While early movers have been in real estate, the real value comes from investing in operating businesses
By Philip Ruppel, Vice President at Advantage Capital. This post originally appeared in CityBusiness.
The sad reality is that parts of this country and Louisiana need innovative ways to attract investors if they’re to thrive. A generation ago, many of these communities had working economies, a strong social fabric, and a way of life that drew a stream of newcomers. Now, especially in rural areas where as many as 1 in 5 Americans live, the situation has worsened. Today, some rural communities experience more deaths than births. The situation isn’t much brighter in some urban locations, with an uneven economic recovery favoring a handful of cities.
We can’t rely on traditional sources of venture capital to revitalize economically distressed areas. Coastal states like California, New York and Massachusetts draw almost all of it. The top 50 cities draw 97% of all venture capital. The top 20 cities account for 90% of it.
Practical solutions are possible for states like Louisiana. These include an innovative new approach to driving investment capital into underserved communities, both rural and urban. The federal Opportunity Zones incentive, a new economic development tool brought about in tax reform, seeks to revitalize distressed areas. Opportunity Zones provide a capital gains tax incentive for investors, while driving investment to low-income communities struggling with high poverty and sluggish job and business growth. The program represents the first new major federal effort to support these communities in nearly two decades.
American taxpayers have over two trillion dollars in unrealized capital gains in stocks and mutual funds alone – gains that may be immobilized largely to avoid paying capital gains tax. That is a huge untapped resource for creating jobs and spurring investment. Investing capital gains in Opportunity Zone funds can give investors a sizable federal tax break. It also means capital flows into areas that historically have not seen this level of investment.
In Louisiana,150 census tracts nominated by Governor John Bel Edwards and certified by Treasury have been selected as Opportunity Zones. These communities span the state and include a diverse cross-section of parishes including Caddo, Desoto, Pointe Coupee, Lafourche, St. Helena and St. Mary. Many of these designated low-income areas are ripe for long-term investment capital to finance new projects and enterprises, and investors are taking note. The opportunity to defer or avoid taxes on capital gains is vital to attracting investment.
Donald Hinkle-Brown, the CEO of Reinvestment Fund, a community development group, recently advised the New York Times that to bring investors into distressed communities, “you have to hit them in their sweet spot,” meaning finding ways to reduce capital gains. The Opportunity Zones program capitalizes on that sweet spot, jumpstarting development and revitalization in low-income communities. It also complements existing federal and state tax-incentivized economic development programs, expanding impact. The next step, however, must be for states and Congress to develop a way to make Opportunity Zones more business friendly.
Despite strong potential and public interest, Opportunity Zones still face important public policy questions. The scope of opportunity, along with technical questions as to exactly how the tax breaks will work, remains to be defined. Investors need greater clarity and guidance if they’re to jump in with both feet and drive major economic impact.
As established in 2017 tax reform, the program includes structural elements that favor permanent financing for real estate development. While early movers in the space have been real estate developers and investors, real development value can also lie in investments in operating businesses. After all, it’s operating businesses that create jobs and growth. Further guidance addressing this issue of how to invest in operating businesses within Opportunity Zones is yet to come. The Treasury Department has signaled its intent to provide guidance that facilitates patient capital for operating business finance.
The New Markets Tax Credit (NMTC) program has proven the value of providing incentives for investment in growing businesses. And newer rural jobs programs have shown how focused investment in rural small business can help with business expansion, job creation and economic vitality. As complementary tools, Opportunity Zone funds can enhance these opportunities to help low-income areas and surmount the existing problem of lopsided risk capital in major cities and already well-capitalized areas.
Importantly, investment in Opportunity Zones can be anywhere in the country, and states are increasingly competing for investors and their capital gains, looking to attract investment dollars and drive private capital into their designated zones. Many states are trying to tip the scales in their favor, pulling marketing into play with investment prospectuses, or highlighting local assets, such as colleges and universities or infrastructure. Many are also looking to existing tax credit programs like NMTC or rural jobs to help serve as important leverage to drive Opportunity Zone investment.
The key to reviving and revitalizing distressed communities lies in growing strong businesses and jobs, creating a catalytic effect on families, communities and local economies. Within rural communities, it’s ensuring that these areas support businesses that attract people, services and further development. Imagine the potential when economically challenged areas become candidates for new investment and growth in business, reinvigorating entire communities and spurring positive socioeconomic change.
There is work to be done. Ensuring that Opportunity Zones are successful requires thinking through with private and public parties how to protect existing residents and businesses while creating opportunity that’s needed for future growth. For places in which median household incomes remain far below the national level and the poverty rate stands well above the national average, Opportunity Zone financing offers new beginnings. And a future that benefits communities, residents and investors.
This article was written by New Orleans-based investment firm Advantage Capital, a company that began as a startup and has become a national leader in using tax incentive approaches that deliver bottom-line results in the form of successful companies and high-paying, permanent jobs – the foundation of any prosperous economy.
This article was prepared for informational purposes and does not constitute an advertisement concerning investment advisory services or an offer to sell or a solicitation of an offer to purchase any security or investment product, including any interest in any fund or investment vehicle managed directly or indirectly by Advantage Capital.