal projects and solar projects. I don’t recall the exact numbers, but I think you said 8,700 different designations for Opportunity Zones. How much does agriculture constitute of that 8,700?

Steve Glickman:           

About 25% of the zones are rural, you’re talking about a couple thousand zones. Those zones, because all census tracks tend to be geographically much bigger because census tracts average 2 to 8,000 people and 2,000 people can spread over a huge distance in rural communities. That means the type of projects are likely to be different. So you’re likely to see energy and infrastructure projects, agriculture projects, stuff that’s energy and land intensive, stuff like data centers, which again doesn’t sound like it creates a lot of jobs because it doesn’t, but those add a tremendous amount of impact to the local tax base through energy in sales tax and property taxes. So there’s going to be all kinds of projects. I think rural investing is in general harder to do because it’s farther away from capital market and there’s less opportunities for what our traditional markets in this space, real estate and business investment. But I hear about investments and working on deals in rural communities all time. It’s a harder nut to crack but one this program is certainly useful for.

Gino Borges:

Will this apply to state taxes or only federal taxes?

Steve Glickman:           

It depends on the state. It depends on whether you’re staking forms to federal tax return. About 30 states do conform, including New York, which has about an 8% capital gains rate. Ten states have no capital gains tax. It’s mutual and Penn State’s broken form; the biggest outlier being California, which has a 13% gains rates. It very much depends on the state and that’s just the capital gains tax part of it, which obviously matters. But there were other incentives that states are offering on top of this program for prioritizing projects within this program. So Maryland, Michigan, Ohio, Puerto Rico, and others all have incentives specifically tied to this program where they’re offering other state tax incentives beyond capital gains such as sales tax or construction taxes or property taxes and other incentives to the program. Increasingly there’ll be more and more of this, in a way that is hopefully additive in a race to the top, and not the type of economic incentives you typically see, which is a place mortgaging its tax base for 10 years or more. That would defeat the purpose of what this program will successfully do, which is provide more public revenue on top of the private investment that will allow for a lot of the infrastructure building that you’re going to want to see in these zones. But, you’re already starting to see that.

Gino Borges:

Can you give us a sense of how you’re currently helping out people that have this intention to bring the money together and maybe some communities? Just to give us a flavor of how multidimensional Opportunity Zone are.

Steve Glickman:           

I work mostly with opportunities on fund managers. Think of these as like bespoke private equity fund managers across a bunch of different asset classes and a bunch of different geographies. They tend to invest nationally. They mostly are real estate but not all. One is a fund investing in the heartland, one is a fund that really invests more in third tier markets. One’s a large impact investing firm in renewable energy and telecom infrastructure fund. One’s a film studio and production company, focused on doing production in Opportunity Zones, focused on women-centered content. There’s lots of different things you can do with this program. Now a few of my clients are wealth managers. I’m kind of their all-purpose consigliere or advisor to what’s specific to the Opportunity Zone part of investing, which is construction and compliance and strategy and finding the right partners and relationships in this space.

They’re doing what they normally do, which is, be a really good real estate investor or a really good film and studio company. I can help them make it work within the contours of this program. I tend to work just for bandwidth reasons with large ambitious funds. Everyone’s new, so everyone’s at ground zero here but I’m trying to figure this out and want to deploy lots of capital around the country.

Gino Borges:

We have a question from Jennifer. She owns a property in an Opportunity Zone. Is there something special she can do to take advantage of her property being in an Opportunity Zone?

Steve Glickman:           

Yeah, it depends on what your goal is for where you want to be in the market. Keep in mind there’s an inherent limitation for people who own assets in zones, which is, there’s something called related party tests, which says that if you already own the asset and you’re going to be the capital and the investment as well, you can be no more than 20% of the capital stack of the new economic interests in that project as a way to facilitate new outside capital to come into these projects. But, your assets should be more marketable, should be able to get a higher price. It should be interesting to a bigger group of investors. This is a program that really helps raise capital if you’re looking to sell your asset, either all or mostly to outside investors. This should be a program that helps you do that, whether it’s a real estate project or whether it’s a company in this zone. What this program really provides is a subsidized way to get capital. It won’t change the underlying dynamics of your investment. You know, in terms of making it a bad investment or a good investment and it probably won’t change the type of investor that comes in. It will just put you on the radar screen of have far more capital opportunity.

