On Monday, May 20th Hawley Troxell tax attorney Rick Smith participated in a panel of experts for Idaho Business Review. The panel discussed Opportunity Zones. Below is a report of the discussion posted by Idaho Business Review.
A provision of the jobs and tax cut act passed in December 2017, Opportunity Zones offer governors the chance to designate low-income census tracts for a federal tax incentive, and hopefully, boost development as a result.
Under the rule, each state is allowed to take 25% of its eligible census tracts and designate those as Opportunity Zones. Eligible census tracts must have 25% or more of the households in poverty or the median income within the census tract must not exceed 80% of median family household income.
To pick zones, Idaho created a request for proposal (RFP) process and personally reached out to every city, county, tribe, and economic development organization that had eligible census tracts within its area of jurisdiction. The state received 59 submissions for 28 slots, which were reviewed and vetted by the governor’s economic advisory council. Every jurisdiction or entity that submitted a proposal was given at least one Opportunity Zone. The remaining zones were targeted toward rural areas — parts of the state that, without this designation, would have a harder time attracting investment. Seventy percent of Idaho’s zones are in rural communities.
The federal government draws census tracts based on population, so those in communities like Meridian and Boise may be a few square miles, while those in rural areas are 30 or 40 square miles.
Sharon Fisher, IBR staff writer
Roy Brewer, partner with Brewer Lofgren
Travis Burgess, CPA, partner at Eide Bailly
Gregg Davis, CFO, licensed real estate salesperson at the Nancy Lemas Team – KW Commercial
Jerry Miller, economic development specialist with the Idaho Department of Commerce
Richard (Rick) Smith, partner at Hawley Troxell
Bill Truax, president of Galena Opportunity Fund
What Opportunity Zone developments have been announced for Idaho?
None of our clients have purchased any Opportunity Zone property yet. I don’t know of any actual developments that have been planned other than the one that the Galena Fund, I believe, has in the works.
Opportunity Zone specific, no, I wouldn’t say that there’s any announced deals yet, but development is a long cycle. You may be negotiating on contracts, you may be working under the auspices of an Opportunity Zone execution, you just haven’t done or announced it.
Frankly, there’s a lot of people that are doing it. Caleb and Company have just started a project in downtown Meridian that I don’t think they raised as an Opportunity Zone deal but would have been had they chosen to put the brakes on and go raise capital that way. That’s one of the most interesting things about the Opportunity Zone. You may be already thinking about doing those developments whether or not you’re going to get the Opportunity Zone benefit.
Also, they can be individual asset funds. They may not be a public fund that’s available toward other investors. It may just be a single investor that’s taken their funds from their gain, formed their own Opportunity Zone fund and done that development without letting anyone else know. There’s no reporting required.
Does anybody else know of any actual developments that have been announced? Other than Galena, are there any Opportunity Zone funds for Idaho that we know of?
There are a couple funds that are working here in Idaho, but they’re not focused on the same things. There’s a group out of Utah that’s looking to develop here. I think they’ve already got a couple potential projects in the works. They’re hospitality-based, so we don’t compete with them really. Plus, the space is so big that competing is kind of a funny concept. There are a couple, like was mentioned, ‘fund’ is the term that they described each individual transaction. Each property is a fund that that person may only be doing one real estate deal. We organize as a fund in the commingled capital sense. Any structured like us, I haven’t heard.
The IRS announced new opportunities and guidelines a few weeks ago. What are they and how will they change Opportunity Zone development in Idaho?
The IRS came out with proposed regulations, first in October of 2018, and then refined and clarified those proposed regulations just last month on April 17. It makes interesting reading. Anybody who really is going to get into this, I would encourage you to read the regulations and in particular the preamble to the regulations. It gives a lot of detail about how the IRS is thinking about implementing this program. I was really struck by the fact that the IRS, in my view, has consistently been pretty generous in interpreting the statute in a way that encourages the formation of Opportunity Zone entities and Opportunity Zone development.
Going through the regulations, I noticed at least 10 situations where clarification was given in a way that I think, again, encourages economic development. One example I thought was particularly striking, the proposed regulations, they aren’t final and probably won’t be final until at least later this year. The version that was issued in April was soliciting additional comments on a number of issues. One issue that the regulations addressed is, what if an Opportunity Zone entity, a business, has an investment that’s already an active trader business in an Opportunity Zone and the entity decides to sell it and wants to invest in another Opportunity Zone property or business? Can it basically roll over the gain and still preserve its tax incentives? The IRS indicated that, yes, it can do that. There can be sales within the Opportunity Zone business without generating a gain as long as the proceeds of the sale are reinvested in an Opportunity Zone property within 12 months after the sale of the initial property.
