The Education Opportunity in Opportunity Zones

Can incentivized investment in distressed communities close the prosperity gap?



By 07/02/2019

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More than 8,700 newly created Opportunity Zones are now racing to attract a portion of the $6 trillion in capital that may flow under a provision of the new tax law enacted in 2017. The law uses a package of tax incentives to jumpstart economic development in distressed communities by financing local startups, building small businesses, or developing properties—but there are also opportunities for education institutions and workforce-development programs.

A lack of investment in distressed communities

A growing body of research has revealed geographic prosperity gaps across the United States. Recent economic growth is concentrated in large, metropolitan areas with populations of over 1 million, which have experienced 72 percent of the nation’s job growth since the financial crisis. Nearly half of the net increase in business establishments from 2007 to 2016 took place in just two cities: Washington, D.C., and New York City.

Millions of Americans now live in distressed communities characterized by higher rates of poverty and lower levels of income, educational attainment, and workforce participation. Pockets of the country also struggle with higher rates of “deaths of despair” due to suicide, drugs, and alcohol—symptomatic of a larger sense of lost opportunity.

 

Figure 1. Distressed Communities are Home to Millions of Americans

In distressed communities, poverty is higher, and educational attainment is lower.

Figure 1. Distressed Communities are Home to Millions of Americans

Source: Economic Innovation Group (2018 Distressed Community Index)

 

Too many communities have become poverty traps. It’s no wonder that economist Raj Chetty has found that where children grow up matters for their economic prosperity as adults. Working with the U.S. Census Bureau, Chetty and his team at Opportunity Insights were able to produce an Opportunity Atlas that mapped the disparities neighborhood by neighborhood. Chetty and team found that a low-income child growing up in a less-poor community is more likely to climb the economic ladder than a child who spends her entire life in a low-income area.

In 2015, the Economic Innovation Group, a bipartisan policy center launched by Sean Parker, brought together a group of economists from across the political spectrum to discuss possible causes of these troubling trends and identify potential solutions. These experts discovered that, while struggling communities each faced a series of complex and interrelated challenges, they shared one common barrier: a lack of access to capital needed for community and economic development projects.

Distressed communities have hopes and dreams, but no one is investing in them. The Federal Reserve found that banks now make fewer loans of less than $1 million than they did before the recession. Nearly 75 percent of all venture capital is invested in just three states: California, Massachusetts, and New York. Philanthropic support is also concentrated in a handful of areas. An analysis of overall philanthropic giving revealed that Alabama receives an average of $130 per capita in grantmaking, below the national average of $451 and well below the New York City average of $1,966. When it comes to education, the Philanthropy Roundtable estimates that 90 percent of K–12 giving is concentrated in urban areas.

The economists assembled by Economic Innovation Group proposed designating these distressed communities “Opportunity Zones” and offering investors incentives to funnel capital into revitalization projects. The concept drew the support of a bipartisan congressional coalition led by Senators Tim Scott (R-SC) and Cory Booker (D-NJ) and Representatives Pat Tiberi (R-OH) and Ron Kind (D-WI), with a group of almost 100 cosponsors. The legislation was eventually included in the broader overhaul of the tax code signed into law in 2017.

How does the Opportunity Zone program work?

The program consists of two parts. The first asked governors to identify up to 25 percent of their low-income census tracts for certification by the U.S. Treasury Department as Opportunity Zones. These designations last ten years and cannot be changed. States, territories, and the District of Columbia designated a total of 8,700 Opportunity Zones, which are home to nearly 35 million Americans.

 

Figure 2. Where are the Opportunity Zones?

Governors identified up to a quarter of their low-income census tracts for Opportunity Zone certification.

Figure 2. Where are the Opportunity Zones?

Source: PolicyMap

 

The second part creates a “Qualified Opportunity Fund,” a new investment vehicle to finance projects within Opportunity Zones. After investors sell appreciated assets such as stocks, bonds, real estate, or businesses, they can reinvest the money gained from those sales into a Qualified Opportunity Fund. These Qualified Opportunity Funds then invest in certain equity-financed projects located in an Opportunity Zone, including businesses, property redevelopment, or new construction. The law offers investors three tax incentives that grow the longer the investment stays in an Opportunity Zone: deferred payment of the federal capital gains taxes on the reinvested amount until 2026, a tax liability reduction of up to 15 percent if they hold the investment for up to seven years, and no taxes on any generated gains from that investment if held for at least ten years.

Benefits for communities and investors

This approach has several strengths. It offers low-income communities a flexible tool to support their own local approaches to economic development. Some may need affordable housing, while others need broadband or capital for growing businesses. It also rewards patient capital; investors must hold their investments in the community for at least ten years to secure all the benefits.

