Episode #115: Steve Glickman, Economic Innovation Group, “Ultimately, If You Hold for…10 Years or More…You Don’t Pay Any New Capital Gains – Ever”
Guest: Steve Glickman is the co-founder and CEO of Economic Innovation Group. He’s responsible for the strategic and operational leadership of EIG. He previously served as a senior economic advisor at the White House under President Barack Obama, special advisor to the U.S. Department of Commerce, and counsel to former Congressman Henry Waxman. He’s also an Adjunct Assistant Professor at Georgetown University, where he teaches on economic diplomacy and international trade in the Masters Program for the School of Foreign Service.
Date Recorded: 7/20/18 | Run-Time: 51:36
Summary: Meb jumps right in, asking “what is an opportunity zone?” Steve tells us about this brand-new program that was created this past December. Most people don’t know about it yet. It was the only bipartisan piece of the Investing in Opportunity Act, which was legislation packed into the tax reform bill.
Opportunity zones were designed to combine scaled investment capital with lower-income communities that haven’t seen investment in decades. You can essentially roll-over capital gains into opportunity funds – special investment vehicles that have to deploy their capital in these pre-determined opportunity zones. It could be a real estate play, a business venture play, virtually anything as long as the investment is in the opportunity zone and meets the appointed criteria. And the benefit of doing this? Steve tells us “ultimately, if you hold for…10 years or more in these opportunity zones…you don’t pay any new capital gains – ever.”
Meb hones in on the benefits, clarifying they are: a tax deferral, a step-up in basis, and any gains on the investment are free of capital gains taxes. He then asks where these zones exist now, how one finds them, and how they were created. Steve tell us the zones exist in every US state and territory, including Puerto Rico – in fact, the entire island of Puerto Rico is now an opportunity zone. Steve goes on to give us more details.
Soon, the conversation turns toward the problem these opportunity zones are trying to solve – the growing inequality in America. As part of this discussion, Steve tells us about his group, EIG. He created it to work on bipartisan problems that had private sector-oriented solutions. He wanted to address the unevenness of economic growth in the US – why are some areas getting all the capital, while others are getting left behind? Meb points the guys back to opportunity zones and how an investor can take part. He asks what’s the next step after selling all my investments for capital gains. What then?
Steve tells us all the capital has to flow through an opportunity fund. It can be a corporation or partnership, include just one investor or many, can be focused on multiple investments or just one…. Most people have identified a project in which they want to invest, but some groups are now creating funds to raise capital, then will find a deal. Steve provides more details on all this.
There’s way more in this special episode: the two industries that the government won’t allow to be included in opportunity zone investments… The three different tests for how a business qualifies as an opportunity zone investment… What regulatory clarity is currently missing from the IRS… The most common naysayer pushback they’re hearing… The slippery issue of gentrification… And far more.
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Interested in sponsoring an episode? Email Jeff at jr@cambriainvestments.com
Links from the Episode:
- 2:00 – Introduction to Steve
- 2:44 – Idea of opportunity zones
- 3:52 – Investing in Opportunity Act
- 6:30 – EIG opportunity zone resources
- 6:40 – Where to find opportunity zones
- 8:23 – EIG opportunity zone map
- 8:29 – How this solution originated
- 12:44 – What’s the next step for someone interested in this program
- 16:08 – Walking through an example of how this would work
- 19:12 – How are funds approved for this program
- 20:27 – Sponsor: The Idea Farm
- 21:36 – How would investment in stocks work
- 22:55 – How this impacts real estate investing
- 26:33 – How farming would qualify
- 27:22 – What happens to cash flow as part of these investments
- 28:26 – Best use case are investments with large capital gains
- 31:04 – Examples of real-world cases of opportunity zone investments
- 35:00 – What happens if your investment is acquired
- 37:38 – Most common detractors of this program
- 41:19 – Best resources for getting started with this
- 42:45 – Other projects and focuses for EIG
- 46:56 – New Markets Tax Credit program
- 48:56 – Steve’s most memorable investment
- 50:27 – Best way to follow Steve – @stevengglickman, EIG.org, and LinkedIn
Transcript of Episode 115:
Welcome Message: Welcome to the Meb Faber Show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information visit cambriainvestments.com.
Meb: Welcome, podcast listeners. It’s summertime episode. I’m really excited for today’s show since I think it’s gonna tip you off to a huge opportunity that very people know about. Fortunately, our guest is a master on the subject. He’s co-founder, CEO of the Economic Innovation Group, a non-profit research policy and advocacy organization. He’s also the adjunct assistant professor at Georgetown where he teaches on economic diplomacy and international trade. He’s also a senior economic advisor of the White House National Security Council and National Economic Council. You’ve also probably seen his work in a million different publications like Bloomberg, U.S. News, Wall Street Journal, basically everywhere. We’re thrilled to have him on the show today. Welcome to the show, Steve Glickman,
Steve: Thanks for having me on. I’m excited to be here.
Meb: Steve, normally, we do a background for our guests, but I really want to cannonball right in and we’ll kind of weave in what you’ve been up to as well. So, I kind of found out about this topic of opportunity zones a few weeks ago, maybe a couple months ago, and was really surprised I hadn’t heard more about. And then the more conversations I had with a lot of my friends and investors and fellow CIOs, they also hadn’t heard that much about it. So, why don’t you give me a brief overview and start at ground zero? What are Opportunity Zones?