The proposed regulations go on to say, and this I thought was kind of remarkable for the IRS to go out on a limb like this, they said, ‘We don’t really have any explicit statutory authority to do this. Some of the comments that we would like to see would be for commentators to advise us on what statutory authority we can hang this policy on and give us more explicit statutory authority for allowing this kind of churning.’
You can actually be buying and selling properties within the Opportunity Zone business during the holding period. It’ll be interesting to see if the final regulations re-incorporate or keep this incentive. That’s an example, I think, of some of the attitude of the IRS and Department of the Treasury in trying to encourage these developments. As I say, there’s probably 10 or more examples like that of cases where they’re taking a pretty progressive approach.
The last part of the question, ‘How’s that going to affect Idaho?’ Who knows. But the more that the IRS is kind of being liberal in applying and interpreting the statute, logically, then, the more development that we could expect to see in Idaho and every other state. I think it’s a more positive development.
From an economic development perspective, the revised guidance that came out in April was a huge relief to the community. When the initial guidance came out in October, the guidance said that for a business investment to be eligible, the business has to generate 50% or more of their gross revenue from within the zone. That interpretation pretty much ruled out any sort of manufacturing business or any sort of business services business where you might have clients that are all over the country or all over the world. In April, they refined that business test and said, ‘We’ll still leave the gross income test in place; however, if 50% or more of your employees are working in an Opportunity Zone, then that meets the test. If 50% or more of your payroll is paid to employees and contractors who are working within an Opportunity Zone, that meets the test.’ That was a big sigh of relief for those of us in the economic development community who would like to maybe see this as an opportunity to leverage some manufacturing or some high tech investments in some of our Opportunity Zones.
Bill, did it have any effect on your fund?
Yes, absolutely. In this industry, since it’s so new, everyone is kind of sitting on the sidelines waiting. They look to their professionals, whether it’s their tax attorneys, their wealth managers, their CPA firms, to provide that foot forward as they move into the space they’re interested in. I think they just don’t understand.
I think second tranche clarifications provided what we thought most of the issues were going to play out like as far as real estate investments are concerned. They also solidified one of the most important things, I think that is necessary for the effective allocation of capital in the near term, and that’s to think about the gains and where they come from. If you sold a piece of real estate in 2018, you sold it before 12/31, your gain recognition event is June 28 of 2019, so you have until June 28 to make an investment in a qualified Opportunity Zone. Many people here in Idaho don’t know that, and I think that’s consistent with a lot of the places that we’re presenting at. That’s a very short window.
The fact is that you’ve already recognized the gain; you’re already going to foot the bill for the tax. If you’re looking to put it out there, it’s now. For us, there a lot of people coming now saying, ‘Hey, we found out we’ve got this limited window to come in. Do you still have room for us?’ I’ll say, ‘Hey, we’re an accredited investor-only fund, so maybe yes, maybe no.’
The second thing is, you have to place it into projects that are going to meet the compliance with the 31-month window. If you’re going to take the bet, you’ve got to place it somewhere where you know the execution is not a question. For us, at the fund level, it’s been hugely important. We’re negotiating right now with a $100 million gain client who’s going to come into various assets at the fund level. I don’t have the problem of selling $100 million gain property, but he does. So they are very interested in being able to move in and move quickly. I think that, for our fund strategy and being able to channel capital in Idaho, is fantastic.
I will say that the clarifications were enough at the real estate level for people to make reasonable investments in the deals. There’s a lot of questions on some of the business side issues that we’re not comfortable with.
Roy, how has this affected your clients?
Our clients seem to have individuals on staff, or perhaps whole departments, that address the tax issues. We’re accustomed to reading regulations related to the environment and wastewater treatment and brown fields and zoning, pump plants, general plants. Frankly, I find the tax code to be a numbing experience. Our clients have the expertise. We infer from their enthusiasm, they like the Opportunity Zone opportunity, and they have the tax expertise on staff. They keep telling us we need to do due diligence on certain properties because we’re ready to invest.
I attended the crew meeting where Jerry spoke a few weeks ago and gave kind of the outline of the second round explanation. After that meeting, I was very enthusiastic about the new regulation that came out, and I think it will definitely make it easier for people to feel comfortable moving forward as well.
To reiterate what some already said, Bill is right — a lot of things played out the way that we thought. As Jerry mentioned, the big question mark was that 50% gross receipts within the zone. I think a lot of people felt like that was going to kill any qualified Opportunity Zone business investments because it’s hard to get the revenue in an economically distressed area. I feel like it opens it up quite a bit.
How it changed things in Idaho, I don’t know, but the clock is ticking. Like Bill mentioned, the clock is ticking for 2018 gains. There’s still some gains that occurred at a portion later in the year that you still have time to invest in those. Even if taxpayers already filed their tax returns, then you can always amend those or, if they’re on extension, then you can defer the gains on those, even if they paid that gain with the extension or not. There’s still some opportunities to invest on those.
