The Guru Is In
The wonderful new markets of OZ
By David A. Smith
5 min read
In 2001, roughly as the New Markets Tax Credit (NMTC)was coming into effect, Apple introduced the iPod. It did only one thing—fully portable personal music—though at the time Apple’s wizard, Steve Jobs, made that only thing sound insanely great. Although starting slowly, the iPod took off in 2004, and became a huge seller.
Then came the iPhone.
Today, the few remaining iPods are collectibles valued not for their utility but solely for their nostalgic scarcity.
For more than 40 years, urbanist policymakers have sought to create incentives that would do for community development (CD) and economic development (ED) what accelerated depreciation, the Community Reinvestment Act and Low Income Housing Tax Credit (LIHTC) have done for affordable housing – create a robust national ecosystem that reliably flows capital into socially impactful real estate. The first attempt was the Enterprise Zone, an umbrella term for a potpourri of state and local incentives—reduced regulations, tax exemptions or rebates, targeted tax credits or concessionary financing—intended to “energize community capitalism in distressed areas.” New Markets was the second. The third was the Choice Neighborhoods Initiative (CNI), an effort to repurpose and rebrand HOPE VI away from severely distressed public housing into transforming entire neighborhoods, but CNI never had a fair shake: too little money, too many mandates, too much regulation and process, and too little Congressional or Administration support.
Now has arrived the 4G model, the Opportunity Zone, and judging by the rising buzz with which it is being greeted – more than 1,300 people at an OZone conference a few weeks back – it’s about to burst on to the scene as the hot new product.
The reasons why are revealed by a comparison of features:
- NMTC is structured around debt – risk-averse, fixed-payment, collateralized, exit-reliable debt. OZones are designed for equity – risk-tolerant, variable yield, upside and success dependent.
- NMTCs are capped. OZones are uncapped.
- NMTCs are competed and awarded by Treasury’s CDFI Fund. OZones are as-of-right.
- NMTCs must flow through Community Development Entities (CDEs) that must be pre-certified by Treasury. OZones go through funds that are qualified by virtue of what they invest in, so anybody can form one.
- NMTCs can be earned on only a discrete subset of real estate properties (and importantly, exclude purely residential uses). OZones are ecumenical – any kind of property except ‘sin’ businesses qualifies.
- NMTCs don’t work with housing. OZones do, and readily handle mixed-use.
- NMTCs are governed by a thicket of rules and requirements. OZones have fewer, partly because they’re newer and partly because they’re less circumscribed by statutory requirements.
- NMTC is top-down: money flows from Washington (Treasury) to intermediary entities (CDEs) and thence into individual properties. OZones are bottom-up: put a wrapper around an OZone geography, buy property inside it, and you have a fund.
From the perspective of capital formation and capital flexibility, these are compelling comparative advantages – especially for new players already active in urban markets but not in affordable housing or community development. Investors already familiar with §1031 like-kind exchanges and the Tenants-In-Common (TIC) model of making §1031s into funds will readily grasp the investment advantages of OZones.
Against these significant common-sense advantages, where is NMTC comparatively superior?
- OZones are still being conceptualized and defined. NMTCs have well-bounded rules.
- OZones are not a natural fit for banks (which generally can’t own equities and don’t generate capital gains) and their CRA-earning potential is at best latent. NMTCs are bank-compatible and CRA-approvable.
- OZones have yet to demonstrate investment paradigms – all of us are experimenting. NMTCs have multiple proven models and real estate typologies.
- OZone intermediaries or fund sponsors have yet to emerge. NMTC’s market leaders are known and configured for NMTC leadership.
- OZone practice is still in its infancy. NMTCs have plenty of practitioners who have figured out how to make them work.
- OZones only apply in specific, bounded, fixed locations. NMTCs can be used more widely.
In short, while OZone is a new product still creating its market, NMTC is a proven if supply-constrained product with a large base of installed users.
But those arguments could have been said (probably were said) by iPod loyalists around about 2007 when Apple trumped its own ace. The iPhone was simply and instantly a better product and from its introduction, iPod was first devalued, then doomed.
While NMTCs can work alongside OZone investments, it’s hard to see how NMTCs sustain their pricing against the yield competition of new OZone products entering the space; likewise, developers that now choose to conform their properties to NMTC compatible uses can diversify, so NMTC may see a decline in its real estate product pipeline, especially if the volume of OZone fund activity starts to swamp NMTC’s aggregate volume.
How will we know? Watch the behavior of NMTC fund sponsors and NMTC developers. The speed, volume and sophistication of OZones’ early adopters, funds and properties will tell you everything you need to know about the two products’ relative futures.