Steve: Sure. Well, first of all, I’m not surprised that people are still learning about this in real time. This is a brand-new program that was just created last December as part of the big tax reform legislation that passed through Congress. It was better known for things like the limitations and how you can deduct state and local taxes and how it adjusted the corporate and individual tax rates. But one piece of it and arguably the only new bipartisan piece of that tax reform package was a piece of legislation that we snuck in there called the Investing and Opportunity Act. It was a bill that was championed by Senators Tim Scott from South Carolina, Republican, and Cory Booker from New Jersey, a Democrat, and two members from the house, also Republican and Democrat, Pat Tiberi and Ron Kind from the Midwest. And ultimately, it had about 100 members of Congress who co-sponsored it. And that legislation, which had been around for a couple years but kind of flew under the radar, was packed into that tax reform bill, thanks to the good work of Sen. Scott and Booker. And people I think are learning about it in real time as they finally got through the other thousand pages of the tax code changes. A few of those pages are this program which is now called Opportunity Zones.
And let me just kind of take a step back and talk about what it’s designed to do. The problem it’s designed to solve from a policy perspective is how you connect new sources of equity capital at scale systemically to places that haven’t seen a lot of capital investment for, in some cases, decades. And it does that through a really powerful tax incentive that we think will create some excitement among existing investors who have capital gains in the stock market or in real estate holdings, or in anything else to essentially roll over those capital gains into what are called Opportunity Funds, special investment vehicles that have to deploy their capital into these Opportunity Zones that are built in these low-income communities all around the country, and they can invest in just about any asset. And if you do that, you get a really substantial capital gains incentive. Ultimately, if you hold for a long period of time, 10 years or more in these Opportunity Zones, and you earn appreciation on what you invest. You invest $1 million at year one, it’s worth $10 million at year 10, you don’t pay any new capital gains ever as long as you held it at least 10 years. So, that’s the biggest part of the incentive but there’s obviously a lot of pieces to how this works that make it a little more complicated than that.
Meb: All right. So, we’re gonna dive. We have a million questions, but I just want to restate that for the investors listening. So, if you sell a company, you got a million bucks, there’s kind of three big benefits. One is you get a tax deferral on those capital gains. You don’t have to pay them right then, so you get away five, seven years, then you get a step up in basis on that up to I think, 15% perhaps.
Steve: Correct.
Meb: And then, like you mentioned, one of the biggest ones is any gains on that actual investment are free capital gains and there’s a lot of good websites we can type in, I think your website as well. Well, links in the show notes to calculators that show you how this works and everything. So, a pretty monster benefit. So, all right. So, tell me a little bit more about where these Opportunity Zones exist, how can you find them, what’s the process on how they were created.
Steve: So, there are Opportunity Zones in every state in U.S. territory around the country. That includes, for example, in Puerto Rico, the whole island of Puerto Rico is now one big Opportunity Zones. In general, from just about every state, the governors were in charge of selecting their zones and they could pick from 25% of their low-income communities. And low-income communities make up on average about 40% of a state, so really, across the country, we’re talking about 10% of the country now on average more or less are Opportunity Zones, and that’s really in every city across the country. The Opportunity Zones now make up about 8,700 census tracts. It’s about 75% urban, about 25% rural and the nature of those tracks is different depending on where you are. So, for instance, if you’re in New York City, there’s, I think, only one track in Manhattan, south of Harlem. But if you’re in Cleveland, Baltimore, Milwaukee, Detroit, a lot of these former Rust Belt cities have struggled economically, their whole downtown, and certainly, their central business district is now one big Opportunity Zone.
And so these are going to look different depending on how local economies are doing and the decisions, frankly, that governors made and the effectiveness of mayors in advocating for tracks within their cities and towns. But you can find a totally interactive map on this, a few places, one of which is on our website at eig.org and you can type in any address or city or county, and you can see what the map looks like. And if you or project you have, or a business that you’re running, or investing in falls in one of these zones.
Meb: So, the problem is trying to solve, and I find this fascinating because I always spend a lot of time on the maps, was you’ve heard so much in the media, in the community, online about the growing inequality in America and how certain people have just been left behind in certain areas. And I’m a capitalist, so I love any sort of solution that incentivizes people to kind of solve the problem through incentives or whatever it may be. Talk to us a little bit about kind of, there tends to be this growing disparity and how you guys came along with this solution, by the way. Like, was this something that just sprung out of your mind one day with the economic group? Or what was the origin genesis of how you guys decided to solve this problem into somewhat pretty unique manner?
Steve: So, EIG is about five years old. We launched in early 2013 just as I was leaving the White House. I launched it with partner and co-founder, John Lettieri, and we both worked very closely with EIG’s Chairman, Sean Parker, on standing up the organization initially. And it was always being set up, essentially, to work on bipartisan problems that had private sector-oriented solutions and specifically were related to how you deal with the unevenness of economic growth in the U.S., why such a small handful of places were really capturing all the games from the economy, creating all the businesses, getting all the capital, and why a lot of other places were being left behind. Obviously, that have all sorts of…that create all sorts of issues whether it comes to health outcomes, economic outcomes, political outcomes in this country. Arguably, the 2016 election is one additional data point in this discussion of what happens when places feel left out of the economy. And we spent the first couple years really just studying the problem. We put out what’s now a pretty well-known index called the Distressed Communities Index, which evaluates every zip code in America according to a bunch of different indicators on education, housing, business growth, income and other factors to map the whole country out and see how communities compare with each other. And we saw places that were disproportionately distressed and what that meant.