The other clarification they gave is just like what everyone was assuming: net 12/31 gains do qualify for capital gains. 12/31 is anything in excess of depreciational gain recapture. 12/45 gains are going to be your depreciational recapture that’s treated as ordinary income and taxed as ordinary income. Anything above that amount, you’ll have 12/31 gains that are treated as capital gains. Those capital gains are also treated just like investment capital gains or other gains.
Compared with other states, how does Idaho stand in terms of its opportunity zones? How desirable are Idaho’s opportunity zones to investors, compared with those, say, in New York or California?
It all depends. Idaho, there’s not a lot of activity. With other states, it seems like they’re really triggering. Colorado is a really active state as far as promoting some of these funds, and California as well. I don’t know how to prepare them because we’re not seeing a lot of activity in Idaho right now as far as development or announced development funds. I’d say there definitely is more activity in other states. Colorado is one where I’ve seen a lot of activity. Maybe I have more clients in that area as well as California. It seems like California and Colorado right now have more activity and more announced development funds or qualified Opportunity Zone developments than Idaho does at this point.
Idaho hasn’t seen a lot yet. Other states have seen more activity. One thing I did want to comment on at some point during the program, and this is as good a time as any, is that we’ve heard a lot about how the clock is ticking and that time is of the essence here in deciding on whether to invest in Opportunity Zone businesses, and that’s probably true. I just want to remind everybody and have everybody remind your clients, if you have clients in this area, don’t let the tax tail wag the dog, right? You can get into a fund, but it’s just like any other investment. Make sure you vet the promoters of the fund, the leaders of the fund, don’t forget your basic business instincts about making sure you know what you’re getting into and that everything is tied down.
I can just see situations where this looks like something where somebody can come to you with a great deal, and if you haven’t vetted it, you could lose all of your investment. Do what you normally would do in making a major investment and make sure that you’re not blinded by the potential good tax opportunities here.
One thing that I think is going to come into play in Idaho as we get a little bit later on the calendar, on the clock, is the fact that in Idaho we have a reputation for being able to do deals quickly and getting projects up and running in a very quick manner. We’re the state that has a reputation for having the world’s largest yogurt factory built in under 12 months. We don’t offer quite the sweet incentive package that other states offer, but, where we have really competed against our neighbors and other states in the country is our ability to get projects done quickly and get them up and running more quickly. That’s just one of the advantages you have in a small state like Idaho. Where there is a barrier, in a couple phone calls, we can have the governor on the line to be talking to that company to see what we can do to work up those regulatory kinks and issues.
The other thing I think we’ll see is as these large national funds are looking to diversify their portfolios and they do their Colorado investments, they’ll be looking for maybe some smaller investments or investments that are outside of the Colorado or California or Oregon envelope. They’ll be looking at a place like Idaho to park some of their opportunity funds, just because it makes sense to balance out your portfolio and not have your eggs all in one basket, and the fact is that we have a really great reputation as a state for doing projects and doing development.
We were structured to deal with the Idaho issue. I think Roy is here as a testament to the fact that the Opportunity Zones in Idaho are favorable generally because the Idaho market is favorable. Folks are coming to better cap rate arrangements when they move into the Idaho market. That’s why they’re here. I was just on a panel with families down in Houston. I took a poll of the audience: ‘How many of you know where Boise is?’ Probably 75% raised their hands, mostly because of the football program, probably. Then I asked a subsequent question: ‘How many of you know where Twin Falls is?’ One guy raised his hand. Twin is never going to get that institutional or family office group to come and invest in a development no matter how compelling the story is unless their neighbor somehow knows the developer or something like that.
Galena was formed specifically to try to allocate some of that capital waste that exists out there into the Idaho market. Specifically, because we believe there are better and more viable investment opportunities in some of these three cap deals that are being done in California or something or some of these other tighter markets.
The Boise Opportunity Zone is a little bit of a challenge. It doesn’t have as many larger scale opportunities as some of the other ones. I think our opportunities out there are great; it’s just making people understand that if they make an investment, they’re making it in real estate that makes sense. For folks here locally, they can get over the Twin Falls issue or Pocatello or Post Falls, but outside of the state, not as many.
We have several California-based clients, builders, developers and an investment group that have expressed a lot of interest in Opportunity Zones specifically in Meridian and Nampa. The investor group has said to us, ‘We will not invest in California.’ The reason is the regulatory environment. For example, we were successful in getting approval for a multifamily project in a city where the project was consistent with the general plan but needed a rezone. It still took several years to get the first approval. There was litigation. The approval was withdrawn by our client, resubmitted, several more years to get an approval, sued again. That suit was withdrawn after six months — four years to get a multifamily project approved when the project was already consistent with our general plan. It’s pretty burdensome.
