O-Zone Defense | The Turnover

The Opportunity Zone

In the summer of 2020, NBA players demanded that its Board of Governors be more proactive on social justice change as a response to the Jacob Blake shooting and Black Lives Matter movement. To hold them accountable, the Player’s Association demanded a plan that included not just financial commitment, but action. In the end, the Board of Governors agreed, but can we trust them to uphold their commitments?

Take for instance Dan Gilbert, the controversial owner of the Cleveland Cavaliers. You probably know him as the guy who clapped back at LeBron (through a letter posted on the Cav’s website) after he originally left the team in 2010. To be fair to Gilbert…Twitter wasn’t as popular back then.

After some deep digging, I found a page from Gilbert’s off-court playbook called “O-Zone Defense”. The play calls for the star player to manipulate a tax incentive program introduced by the Trump administration through the 2017 Tax Cuts and Jobs Act (TCJA).

The Game Plan

The Opportunity Zone program works as a quid pro quo where wealthy investors commit money to a type of investment fund called a Qualified Opportunity Fund (QOF). QOFs must then direct at least 90% of the money received to Qualified Opportunity Zones (QOZ). For choosing to commit capital to QOFs, investors receive preferential tax benefits.

QOZs are communities that meet established poverty & income limitations which are set by the government. However, simply meeting the limitations does not automatically classify a community as a QOZ. It must be nominated by the state and approved by the Department of Treasury.

The program was pitched as an economic development tool—QOZs use the money they receive to invest in themselves¹ for economic growth. Ultimately, the goal of the program is to help level the uneven pace of growth between distressed and non-distressed communities.

Tax Incentives: X’s and O’s

To fully understand the tax benefits from utilizing the OZ program, let’s zoom out to talk Investments 101 and what a capital gain is.

Simply put, a capital gain is the profit you’ve made upon selling an asset. The most common example is buying and selling stocks. When you purchase a stock, you immediately establish a basis (the amount of money you spent to buy the stock). If the stock grows in value and you sell it, the difference between your total sale proceeds and basis is considered a capital gain.²

Capital gains sound wonderful (after all, you’ve made money!) BUT there’s a catch and his name is Uncle Sam. Anytime you make money, a portion of that is owed to the government and capital gains are no exception. In fact, the upper limit of capital gains tax is 20% or 1/5th of the money you’ve made.³

If you’ve sold a couple stocks and made some pocket change, the tax bill isn’t a big deal. However, when we start applying the concept of capital gains to different asset sales, the dollar amounts can become dizzying. For millionaires that are selling multi-million dollar properties or businesses, the capital gains tax is worth losing sleep over.

Enter the Opportunity Zone program which allows investors to invest their capital gains into a QOF. The tax benefit they receive for their investment is the ability to defer & possibly eliminate the capital gains tax they would owe. If the investment is held in the QOF for 5 years, 10% of the tax bill goes away. At 7 years, the 10% jumps to 15%. If the investment is held for 10+ years, the entire capital gain tax bill is eliminated.

To summarize: the tax incentives that millionaires receive for participating in the OZ program are enormous.

The Box Score

We’ve established the program benefits for one side of the equation, but how about the other?

Long story short, with the TCJA being put into effect only 3-years ago, the results are still unclear.

Proponents of the program argue that it’s working exactly as intended pointing to increasing property & land values within O-Zones.⁴

However, as with most large-scale economic policies, the nuances are key. When you break down properties into 3 different categories—existing property, redevelopment property, and vacant land⁵—studies show that the increases in value are largely associated with redevelopment (14.2%) & vacant (20.9%) properties rather than those that are existing already. Why the difference in impact? Redevelopment properties & vacant land, by program definition, are more likely to qualify to receive the tax incentives and capital.

To make matters worse, opponents of the program argue that the intended beneficiaries of the O-Zone program aren’t receiving the benefits. Existing properties in distressed communities are largely minority owned or minority populated. QOFs aren’t investing the money into improving affordable housing deals or injecting equity into existing businesses. Instead, the funds are being directed to help build luxury apartments & hotels in these communities signaling the early stages of gentrification.

Perhaps QOFs are to blame here! The easy conclusion to draw is that QOFs should redirect funds to help benefit existing businesses/properties. But are they incentivized to do so? TL;DR⁶—no I don’t believe they are and though QOFs are at fault for misdirection of investments, the incentive structure is the big elephant in the room.

