CDFIs can bring critical assets to Opportunity Zone projects, if not equity investment experience
Although many Community Development Financial Institutions (CDFIs) may have limited experience with market equity instruments, they are well-positioned to play a pivotal role in the Opportunity Zones ecosystem.
Opportunity Zones: Old Game, New Players, Same Community Development Goal
The federal government created Opportunity Zones as part of the 2017 Tax Cuts and Jobs Act to entice traditional investors to direct capital—specifically, capital gains— toward developments in “economically distressed” low- and moderate-income (LMI) communities, areas these investors have historically overlooked. In return for such equity investments, investors receive several tax benefits that vary in accordance with the period the capital remains invested in a Qualified Opportunity Zone (QOZ).
Nationwide, states have designated over 8,700 census tracts as Qualified Opportunity Zones. Tennessee counts 176 Qualified Opportunity Zones – 79 in the Appalachian region – the state assigned through a strategic and data-driven review that considered feedback from city and county mayors, alongside state priorities and initiatives. The working group that led Tennessee’s review included representation and recommendations from Tennessee Department of Economic and Community Development, the Tennessee Department of Environment and Conservation, Tennessee Housing Development Agency, Tennessee Valley Authority and LaunchTN.
The working group prioritized the following factors when assigning census tracts the Opportunity Zone designation:
- Business development and brownfield redevelopment opportunities;
- Retail, commercial and tourism development opportunities;
- Community and rural development initiatives;
- Low-income housing development opportunities; and
- Proximity to entrepreneur centers, technology transfer offices, and colleges and universities.
Equity Takes the Field, But Debt Should Still Be in the Game
Only equity investments (stock, preferred stock) or partnership interest (including a partnership with special allocations) – not debt investments – in a designated QOZ census tract qualify for tax benefits. Eligible investments also include most real estate, business property, and business stock located within a QOZ. To qualify, guidelines also stipulate a QOZ business must locate 70 percent of owned or leased property within the QOZ, along with a percentage of intangible property and revenues based on activity in the zone.
But the exclusion of debt from qualifying investments for Opportunity Zone projects does not preclude a role for debt financing in the projects. Many OZ projects may seek senior or subordinated debt in order to fill a gap in their capital stack. Likewise, a developer may still obtain a senior mortgage loan secured by the property or other debt financing for the property.
In other words, the investors in the Opportunity Zone Fund must contribute equity, not debt, but this does not limit the ability of the property owner to obtain debt as an additional source of financing for the property. In fact, a developer could obtain multiple sources and types of debt and equity financing, and still qualify to accept Opportunity Fund investments as one part of the capital stack.
Community Development Financing Expertise
Although many Community Development Financial Institutions (CDFIs) have limited experience with market equity instruments, they are well-positioned to play a pivotal role in the Opportunity Zones ecosystem.
CDFIs have a long history of bringing debt capital to these very communities by offering targeted resources and innovative programs to leverage federal dollars with private sector capital. Today, a network of roughly 1,100 CDFIs operates nationwide and bridges diverse private and public sector investors to create economic opportunity in low-income communities. In 2016, CDFIs originated more than $5.03B in loans and investments to 12,500 businesses, financed 27,900 affordable housing units, and provided education to 452,000 individuals.
CDFIs are in a better position than other participants for several reasons:
- they can easily provide low-cost long-term funding to any part of the transaction, whether at the QOF level, the second-tier entity or the direct property level;
- they can elevate the attractiveness of their participation by providing senior or subordinated debt instruments that are tailored to the specific needs of their low-income community-based assets AND the needs of the short and long-term investor, and;
- they have long track records of successfully partnering with banks and other financial entities to create a capital stack that works to generate real impacts in economically underserved communities.
Opportunity Zone Fund investors who are new to community development financing might overlook CDFIs if they don’t have experience working with equity instruments. That’s a mistake. They have assets that are just as or more critical – an understanding of the role debt financing can play in equity-driven projects and deep experience financing community development projects in the communities Opportunity Zones aim to benefit.
Pathway Lending sees great potential, particularly in affordable multi-family housing and other commercial real estate development, for Opportunity Zones to impact Tennessee communities in ways that are consistent with the mission we’ve pursued over the last two decades. If you want to learn more about Opportunity Zones, get in touch.