And concurrently we knew we want to offer a public policy solution that was totally new but based in this really rich history of, a bipartisan history of, place-based policymaking and we kind of lost that. This was really popular in the ’70s and ’80s, Jack Kemp, Bill Clinton in the ’90s worked in a number of things together. But really, in the last 20 years, the most recent example of something called a New Markets Tax Credit, we really gave up on place-based policymaking. I think there was a consensus in the kind of wonk community, in the economist community that these zone programs didn’t work. And so we studied that and we determined that it wasn’t because there’s something wrong with incentivizing or tying capital to certain types of markets, it’s because the incentive structure was done all wrong in the past. The incentives were too small, they weren’t scalable, they weren’t flexible. They were super complicated to take advantage of, so no one practically use these programs.
And so our bet was if you create a brand-new model, one that could scale as much capital as they could bring in, and there’s, by our calculation, about $6 trillion in unrealized capital gains. It could be rolled into this Opportunity Zone program, was rolled over through essentially private sector vehicles, whose Opportunity Fund function like just about any other type of fund out there. And there wasn’t a government intermediary to have to pre-approve projects or that created a bunch of red tape around how you did this. You could move capital at scale in these communities. And that’s what we basically worked on. What model would both be attractive enough for investors to use on the one hand, and then have enough parameters and safeguards so we knew the capital was, one, going to places that need it, two, going to investments that were economically productive, and three, ultimately creating more businesses and jobs. And we think this program has all that.
Meb: I love it. So, okay. So, we got the background, we got a little bit of overview. We’re gonna start to get into a little more specifics because a lot of the research online, as you mentioned, some of the final ink seems to be getting finished, where the locations or whatnot. But say I’m an investor and I’m listening to this podcast, I pulled over the side of the road while I’m driving because it’s so interesting and I said, “Okay. I’m going to go sell all my highly appreciated Amazon stock or my bitcoin or my house, whatever it may be that I got capital gains. I got a million bucks. What’s the next step?” I think you need to start a fund. Maybe walk us through what people need to do?
Steve: Yeah. So, it sort of depends on kind of where you sit as an investor. So, all capital in this program has to flow through funds. The funds can be as simple as complicated as you want them to be. They can be a corporation or partnership. So, they can be an LLC, a C corp, an LLP. They can be structured however you want. They can include one investor only or a whole group of investors. They can invest in one project or a bunch of different projects. They can be real estate focused, or private equity style, or venture capital, or infrastructure style. We know of people who are creating funds that looked like all of those pieces of it. For most folks, they either have identified a project they want to invest in because they know it’s in one of these zones and so they’re going to raise this rolled over capital to invest in it, so they’re creating a fund just for that project, or there investors now who are used to creating funds and they’re going to raise their next fund as an Opportunity Fund and solicit capital into the program that way.
I’d be surprised if that many people created their own funds for their own capital because it’s a lot. You’re going to have to work with lawyers and accountants to structure the fund and you’re going to have to be able to find a deal to invest in, but you could do it all yourself. That’s not usually what we’re talking about, but it’s possible.
And then the only thing that separates an Opportunity Fund from many other funds is really two things. There’s a practical stuff you have to take which is that with the funds tax returns next year, you’re going to have to file a form which Treasury hasn’t put out yet that says, “I’m an Opportunity Fund and I’m committed to investing 90% of my capital in Opportunity Zones,” which is the requirement and IRS will test the funds in some way every six months to ensure they’ve got their capital deployed in these zones. So, that’s the kind of practical compliance piece of what’s required.
And there are certain kind of rules and methodologies for how you actually have to deploy the capital. Now, depending on what you’re looking to invest in, that could be really simple. If you’re just investing in a brand-new business, you just put the money in that business and you’re done. If you’re investing in existing piece of real estate that you’re going to rehab into something else, it’s a little more complicated. There’s test this program has to ensure that you’re not just sitting on a vacant piece of property or you’re just a shell corporation or you’re just moving your headquarters, but to make sure you’re making a real investment. And so I’m sure you’re going to want to talk through that, but let’s just say there’s certain practical test. So, this is going to take some level of expertise to ensure you’re not running afoul of the rules of the program.
Meb: And so if I remember correctly, you have 180 days to make the investment after selling the original investment, correct?
Steve: That’s correct. Once you realize your capital gains, so once you sell your stock or your real estate, you have 180 days to invest that into a fund.
Meb: I got a lot more questions. So, like, let’s say I’m investing into a start-up or a business in Detroit, could this be any business? Could this be a coffee shop? Could it be a start-up internet company? Are there any rules? Like, do they have to do business in Detroit? Could they be a two-person shop? Are there any sort of rules or regulations around what sort of business that is?
Steve: Yes, but it’s really broad. All the examples you described would work. The business can be involved in any kind of industry. There’s two exceptions to what the business can’t be. One, it can’t be essentially a financial services business, meaning it can’t be primarily deploying capital. So, you can’t invest in a bank in Detroit, or a payday lender in Detroit, or another fund in Detroit. So, that category of investments isn’t allowed in the program. And the other category investments that’s not allowed are what are called sin businesses. So, anyone who’s done community investment kind of tax incentivize programs in this space before will have a somewhat of a sense what that means, but typically it means you can invest in country clubs, golf courses, liquor stores, massage parlours, etc. But other than that, you can invest in anything else, anything else presumably you think is going to appreciate and if you hold it long enough will earn you a capital gain, because that’s really the big benefit in this program.