We’re now in the process of getting another multifamily project through another city, and it’s already been two years. As Jerry mentioned, in Idaho, the regulatory environment is much different than California. It’s become such a burden in California that we see clients no longer investing and expressly pursuing opportunities elsewhere. When the investor group came to us, they didn’t say, ‘Where do you think we should go? We hear Idaho is pretty cool.’ They said, ‘Meridian and Nampa.’ They had done their research and they knew exactly where they wanted to go.
Just to tag onto a couple things other people have said, I think Idaho, regardless of the Opportunity Zone program, they’re funneling money here from everywhere. It’s coming in from California, Oregon, Washington and Colorado. It has been for years. I think that has a lot to do with our geographic isolation here. We’re kind of isolated from the storms, whether they’re good or bad, in the economies of some of the larger cities just by location. Our highs aren’t as high, but our lows aren’t as low, so investors look at us as a place to make a little bit of a safer investment.
I think that the growth here in the last 10 years has been phenomenal. People are seeing huge returns. I think regardless of whether an Opportunity Zone was here, people are going to bring their money. The Opportunity Zones have sweetened that deal for them a little bit more, especially Meridian and Nampa. Like you said, those are great locations. I know they’re not a huge geographic parcel. I think some of the investment that might happen there might actually be in the business area versus the real estate area. It’ll be interesting to see how that plays out.
A few weeks ago, Utah got some Opportunity Zone development. How come Utah has Opportunity Zone development already and Idaho doesn’t — what’s the holdup?
One thing to keep in mind is that different investors have different goals, different strategies, different thoughts, feelings, gut reactions to investment. Investors like to be close to their investments. You look at the Salt Lake area, and just by sheer numbers there’s probably a bigger pool of investment dollars there than there is here in the valley. Yes, you’re going to probably see these deals happen first in the large, major metro areas before they filter down to the smaller metro areas and into the rural areas. I don’t think Utah is doing something different that we’re not doing here in Idaho. It’s just a numbers game, and they have those numbers there that we simply don’t have.
I think you’re referring to the PEG Deal in Utah. That was a student housing with UVU. That was a long time in the works. All they did was stopped, then changed the nature of their capital raise. If you take a step back, Opportunity Zones were designated based on 2010 Census data. Some of those markets may have already turned substantially from where they’re at now. One we’re working in the Puget Sound area, you wonder whether it’s really an Opportunity Zone or not because it doesn’t feel distressed now.
Idaho didn’t have the ready-made deal on the Boise bench. The Boise bench is old; certain areas are tired. It’s moving, but it’s a really long play. Idaho’s will come. We’re working on a bunch of transactions that will hit a PR wave. I will say also that we’re not so concerned about being first. We see investors not wanting to exit 10 years from now from the fund. You can stay in a fund until 2047, and if you think about the compounded annual growth, tax free through 2047, that is a phenomenal amount of capital gain that you would be able to harbor for that amount of time. I learned from a guy in Manhattan who said, ‘Hey, we’re doing an OZ deal in Manhattan.’ Why would I ever want to sell that? I don’t want to. I have zero interest in selling it. We’re looking at the long game. The deal has to make sense; it has to be a great addition to the cultural fabric from our perspective, and the demand has to be solid.
I agree. I think the demand has to be solid. You have to do your market analysis, your due diligence to make sure the project works. As to why Utah has Opportunity Zone development and Idaho doesn’t, I think California can speak to that.
I’m an Idaho boy, born and raised, and do business strictly here in Idaho, so I don’t know too much about the Utah project or those other markets, but I do see that I think Idaho has a wave coming with these investments that will be here. People are going to have to get their projects going quickly to take full advantage of the program. They need to get their deals done by the end of this year. That’s created a little bit of urgency for some of our clients. I see the brokers’ heads shaking in the audience to get people to move that may have been considering selling a project that they may have here in the area but didn’t know where they were going to put their funds. 10/31 exchange is tough because of the timelines and finding a replacement property that’s suitable in that timeline that gives them a return that they’re looking for. An Opportunity Zone fund has been something that a lot of people’s ears have perked up when we’ve talked about the option. I think that will be coming here soon.
I agree with what Jerry was saying. People like to be close to their investments. A lot of my clients when we are talking about this, their question is, ‘Well, what’s around here?’ I don’t know if this is true in Utah, but I think it’s true everywhere when people have especially big numbers. If they have a $1 million more invested in something, they like to drive by every now and then and just see how it’s going.
Maybe part of that too is, I feel, at least with the conversations I’ve had with clients, Idaho investors are a little more conservative. This is something new — it took 10 months for the IRS to bring out any proposed regulations. Then, we still had a lot of questions. Now, we have round two of proposed regulations. I’ve heard rumors that there will be a round three of proposed regulations before there’s even final regulations. I’ve even heard there may not even be final regulations because it may take them so long to get around to it that all of this sunsets by then.
