A plywood fence hides what remains of a small daycare center, coffee shop and auto body place that were demolished last month at 6th and Hobart Street in Koreatown, one of Los Angeles’ fastest-developing neighborhoods.

It’s a few blocks from the sleek Line hotel and just off busy Wilshire Boulevard, a strip dotted with luxury apartment complexes and construction work on a new subway line. The site is slated to become a Hyatt Centric hotel — and if all goes according to plan, it will also save its investors a tidy sum because of a massive new tax incentive program born from President Donald Trump’s Tax Cuts and Jobs Act a year and a half ago.

That law made it substantially cheaper to back either real estate projects or operating businesses in one of 8,764 low-income, high-poverty census tracts across the country that have been designated “Opportunity Zones.” One in ten Americans now live in one of the zones, which were chosen by state governors out of the thousands of eligible tracts; they span downtowns, rural areas and desperately poor neighborhoods — as well as upscale urban playgrounds.

The program’s backers say it will push capital into places that have historically missed out on it, and they intentionally crafted it to be free of the many rules and restrictions that have guided similar programs in the past. Opportunity Zones are not subject to criteria set by state governments like Low Income Housing Tax Credits, for example, or funneled toward mission-driven developers and lenders like New Markets Tax Credits, which allow investors to lower their income taxes by providing capital in depressed communities.

Bryan Shaffer, left, and Leo Y. Lee at the site of a new luxury hotel in Los Angeles' Koreatown. Shaffer is helping Lee, the developer, line up financing for the project. They are seeking Opportunity Fund investment for part of the cost.

In doing so, however, they opened up large tracts that were already magnets for investment, potentially sucking any new dollars away from places that could really use it. And even though data is scarce and capital is only starting to flow, anecdotal reporting suggests that Los Angeles is a microcosm of how the program is playing out nationally.

Along with Koreatown, tracts designated as Opportunity Zones include parts of Hollywood, Downtown, and the Arts District right next door, which TimeOut has dubbed “LA’s trendiest neighborhood.” So far, that appears to be where most of the deals are getting done — rather than places like Census tract 5425.02, better known as Compton, where the median household income is $35,457, barely half of the national median. About 35% of people there live below the poverty line — almost triple the national poverty rate.

Bryan Shaffer is a principal with George Smith Partners, a boutique firm that helps developers finance complex deals. He’s working on the Koreatown hotel project, and can name a handful of others in the neighborhood that are also looking for capital from Opportunity Funds, the tax-advantaged investment vehicles that can funnel money into businesses or real estate projects located in Opportunity Zones.

“Accountants and attorneys looked at this and said, ‘Wait a minute, this could be huge’,” Shaffer said. “The question from the community development side is: It’s good that we’re seeing more development in Koreatown, but is there a point where it spreads? It’s not a clear picture.”

That’s left people who are interested in community-oriented development — projects like affordable housing, health care clinics, grocery stores and businesses that employ local residents — scrambling for the attention of investors who might be willing to accept a normal return, rather than a super-charged one.

And the way the Opportunity Zones have been set up, both investors and the people trying to attract them face a deadline. The value of the tax break starts to decline after the end of 2019. Even though it still has value in future years, fund managers seeking to maximize their return are prospecting deals that are shovel-ready, low risk and straightforward.

Toys lie on the ground as a preschool is cleaned out before it gets demolished at a construction site in Koreatown.

Maurice Jones is president of the Local Initiatives Support Coalition, a national community development nonprofit, which is helping communities leverage Opportunity Zones to further their own goals. The sense of urgency among investors, he said, makes it harder for communities to attract capital for complicated projects in marginal neighborhoods.

“There’s a panic going on that is a constructed panic,” Jones said. “The more people say ‘this can only happen this year,’ the more it will only happen in a few places. People need to stay calm.”

A tax break with no strings attached

Opportunity Zones were born as an idea that both liberals and conservatives could love.

The tax provision was the brainchild of the Economic Innovation Group, a think tank cofounded by the Napster entrepreneur Sean Parker. It found legislative champions in South Carolina Republican Senator Tim Scott and New Jersey Democratic Senator Cory Booker, who slipped a section into the omnibus tax bill steamrolling its way through Congress in late 2017, attracting little attention amid the debate over deep corporate and individual tax cuts.