Aside from the type of industry you can invest in, there’s also a test even within that industry how you know a business qualifies. And there’s basically three different tests. Test one is that all of the tangible property of that business has to be in owner’s zones, and what that means is it’s stuff. So, anything it owns or leases, its office space, its computers, its desks has to be within Opportunity Zones. It doesn’t just have to be in Detroit. It could be an opportunity zone all over the country or congested within one city. So, that’s test number one. Now, that’s not a test of your intellectual property and it’s not a test of your employees, it’s just a test to your stuff. Two, is that you’re actually doing business. So, you can’t just be a shell corporation, you have to be what’s called an active conduct business. And the third big test is related to whether you’re a brand-new business or you’re an existing business. And if you’re a brand-new business, you’re good. If you’re a business that has incorporated or been created for the purpose of being an Opportunity Zone business, then there’s nothing else to qualify. If you’re an existing business, there’s actually a big debate over how you qualify.
And this is one of the places and this is a really important caveat, really, for a whole conversation. We are missing some of the regulatory clarity, we need from IRS to know about every possible type of investment model that will be used in this program, and in fact, even some really basic rules for like how long funds have to invest. And one place that we know there’s some grey area is how you improve an existing business so that it qualifies with this program. And really, that test is pretty murky right now.
Meb: So, if you invest in a start-up in Detroit, do their sales have to be in Detroit or their sales could be anywhere? Revenue could come from anything?
Steve: Yes.
Meb: So, who certifies the actual business? Is the business declares, “Hey, we’re an Opportunity Zone business,” or do I have to self-certify as the investor?
Steve: Yeah. So, there’s really no certification of the business, it’s really only certification of the funds deployed in the capital. The funds have a lot of responsibility in this program. They’re the kind of core intermediaries and they’re going to have to make a determination that the business they’re investing in meets the of test to the program, and the reason they have to do that at all is because they’re going to have to commit to IRS and prove to IRS in some way or at least tell IRS in some way every six months that they’ve invested 90% of their capital in qualified assets. So, really, the funds are making their own determination about it based on their read of the statute and hopefully, we’ll get more and more clarity from Treasury and IRS that makes that easier for fund managers. But if you’re investing right now, which you could, there are funds right now, there are investors who are utilizing this program right now, there’s a real estate being invested right now through this program, you’re essentially making your own determination that this asset, this business meets the test of the program. Now, businesses could self-certify and say, “Hey, we’re an Opportunity Fund business, but it’s not a kind of a formal real thing under the way this program works.
Meb: And so, we talked a little bit about private kind of start-ups and it’s a little murkier for currently run businesses. You and I talked about this before, but I assume that public company stocks… I think I saw that the rules currently were that it had to be at the IPO or initial transaction. Maybe talk about, do you think if you had to guess, would public stocks be something that would ever be included or probably not?
Steve: So, it has to be originally issued stock, the stock you’re buying Opportunity Zone companies. The reason why public stocks are probably unlikely is it’s because they probably want me to test at the program. So, you’d have to be buying stock that you’re holding for 10 years in a company that has all of its stuff in Opportunity Zones for that whole span of time that you’re invested in it and it’s meeting all those other rules. And for really, really large companies and for just about any public company, that’s going to be pretty unlikely. I suppose it’s possible in some scenarios, but there is not much of a market right now around this. You got to assume most of this are going to be private market holdings whether they’re companies or real estate.
Meb: Well, if it ever develops, we got two great tickers for…we picked up off the NYC including one which was just OZ for Opportunity Zone and I was laughing because I think that used to be an Australian ETF for OZ. So, okay. So, we covered the kind of private-public side and the businesses. I think the big use case for this or a big chunk of it will be real estate. And so maybe talk a little bit about, could I just go buy a home in Detroit and call that an Opportunity Zone investment? Or like, what are the rules around real estate that apply to this is sort of investing?
Steve: I’ll get to that in a second. Let me talk to the premise though of the question for a second. There’s no doubt that real estate assets are the big movers in this program right now. And those are mostly for kind of circumstantial reasons. One, community investment has typically met real estate investment. So, there’s a lot of muscle memory in that community about how to take advantage of tax incentive structures particularly for real estate. And two, kind of the obvious reason, that real estate is not going anywhere. There’s no chance it’s going to move out of the zone, qualify one day and not be qualified the next day. And so I’m sure a big chunk of the capital is moving will be in real estate, at least initially.
But the other piece I’d throw out there is that the big incentive for this program are on investments that have really big multiples. And typically, that’s not the case in real estate. If you’re a business investor, let’s say you’re a venture capital investor, and you’re looking for a company that’s going to be a 20X return or more and you’re able to not pay the capital gains on all of that upside because you held it for 10 years and it was growing in an Opportunity Zone. Well, that’s obviously a big win for the community because we think this will encourage the setting up of companies in these zones whether they’re new or whether it’s a company moving to those zones. And we didn’t really talk about that, but that’s another easy place to qualify if you’re moving from outside of zone to inside of zone. But there’s going to be a big incentive then in the market to make those sort of business investments.