Opportunity Funds allow for enormous flexibility in terms of who can establish them, what they invest in, where they invest, and whether the fund’s goal is to maximize social impact or balance financial returns. Fund managers can be institutional banks, community development finance institutions, universities, or impact investors. Funds can focus on a single city or support projects anywhere in the country. Unlike other economic development programs, such as New Markets Tax Credits, there are no caps on the number of funds or the investment amounts that can be raised. Already, there are at least 90 funds with nearly $30 billion pledged, a number expected to grow as the Treasury provides additional regulatory clarity; Economic Innovation Group estimated there are $6 trillion in unrealized capital gains that are eligible to reap the tax benefits the law provides.

Potential drawbacks and problem areas

While the Opportunity Zone program offers significant potential for positive impact, there are several areas of risk. Previous placed-based policies, including Empowerment Zones, Enterprise Communities, Renewal Communities, and Promise Neighborhoods, have had mixed results. As the California Budget and Policy Center put it, “The inconclusiveness of the research exploring the connection between economic development tax incentives and community outcomes suggests that the costs of such incentives may outweigh the benefits.”

These past efforts targeted the tax incentives on a project-by-project basis in an expensive, cumbersome, and time-consuming process that discouraged many from applying. The authors of the Opportunity Zone policy sought to remedy this by focusing the tax incentive on investors instead of projects. Once funds are pooled in an Opportunity Fund, they can be invested in projects through the familiar processes and timelines used for most investments. Risk is also shared under this structure, as investors and fund managers must identify good projects in order to make the investment pay off.

Given the history of past policies and programs, it is possible that investments may lead to gentrification, displacement, and inequitable development, but this risk is likely localized to a handful of regions, such as San Francisco, New York City, and Washington, D.C. New research by the University of Minnesota Law School’s Institute on Metropolitan Opportunity found that the most common type of change over the last two decades has been not gentrification but rather poverty concentration. In areas where there is a population-displacement risk, mayors and state policymakers can also use other financial incentives and permitting processes to help prevent displacement and encourage projects with greater social impact, such as prioritizing affordable housing over a market-rate condo.

A further critique of many placed-based programs is that they result in tax giveaways for investment that would have occurred anyway. Investors could flock to the projects that have known deal pipelines, such as real estate, in the markets they know best, such as major metropolitan areas, instead of taking on challenging projects in struggling locales.

Addressing this risk requires new services to help investors and project organizers find each other across the 8,700 zones. One such service is the Opportunity Exchange, which is working with several cities and states to serve as a searchable listing of projects. The platform also assigns a social impact score based on the OZ Reporting Framework developed by the U.S. Impact Investing Alliance, the Beeck Center for Social Impact and Innovation at Georgetown University, and the Federal Reserve Bank of New York. Expanding services like the Opportunity Exchange can help connect overlooked communities and high-impact projects with investors.

Even so, the Opportunity Zones program lacks the organizational infrastructure taken for granted in the education sector. There isn’t something like Chiefs for Change for Opportunity Zone coordinators or the Council for Chief State School Officers for state economic-development directors. Thanks to the work of the Economic Innovation Group, Accelerator for America, and the Local Initiatives Support Corporation, there are more ways for participants to share best practices, but philanthropic support of capacity-building organizations will be critical to the program’s long-term success.

How can Opportunity Zones impact education?

Education and workforce institutions are the backbone of most communities. If the goal of the Opportunity Zones program is to empower residents, then investing in educational opportunities will deliver powerful results for future generations and future success.

Early-childhood and afterschool care

High-quality, affordable childcare is essential to families’ economic stability, parents’ ability to work, and children’s healthy development. Many distressed communities, however, are afterschool deserts where families have limited access to afterschool care, tutoring, and other enrichment programs.

Qualified Opportunity Funds could be used to purchase or build new facilities or rehabilitate existing ones for providers. The city of Dayton, Ohio, for example, is pitching investors the chance to build a new public library and afterschool community center. Investments could even finance small businesses operating tutoring or early care programs.

Elementary and secondary schools

According to the 21st Century School Fund, there are 13,536 elementary or secondary public schools located in Opportunity Zones. On average, 71 percent of students in these schools come from low-income families. Many of these schools are also struggling, likely reflecting the distressed communities they’re serving. GreatSchools provides a snapshot of school quality based on data indicators and found that the average rating for schools located in Opportunity Zones was 4.0 out of 10.0, compared to 5.2 for those located outside an Opportunity Zone.

School districts in these low-wealth areas could tap into Qualified Opportunity Funds to improve their buildings. To deliver these modern schools, developers and a school district could form a public-private partnership using ground leases to transfer building ownership to private investors, while leaving the local school district in control of ongoing operations. The investment from a Qualified Opportunity Fund could then finance the renovations, with ownership returning to the district at the end of the term. This approach can be used by district schools, charter schools, and private schools.

