Opportunity Zone Investment Is Still Flocking To Areas That Don't Really Need It

When the opportunity zone program was created five years ago as an incentive for investors to pay closer attention to economically disadvantaged communities, critics worried the program would instead benefit wealthy taxpayers and leave out the disenfranchised neighborhoods that the program promised to lift up. 

That concern appears to have come to life in California, specifically in Los Angeles, which has been a hot investment target for opportunity zone investors since the beginning of the program. 

Opportunity zones were supposed to disrupt the traditional flows of capital and direct them toward struggling areas, but it appears OZ investment nationally is just following that same path, said Jorge González-Hermoso, research associate at The Urban Institute.

The Urban Institute did an early assessment of the program in 2018 that found that the program was skewed in favor of investments that have higher rates of return. An April 2021 study from two economists at the University of California, Berkeley, that looked at Internal Revenue Service data from 2019, right before the IRS issued final regulations for the program, found similar results.

Though opportunity zones were designed to stimulate investment in communities that need it, the program isn't altruistic, Clearinghouse CDFI Chief Fund Officer Yves M. Mombeleur told Bisnow. “We have to provide a good rate of return for investors, and California does that.” 

It isn't entirely known how much money has been invested in opportunity zones using this incentive — part of a number of reasons why there have been calls for greater transparency in the program virtually since it began. 

But California has been a popular choice for those making use of the program since it started. One of the few groups that regularly tracks investment into OZ funds, national accounting firm and consultancy Novogradac, found a total of $24.4B invested in qualified opportunity funds in California in the second half of 2021 — the most of any state and about $1B more than the next state, Arizona. 

California has been the top state for investment since Novogradac started tracking the data point, the company said. Los Angeles, which is always around the top, was No. 2 among cities, with nearly $679M in planned investments through qualified opportunity zone funds. 

Mombeleur’s company is invested in two opportunity zone projects in the LA area. One is in Long Beach’s bustling downtown, and the other is in Los Angeles’ Koreatown neighborhood. 

Koreatown is often cited by local critics of the program as an example of an area that matches the criteria for becoming an opportunity zone but didn’t appear to need much help attracting investment. 

The neighborhood, which sits a short drive west of Downtown Los Angeles, was decimated during the 1992 civil unrest known widely as the LA Riots, but it has recovered in the decades since. Along the way, it gained popularity among young professionals returning to the heart of the city while it maintained its status as an immigrant neighborhood of not only Koreans but of Central Americans, Oaxacans and others. In late 2018, local real estate and development website Curbed LA was tracking at least 51 projects in the pipeline or underway in the neighborhood’s boundaries. 

“Koreatown is a growth area,” Mombeleur said. “It’s cool. It’s trendy.” 

Because of the sheer number of opportunity zones in LA, there are bound to be some that are safer bets than others, Mombeleur said. Investors are going to find the least risky areas and put their money in projects there, regardless of what city or state they are in, because they are looking for a return on their investment.

Carmen Hill, an adjunct real estate professor at Cerritos College and a local advocate for the opportunity zone program, has observed a lot of investment happening in opportunity zones where gentrification has already taken hold and where steady streams of wealthier residents are flowing in. 

She pointed to the opportunity zone that includes the Baldwin Hills Crenshaw Mall. The mall sold in August for more than $140M with entitlements to add housing, offices and green space on the 42-acre site. 

Maybe 10 years ago that area was struggling, Hill said, but now, “they’ve got houses selling for over a million dollars there.” 

While some of that is partly due to the incredible competition for more space during the pandemic, rising home prices and accelerating gentrification were already hot topics in the area and in a handful of other South LA neighborhoods before the arrival of the coronavirus. 

Sources pointed to the state’s need for housing as a driver for OZ investments. Nationally, more than half of the opportunity zone funds tracked by Novogradac reported at least some focus on residential development in the second half of 2021. Those funds represent 78% of the total equity raised by these funds. Of funds that don't target residential projects, the most popular developments are office and retail projects. Novogradac’s Parker said that residential and commercial projects are the most popular types of projects in California.

However, because it isn't required to report the types of projects that are funded through the program, it isn't known for sure whether housing is the dominant vehicle for investments in the state or city, nor is it known how effective the program has been at making an impact on the communities where projects are created. 

While it is understandable that investors “picked the 'low-hanging fruit'” among opportunity zones in the early stage of the program, before the IRS’ final rules were issued, “it would signal that OZs had undershot their potential to activate more private investment in the country’s most struggling neighborhoods,” the UC Berkeley report's authors wrote.

“The goal — and the challenge for policymakers — is to ensure that the map of OZ investing diversifies significantly from here,” they wrote. 

On a national level, states appear to be divided on whether or not the program has been helpful. A 2021 survey by the U.S. Government Accountability Office of all 50 states and five U.S. territories found that 20 states felt that the program had been a net positive while 20 other states were unsure whether the program had had an overall positive or negative effect for them. 

Fourteen states said the complexity of the program created challenges to its implementation and suggested that training for tax professionals, as well as potential investors and local leaders, might help boost participation. 

Within LA and Southern California, Hill said opportunity zones to the east of Los Angeles deserve investment just as much as LA does. Riverside and San Bernardino counties, often paired up and called the Inland Empire, could attract more investment by promoting their business-friendliness, she said. 

Mombeleur said LA’s reputation carries weight, especially with out-of-state investors, and it might take a bit more marketing to draw attention away from LA. 

“When you go outside of California, people know LA, but they don’t know Rancho Cucamonga, Riverside or Corona,” he said. 

The Inland Empire is poised for exponential growth, Mombeleur said, adding that he wouldn’t be surprised if the attention on the Inland Empire that followed the pandemic causes more potential investors to look into opportunity zones there too. 

But Brent Parker, a partner at Novogradac based in Long Beach, said he wasn’t so sure that the areas were being ignored by opportunity zone investors. Riverside County and San Bernardino County are made up of lots of smaller cities, he said, and there might be significant investment there, but because it is going into smaller cities instead of one large city like LA, it doesn’t pack as much of a punch. Novogradac doesn’t track investments on a county level. 

“I'd be curious on a county basis to see how San Bernardino County measures up” compared to LA County, Parker said. “And if you added San Bernardino County and Riverside County together? I don't know what the answer is to that, but I'm sure there's a lot of investment in those counties.” 

Parker said there has been a consistent increase in the number of OZ funds that are sharing information with Novogradac for its reports and generating their own impact reports for their funds. Increased transparency can only benefit the program and add legitimacy to it, he said. 

“It only helps the incentive in the long term,” Parker said.