But right now, you’re totally right. There’s a lot of moving among the real estate community because, really, the third point, it’s really easy to identify real estate assets in Opportunity Zones. It’s harder to identify investable businesses in the zones just because that’s kind of how those two markets work. And if you’re investing with a piece of real estate, it’s a similar set of tests. Obviously, you got to be in the zone, but you’re either in or out. That’s pretty binary. Two, you’re essentially making a determination that the asset is new, so you’re building it from the ground up, or it’s already there, it’s a real estate. It’s already being used for rental real estate, and you’re going to convert it to something else. And if you’re converting it to something else, there’s a really clear test in the statute that lays out what you have to do. If you invest a million dollars in a piece of real estate that’s existing, you have to improve it by at least the same amount you invested in it over 30 months. So, day one, you invested a million, by the end of 30 months, sometime during that time, you’ll have to invest another million in order to qualify for the program. And so that’s going to work for certain types of rehab projects in certain parts of the country and it may not work for others because you’re going to have to spend so much money up front to buy the property, you may not be able to put enough into it of rehab to qualify.
There’s one other test, and that’s that the real estate you’re buying has to be part of an active conduct business again. So, you can’t buy it for just a home that you’re going to live in or sell. It has to be like a rental property that’s going to be in business for 10 years, or it can be a commercial development, or a multi-family, or affordable housing, or lots of other types of things you could think of in the real estate in universe, or infrastructure, but it’s got to be part of the business. So, it’s got to be a part of a business, it’s got to be in the zone, and you got to improve it if you’re not building it from the ground up. And that’s basically the core test.
Meb: And so I assume as I listened to this, I keep coming up with a million questions, farming like in farmland, that would qualify as a business I would assume?
Steve: So, the question is what you’re investing in that scenario. If you’re investing in the farm itself and you can buy stock in that LLC maybe that owns the farm that might be one type of thing you could invest in. If you’re actually buying the farmland, I think it’s a little bit of an open question of whether you have to improve it or not and whether the farming is improving it in the right way or not. And land is kind of in this funny space. In fact, we don’t even know when you calculate what you have to improve whether you have to factor in the value of land as part of that improvement or not. So, there, again, this falls within one of those open questions of how IRS is going to define some of these core provisions of how the program works.
Meb: I would assume that farmland, if you’re running it as a business, is producing crops would totally qualify. The challenge going back to what you mentioned is I assume also that any earnings or income, dividends getting spit out of the company don’t qualify for any sort of tax treatment, correct?
Steve: Yeah, that’s true for anything. So, whether it’s a business, a piece of real estate or farm, the only thing you’re being incentivized for is the value of your equity stake in that asset or business and the appreciation of that, the growth in that over the period of time you hold it. Let’s assume everyone’s holding it for 10 years because, let’s say, you get that big back end and set up. But if in the meantime it spits out cash flow because let’s say, you own a building that people are leasing and businesses are leasing and it’s spinning out ordinary income cash flow that way, that’s just treated at the regular rates. Or if the business is pushing out dividends or if a farmland is putting out some kind of distributions, again, all that’s just treated like under the regular tax code especially what’s treated, especially as your ownership stake in any of those assets.
Meb: But kind of going back to the point you made that I think is pretty important here is that I’m sure people will do this for real estate and farmland, etc. But it seems like the best use case is stuff that you have the big capital gains on. So, I would assume that a lot of the start-up community venture capital, this seems like the really the perfect use case for this? Is that… Even though people may still do it for real estate and farmland, it seems like shielding the capital gains is the best possible use of the tax incentive.
Steve: Yeah. I mean, it’s the most powerful part of the tax incentive for sure. So, real-time venture capital investors who are thinking about ways to use the program. The only limitations are kind of the practical limitations of the market is much more developed around real estate than businesses, kind of like we talked about before. But even like taking a step back from that, I think the bigger point to realize is this is really creating a brand-new market that doesn’t exist. There is no real market now that ties equity capital because most of these community investment programs have been predominantly debt finance. It provides equity capital for individual investors anywhere in the country, anyone can participate in this program that has capital gains whether they are corporation, institutions, or just an individual investor who has sold stock that day and wants to roll over that into one of these funds, and the businesses and real estate that are in these communities that typically have been separated from capital markets. So, the funds are going to be kind of filling in this gap, they’re going to be building the market because they’re going to be connecting the capital to the deal flow, unless, of course, you’re sitting right in that community and that’s going to be a lot of the kind of early users of this program.
And I think there’s a little bit of a psychological bar almost in some of the venture capital community where they believe the best businesses in the country are obviously in New York, San Francisco, or LA, and so that’s where we should invest. And increasingly, and Steve Case is obviously one prominent investor voice that has been blowing the horn on this all the time, you got to assume there are entrepreneurs all over the country that are building interesting businesses all over the place. The talent is cheaper, the real estate is cheaper, the market is not nearly as hot as, let’s say, Silicon Valley, and so the question is, “How and will this change behaviour, not just of where businesses go and set up shop or whether they stay in communities instead of going to the coast, but will investors really start to take this seriously and move en masse to these communities?” And you’re starting to see it now and that’s the big bet and we think you can get there because we see this as like $100 billion asset class a year which to give you a frame of reference is twice as big as the venture capital industry.
Meb: Yeah. It’s interesting. You started to see, as we did research for this podcast, a number of these fund companies. There’s a lot of online portals that do say, real estate investing, like Fundrise, we’ve had a couple of them on the podcast in the past. I’m sure AngelList at some point will start to have a little checkbox that says, “By the way, this is probably an Opportunity Zone business.” I imagine a lot of the platforms will eventually develop. I know it’s really early, but I assume you started already sees investments happen or any that you can kind of talk to and not specifically you don’t have to, but as kind of examples of things that are happening already with whether it’s funds or as far as multi-asset funds or individuals starting to already move into this because I actually tweeted about it and people said, “Hey, I know someone who’s got 80 million. I know someone who’s doing this with this, this, this.” Anything you’ve seen already is kind of early use case of this?
