We’re witnessing the inception of an investment asset class and a potential game-changer: an innovative economic development program that is structured to simultaneously benefit struggling U.S. communities, developers, issuers, investors — and the nation at large.
From 1990 to 2000, the U.S. economy added 20.6 million jobs, broadly distributed across the country. But since the Great Recession, the benefits of economic growth have been anything but equitable. Nearly three-quarters of all new job creation between 2010 and 2016 has taken place in a handful of metro areas. The businesses and individuals who have benefited from this robust economic growth are now sitting on some $6 trillion in unrealized capital gains.
In the bottom two-fifths of the nation’s zip codes, where 1 in 3 Americans (108 million citizens) live, the situation is considerably bleaker. Instead of gaining jobs, these areas lost 2.3 million of them between 2000 and 2015, with the lion’s share of those losses (2.2 million) suffered in the bottom quintile. The distress in these communities goes deep — measurable not only in vanishing employment and capital flight, but also in key indices of well-being such as education, public health, addiction rates and mortality.
These widening disparities, which increasingly resemble a vicious cycle, threaten the entire nation. The United States is less productive, less innovative, and less resilient when its economy leaves entire communities behind.
Enter the Opportunity. A provision in the recently enacted Tax Cuts and Jobs Act led to the creation of a program aimed at encouraging long-term investment in so-called Qualified Opportunity Zones — distressed areas across all 50 states and U.S. territories that meet certain criteria. The program contains powerful tax incentives for investors to put their capital gains to work in Qualified Opportunity Funds.
In so doing, it opens up enormous potential for issuers and developers looking to raise funds at attractive rates — and to do so without the marketplace limitations of, say, the EB-5 visa program. All while helping build an economic engine in underserved areas ripe for development.
What are Opportunity Zone Funds? Opportunity Zone Funds are qualified private-sector investment vehicles that invest at least 90 percent of their capital in Qualified Opportunity Zones (many of which align with the EB-5 Targeted Employment Areas). The model enables a broad array of investors to put their realized capital gains to immediate use to benefit underserved areas, under specified conditions — including creating “substantial improvements” to existing properties or businesses. Those investors then achieve significant tax benefits, such as a temporary tax deferral for capital gains; a progressive step-up in basis for investments in the Opportunity Zone Funds held for 5 or 7 years; and a permanent exclusion of capital gains from the investment if it is held for 10 or more years.
Everyone benefits. Opportunity Zones have the potential to be a game-changer for all parties — investors, issuers, developers, entrepreneurs and communities. The program builds wealth for more than one constituency. It is flexible, nationally scalable and open to all. No pre-approvals are needed and there is no fixed cap on investment size or on the tax benefits that may be claimed.
The benefits don’t stop there. Opportunity Zone Funds concentrate capital rather than diffuse it. They reward patient capital: the system is designed so that benefits accrue over the longevity of the investment. And they facilitate potentially high-growth startups where new jobs are most needed. Best of all, they give investors a stake in the future well-being of entire communities — not just individual projects — helping to unlock local economic benefits that could accrue for decades.
For these and other reasons, we believe Opportunity Zone Funds, which, like EB-5, were born of bipartisan Congressional initiatives, could be lower in cost than traditional capital — yet with fewer political uncertainties, complexities, or ramifications than the EB-5 market.
A robust opportunity requires robust administration. Opportunity Zones hold tremendous potential for issuers. But they demand careful administration and rigorous oversight — the more so since this asset class is brand new, and regulatory guidance is still a work in progress (complex conditions that can invite fraud as well as increase the likelihood of honest error). And, because the program is driven by the IRS, its requirements go well beyond those typically imposed by the SEC. The Treasury Department has been given broad authority not only to regulate Qualified Opportunity Funds, but also to assure that their many operating conditions are being complied with — and to impose penalties for violations or abuse.
The fund administration solutions used for other asset classes are simply not adequately suited to the needs of Opportunity Zone Fund managers and their investors. In most cases, the investor’s primary motivation will be the tax-deferral benefits. A poorly administered fund will not only run the risk of investment loss (as do traditional funds) but also run the risk of an investor being denied the desired tax benefit, owing back taxes, and facing additional fines. Specialty funds like Opportunity Zone Funds require third-party fund administrators with purpose-built administration solutions.
Why NES Financial? NES Financial is perfectly placed to help issuers and investors navigate this extremely promising but tricky new market across the entire investment life cycle. We remain dedicated to our founding goal of bringing the highest levels of security, transparency and compliance to stakeholders involved in complex financial transactions. We thrive in markets where knotty issues such as compliance, reporting, security, lack of transparency, fraud or abuse are material operational concerns. And our Silicon Valley pedigree means we are nimble — able to quickly develop and configure technology-driven administration solutions to adapt to changing conditions.
NES Financial sits at the perfect nexus of services, people, experience and technology for this nascent market: We are the experts on the tax-deferral benefits and mechanics of 1031 like-kind exchanges. We are the experts at tracking and administering EB-5 projects, and ongoing compliance. And leveraging our expertise and technology in fund administration for private equity, we are now bringing to market a purpose-built solution for Opportunity Zone fund administration. With several client wins already, we are positioned to be the leading fund-administration provider in this dynamic new market.