I think investors are a little bit more conservative in Idaho. I don’t know if that’s fair to people in Utah. My clients at least have a lot of questions before they do want to throw that money into a fund, so they’re sitting back asking questions, asking who else they can talk to on the legal side, who else they can talk to with Bill at Galena Opportunity Funds.
The only thing I can add is that I’ve done a lot of work with the Idaho Legislature and various clients in pushing and trying to get enacted tax incentives in various areas, sales tax, property tax, income tax. Utah is always one of the states that the legislatures look to as a model for passing this type of progressive and aggressive tax incentive legislation. Utah is a regional leader in pushing this kind of thing. Utah is just very good at economic development.
I don’t find it surprising that we’re lagging a little bit behind Utah in terms of Opportunity Zone development. I do think it’s a good idea for us to continue to model Utah and try to keep up with Utah because they are so aggressive. I think we’re getting there too. The Idaho Department of Commerce, over the last 10 years, has really advanced Idaho’s agenda in developing business and creating and taking advantage of business opportunities.
Some of you have mentioned Boise and that Boise is kind of on the list because people have heard of it. A couple of you have mentioned Meridian and Nampa. What are some of Idaho’s most notable and desirable Opportunity Zones and what makes them that way?
I would say that the potentially easiest ones to work in are Twin Falls and Meridian, both very pro-development. Boise has solid fundamentals. The problem is getting access to the real estate for a fund like ours. We are doing larger scale transactions outside of market, generally, so that we can do smaller scale transactions here in the $10-20 million size range because that’s probably more of the specific demand patterns that we’re going to be dealing with.
Meridian has large enough tracts available that you can get a scale deal done. I think that’s a lot of the theme. One thing I want to say though, is, nationally we’re barely starting to talk about Opportunity Zones here. Nationally, the discussion has already moved into, ‘Okay, we’re doing OZ now. How do we do OZ right in a way that benefits a city most? Do we do the transitory and development-type stuff? Do we focus on integrating health care and housing? How do we make it a better arrangement than just doing another multifamily deal?’ That’s where the discussion has gone.
We see a lot of interest, not just simmering. It seems like it’s looking for the right operators from major philanthropies that want to make a yield on their invested dollar, but they’re looking for the Opportunity Zone investment that has a story behind it. We had already been discussing that. I hope St. Al’s doesn’t get mad at me. In the Opportunity Zone space, we’ve been pressuring St. Al’s to figure out how to help us get a deal done down there. I say pressuring, but they’re very willing to help. I think that is going to be part of what it takes to get the most notable Opportunity Zone developments done, especially in the valley where you’ve got stresses from population growth, strains on transportation corridors. You have to get in there and do that type of development. I think you look at that sort of cohesive development play, and I think you have a fantastic Opportunity Zone in Boise’s Opportunity Zone. It’s just difficult to get to the real estate. For us, it would be Meridian, Twin Falls. We like Pocatello, Post Falls, and we like Boise.
Roy, how did your clients hear about Meridian and Nampa? What appealed to them about it?
Part of it was in the industry they’re in. They follow the trends, look at population growth, job growth, affordability, why are people moving here. Part of it is job growth; part of it is lifestyle. A big factor is affordability. Then they considered, ‘We might like Idaho in general; where should we go specifically?’ Then, it was a regulatory environment. How quickly can they get projects approved compared to three, four, five, six years in California? When can we see a return in our investment? Meridian and Nampa, Boise as well, but more so Meridian and Nampa, really came up high on their list when they did their spreadsheet analysis.
I think obviously we’ve talked about Nampa and Meridian. Other than that, there is probably some opportunity around the area in McCall, in that zone, some workforce housing, that sort of thing to go in there. I think a lot of the money is looking at Meridian and that four blocks there. It’s just a really great area with a lot of great fundamentals and great access. It’s downtown. I don’t know the actual streets, but I think it’s Pine, Franklin, I-84 and Cloverdale. I think those ones are the strongest, but there’s opportunity out there in those other outlying areas, like you mentioned. Twin Falls is a great fundamental market as far as growth. They’re doing really well down there. I think there’s opportunity for multifamily down there as well.
I think the most desirable is one that’s going to give the biggest return to the clients. The clients looking for the turn and what that means, and they can have a 100% guarantee they’re going to have a gain on this property. That’s probably going to be more desirable.
I don’t really have much of a sense of what the individual markets are in terms of the best opportunities in Idaho. I will say that it kind of points out what I see is kind of the investment risk in Opportunity Zone investment. That is, as the other speakers have mentioned, the biggest payoff is if you do it for the long term, if you stay in it for the 10 years. You just have to realize that you’re making a big investment in a long-term investment in an economically depressed area. What’s that going to look like in 10 or 20 or 30 years? You need to do your due diligence and make sure, if you’re the only investor in this particular Opportunity Zone, you’re not going to lift up this economically depressed area all by yourself. You have to have a sense of what else is going on in this area, and what is it that’s going to make my investment profitable after 10 years?