Steve: Yes. A couple of things. One, let me kind of put that caveat out front that a lot of investors are waiting to get more regulatory clarity from Treasury and IRS. So, some of the market is… A big chunk of the market is waiting for that. And with that being said, there are already a number of funds that have either formed, there’s been some recent press on some funds that have gotten off the ground and are already in the process of forming, and they take pretty much every type you can think of. There are venture capital funds that are looking for businesses in these zones that are starting to ramp up. You see some specialized stuff, like, for instance, there’s a lot of equity capital interest in Puerto Rico, and rebuilding the island, investing in assets there after the hurricanes. And because the whole island is one big Opportunity Zone, we are really interesting test case for whether and how this changes the way capital flows in the place like that.
And then what you see very commonly now is people who have identified, “Hey, my real estate project or this development is right in the middle of the zone. We’re going to put equity capital in here. Let’s structure this as an Opportunity Zone project to get some of the muscle memory of how you do this and then we can start doing this for projects all over the place.” And I think what you’ve seen in that regard is real estate and project developers start to re-prioritize their deal flow and to say, “Hey, I’ve got 100 projects that can invest in. Let’s first identify the 10 in Opportunity Zones and focus on moving capital those first because we want to take advantage of being an early mover, we know people who have investors who have capital gains events this year, and so they’ve got to move it into a vehicle within 180 days. So, we want to capture some of that.” So, this market is all building in real time, but it’s building across every sector you can think of.
One other that we hear from a lot is like the clean energy infrastructure sector. So, we hear from folks who were involved with solar panels or wind turbines to say, “Hey, this is perfect. With big zones in rural areas in the Pacific Northwest, or in the southwest of the U.S. And this makes a lot of sense for us to put our project or to structure our investment around.” And so you’re seeing all types. It’s not just the investor community by the way that’s organizing around it. You also see cities start to organize around it. I’d say you start to see them organized around it in as determined way as you saw around the competition for Amazon HQ. Except in this case, they’re actually likely to get some kind of benefit from it. And most of the cities that competed in the Amazon HQ battle were never going to be realistically a place that Amazon was going to roll in 50,000 people. But there are communities and all over the country. We just got together with 16 mayors down in Las Vegas and Los Angeles who are organizing their whole economic development strategy for the next 10 years around how to make Opportunity Zones work, how to tie in permitting and zoning and workforce development with that now the new private capital they’re going to be seeing in the zones they’ve created in their cities.
Meb: Awesome. Two follow up questions. One is… By the way, just to comment on Puerto Rico. Puerto Rico is interesting because there’s already some tax benefit structures in place where if you live there, you get a certain cap on, I think, dividend and capital gains, but also if you domicile a corporation there. So, there’s like a quadruple tax benefit if you’re in Puerto Rico somewhere. Jeff, we needed to do a reconnaissance trip down there and go check out the surf and everything else.
Steve: I’m available for that too…
Meb: Good.
Steve: In case you’re looking for another hand.
Meb: Well, you and I can co-sponsor… Actually, you can do it. I’ll promote it. The first Opportunity Zone conference in Puerto Rico. That would be a good locale.
Steve: Love it.
Meb: What happens if you invest in a company, I say, I invest in a startup in Detroit, it’s making the world’s best coffee, two years later it gets bought? What happens in that scenario? Are you screwed? Can you roll it forward? Is it… Who knows?
Steve: Again, business investments are always going to be a little more complicated. There’s a certain recognition that the investors and the fund have limited control at least over what the businesses do. In that scenario, you’d be in a little bit of a tough spot. But let me tell you about the way that would practically work. So, there’s one specific provision to be aware of in the statute and that’s that there’s a five-year off-ramp for business investments you make that become unquantifiable. You have five years, essentially, to then off-ramp that and redeploy it into a qualified asset. Now, if you’ve held that asset for six years already, and then it goes public or gets bought by someone else, you’re good. You’ll get credit for that full tenure hold because you’ll get five additional years of time to hold it as an unqualified asset.
But in your scenario, if it’s all the year two, you basically have five years to both liquidate your stake and redeploy that capital into an asset that then qualifies. It’s not ideal because it forces you to find a new investment and you may restart your clock on that 10-year hold, but it doesn’t penalize you in the way a lot of other programs do. And let’s say worst case scenario, you can’t find anything in five years, which is a long period of time. So, a way to redeploy it or a way to liquidate it, the penalties in this program are fairly low actually. It’s essentially equivalent to the underpayment tax penalty rate that you get for having a deferral basically of that original capital gains, but you then have that money invested in quantifiable stuff at the end of the day. But there’s lots of ways to avoid that just by finding another place to put that capital within that five years.
Meb: I’ve been writing for over a decade, so I’m well aware there’s a lot of haters out there. But I write about quantitative finance, so thankfully mind stuff is too boring to get too many. But this is the intersection of not just money and investments, but communities and politics all wrapped into one. So, I’m sure you’ve been defending against some haters out there. What’s kind of the most common naysayer comments that you guys received? Because I imagine there can be somebody saying, “You know what? You guys are actually just trying to make rich people richer and they’re the only ones that are going to benefit.” What are some common two or three things you hear quite often that are kind of nonsense or may even have some validity?
