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The HUD – Opportunity Zone Connection June 19, 2019

The HUD – Opportunity Zone Connection June 19, 2019. Today’s Topics. Opportunity Zone and Opportunity Fund Basics Opportunity Zone Investment Incentives How Communities Can Take Advantage of Opportunity Zones. Using CDBG/Section 108 to guide investment

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The HUD – Opportunity Zone Connection June 19, 2019

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  1. The HUD – Opportunity Zone Connection June 19, 2019

  2. Today’s Topics • Opportunity Zone and Opportunity Fund Basics • Opportunity Zone Investment Incentives • How Communities Can Take Advantage of Opportunity Zones • Using CDBG/Section 108 to guide investment • Tips for streamlining compliance with HUD Requirements • Opportunity Zone Mapping Tool and other Resources

  3. Opportunity Zone Acronyms These acronyms are commonly used in discussions of Opportunity Zones: • QOZ: qualified opportunity zone. • QOF: qualified opportunity fund. • QOZP: qualified opportunity zone property. • QOZB: qualified opportunity zone business. • QOZBP: qualified opportunity zone business property.

  4. Opportunity Zones • Opportunity Zone Basics: • Enacted as part of the Tax Cut and Jobs Actin 2017 (P.L. 115-97). • 8,700 low-income/high poverty census tracts designated by governors/DC mayor. • 77% of the qualified Opportunity Zones are in urban and suburban areas and 23% are rural. • 69% of Opportunity Zones qualify as severely distressed under CDFI Fund classification. • Average Opportunity Zone’s housing stock has a median age of 50 years, more than ten years older than the U.S. median. *Source: CDFA

  5. Opportunity Zone Qualifications • Eligible census tracts satisfied the definition of “low-income community” per the Internal Revenue Code. • Low-income community census tracts where the poverty rate is at least 20% (metropolitan census tract) or the median family income does not exceed 80% of the statewide median family income (non-metropolitan census tract). • Non-low-income census tracts were eligible for designation if: • The tract is contiguous with a designated Opportunity Zone AND • The median family income does not exceed 125% of the median family income of that contiguous Opportunity Zone

  6. Qualified Opportunity Funds Qualified Opportunity Funds are investment vehicles for taxpayers realizing capital gains to catalyze investments in distressed neighborhoods. • If a taxpayer makes a timely equity investment in a QOF, • And the QOF makes an investment in Qualified Opportunity Zone Property, • The taxpayer gets tax benefits. • Any entity organized as a corporation or partnership can self-certify to create an Opportunity Fund. • Opportunity Funds can be established for specific projects or for types of projects.

  7. Opportunity Zones Investor Incentives • Temporary Deferral of Tax Liability: If capital gains are reinvested in a QOFwithin 180 days then taxpayer can defer paying capital gain tax on those earnings until the Opportunity Zone investment is sold or until 12/31/26 (whichever is earlier). • Reduction in Tax Liability: • Partial Exclusion of Deferred Capital Gains: If an investor holds QOF investments for a certain period of time, then investor gets a reduction in tax liability depending on the number of years it remains invested (at 5- and 7-year mark) • Permanent Exclusion: If an investor holds QOF investment for at least 10 years, it does not have to pay any capital gains taxes on income from the sale or exchange.

  8. Opportunity Zones Investor Incentives 5 years 10% increase in basis of QOZ investment Taxes paid on deferred capital gains 7 years Additional 5% increase in basis of QOZ investment 10 years Permanent Exclusion of gains accrued in the QOZ through 2047

  9. Opportunity Zone Funding Process A Qualified Opportunity Fund must invest 90% of its assets (tested every 6 months) in Qualified Opportunity Zone Property(stock, partnership interest, business property). Eligible Investors QOF Investments (Any taxpayer that realizes eligible gain for Federal tax purposes) (C corporation, S corporation or partnership) Stock of Qualified Opportunity Zone corporation Interest in a qualified opportunity zone partnership Business Property in a Qualified Opportunity Zone