Jerry, I’m not sure if you’re allowed to show favoritism among the zones in Idaho, but do you have anything to add to this?
They’re all great. They’re all my favorites. A lot of the discussion has really focused around the real estate space and maybe that commercial development space. Let me talk about maybe some of the opportunities that are out there for industrial development. For example, we have a zone in Minidoka County that touches the south side of Rupert. You have great access to the highway; you have rail going through there. They have capacity for water, sewer. It’s one of the few areas left in the Magic Valley that hasn’t been tapped out and built out industrial wise.
Looking over in western Canyon County in the two zones we have in the Parma area and Wilder area, once again we have accessible rail, easy access to highways, infrastructure, water, sewer capacity. If somebody is using opportunity funds to do something in the industrial space, those two areas might be very attractive to them.
If you look at the area of technology, we have two zones in Moscow, Idaho. University of Idaho is located in Moscow, Idaho. Our friends over in the people’s republic of Washington, didn’t designate Pullman as an Opportunity Zone. There may be an opportunity there to pull startups in tech and innovation businesses in that university cluster there, get them to set up roots in Idaho to get up and going.
We’re seeing, both in Idaho and nationwide, a resurgence in interest in development in downtown areas. We have some zones that are perfectly situated for downtown redevelopment. Our Pocatello zone covers old town Pocatello. Our Twin Falls zone covers downtown Twin Falls. The zone we have up in the Sandpoint area covers most of downtown Sandpoint.
There are a lot of great opportunities that are out there. Once again, they’re not in the name-brand areas of the state, so it might take a little while for those to get discovered to get promoted. It really is going to depend on the type of deal and the type of project that you’re doing as to which Opportunity Zone is going to be the right one for you. Somebody looking to do something in the value of added timber space, they’re probably not going to look at Meridian or Boise.
New Jersey has just set up some Opportunity Zones to develop things like self storage facilities and came under some criticism. What should Idaho municipalities do to attract Opportunity Zone investment, and how should municipalities guide the sort of Opportunity Zone development they want, like affordable housing?
I think the opportunity here is for elected officials in cities and counties and for executive staff to give direction to prospective investors who come to meet with them, and ask them ‘What type of development would you prefer to see in your OZ’s?’ Just give a straightforward answer. There are, I believe, other incentives rather that cities and counties might be able to offer. In California, we refer to them as redevelopment zones. In Idaho, it’s urban renewal zones. You could couple local financial incentives with the tax benefit of Opportunity Zones. An OZ, by itself, may not convert what would otherwise be a bad investment into a good investment. An OZ, perhaps coupled with urban renewal zones and financial incentives in both, may very well tip the scale for some investors in favor of investing in what might otherwise have been a marginal investment.
I think the dialogue between prospective investors, elected officials and city and county executive staff would be very helpful. A candid conversation, in our experience, goes a long way in making a successful project.
I think one of the controls that local municipalities and counties have is zoning. You control those zonings and make them more attractive to development of certain types. If there is property that comes up in one of those Opportunity Zones that the city has kind of a vision for, they can affect that by changing zoning or requesting that someone use that zoning when they re-apply for that zoning change.
To follow up on what Roy may have mentioned, there are some tax incentives that local governments control or at least have some input on. One of the major ones is the five-year property tax exemption. That’s really under the control of the county commissioners for each county. So if they want to encourage a particular type of development, whether it’s low-income housing or something else, they can direct their discretionary granting of those exemptions to that type of activity.
There’s also other things that local governments can do. They can work with the Department of Commerce in encouraging the granting of other incentives like the tax reimbursement incentive that has some local participation components to it. Then there’s also zoning, of course.
One thing I would like to see communities do more of is promote their Opportunity Zones. When you go into a website for a Meridian or Nampa or Twin Falls or Lewiston, and you’re seeing all of the flashy messages, there should be one that comes right at you that says, ‘We are an Opportunity Zone.’ Then have your sales pitch right there for the asking for your particular Opportunity Zone.
Second thing, is that some of our larger communities, so your Boise, Nampa, Meridian, Lewiston, Pocatello, they have their own community development block grant funds that they get directly from the federal corporate. The federal corporate is now putting out guidance that they would like to see their dollars deployed more thoroughly into Opportunity Zones. There’s an opportunity there with that option to figure out ways how they can use their block grant funds to leverage Opportunity Zone developments. It might be upgrading infrastructure or it might be assisting with dealing with conditions or working with other state incentives that are out there to clean up brownfield areas.
For the smaller communities, they have access to the Idaho Community Development Block Grant program. For the really small rural communities, we have the Idaho Gem Grant program that we can quickly deploy those funds to partner up with communities that are trying to leverage projects.