Steve: There’s all sorts of potential critiques around the program. I think, for the most part, we hear a lot of excitement about it from investors and from mayors and governors. Everyone is excited for something new because the existing stuff hasn’t been working for not just 10 or 20 years, but arguably for 30, 40, 50 years. One, it requires a little bit of creative thinking, a new approach to economic development, period. This program is designed to target the market to work in ways it would normally work but in these communities that it’s overlooked for so long. And there’s a lot of scepticism, I think, in general, by a certain part of the community whether it’s folks who have engaged in traditional community development work who see that as a threat or who distrust that the investors are going to use the program like the program’s intended. So, I think there’s some level of distrust there.
Then I think you’ve got this kind of competing critique of either, one, this will never move enough capital, investors will never really look at these areas. We think that’s wrong, but there’s some people who believe that and I think the market will prove that that’s wrong. Or the other piece of it, that the capitalism is coming so fast to places that it’s going to lead to real gentrification concerns. And let me be clear, gentrification is an issue in certain markets that are getting lots of capital. It’s an issue in DC where I live, it’s an issue in New York and San Francisco and LA. We didn’t look at this, but actually, the Urban Institute which is arguably the premier think tank around gentrification in the country looked at all the Opportunity Zones that were selected or at least most of them at that point. And they have this index they use of rapid socio-economic change which is basically a way of saying what places are subject to gentrification. And they found only 4% of Opportunity Zones that were selected were at risk of being gentrified and 96%…
And the reason for that when you kind of break it all down is that for 96 places there were place of Opportunity Zones, the problem is for them is not that they’re getting in so much capital and they don’t know how to deploy. The problem is that they’ve been cut out of capital markets forever and they’re desperate for capital. They’re desperate for new business creation where many of these places haven’t created new businesses in 15 years, and they’re desperate for new jobs, and they’re desperate for the kind of skin in the game that comes when equity investors have a stake in your community and want to see it grow. And that’s really the problem this program solves for.
And I’d argue that for sure, there are examples of places around the country where if this program supercharged how quickly investment came in, it’s something the communities are going to have to deal with. But the other side of that you can argue is the reason they’re going to so few places is because there’s been no reason for investors to look at a bigger part of the marketplace. And I think if investors have a bigger part of the country to choose from, that will actually be better for even the communities that are getting a ton of capital now because it will provide the opportunities for investors to look at other markets and other assets. And will kind of decrease some of that pressure seeing on a handful of markets where everyone’s been going.
Meb: I love it. So, say you’re an investor listening to this, first of all, I assume you don’t have to be accredited but still follow the accreditation rules for start-ups. What are the best resources? I know this is just starting, your website eig.org. Any other particular resources you think are good starting points where people want to find out more?
Steve: So, our website provides a lot of that baseline information. It has a searchable map, the basic rules of the program. We keep it pretty well updated around rules coming out from Treasury and IRS and coming out from individual states about this program and other commentary. There are other organizations that are engaged in this as well to different degrees and are organizing and creating sites around it. But information is pretty uneven now. And there’s a lot of myths and innuendo about how this program works or interpretations of what Treasury and IRS is likely to do. And until IRS provides that clarity, there’s really not a lot of other great sources for a definitive information about it. Obviously, IRS and Treasury also have a website on this where they’ve got their map and rules as well. So, they’re either going to be another good kind of obvious source for information.
But we talk with investors and fund managers around the country every day. So, I encourage folks to reach out to us directly as well when they have specific models or specific questions. And we can help provide information and also help put them in touch with other both service providers and other organizations that are thinking about this with a lot of nuance and depths.
Meb: It’s exciting. It’s gonna be fun to watch this develop. We may have to have you back on the podcast in 6 or 12 months to get some updates. Talk to me a little bit. We don’t have too much more time. But talk to me a little bit about… It seems like you got a curious mind. This is a really interesting creative solution to kind of what’s plaguing a lot of what’s going on in the U.S. right now, I mean, versus a lot of the nonsense we hear a lot of time on the media. What else are you guys up to at Economic Innovation Group? Are there are some other projects that you guys are working on or is there anything that you’re thinking about that’s got you particularly excited or is this like take up 110% of your time every day?
Steve: In general, we’re in the business of helping policymakers and the media and local leaders understand the trends that are impacting their communities and best practices, emerging places, and specific policy outcomes that matter to places. I’ll give you a couple examples of things that we’ve focused on in the past. There are regulatory issues that are unnecessarily reducing the dynamism of economies all over the country in every state, like, non-compete agreements which I think you’re seeing a lot more focus on with that. In particular, larger companies use to prevent workers for being mobile and moving from business to business, and in a lot of cases, creating their own businesses. So, that’s a big issue. There are regulatory issues like occupational license thing where as hairdresser in one state to become a hairdresser in another state you got to take 1,000 more hours or 1,500 more hours of instruction to get your license. That is just really designed to keep people from moving and competing.
And so there’s a lot of questions around what makes our economy competitive and what empowers workers to move jobs and move between states and create businesses that we’re lacking. And obviously, a big chunk of that even separate from this is the gender and demographic differences of who’s able to start companies in this country, who’s able to get capital. One percent of venture capital goes to African Americans, 10% goes to women. And I don’t think anyone really thinks that white men are the only people that have good ideas worth investing. In fact, there’s a lot of studies that show women entrepreneurs who get venture capital are way more successful than men, pound for pound.