  10. Opportunity Zone Proposed Rule Update The IRS released a proposed rule update in April 2019 clarifying outstanding questions regarding business investments. • A business funded by a Qualified Opportunity Fund and located in an opportunity zone, could qualify for the tax incentives if it meets one of three "safe harbors": • at least 50% of the hours the employees or contractors work are spent within the QOZ, • at least 50% of the amount paid by a business to employees and independent contractors are for services performed within a QOZ • tangible property located in a QOZ and the management or operational functions performed in the QOZ are each necessary for the generation of at least 50% of the gross income of the business. • Qualified opportunity funds will now have a one-year grace period to sell assets and reinvest the proceeds into another Opportunity Zone investment. • A building or other structure that has been vacant prior to being purchased by a qualified opportunity fund will satisfy the original use requirement. • The term “substantially all” is defined wherever it’s used in the statute.

  11. Opportunity Zones Investor Incentives - Example Investor holds the QOF stake for 10 years Susie has $100 of unrealized capital gains in her stock portfolio. She decides in 2018 to reinvest those gains into an QOF that invests in distressed areas of her home state, and she holds that investment for 10 years. Susie is able to defer the tax she owes on her original $100 of capital gains until 2026. Further, her basis in the QOF is increased by 15% (effectively reducing her $100 of taxable capital gains to $85). Thus, she will owe $20 (23.8% of $85) of tax on her original capital gains when the bill finally comes due. In addition, since she holds her QOF investment for at least 10 years, she owes no capital gains tax on its appreciation. Assuming that her QOF investment grows 7% annually, the after-tax value of her original $100 investment in 2028 is $176. Susie has enjoyed a 5.8% effective annual return, compared to the 2.8% an equivalent non-Opportunity Fund investment would have delivered. Total tax bill in 2028: $20 After-tax value of investment in 2028: $176 Effective after-tax annual return on $100 capital gain in 2018: 5.8% Source: Economic Innovation Group https://eig.org/wp-content/uploads/2018/01/Tax-Benefits-of-Investing-in-Opportunity-Zones.pdf

  12. How Can Local Governments Take Advantage of OZ’s? State and local governments should take an active approach to directing Opportunity Fund investment. They can: • Identify available sites and properties in Opportunity Zones • Look for ways to complement Opportunity Zone projects, e.g., locate public facilities and other buildings in the area that could be rehabilitated (work with local governments to encourage the use of CDBG/Section 108 funds for predevelopment costs) • Prepare sites for Opportunity Fund investment by Identifying specific development needs for the area (can use CDBG/Section 108 funds to begin necessary public infrastructure improvements and develop pad-ready sites for vertical construction) • Identify and plan for infrastructure to be rehabilitated (capital improvement plans, refer to the community’s Consolidated Plan and Action Plan) • Streamline local government processes (zoning, permitting, etc.) for Opportunity Zone projects • Work to ensure zoning in Opportunity Zones aligns with the type of development being targeted for the area

  13. How Can Local Governments Take Advantage of OZ’s? Convene the stakeholders and build partnerships • Identify key stakeholders in Opportunity Zones and form an action committee • Collaborate with regional partners private, public and non-profit partners (involve CDBG grantees and community development professionals) • Local decision makers should become partners with the Opportunity Fund investors so they can help direct the use of the Opportunity Funds and help shape and track the outcomes from those investments

  14. How Can Local Governments Take Advantage of OZ? Local governments can combine these efforts into an Opportunity Zone Investment Prospectuses- • Erie, Pennsylvania: https://www.erie.pa.us/Portals/0/Content/News/City%20of%20Erie%20Investment%20P rospectus.pdf • Louisville, Kentucky: http://www.acceleratorforamerica.com/sites/default/files/inline-files/Louisville%20Prospectus%20version%2011%2010312018 0.pdf • Oklahoma City, Oklahoma:http://www.acceleratorforamerica.com/sites/default/files/inline-files/OKC%20Prospectus_Phase2_v10_2.pdf • South Bend, Indiana: https://southbendin.gov/wp-content/uploads/2018/11/South-Bend-Prospectus.pdf • Stockton, California: http://www.stocktongov.com/files/StocktonOZProspectus.pdf