The other thing, and this has already been mentioned, is one of the things we do in Idaho, is we do speed. Maybe for communities that think about how they can restructure their permitting processes to accelerate the approval of projects that might be going down in Opportunity Zones.
Some people in the historic preservation community are concerned about Opportunity Zones because some of them remember urban renewal in the 60s. In the name of progress, all sorts of beautiful buildings were torn down. They’re concerned that there doesn’t seem to be any protections for historic preservations in Opportunity Zones. To what degree should that be an issue for Idaho?
We don’t have as many buildings that are that old. It’s maybe less of an issue here than it is in other markets. We do obviously have some older properties in downtown Boise, but that’s obviously not where the Opportunity Zone is. Some of the older areas of Twin Falls maybe or even Nampa may have some historic issues, but I think they’re minimal in comparison to other markets. I think there’s historic tax credits that can be used. I think a lot of the fund operators, they’re going to do things that are going to help the community in general. If they could maybe move that building to another location, I think a lot of them will.
It really doesn’t hit the income tax side of it, so just on personal opinion, I think that developers and fund managers need to keep that consideration. You want all parties to be happy, and you want it to be successful in the communities that you do these Opportunity Zones in. I would just assume they would take those into consideration and deal with them appropriately.
One of the things in the regulations is that if you’re doing your Opportunity Zone project and it’s a rehab project, where you’re fixing up a building, there’s a requirement that you have to spend an amount that’s equal to the assessed value of the property at the time you require it, less the cost of the land, in rehabilitating it in the project. So let’s say I purchase a property for $1.5 million, the land appraises out at $500,000, the building appraises out at $1 million. In order to make it eligible for the Opportunity Zone incentive, what I have to do as a developer now is invest another $1 million into the building, whether the building needs $1 million worth of rehab or not. That can make it kind of tricky when it comes to preserving the building. In some cases it might make sense under this incentive to knock it down and start brand new. That’s where that concern is coming from the historic preservation community.
There are a couple things though that preservationists have that they can use as tools to combat that. One is the historic preservation tax credit. That can help with the cost of a project potentially and help address that issue regarding rehab. Another selling point is that in many communities across the country, your historic buildings, square foot per square foot, are the highest value buildings. You just look around the north end of Boise, and you have these little tiny homes that you can sell and buy a mansion out in Middleton somewhere for it. As long as there’s a perceived economic value in historic preservation, I think they’ll be able to hold their own under this wave of Opportunity Zone investing.
Something that might help would be if there were a state historic tax credit like many states have that can be used in conjunction with the federal credit. We’ll just have to wait and watch the marketplace and see how it all plays out.
We like historic. We don’t want to demolish any historic buildings we don’t have to.
Some of you have mentioned that this was all predicated on the 2010 Census and that some of the zones that were kind of economically depressed back then are maybe not so much now. What should developers due to keep opportunity zones from becoming overly gentrified?
I just ask the question, what’s wrong with gentrification? Maybe that’s not a bad thing.
It’s a very real problem for sure. We’re trying to be as sensitive as possible. It’s tough. You try to pair with, say, low-income housing tax credits to offset some of the housing units that would be lost. That’s a very finite source of capital to do that. What we’re doing is trying to take a holistic view and look at those underutilized areas and try to minimize its placement wherever we can. It’s going to happen though, gentrification, I think. In Boise, it’s going to happen whether it’s an Opportunity Zone or not.
I’ve read about and heard about the issue. I’m not sure I fully understand or appreciate why it’s thought to be an issue. I think single family subdivisions evolve over time as folks who have lived there for a long time, their kids move out, they retire, they move out. Neighborhoods evolve.
I think it’s the natural order of development and redevelopment. I think that developers do need to be a little bit sensitive, but it’s not really their responsibility, I don’t think. The community, if they have an issue with it, will speak up in those planning and development meetings like they do about how they’re going to raise their rents and all of those things.
Opportunity zones have been criticized by some as a tax break for areas that would be developed anyway. To what degree is that true in Idaho?
This is an interesting tax policy issue about kind of the ethics of tax incentives to begin with. There’s a large school of thought in the tax community that tax incentives are not economically efficient regardless of the type. The National Tax Foundation puts out surveys every year ranking states in terms of their state tax policy and tax structure. They actually give kind of demerits for states that have tax incentives. They’re a pretty conservative group, the tax foundation. You’d think they’d be kind of taxpayer friendly, but they discount the value of giving tax incentives.
I think particularly state tax incentives are subject to a lot of criticism and scrutiny because what ends up happening, and we see it all the time, is states compete against each other. We were talking about Utah versus Idaho a few minutes ago. States compete with each other to offer the best tax incentives. Look at what happened to Amazon last year with New York and all of the cities that were campaigning and offering greater and greater incentives to Amazon to place their new headquarters. They call it a race to the bottom: the state that gives away the most is going to probably attract the biggest investment. I think part of that tax policy argument is, why give people a tax incentive if they’re going to locate there anyway? I think some of those arguments could be made with respect to Opportunity Zone investments.