The 21st Century School Fund has also suggested that developers partner with school districts to modernize underutilized school facilities as mixed-use community centers, involving partners such as health facilities, childcare centers, libraries, and even elder-care service centers. This approach is aligned with that of many emerging “community schools,” which work with families, students, and community organizations to identify and address unmet needs.

Developers can also incorporate new school construction into their projects. For example, the developers behind Greenpoint Landing in Brooklyn, New York, are building 5,500 new apartments, 1,400 which will be affordable, along with nine acres of parks and a new public school serving preschoolers through 8th graders. Other cities with large development projects could embrace a similar approach.

There are ways to leverage these resources for adjacent needs, as well. RBH Group is using Opportunity Zones to finance workforce housing for teachers in “Teacher Villages,” a strategy that could be important for cities with a higher cost of living.

Charter schools

While at least 22 percent of charter schools are located in Opportunity Zones, nearly 70 percent of Opportunity Zones are actually “charter deserts,” or areas of three or more contiguous, moderate-to-high-poverty census tracts without charter elementary schools. All things being equal, a charter network may want to consider expansion into Opportunity Zones to tap into Qualified Opportunity Funds, an additional source of facilities funding that can complement other forms of financing.

Developers can also include charters or private schools in mixed-used properties built using Opportunity Funds. Starwood Capital Group, for example, announced a development in the South Bronx that will be home to Zeta Charter School, along with retail and apartment units.

Even if charters don’t receive any Opportunity Fund investment, they can be part of a community’s revitalization plan. In Florida, charter schools can apply to be “Schools of Hope,” which allows their networks to establish new charters near low-performing schools. Governor Ron DeSantis has proposed expanding the program to allow charters to serve students in other Opportunity Zones, potentially bringing new education options to children in distressed areas.

Colleges and universities

Nearly every governor designated Opportunity Zones near universities and research institutions, creating the potential for commercializing research, supporting technology transfer, incubating student startups, and expanding student housing. Universities can serve as important anchor institutions in facilitating community planning. Arizona State University and the University of Delaware are already playing this role by leveraging their faculty, research, and convening abilities to assist communities with planning and development.

Higher-education institutions can also benefit from Qualified Opportunity Fund investments. Almost half of Historically Black Colleges and Universities are located in Opportunity Zones. Some of these campuses will receive investment from a newly created $50 million Opportunity Fund led by Renaissance Equity Partners, the HBCU Community Development Action Coalition, and Calvert Impact Capital. Similar funds could be established to support projects near community colleges or other institutions. For example, some research has suggested that when students live on campus, graduation rates tend to be higher. Opportunity Funds could allow colleges to expand student housing to serve more students and thereby improve outcomes.
Universities can also leverage their proximity to Opportunity Zones to create entrepreneurship incubators for students. Qualified Opportunity Fund investments could support building a dedicated facility and provide start-up capital for the most promising ventures.

Workforce-training programs

Communities have to create workforce-development programs to give residents the skills needed for new jobs—and to attract business development from companies that require those skills. Governor Larry Hogan, for example, is targeting state job-training funds in Maryland Opportunity Zones.

Workforce-training providers can also benefit from Qualified Opportunity Funds to build out services. The technology-apprenticeship provider Kenzie Academy is located in an Opportunity Zone in Indianapolis, which allows it to tap into Qualified Opportunity Funds as part of its fundraising rounds. Kenzie also recently announced a partnership with Hypothesis Studios that will use Kenzie graduates as candidates for roles at the startup organizations in Hypothesis’ portfolio.

Some Opportunity Zone businesses are even providing job training. Michigan-based Chart House Energy uses investments from Qualified Opportunity Funds to install solar panels and pass discounted energy costs to host facilities, which may include schools. But the company has also committed to hiring and training local residents, creating a new employment pipeline, and driving inclusive growth.

Business incubators can provide workspace, seed funding, mentoring, and training for entrepreneurs in fields like tech and advanced manufacturing. In Ohio, the Youngstown Business Incubator and Bounce Innovation Hub offer places for entrepreneurs to learn more about advancing manufacturing and 3D printing. In Michigan, projects like the Detroit Grocery Incubator help address the problem of food deserts by supporting entrepreneurs who wish to set up local grocery stores.

Entrepreneurs

Growing local businesses is an important part of addressing poverty and one of the primary objectives of the Opportunity Zone program. According to the Kauffman Foundation, for every 1 percent increase in the rate of new businesses started in a state, there is a 2 percent decline in the poverty rate.

