Will the Renewables Industry Seize the Opportunity of Opportunity Funds?

A new tax incentive could mean big money. But questions remain about its equity implications and whether the industry will use it.

Clean energy advocates are working to raise awareness about a “giant money fire hose” made available to the industry starting this year.

The glut of cash, tied to a portion of the federal Tax Cuts and Jobs Act of 2017, stems from an incentive framework called Opportunity Zones. The sleeper provision offers tax benefits to equity investors that put money into over 8,700 designated “economically distressed” opportunity areas. It’s designed to encourage investment in low-income communities that haven’t seen equal attention from investors. 

The incentive holds several tax benefits, but it’s basically a capital gains shield. Equity investors can defer taxes on gains put into an “Opportunity Fund,” the investment vehicles organized to invest in the zones, until December 2026. If investors hold their investments for five to seven years, they can increase their basis on the investment by 10 and 15 percent, respectively. If investors hold their investments for at least a decade, they also don’t have to pay out taxes on capital gains made from investments in those zones.

The law is purposely flexible and scalable, with no cap on the money that can be deployed and few restrictions on the sectors that can take advantage, according to the Economic Innovation Group (EIG), a research and advocacy organization that helped design the legislation that modeled the Opportunity Zone provision in the tax bill.

In testimony to Congress, EIG President and CEO John Lettieri said, “This incentive has the potential to unlock an entirely new category of investors and create an important new asset class of investments.” 

An EIG analysis estimated $6.1 trillion in unrealized capital gains was floating around in 2017. That’s such a huge lump of money that even if just a portion of it went to Opportunity Zones, EIG said it would already be the largest economic development initiative in the U.S. And, according to several experts watching the space, there’s big potential for the clean energy industry to take advantage.   

“Industry folks should be jumping all over this,” said Jon Bonanno, chief experience officer at the nonprofit California Clean Energy Fund. “It’s a giant money fire hose, and we want to point it at the things we want.”

So far, much of the attention for Opportunity Zones has focused on the real estate industry. But because renewables projects are also long-term, place-based investments, advocates say clean energy is a natural fit. Wind and solar also don’t have the same gentrification and displacement implications tied to real estate development in low-income communities, one of the biggest concerns about the program.

The potential financial benefits are so great that Bonanno characterized it as a “watershed moment” for the clean energy industry.

“This is really an incredible mechanism,” said Bonanno. “It creates such compelling returns that we will see these assets going mainstream because of it.” 

“Almost as simple as looking at a map” 

According to those working on Opportunity Zones, if a developer locates a project in one of the thousands of zones located throughout the U.S. and U.S. territories, it can be eligible for funds from a certified fund. That money would come into the project timeline at the same time equity usually does.  

“For developers, it should actually be fairly straightforward and almost as simple as looking at a map,” said Cody Evans, a graduate student at Stanford University, who has been researching Opportunity Zones with professor Dr. Rebecca Lester. “From the developer’s perspective, it wouldn’t necessarily look any different than any source of funding; it would just likely come at a lower cost of capital.”

Evans added that developers also have to pass two tests to qualify property for the incentive. Projects have to add “substantial improvement,” increasing the basis of the property compared to the pre-investment value. Projects also have to derive 50 percent of gross income from active business in the zone. 

For wind and solar developments, those qualifications should be pretty easy to meet. But so far, Evans said, “there’s a lot more runway for the industry to wake up to this tool and take advantage of it.”   

Gregory Rosen, founder and principal at High Noon Advisors, said any opportunity that lowers the average weighted cost of capital for renewables deserves some attention. But he said recruiting investors will likely fall on the industry. 

“Part of it is up to the industry to be proactive in educating folks,” said Rosen. “The jury is still out on how many [Qualified Opportunity Zone] investors there are that are interested in investing in solar.”

According to a list compiled by accounting and consulting firm Novogradac & Company, out of 49 funds that have registered to join the firm’s Opportunity Zone Listing, only three mention solar as an investment focus. After a call for letters of inquiry from fund managers working on Opportunity Zone projects, the Rockefeller Foundation — working with the Kresge Foundation — said only one of the 141 responses it received had a clean energy focus, and even that had a real estate bent, describing its aim as “energy efficient property development.” 

Bonanno called the lack of attention for renewables “abysmal.”

“The renewable energy business needs to get their act together and focus on this,” he said. 

Despite the delay, those watching the funding expect 2019 to be a “boom year,” said Abraham Reshtick, a business and tax attorney at Mintz. That’s in part because investing this year allows investors to realize the most benefits with the timeline of the incentive. The incentive can also be paired with the soon-declining federal Investment Tax Credit and Production Tax Credit benefits.

At the same time, Reshtick added, “There needs to be the right opportunities.”

“It’s the next few months that will give us the best indication as to whether this is an attractive enough program,” he said.   

“Our collective responsibility” 

Even as advocates urge the renewables industry to leverage the funding, though, they also caution that regulations for Opportunity Zones are yet to be finalized. 

The IRS released an initial batch of proposed guidance in October, offering some clarity on the particulars of the law. But the agency canceled a January 10 public hearing on those regulations due to the ongoing government shutdown. It’s anyone’s guess when that meeting will actually happen. Investors are also awaiting additional guidance.   

In the meantime, it’s difficult for funds to fully organize. Though those working on the funding, like Rockefeller and Kresge, have seen a surge of activity — Rockefeller said the responses they received are a “testament to the enormous market interest” — adoption will be halting until there’s more clarity.

Before the rules are finalized, stakeholders are also hoping for some changes. Currently, Evans said, the rules make it difficult for multi-asset funds to participate in the program. He said allowing that participation would encourage more investment and allow diversification of risk across a portfolio. 

And an “insane oversight,” according to Bonanno, is the lack of a community impact requirement tied to the funding. Though the program is structured to increase investments in low-income census tracts, the law doesn’t say the project necessarily has to benefit the community in any measurable way.

“You could just be a banker and you could invest in a solar project — you stick the solar project in an Opportunity Zone. They don’t see a penny, they don’t get any of the work, and honestly, it’s not necessarily helping those communities,” said Rosen at High Noon Advisors. “It’s our collective responsibility to take these opportunities and proactively have them benefit communities.” 

This is especially a concern in Opportunity Zones already experiencing displacement of low-income residents and communities of color. Though EIG notes that under 4 percent of the selected census tracts have seen high socioeconomic change between 2000 and 2016, some communities are skeptical.

A study that looks at the potential for gentrification stemming from the Opportunity Zone program, conducted by a national coalition of real estate developers and investors called LOCUS, in partnership with George Washington University, highlighted downtown Oakland, downtown Portland, downtown Newark, and Seattle’s downtown and International District as the most vulnerable for “accelerated gentrification” without policies in place to stop it.

Past research has also suggested that place-based tax incentives don’t equate to improvements for communities.

But staunching the negative impacts of the law may be left to states and cities. California, for instance, still has a state-level capital gains tax in place and could require certain community impact requirements in order to grant an exemption. 

How implementation shakes out will be especially important in states and metropolitan areas where gentrification is already an issue. In the LOCUS ranking of vulnerable areas, 13 of the top 50 vulnerable locations are in California and 13 are in New York. Many of the most vulnerable Opportunity Zone locations are also in states with significant renewables development, including California, New York, New Jersey and Massachusetts.

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