I will say a lot of states have Opportunity Zone investments. Idaho has never had it as a state policy except for maybe some of the funds that are available for smaller cities. It has been a part of the tax policy of many states for a long time. I think you could make a better argument, frankly, for the Opportunity Zone-type of tax incentives because it really is targeted for economically depressed areas. There is a kind of legislative purpose in giving tax incentives for that reason.
As to whether or not that’s true in Idaho, I don’t know if Idaho is going to be any different than any other state in whether or not economic Opportunity Zone incentives are good tax policy. I think the same debate could occur here in Idaho. If we need relief in economically distressed areas, we probably need it as much as any other state.
Two points, and this is true of any tax incentive that’s out there. First is that tax incentives aren’t magic bullets. A tax incentive isn’t going to take a deal that didn’t pencil out before the tax incentive, then suddenly make it pencil out after the tax incentive is in place. What I have seen, in my 20-plus years of experience, tax incentives can maybe make projects happen quicker than they would happen on their own.
Maybe a company has a five-year window to bring a product to market or to complete phase one of their expansion. Then the incentive comes along, so that enables them to have a little bit more money in their pocket up front, so they implement their business plan more quickly. Or maybe they were thinking of building a 100-unit apartment building, then the incentive comes along, and now they’re doing 125. It helps sometimes projects happen more quickly or maybe happen a little bit larger than they would be on their own.
In terms of taking a project that was a dud before the incentive came in place and suddenly making it a viable project after the incentive comes into play, I don’t see that happening. One of the things that we do a little bit different here in Idaho than in other states is that all of our tax incentives are performance-based. So the company has to do the investment or the company has to create the jobs before they can claim the credit. Other states, they do it upfront, and then if the business doesn’t perform, well you see the horror stories in Forbes and other publications about companies walking away after being offered huge incentive packages.
Circling back to Opportunity Zones, this was a topic that came up when the advisory council gathered around to pick the zones. They purposely, when it came to allocating those at-large zones or those extra zones, looked for those areas that we wouldn’t naturally think of as being right for investment opportunities.
In Idaho, I’d say we kind of took a little different path in that we selected areas that would have a hard time attracting investment otherwise first in deploying our zones before looking at areas that would be low hanging fruits.
We’ve gotten a higher-level threshold in place recently in what we’ll analyze at a pitch level, because we pitch hundreds of deals. We’ve got one in downtown Portland — Ritz Carlton. That thing was going to happen whether or not it was an OZ. We’re not interested in that kind of deal. It’s not within our fund mission. They don’t need our help with that kind of thing. Idaho does need our help.
I think Boise’s Opportunity Zone, even though it’s got some attractive potential options after you dig through it, it will meet the threshold that would merit investment from our fund specifically. Meridian is a little bit easier because it’s got a little bit more blank slate dirt down there that’s easier to get at. I don’t think these developments would’ve happened without the Opportunity Zone in many cases in Idaho. I think it’s sort of put the focus, the lens, on each specific market to help drive the discussion and the narrative toward ‘is this potentially viable?’ So I think for most areas in Idaho, it is a good discussion framework. I don’t think it would’ve happened without the OZ.
I think Rick is correct that this conversation probably occurs in every discussion about public policy that relates to an incentive, whether it’s a tax incentive or expediting the approval process in the incentive. I think the fundamental question to be asked is, if one thinks that a particular question would have occurred even absent an Opportunity Zone incentive, the question is, did it happen? If it didn’t, why not? Then if it did not happen, I think Jerry raises a very good point, perhaps the incentive, although it would not have converted a bad deal into a good deal. Perhaps the incentive allows that particular project to come to market much more quickly. That achieves the intent of incentive, which is to make things happen.
We’re talking about Opportunity Zone as an investment and whether or not there is any sort of economic benefit or deal at the developer level. Depending on which accounting or evaluation shop you use, whether it’s KPMG, or whoever you want to get your analysis done by, 300-500 basis points is the potential yield addition from an investment through an Opportunity Zone investment structure. That’s a substantial amount of return generated from the tax side. It is not inconsequential when we’re talking about whether it’s enough to move the needle. It is enough to move the needle, but you’ve got to do your diligence, like they said.
I think back to Jerry’s point that he made earlier, that the state really focused on making these in a lot of the rural areas. Those are probably areas that would have not seen people even considering them for investment without the Opportunity Zone in Idaho. What our state did was good for those areas, and I think it’s directed some attention toward those areas like maybe the Homedale area along the Snake River that otherwise wouldn’t have been in the discussion with those investors.