President Donald Trump recently signed an executive order designed to add muscle to the federal Opportunity Zones tax break initiative. However, an analysis emerged showing only two in 100 of the economically distressed areas targeted for property investment meet community activist goals for financial success.

A new report by Smart Growth America, a coalition of community advocacy organizations, ranked the nation’s nearly 8,700 zones for their potential to deliver on benefits for communities, the environment, and investors, or what it calls the triple bottom line. The initiative, passed by Congress late last year, intended to give tax breaks on capital gains earned through investments in real estate areas the government labels “economically distressed”.

Based on the group’s analysis, only 2 percent of the zones can deliver on that triple bottom line. The report notes that there is enormous concern among local policymakers and community groups concerned the tax incentive will fund disruptive gentrification, displacement and accelerate climate change.

The importance of the initiative’s success is growing as increased investment pours into real estate through the program. A closer look at the commercial property investment sales activity and pricing in the zones in the neighboring Washington, D.C., and Baltimore markets, for example, shows that as in other areas, there has been a huge surge in deal volume in those areas this year after the program took effect compared to 2017, according to CoStar data.

It is unclear whether that surge has produced tangible improvement in property values to this point. Sales volume of commercial, multifamily and land properties has skyrocketed in 2018 to $1.39 billion from $855 million last year. Even so, the data show mixed results on what has been happening to property values in those deals.

The average sale price paid per square foot or unit were lower this year for land, retail and multifamily deals, specifically 40 percent less for land; an 11 percent reduction for retail; and a 5 percent drop for multifamily.

One of the primary goals of the initiative is to improve the access to affordable housing in these zones in economically distressed communities. To this point at least, the property types benefiting most from the surge of investment in the Washington and Baltimore zones were nonresidential properties. Industrial property pricing was up 28 percent and office property prices gained 11 percent.

At a White House executive order signing ceremony establishing the White House Opportunity and Revitalization Council on Dec. 12, Trump said “the resources of the whole federal government will be leveraged to rebuild low-income and impoverished neighborhoods that have been ignored by Washington in years past. Our goal is to ensure that America’s great new prosperity is broadly shared by all of our citizens.”

Disparity Concerns

Housing and Urban Development Secretary Ben Carson will lead the new council.

Also at the signing ceremony was Darrell Scott, a pastor and member of Trump’s executive transition team.

“For decades, job growth and investment have been concentrated in a few major metropolitan areas. This has created a geographic disparity — a very big one, in many cases — where some cities have thrived, while others have suffered chronic economic and social hardship,” Scott said. “With opportunity zones, we are drawing investment into neglected and underserved communities of America so that all Americans, regardless of zip code, have access to the American Dream.”

It will probably take a longer track record before a consensus is reached on whether the new tax initiative narrows that disparity. Not all of the zones are created equally for new business or real estate investments, according to the Smart Growth America report.

According to the report, the majority of the designated zones are low density, drivable suburban areas with significantly higher housing and transportation costs, higher greenhouse emissions and lower quality of life. Ninety-eight percent of the designated zones fail to qualify as a Smart Growth potential opportunity zone.

The 2 percent that scored 10 or higher represent fewer than 700,000 people who currently live in zones that are walkable urban places with smart growth investment potential, according to the report.

By comparison, the country’s designated zones are home to about 35 million Americans.

“History has repeatedly demonstrated that investment without protective equitable policy and process mechanisms lead to gentrification, displacement and a lack of access to benefits in many low-income and communities of color,” the report stated. “Without any guidance from authorizing legislation or proposed Treasury regulations, investors, local policymakers and stakeholders are asking which opportunity zones have the greatest potential to create vibrant, inclusive” walkable communities.

Cities Ranked

Among the top 30 U.S. metropolitan areas, Smart Growth America said New York, Los Angeles, Philadelphia, and Chicago earned the top scores for zones with the most smart growth potential. Charlotte, San Antonio, Orlando, and Dallas received the lowest scores.

Some skepticism is also emerging in the commercial real estate industry whether the initiative will produce desired results. Skip Dolan, principal of Dolan Commercial Real Estate Services in northern New Jersey, delved into studying the real estate benefits of the initiative when word of the program first began circulating widely earlier this year.

“We became diligent students of the opportunity zones and have attended several high-level seminars to learn more, especially about what we do not know,” Dolan said. “Additionally we made investments in technology to better gather information on properties in the OZ across multiple asset classes.”

The bottom line: Dolan said his customers see it as an alternative to doing 1031 exchanges but are not that excited about jumping on the program’s bandwagon. Under tax rules, a 1031 exchange allows an investor to sell a property to reinvest the proceeds in a new site and to defer capital gain taxes.

“We do not see compelling economic or deal making benefits for our customers to participate in the OZ outside of the treatment of reinvested proceeds,” he said. “Which begs the question, if someone has a good income producing asset with a low cost basis whether a stock or real estate why would they sell and take the development risk?”

Opportunity zone tracts were picked based upon input from local mayors to the governor and as a result, there was no consistent application for a particular asset class or area, Dolan said.

“Remarkably we have seen wide swaths of unproductive, ‘environmentally sensitive’ wetlands and large cemeteries included in designated zones — in a word: crazy,” he said. “OZ designation will not increase rents, returns, lower interest rates on financing or improve a property’s location. OZ might be the one that started out as a bang and ends as a whimper.”

It is still in the early days of the initiative and it will take a while to see tangible results, HUD Secretary Carson said.

“Too often, new investments into distressed communities are here today and gone tomorrow,” Carson said. “By offering incentives that encourage investors to think in terms of decades instead of days, opportunity zones ensure that development is here today and here to stay.”