Opportunity Zones give investors the chance to add Qualified Opportunity Funds to their portfolios and thereby support overlooked entrepreneurs in distressed communities. Hypothesis Studios, for example, is searching for mission-driven founders in Opportunity Zones who are trying to make an impact in sectors including healthcare technology, education technology, agricultural, and the Internet of Things. Modeled after the famous Edison Labs, Hall Labs in Utah has 25 companies and employs more than 200 engineers, scientists, and specialists. Hall Venture Partners is launching an Opportunity Fund, giving investors the chance to participate.

This same approach could be used by education investors to attract private capital to the launch and growth of education and workforce solutions. It could also be used to help target underserved populations, such as minority or female entrepreneurs.

For entrepreneurs, launching their startups in an Opportunity Zone creates a new fundraising advantage. For example, the next-generation assessment startup Imbellus is located in the heart of a distressed Opportunity Zone in Culver City, California, which means the company is eligible to receive Opportunity Fund investment as part of its next venture raise. This additional capital would help Imbellus accelerate its work developing new assessments through learning science, psychometrics, and artificial intelligence.

Incubators and accelerators could also be established within a zone to help jumpstart new education businesses or nonprofits. Matt Candler of 4.0 Schools, for example, is exploring the use of Qualified Opportunity Funds to develop small, creativity-boosting, approachable spaces like microschools and maker spaces.

Facilitating the success of Opportunity Zones

Investment is not guaranteed just because a community is designated an Opportunity Zone. It is up to mayors, community leaders, and local business leaders to bring projects to investors, define priorities, and provide additional support. Only then will Opportunity Zones drive inclusive growth.

How policymakers can help

Mayors and governors are well positioned to identify community assets and needs by evaluating current conditions in their Opportunity Zones. To this end, the Accelerator for America and New Localism Advisors is working with cities like Cleveland, Ohio, Erie, Pennsylvania, Louisville, Kentucky, Stockton, California, and South Bend, Indiana, on investment prospectuses that describe local demographic and economic trends, assets and anchor institutions, and potential projects for investors. The Local Initiatives Support Corporation has also released a playbook to help communities with their planning. Education and workforce institutions need to join these discussions to inform the work and potentially benefit from investment.

Policymakers will need to leverage state support through grant-preference points, eligibility criteria, or other state incentives to make projects in their Opportunity Zones more attractive for investors. So far, more than 150 bills addressing some or all of these policy levers have been introduced this year. Proposed legislation in Alabama, for example, would provide $50 million in tax credits to impact-oriented Qualified Opportunity Funds, which benefit projects in rural areas, technology companies, workforce-training providers, and affordable-housing developments.

But state policymakers do not necessarily have to pledge new funds, and, in many cases, can use existing state and federal dollars. The U.S. Department of Education is giving competitive preference to career- and technical-education projects serving Opportunity Zones under the Innovation and Modernization Grant Program within the Perkins Act, a federal law funding career and technical education. States can follow the federal government’s lead by making the Opportunity Zone designation an indicator of need in their own state grant programs. Or they can award bonus points for competitive grants allocated under the Every Student Succeeds Act.

These approaches allow states to encourage the types of development they want to see in Opportunity Zones and prioritize the projects most likely to benefit residents.

The role of philanthropic organizations

Philanthropies also have a critical role in the success of Opportunity Zones, particularly in terms of capacity building. Foundations can support local planning or provide funding for a dedicated Opportunity Zone coordinator. Along these lines, the Rockefeller Foundation announced that six cities will receive financial support for the hiring of a Chief Opportunity Zone Officer, who will be embedded in a city government or a city economic-development agency, and two community-engagement specialists. The Economic Innovation Group is also in the process of securing support for a forum where Opportunity Zone coordinators can exchange best practices and develop shared strategies.

Qualified Opportunity Funds also give foundations another tool besides traditional grants and program-related investments. For education and education-adjacent foundations, these funds offer unique opportunities to improve student outcomes. A “Whole Child” Opportunity Fund, for example, might complement school-based philanthropic endeavors by investing in a new grocery store in a food desert, building affordable housing for a low-income community, or creating dedicated space for tutoring and afterschool programs. Though these projects would normally be outside their grantmaking scope, Qualified Opportunity Funds let foundations address pressing needs by leveraging outside capital directed at mission-aligned projects.

Opportunities are what we make of them

The Opportunity Zones program is the largest community-development initiative in a generation, but its success isn’t guaranteed. Policymakers, mayors, community leaders, investors, developers, and philanthropic organizations will have to work together to get the best results for Opportunity Zone residents. If education leaders pursue these investment opportunities, they, too, can benefit from the program—and ensure better outcomes for those in distressed communities for generations to come.

John Bailey is an advisor to the Walton Family Foundation and a visiting fellow at the American Enterprise Institute. He previously created the Opportunity Zone proposal announced by President Bush in 2004.




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