Gino Borges:

I was asked this question a couple of days ago where a lot of raw land within these particular zones has been bidded up to the extent that like when all of a sudden the developer goes in and tries to pro forma a potential project, that part of the game that one would have anticipated for that particular project is seen as being compressed as a result of some aggressive pricing on the raw land or these lots.

Steve Glickman:           

I’m not too worried about it because it still has to deal with the market place. So either people will find that price to be worthwhile to buy or they won’t. I think there are a number of markets where land prices have gone up, but few of those markets have seen that many transactions at those prices. As there is more capital coming into the market, I expect that will justify higher prices because good deals will be scarce but right now I don’t think, unless you’re in a small handful of market, that there’s a lot of justification for price increase yet because there’s just not enough aggregate capital in the marketplace. But over time there should be more capital than deals that should lower the rate of return that investors can expect and create cheaper capital and it should create higher prices. That’s the goal. We’re trying to appreciate local geographies, whether it’s businesses in these markets or real estate or other projects as a way to build the basis, and build the economic growth in these places. So that’s a good outcome. I just think for many of these markets now, they’re probably being smart and trying to predict the fact that there’s more interest. But they’re probably a little early and we’ll see what the market will bear in terms of prices there, the funds we’re willing to pay.

Gino Borges:

We have a question from Jeffrey who’s asking what abuses of the program are you seeing so far?

Steve Glickman:           

I’m not sure I’m seeing abuses yet per se, except I certainly see plenty of funds that are operating without the intent this program was created. But that’s in some ways, okay. If the program is designed in a way to be resilient to all sorts of different types of intent by creating certain guard rails around how people have to invest for a long period of time in a way that improves places in a way that invest exclusively in these zones. I think some zones that governors selected are probably undeserving of the program. That’s a small percentage of the zones, but still create headlines that make me cringe a little bit. There’s probably no way to put that back in the bottle. Those have finite things to invest in now and they’re also more expensive markets.

I’m not very bullish when I advise funds that they ought to be going to Brooklyn or San Jose or Oakland because those markets are very competitive and they’re very expensive. This is the program that rewards appreciation. I would bet on smaller deals in lower basis, places that have more room to grow. Think of it like a Warren Buffet approach to place-based investing. Other people don’t see them going where all the rest of the market is. That’s a strategic question. Treasury, I think will come down very hard on real abuses of the program, which are funds that are escaping somewhere into the gray area and not away from the black and white of what’s allowed. I’m very conservative with the funds I work with to tell them that Treasury will be thinking about the intent of this program, when and if they audit funds.

You should expect an overall audit of funds at the beginning of any new program. Those that are not operating in the intent. Charging has a lot of authority today. On the other hand, to be sitting here making an honest mistake or there are factors outside your control as I expect the Treasury would be very lenient and the penalties in this program are very low. They’re essentially the underpayment rate for whatever capital you have invested that don’t quite meet the mark. They’ve already created a lot of allowances for lgovernment action for example, or inaction, that delays your investment and makes you miss your clock. They’ve already said that you’re not going to be dinged for that. There’s no claw backs in the program. So again, I think Treasury understands investors are taking a lot of the risk here, but it’s incumbent on investors not to abuse the program. Easy ways of abusing this program would be like landbanking and just sitting on land. Treasury has said for sure they’re going to ding people for doing that. So don’t do that. Over time I think you’ll see more and more of these models come out including potentially a roundup guidance from Treasury that will say here are the things we definitely think are okay and here are the things we definitely think are not okay. That will provide more clarity so the market can understand what an abuse is and what it’s not.

Gino Borges:

Well, that’s very thoughtful. We have a question from Aaron. In the latest batch of guidance, there seems to be language around buying and selling opportunities zone investments, inside an opportunity zone fund. How exactly will that work tax wise?