  15. How Can Local Governments Take Advantage of OZ? State and local governments are beginning to take action around Opportunity Zones: • Oklahoma Department of Commerce is using a local priority zone program to attract capital to Opportunity Zones by allowing layering of other incentives like state investment tax credits. • Maryland is seeking to pass legislation that would add a 5 percent bonus to Historic Tax Credits for Opportunity Zone projects. • Ohio Governor is proposing a 10 percent state income tax credit to attract investment in Opportunity Zones.

  16. How Can Local Governments Take Advantage of OZ’s? • Build an attractive financing stack • Early research is showing that Qualified Opportunity Fund capital will meet 5-30% of capital needed for a project. • But investors will want to minimize equity investment and will look for other sources of capital • Work with local government partners to create federal funding packages to fill gaps in Opportunity Zone project financing • Introduce additional tax incentives, tax increment financing and other financing strategies to encourage targeted investment in Opportunity Zones

  17. Community Development Block Grants (CDBG) • The CDBG Program provides annual grants on a formula basis to states, cities, and counties to develop viable urban communities by providing decent housing and a suitable living environment, and by expanding economic opportunities, principally for low- and moderate-income persons. • 3.365 billion in FY 2019 • about 1200 grantees nationwide • 30% states, • 70% cities (over 50K) and counties (over 200k), • separate funding for Tribes, Territories, and after Presidentially Declared Disasters

  18. HUD’s Section 108 Loan Guarantee Program • Provides loanguarantees,not grants • Employs the framework of the CDBG Program (e.g., eligibility) • Offers recipients a means of accessing the capital markets • Can fund higher risk project components (e.g., pre-development costs), projects in high risk areas where conventional lenders might not lend

  19. ExampleOpportunity Zone/ Section 108 Project • Hotel Project • Located in a designated Opportunity Zone • Eligible Activity: economic development assistance, loan to for-profit developer under 24 CFR 570.203(b) • National Objective: Benefit to low- and moderate-income individuals through job creation Financing Sources

  20. Who has access to CDBG and Section 108 funds? States CDBG Entitlement Communities (Larger cities & urban counties) • Subrecipient entities (e.g., community development corporations, non-profits) and public agencies (e.g., economic development and public housing authorities) may receive Section 108 funds to carry out projects. $$ *except Hawaii Smaller Units of Local Government * Non-entitlement communities in Hawaii and Insular Areas receive CDBG funds as well

  21. Keep in mind the Big ‘3’ Each activity carried out with CDBG/108 must: • Be an Eligible Activity • Meet a National Objective • Meet Public Benefit Standards, if applicable

  22. Flow of Funds: Project by a QOF or QOZB HUD (Guarantor) 2 Federal Guarantee 1 Lender(Investor) Loan Documents Repayment $$ 3 5 6 Repayment$$ Loan$$ QOF/QOZB 108 Borrower Local Loan $$ 4

  23. Source(s) of Capital & Interest Rates • Variable-rate Financing: Variable-rate based on the 3-month LIBOR (London Inter-Bank Offered Rate) plus 20 basis points (.2%) • These notes may be prepaid at any time without penalty, in whole or in part • Rate reset monthly • Fixed-rate Financing: Fixed-rate financing available through underwritten public offerings (most recent: March 2019) • Rates based on comparable Treasury yields plus small spread • Option exists to pre-pay/defease, with certain restrictions • Term: Up to 20 years