So, there are these big systemic problems that we really care about. One other issue, which I think is really interesting and really controversial, is one of the features of our economy that’s changed a lot over the last few decades and it starts now to look like an economy of the 1930s and 1940s is the amount of market power that large companies have in every industry. And that market power, that corporate concentration in our economy is leading to all sorts of things, little worker wages, and lower investment rate and this huge decline. We’re seeing a 40-year of decline in our ability to create new businesses across the country. And why that’s super important? It’s because new businesses account for almost all the net job creation in America. So, if you’re not creating local businesses, if you’re spending all your time attracting the next big guy, you’re eventually going to lose. And a lot of communities have lost because they never made that transition from a big manufacturing economy to what the economy is today, which is a bunch of innovative people creating businesses.
But with all of that being said, we think that’s super important. We’re really spending all of our time and energy ensuring that Opportunity Zones are implemented in a way that make this program work. And at the bottom line, there are all sorts of ways this program can be improved, this is an experiment where if they want, we’re going to have to improve and iterate on this program over time, we’re going to write more rules, make some changes, watch for things that are happening in the market that may be abusive or may not have been what we were factoring into the program when it was created. But at the very base level, we have to make sure it works as a model, then it’s going to move capital at scale. And if it can do that, it can move $100 billion a year, one, it will be the biggest economic development program in U.S. history. It will move 30 times as much capital as the next biggest economic development program that exists right now. And it may totally change the conversation we’re having about what’s happening in America. And we’re trying to get there.
Meb: I’m excited. I love it. What’s the next biggest program off the top of your head? Is there one in specific?
Steve: Yeah. So, the most recent program and the next biggest one that’s specifically focused around community investment is called the New Markets Tax Credit. And you may or may not know about it. This is really well known in the commercial real estate business and many of the large banks and groups called community development finance institutions, essentially, local community-based investors are aware of this program. And it’s a tax credit style program. The federal government gives about $3.5 billion a year in tax credits to fund what’s not exclusively but largely real estate projects and a lot of these same communities. And that’s been the biggest problem today.
That program was created in a bipartisan way by President Clinton and then the Speaker of the House, Dennis Hastert in 2000, and it’s now almost 20 years old and it’s moving $3.5 billion a year and it’s had an impact on places for sure. It’s the most successful community development program we’ve had really since people have been doing this over the last 40 years or so. But it’s still small. It doesn’t have the scalability that Opportunity Zones has, and it’s… There are very niche group of investors that use it now because it’s fairly complex. And we think this program will change the way people participate in community development in the scale because anyone can really use it, anyone can be an investor and anyone can create a fund.
Meb: Can the governors recharacterize the tracks at any point or are they setting stone in next 10 years?
Steve: So, they’re set. So, every governor in the country had ultimately until sometime in June to make their selection, and Treasury has now certified that map of every Opportunity Zone in the U.S. and the territories. And so when you go to our map, there’s final list of tracks, and those tracks last until the end of 2028. So, that map is set in stone for the next 10 and a half years, essentially.
Meb: Awesome. Steve, we ask one last question to all of our podcast guests and this may bring up some wonderful or painful memories. But the question of the past year has been, personally looking back, have you had a most memorable investment of your own? It could be good, it could be terrible, which is often the case. Anything come to mind? It could be something that when you were a child or even the past year.
Steve: Well, I have to be totally honest that my biggest investment to date is in my house and that’s been a money pit that keeps on sucking from the coffers. And there is another company I’m super bullish and excited about that a couple friends of mine have built in the financial tech sector called aspiration.com which if you haven’t had him on yet, you should. They’re really changing the way that everyday consumers of banking services, they’re changing that relationship and I think they’re going to really cut into a big part of that retail banking market. So, I’m really… I’m excited about things that kind of change the status quo that’s not working. And beyond that, my biggest investment, to just to give you a sense of how good I am at this has been in EIG, the non-profit I run now. So, between the house and non-profit…
Meb: My company is a for-profit and it’s basically a non-profit, so I can sympathize. But listeners, by the way, it’s funny you mention that about the house being a money pit. Listeners, who’ve been listening to this podcast for a long time will be happy to know that I finally sold my 1967 Land Cruiser. I’m very sad about it but talk about money pits that was another one. Steve, it’s been a blast today. Where can people find more information? They want to follow your writing, your tweets, your updates. Where’s the best places to go?
Steve: My Twitter handle is @StevenGGlickman. Our website, eig.org, is a great font of information about Opportunity Zones and just the economics around this stuff. And I’m super active on LinkedIn, so come find me and reach out to me. I want to be a resource for investors who are actually been using this program. We’re building a new market here and it’s exciting to be a part of it on day one, so I want to help whoever is…got that shared interest.
Meb: You better be careful what you ask for. You’re going to get 20,000 new LinkedIn requests next week. And Steve, it’s been a blast. Thanks so much for taking the time today.
Steve: Thank you, Meb. I’ll talk to you soon.
Meb: Listeners, you can always find the show notes. We’ll add links to the EIG, all the other stuff we talked about, resources, calculators, maps, all that to the website of mebfaber.com/podcast. You can always find the archives as well. Leave us a review. You like it, you hate it, you love it. By the time this comes out, our new book will be out, “The Best Investment Writing: Volume Two.” Thanks for listening, friends, and good investing.
