West Michigan developers are taking notice of a new tax deferral mechanism intended to spur investment in both urban and rural areas, even if they lack details on how the program will be implemented.
The 2017 Tax Cuts and Jobs Act created the framework for Opportunity Zones around the country where investors can defer capital gains taxes for a varying number of years depending on how long they maintain their investment in one of the zones. To qualify for the tax deferral, an investor would need to set up an Opportunity Fund that would use the gains to invest in a new eligible property.
The new tax policy could be beneficial to developers such as the Inner City Christian Federation, a Grand Rapids-based nonprofit housing development and management organization, particularly for the mixed-use and mixed-income Tapestry Square project near the intersection of Wealthy Street and Division Avenue.
“Like most developers, we are trying to learn as much as possible while we wait on further guidance from the Treasury Department,” Ryan Schmidt, vice president of real estate development and management for ICCF, told MiBiz in an email.
Schmidt pointed to three specific ways in which the tax policy could benefit ICCF and other developers’ projects. Locating a project in an opportunity zone:
- Helps a developer secure Low Income Housing Tax Credits (LIHTC), the federal tax credits used for the majority of affordable housing development
- Improves a developer’s ability to work with commercial investors on mixed-use projects since they receive a direct tax benefit
- Serves as a tool to keep rents more affordable for “workforce housing” because the added tax benefit can offset lower returns
Schmidt is among a diverse group of West Michigan stakeholders expressing interest in the incentive, but who are stuck in a holding pattern until the U.S. Department of Treasury issues further guidance.
Jared Belka, a partner in the Grand Rapids-based law firm Warner Norcross + Judd LLP who chairs the firm’s Economic Incentives Group, said multiple unnamed clients have inquired about the program upon learning a proposed project falls into one of the designated census tracts.
“In terms of interest, we’ve had a ton of people call … with projects in opportunity zones,” Belka said. “(But) there’s so many people just standing around waiting for some guidance on this. From my perspective, it hasn’t been a high priority for the parties who need to provide that guidance.”
Pending the release of that federal guidance, few investors have opted to create Opportunity Funds to invest in projects, sources said. As well, it remains unclear when Treasury might weigh in on the matter. An inquiry sent by MiBiz to a Treasury Department spokesperson was not returned as this report went to press.
While it has yet to detail its policies on Opportunity Zones, Treasury in April did approve the 288 census tracts across the state nominated by Michigan Gov. Rick Snyder.
“These zones have the potential to help Michiganders take advantage of the full economic development potential in all corners of the state,” Snyder said in a statement at the time. “This is a unique opportunity for investors and promising news for eligible communities.”
The legislation that created Opportunity Zones allows for three different ways to defer capital gains payments depending on how long an Opportunity Fund keeps capital within one of the designated census tracts.
The Michigan State Housing Development Authority (MSHDA) is serving as the main agency for implementing the tool across the state.
Gary Heidel, MSHDA’s chief investment officer, said he’s heard some investors say that Opportunity Zones offer a better investment vehicle than the 1031 exchange, which also allows for deferral of capital gains if the capital is invested in a “like-kind” property.
At least one large financial institution has dipped its toe in the water with Opportunity Zones. Pittsburgh-based PNC Financial Services Group Inc. (PNC Bank) has already built a fund and started deploying capital.
Kevin Rogers, the bank’s community development lending and investing manager, told MiBiz the institution is more focused on community development than the tax incentives and just closed on its first deal in Bethlehem, Pa. It expects several more to close in the near future.
“Our phone has not stopped ringing,” Rogers said, referring to the broad interest in the fund, the size of which he declined to disclose. “We’re hearing from markets that have been quiet for quite some time.”
Good for all, or just some?
Just how widespread an impact Opportunity Zones will have remains a matter of debate.
WNJ’s Belka predicted the benefit could be fairly muted because of the limited number of projects that could utilize it.
“I’d view it along the lines of the transformational brownfield,” Belka said, referring to the enhanced brownfield tax increment financing mechanism adopted by the state last year for large-scale development projects. Thus far, the tool has only been used once.
“Conceptually, I think everyone is very excited about it,” Belka said. “Where the rubber hits the road becomes the issue.”
Likewise, economists who study economic development tools have questions about the likely effectiveness of the tax benefit. Speaking during a recent MiBiz roundtable discussion, Tim Bartik compared Opportunity Zones to similar tools of the past such as enterprise zones, noting that evidence of their effectiveness has been minimal.
Bartik, a senior economist at the Kalamazoo-based W.E. Upjohn Institute for Employment Research, specifically called into question whether the zones — which are intended to boost struggling census tracts — can be effective unless other tools are implemented to address systemic social issues like poverty.
“My point is that (Opportunity Zones are) going to be most attractive in a neighborhood that probably would have gentrified anyway,” Bartik said. “The question is, in a neighborhood like that, what are you doing beyond the tax break to deal with some of the underlying problems of the area.”
Economic developers counter that the tax benefits can close a financial gap on a project and help investors stomach a project that offers a lower return on investment.
“What it basically means is you’ll be able to accept lower-than-market returns for the risk of that investment,” said Greg Tedder, executive vice president and chief community development and marketing officer at the Michigan Economic Development Corp.
During the June roundtable, Tedder noted that if Treasury permits the tax benefits to be coupled with other incentives, developers could realize even more benefits for projects.
“On its own, it might not solve the problem,” Tedder said. “But as part of a capital stack, it’s one more tool that can solve problems.”