The League at Large

At this point in the article, it may sound like millionaires are running away with the game up 77-27 at halftime.⁷ Well…it’s about to get worse. Announcer voice:

*INTRODUCING…at 5’6”…born in Detroit, Michigan…hailing from THE Michigan State University…BILLIONAIRE…DAAANNNN GILBERT!*

Outside of league bottom finishes & several draft busts, Gilbert is the co-founder of Quicken Loans which is headquartered in Detroit and home to 17,000 employees. Through the years, Gilbert’s Bedrock Detroit (a commercial real estate firm) has purchased over 90 real estate investments in downtown Detroit. All in all, Gilbert owns most of Detroit. Prior to the Opportunity Zone program, Gilbert was hard at work attempting to revitalize the city’s struggling economy. He is reported to have spent nearly $3mm of his own dime to buy/renovate real estate projects.

When the TCJA finally passed in 2017 and localities were being nominated to classify as QOZs, Gilbert recognized an opportunity. One Detroit tract that was largely dominated by Gilbert owned businesses & properties did not make the initial list to receive tax breaks. Gilbert and Quicken Loans lobbyists went to work faster than a teenager finding his dad’s Playboy stash. Just SEVERAL WEEKS later, the Trump administration had revised the list to include not just one but three downtown Gilbert tracts. To make matters worse, all three tracts were originally excluded from the list because they did not meet the poverty requirements.⁸

After being classified as QOZs, property values in these Detroit tracts have increased dramatically just a few years later. Money from QOFs is flooding in to help build and boost the assets surrounding Gilbert’s projects. From Gilbert’s point of view, he is the clear MVP – whatever money he was going to spend to boost his Detroit assets is now being covered by QOFs. True, the program worked as intended, boosting property values in a struggling city. At the same time, the communities receiving the benefits were not the most distressed ones in the first place.

This is just one example of shenanigans within the O-Zone program. There are more situations similar to Dan Gilbert & Detroit—each one of them slightly different and corrupt in their own way.

The Next Game

The early returns of the Opportunity Zone program’s goal to spur economic development in distressed communities are disappointing. This is only magnified when billionaire’s like Dan Gilbert swoop in and take advantage of programs to benefit themselves at the expense of marginalized communities often inhabited by people of color.

I remain unconvinced that the NBA Board of Governors (most of whom are billionaires) will take meaningful steps to combat racism as the players are demanding. The most powerful bargaining chip the players have is disruption of the league hurting the bottom-line revenue figures and wallets of the owners. The catch-22 is that the same disruption will hurt their own wallets as well. The path forward is unclear but something needs to change—otherwise, we’re all just Mike Budenholzer failing to make adjustments and going home following another gentleman’s sweep in the 2nd round of the playoffs.

Sources

Footnotes

Common goals include creating affordable housing, spurring creating/growth of small businesses, seeding neighborhood revitalization, improving health outcomes, and much more
For example, say you bought 10 shares of McDonald’s stock at $10 a share. At this point, your basis in McDonald’s stock is $100. 5 years later, the price of McDonald’s stock has doubled from $10 to $20. You decide to sell all 10 shares and walk away with $200. Your capital gain from selling McDonald’s stock is $100 ($200-$100). Happy with the results, you go buy yourself a Big Mac and 20-piece nuggets.
Continuing on with our McDonald’s example, Uncle Sam comes knocking at your door a couple days later. He claims that you owe him money! Since you had a capital gain of $100 from selling your stock, you owe him 20% (or $20) in taxes. You’re screwed because you already spent the money…plus you ate the nugget ☹
As of 1/2018 (a couple years into the program), the average sales price of OZ assets in the top 50 metropolitan areas have increased by 12% while non-OZ assets have decreased by 3% per Reonomy, a data analytics company (source: https://www.reonomy.com/the-opportunity-zone-report).
Redevelopment: depreciated (or decreased) properties likely to be redeveloped
Vacant: building from the ground up
Existing: business already up & running
Like all investment funds, QOFs charge a management fee which is typically a percentage of the total assets they are managing and can range from 0.3% to 2%. Thus, the more money QOFs manage, the more money they make. How does a QOF convince wealthy investors to hand over money to them? They need to convince the investor that there is high potential to earn a strong rate of return (i.e. make back a lot more money). Which do you think is more likely to make an investor money: affordable housing units or that sleek luxurious, high-rise apartment complex?
An actual real-life halftime score between the Mavericks and Clippers during the 2021-2022 NBA regular season.
2 out of the 3 tracts had a significantly higher median income than the surrounding areas. In these tracts lie Gilbert-owned office spaces being leased out to high-profile tenants like Microsoft, JP Morgan, Quicken Loans.