  24. How Section 108 and CDBG Can Be Used in OZs • As a resource to prepare sites to attract OZ investment: • Can be used for site assembly, site preparation, or infrastructure • As a resource to supplement OZ equity in a real estate project, CDBG and/or Section 108 funds can: • Fill project financing gap • Increase return to OZ investors by providing low-cost financing on less stringent terms than other sources • Finance infrastructure on site for specific development • Resource to complement OZ projects, CDBG and/or Section 108: • Can help fund projects in OZ, such as affordable housing, that may not be attractive to OZ investors but are local priorities • Can be used to assist existing businesses to expand operations in OZ

  25. ExampleOpportunity Zone/ Section 108 Project Eligible Activities: • Acquisition of unimproved real property and site preparation National Objective: • Benefit to low- and moderate-income persons by providing permanent residential structures, which will be occupied by low- and moderate-income households • Activities are carried out for the purpose of providing housing, at least 51% of the units of the housing structure must be occupied by low- and moderate-income households. • The Developer intends to market the units to families at 30%, 50%, and 60% AMI Affordable Multifamily Residential • Multifamily development for low-income families • Implemented through two phases • 108 used for site acquisition and improvements in Phase 1

  26. Example Continued Phase 1 – Site Acquisition and Site Improvements   Sources: Section 108 Guaranteed Loan $694,000 Total Sources: $694,000 Uses: Acquisition $649,000 Site Improvements 45,000 Total Uses: $694,000

  27. Example Continued Phase 2 – Development of New Affordable Housing Sources: Bank Loan $ 1,228,117 Rental Production Program Loan 800,000 Opportunity Fund Equity 694,000 Federal LIHTC 6,713,656 Total Sources: $ 9,435,773 Uses: Construction $ 6,140,614 Acquisition 694,000 Land Improvements 348,900 Soft Costs 899,547 Development Fees 1,092,000 Rent and Operating Reserves 260,712 Total Uses: $9,435,773

  28. Tips To Streamline HUD Reporting Requirements

  29. Tips/Tools for Streamlining Federal Requirements • Streamlining reporting requirements can make CDBG/Section 108 more attractive as a local/state source of leverage for Opportunity Zone projects. • Since Opportunity Zone funding does not have any reporting or tracking requirements, streamlining any additional requirements that would come from HUD funding is key. • If a project is in a designated Opportunity Zone, it may meet the requirements to ease HUD’s reporting requirements under presumptive benefit: • If the poverty rate is 20%+ (not in the CBD) or 30%+ (in the CBD), all jobs created/retained will be considered LMI without requiring household income documentation.

  30. Tips/Tools for Streamlining Federal Requirements • If a community has an Opportunity Zone, it will likely meet requirements needed to be designated a HUD Neighborhood Revitalization Strategy Area (NRSA), which also permits more flexibility with HUD requirements: • Can streamline requirements for jobs reporting (same as with presumptive benefit) • Single family housing units can be aggregated for an overall 51% low to moderate income benefit, not 100% • Can provide additional connected services (such as job training) by enabling communities to exceed CDBG public service cap in that area • Designation lasts for 5 years and can be renewed

  31. Opportunity Zone Mapping Tool • The Opportunity360 team from Enterprise created the Opportunity Zone Explorer to help local officials determine which tracts in their state or region have been designated and how they relate to other federal programs and designations. https://www.enterprisecommunity.org/opportunity360/opportunity-zone-eligibility-tool

  32. Opportunity Zone Resources • There are a lot of resources available to learn more about Opportunity Zones: • Complete list of Qualified Opportunity Zones listed in Notice 2018-48 • HUD OZ FAQ • CDFI Fund Opportunity Zone Program Website - https://www.cdfifund.gov/Pages/Opportunity-Zones.aspx • Novogradac Opportunity Zone Resource Center - https://www.novoco.com/resource-centers/opportunity-zones-resource-center • NCSHA’s Opportunity Fund Directory - https://www.ncsha.org/resource/opportunity-zone-fund-directory/

  33. Want more information? Paul Webster: Paul.Webster@hud.gov Joseph Baietti: joseph.a.baietti@hud.gov Section 108 Program: https://www.hudexchange.info/programs/section-108/

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