Steve Glickman:           

Basically if you invest in opportunities, you can start your interest to a new Opportunity Zone investor who is presumably coming in with capital gains. They don’t have to invest in a new fund. They can buy out your interest. But keep in mind there’s a catch to that and that they’re going to have a new time clock and a different one compared to all the other investors in the fund. Typically at least in a multi-investor fund, investors will be locked up. I expect from 10 years from the date the last money comes in. So that everyone’s on the same clock.

That means maybe more like 11 years or 12 years as opposed to 10 years. But if you’re a new investor that comes in, in like year six into this program, once you have a stabilized asset to buy an investment from existing opportunities zone investor, you’re going to be on a new tenure clock past everyone else and you’re not going to pay back your rollover in a couple of years as opposed to having that long deferral. So I don’t know how practical or useful this will be for most funds. The type of funds it will be useful in are funds that are never intending to sell their assets and intending just to hold onto a portfolio, and sell the interest in those funds. Over time, over the course of 30 years cause these funds can hold their interest until 2047. That’s more of an institutional investment model that could work, but that will be a very small percentage of opportunities I imagine.

Gino Borges:

How would you start summarizing this experience for my group of investors that are learning about Opportunity Zone, some know more than others, but in general from what you’re saying, I mean, what words of encouragement, caution, inspiration would you give investors who are considering investing in Opportunity Zone funds?

Steve Glickman:           

We’re at the very beginning of the market, which means, early pioneers will have a risk and reward here. The reward is you get to invest when capital’s at a premium, when you have your choice of funds, when you have lots of assets to take a look at. There’s less competition, and that’s good for both investors and fund managers, but you won’t have benefited from seeing the track record of your fund managers. We’re seeing exactly how the rules of this program play out. You’ll also be able to maximize the actual tax and federal, which is increased in value as you have more and more time for that deferral. Obviously you have more time to hit those marks of that 10% and then the additional 5% discount you can get on your rollover. So there are advantages to being early, but the risk is you’re going to know less about the market and the players in the market.

A lot of these funds will be new. It’ll be funds that have track records in different markets like private equity or real estate investing or venture capital. But they may not have a track record in these markets; certainly not had much of a track with this program. That’s the risk to being early. The second thing I’d say is, keep in mind this is a relatively risky asset class or the federal government would not be subsidizing it. So, that means you’re making a bet on places that may or may not play out. You’re doing development deals that involve development of assets and growth companies by design, which you know, could have big returns but could also fail. That’s probably a bigger risk with business investment than real estate investment, which usually never totally fails.

So it’s a risk to keep in mind. The underlying assets and game plan has to make sense. Your fund managers have to check all the boxes you check for a fund manager. The third thing I’d say is that the extent of the risks though there’s no real new risks because of this program and anything you may have learned about the program over the past year. A lot of the questions you may have will not have answers. So I think that this will be a very exciting time to be part of the market between now and the end of June because of those end of the year clocks I mentioned earlier, you’re gonna see a lot of capital flowing into the program, and over the course of a year, because you have a little cliff at the end of 2019, where you lose 5% of that discount in your capital gains bill. I think you’ll see a lot of capitalizing in the marketplace, which makes it a very exciting time to play.

And again, I think there’s gonna be a very big asset class, $100 billion a year. If you can move that type of capital, it should have a transformative impact on communities. So depending on where you’re coming at this from, the marketing as an impact investor or philanthropic investor or market rate investor, you’re going to see a lot of interesting opportunities to have a big change or to make good on this program. We’re at the very beginning here.

Gino Borges:

This is a big experiment, right? We don’t know for sure if it’s going to work as intended. What if it doesn’t work? They’re not a lot of alternatives. The consequence of not being able to successfully facilitate private investment in these communities is an increasing political divide and some political realities. We’re seeing results around the fact that the economy, even though it’s performing really strongly, at a macro level, low unemployment, lots of job creation, it’s just not working for a big chunk of the country and that has a real impact on our democracy and how it works. The stakes here are big. Most of the conversations I have are around how to do this in the market, but the political and social repercussions I think are just as important and obviously a lot of the driving force for why this program exists at all.