Four years ago, Opportunity Zones brought fervor to the real estate world and intense debate to the community development finance sector. Opportunity Zones (OZ) allow investors to reduce their tax bill on capital gains if they invest those gains into a qualified opportunity zone fund. Keeping gains invested for 10 years allows investors to grow their capital tax free.

At Kresge, we continue to watch OZ developments with interest. The 8,000 census tracts were picked, among other reasons, due to elevated levels of poverty. These are the places we work.

But while sourcing capital from the private equity market in a more scalable way than ever is an interesting idea, and while equity is no doubt difficult to come by in community development work, and while yes, more is needed… like anything, the devil is in the details.

We have always and continue to want this incentive to succeed, but we continue to have trepidations about that. Those fears have only grown as we hear directly from people in communities who say the incentive is causing more harm than good.

Moment of Inflection?

The Biden administration is considering raising the capital gains tax rate for wealthy individuals to help offset stimulus and infrastructure spending. That would make OZ even more appetizing to investors and would likely drive more capital into the sector.

But more money is not always better. OZ doesn’t require measurement, accountability or tracking of any impact beyond dollars in; it rewards appreciation regardless of social impact. This is not a worthy measure. If millions go into a community, but they’re invested into liquor stores, storage units, and condominiums that price people out of housing opportunity, are the people who live there any better off?

We all know the answer to that question.

On the plus side, conversations are also heating up over those needed reforms, including introduction of better safeguards to ensure OZ benefits low-income communities.

We’ve maintained since OZ’s introduction that more regulation would be a good thing. Nothing good grows in the dark, especially as it relates to low-income people and communities. OZ is just the latest example of policymakers and investors doing something to low-income communities rather than with them.

We saw this firsthand when we issued an RFP in 2017 with the Rockefeller Foundation to source ideas on how to crowd in capital to the most distressed Zones. We received more than 150 proposals. But most came from potential fund managers with little to no experience working in these communities. Or they came from organizations in desperate need of cheap, flexible equity to invest in real estate projects, who were willing to become fund managers to get it. Very few had insight on how they would incorporate things like community voice into their processes, how they would align projects with community-identified needs, how they would invest in small businesses, or how they would include long-term job creation in their investment plans.

Certainly, some of this was due to the evolving and early days of the market, and the need for better IRS guidance on areas like small business investing.

But a large portion was also a lack of motivation to truly center community impact. This is still prevalent.

Update on Kresge’s OZ investments

Out of that RFP, we made a $22 million guarantee commitment to back two impact-minded fund managers. We wanted to signal to the market that there are indeed managers out there doing things the “right way,” including committing to being more transparent and impact-oriented than the regulation itself called for. We were proud to commit to those guarantees, which provide risk mitigation against future losses.

One of those funds has closed with more than $80 million of capital commitments from investors and more than $30 million of commitments from foundation and government partners (including Kresge’s $15 million guarantee). Our partners credit Kresge’s early commitment to catalyzing much of the other foundation and social sector partnership. They have a growing pipeline that includes affordable housing, broadband and manufacturing projects, in places like Baltimore, Detroit and Erie, PA. That’s a great success story that we’re proud of.

We also invested through a grant to Calvert Impact Capital in a manager incubator for impact-driven groups that needed support in becoming private equity managers. Of five participants, one graduated and launched a fund. This indicates that the groups most focused on impact early in OZ opted to pursue other strategies, finding the path to OZ capital management too difficult.

Time will tell if more high-impact funds launch and are able to attract capital at terms helpful to their community.

Where do we go from here?

I worry that despite our best intentions, including supporting work calling for more transparency and reforms, Kresge’s early actions signaled optimism about OZ that may have caused significant harm. Our intoxication with the idea of a truly scalable equity tool for community development finance pushed us past critical questions like… Who will benefit most? What happens in markets without community accountability? What did the incentive’s creators know about low-income community investing? And, most importantly, what are the possible unintended consequences?

Kresge’s early action on OZ likely led some of our partners to feel they could not publicly express their concerns, not with their funders and state and local governments talking about the incentive as a positive and rare opportunity for community development. Some good friends in the sector have taken me to task behind closed doors. That’s helped me see more clearly.

In short, I trust our community partners who have been investing in low-income communities far longer than OZ has been around. The majority tell me it’s not working for them, and, in some cases, it’s making their work harder. The news-friendly bright spots are a tiny fraction of capital flowing through this incentive. I’m not interested in continuing to evaluate OZ by anecdote when there are likely billions in investments we will never know about.

There are true OZ believers out there, many of whom I admire. They are trying hard to make the best of a bad situation. That’s thankless, necessary work that shows what might be possible.

However, we can no longer put lipstick on the proverbial pig. The downside risk is too great for the communities Kresge serves. We need full transparency into OZ, we need some level of local accountability for the capital invested, and we need better evidence that the tool can deliver against community needs at scale. Without these, I don’t think the incentive should continue to exist at all.

When our partners deeply embedded in OZ communities say, “This isn’t working,” we need to listen and take that seriously. We also need to ask, “if this isn’t working for our people, who is it working for and at what cost?”

I want that answer, and you should, too. Feel differently? Reach out and help me understand. Let’s have a conversation. What I want is a financial system that better reflects our values and serves people first. While more investment capital is needed in communities across the country, we also need innovative policies to better align incentives between investors and low-income communities. We owe it to those communities and taxpayers to hold ourselves to a higher standard of performance and mutual benefit. Anything less is failing everyone.

Aaron Seybert is the managing director of Kresge’s Social Investment Practice. Follow the team on Twitter @kresgesocinv..