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Opportunity Zones in Texas: Promise and Peril

October 2018

Concerns and Red Flags

Clearly, there is great need in these low-income communities. By directing investment into these tracts, Opportunity Zones have the potential to improve economic mobility and financial stability in the places that need it the most. Among the purported benefits of the OZ structure are incentives for longer-term investment periods (holding at least 10 years secures the most benefit), pooled capital from a potentially broad geographical reach (one need not live in an OZ to invest), and the capacity for investors who might otherwise not have the networks to deploy capital in low-income communities to participate by simply investing prior gains in a qualified fund.

However, there are multiple areas of concern voiced by some—including policy experts such as the Brookings Institution, as well as economic developers in local communities—regarding the implementation of the tool:

  • Guidance: States were required to submit nominations for OZs while little was known about what projects would be eligible, what reporting requirements would exist, and how fund eligibility would be determined. This lack of information meant that states were making tract recommendations with a large degree of uncertainty as to how they would be used. Treasury and the IRS have noted that additional legal guidance will be forthcoming in 2018.
  • Transparency and regulation: Although the bill’s original language does explicitly require that at least 90 percent of fund assets must be deployed in OZs,[1] there are few other criteria that O-Funds are currently required to meet. Guidance issued by the IRS in April 2018 includes the finding that a taxpayer can self-certify to become an O-Fund, with no approval needed from the IRS. (This self-certification is different from the certification approval process that Treasury’s Community Development Financial Institution Fund requires for community development entities accessing NMTCs, as noted in box, “Will Rural Communities Benefit? Lessons from the New Markets Tax Credit Program”.) While this is likely to reduce bureaucratic inefficiencies, the IRS decision has intensified concerns among some community leaders that there may be little accountability of funds and negligible tracking of their investments. Without such oversight, the worry is that funds could be allocated ineffectively, leaving communities with little to no benefit.
  • Gentrification and displacement: Given that O-Funds will be market-driven equity investments, investors will likely be seeking “hot” or “up and coming” areas more likely to yield high returns, as these provide greater incentives for investors. Not only will they see greater appreciation of their assets, but they will also receive a greater tax exemption: If money is held at least 10 years in an O-Fund, investors receive a permanent exclusion from taxes on the gains in the event of a sale. Given these incentives, and because there are few requirements regarding what types of investments can be made (beyond exclusion of the traditional “sin” businesses [2]), Opportunity Funds could potentially direct capital largely to projects in areas already on the verge of gentrifying—places where high returns are most likely. In that eventuality, investors would get a tax break while neighborhoods would simply continue on the path of gentrification, displacing some of the highest-need households from the area. Without incentives for inclusivity in place, this is a risk in these zones.

To understand how likely this gentrification scenario is for Texas, the Dallas Fed looked at census tracts selected as OZs on a few different measures that can be predictive of gentrification.[3] Taking into account home price appreciation and educational attainment, the measure indicates likely gentrification if a tract meets the following requirements:[4]

  • Tract is considered low-income (individual poverty rate of at least 20 percent or median family income of no more than 80 percent of area median income).
  • Home value increase from 2012 to 2016 is in the top 25 percent of all tracts in Texas.
  • Increase in population holding a bachelor’s degree or higher from 2012 to 2016 is in the top 25 percent of all tracts in Texas.

Using these criteria, 62 of Texas’ 628 OZ census tracts are flagged for gentrification. Harris County has the largest number, at 9 of its 105 OZs, while Bexar County has the highest percentage, with 21 percent of its OZs flagged (5 out of 24 tracts).

Finally, we wanted see how this gentrification risk in OZs compares to that in the eligible tracts that were not selected. As Table 2 indicates, there is a significant difference between the two groups with regard to home value growth: OZs, on average, have experienced higher home price appreciation. But this is only part of the picture. Using our gentrification measure, we find that 9.7 percent of OZ tracts have a gentrification flag, compared to 8.5 of their unselected counterparts (Table 3). This difference is not statistically significant. This suggests that, at present, gentrification is not more of a risk for OZs than for eligible tracts that were not selected—though gentrification still remains a concern for nearly 10 percent of OZ census tracts.

Table 3. Nearly 1 in 10 Opportunity Zones Likely to Gentrify

  Eligible, Not Selected Opportunity Zone
Average educational attainment growth 2012–2016 (%) 19.2 21.9
Average home value appreciation 2012–2016 (%) 7.0 9.3
Gentrification flag rate (%) 8.5 9.7
Total number of tracts 2,046 628
Notes
  1. “H.R. 1. An Act to Provide for the Reconciliation Pursuit to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018.” Pub.L. 115-97. Sec. 1400Z-2.
  2. According to the Economic Innovation Group, investment opportunities are very broad, including: “high-growth startups, main street businesses, real estate, manufacturing facilities, brownfield redevelopment, entrepreneurship incubators and accelerators, co-working spaces, rental housing, affordable housing, and more.” Sin businesses include liquor stores, massage parlors and gambling facilities. Opportunity Zones presentation, by Kenan Fikri, Economic Innovation Group.
  3. Gentrification is notoriously challenging to measure, and there is little consensus on the best way. Some studies have looked at education levels and home price growth, some have included race or ethnicity, and others have looked only at median family incomes. A recent Brookings Institution study across states looked at home price appreciation from 2012 to 2016 in the top quartile as a sign of gentrification: “The Early Results of States’ Opportunity Zones are Promising but There’s Still Room for Improvement,” by Adam Looney, Brookings Institution, April 18, 2018.
  4. This methodology is similar to that used by Governing Magazine, as well as the widely-cited peer-reviewed journal article, “Displacement or Succession? Residential Mobility in Gentrifying Neighborhoods,” by Lance Freeman, Urban Affairs Review, Vol. 40, Issue 4, March 1, 2005.

Next: Avoiding Pitfalls: Potential Best Practices »

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