In some ways, it resembles other geographically-defined tax breaks like the state-based Enterprise Zones of the 1980s and the Empowerment Zones designated by President Bill Clinton in 1993, which haven’t proven very successful in the past. But that’s where the comparison ends: This incentive is more valuable and less restricted than any of its predecessors. It applies to almost any type of project, requires no bureaucratic approval or monitoring and has no cap.

According to its framers, that was by design. If the old programs were too rule-bound to make much of a difference, this one would create a much bigger funnel of money, at least some of which would reach underinvested areas — even if a bit of it also ends up leaking out to projects that might have happened anyway.

“What would bother me is not having enough aggregate investment to move the needle. You really need tens of billions of dollars to dig out of this hole we’ve dug,” said Steve Glickman, a former Obama administration official who co-founded the Economic Innovation Group and now runs a consulting firm that advises Opportunity Funds. “The status quo is far worse than what is a massive policy experiment in providing an incentive for investment.”

The openness of the tax break has made Opportunity Zones the talk of investor confabs like the Milken and SALT Conferences last month, which had nine sessions on the subject between them. (SALT is put on by SkyBridge Capital, the investment fund of former White House communications director Anthony Scaramucci, who has started a real estate investment trust focused on Opportunity Zones himself.)

Manny Friedman, CEO and co-chief investment officer of EJF Capital described Opportunity Zones as "the biggest program that anyone has ever seen in their lifetime," at the Milken Institute Global Conference in Beverly Hills in April.

“People in this room do not understand how gigantic this is,” EJF Capital CEO Emanuel Friedman said at the Milken Global Conference in Beverly Hills, barely containing his enthusiasm onstage. “I’m here to tell you this is the biggest program that anyone has ever seen in their lifetime.”

“It’ll be a trillion dollars of equity just to start with. It’s going to transform your lives, it’s going to transform the lives of the people on the stage,” continued Friedman, whose firm is raising a $300 million Opportunity Fund that has already announced projects in South Carolina, Washington DC, and Oakland, California. “If you live in Silicon Valley, you should be selling your house, because every startup is going to be moving to an Opportunity Zone, because the advantages are so mind boggling across the board.”

And it’s not just opportunistic hedge funds. Some of the country’s biggest banks, which have already been lending and investing in poor areas for years as part of their obligations under the federal Community Reinvestment Act, are positioning themselves to benefit from the zones as well. PNC closed a $486 million fund last summer, for example, and Goldman Sachs began setting up funds days after the law passed.

“We’ve been investing in these communities for close to two decadaes, so there isn’t really a change in strategy,” said Margaret Anadu, who heads Goldmans Sachs’ Urban Investment Group, on the company’s podcast. “I think how we’re thinking about it is as another tool in the tool belt.”

Here’s how it works: Someone who reinvests a capital gain worth $100 in an Opportunity Zone in 2019 gets a 15% “step up in basis,” which means she has to pay the federal capital gains tax on only $85 of that original income. At a tax rate of 23.8%, that comes to $20 — and she doesn’t have to pay it for another 10 years.

On top of that, if she holds the investment for at least 10 years, she pays no capital gains taxes on the proceeds from Opportunity Zone investment. The Economic Innovation Group calculated that would result in a net after-tax profit of $76, compared to $36 if the original capital gain were invested in a regular stock portfolio, assuming 7% annual rates of return for both.

Looked at another way, if a stock market portfolio generated after-tax returns of about 2.8% per year, the Opportunity Zone incentive amounts to an extra 3 percentage points on top of that if held for 10 years, which can add up to a lot for larger deals — especially for projects that already looked good to begin with.

And because of how those zones were selected in the first place, plenty of projects fit that description. Tracts could qualify as relatively poor and low-income based on Census statistics from 2011 to 2015, when many downtown areas had just started to redevelop. And the law allowed a few tracts to be chosen based on sharing a border with a qualifying tract, even if they weren’t poor enough to make the cut.

Downtown Los Angles seen from the Lincoln Heights neighborhood.

For example: The entire core of downtown Phoenix is now an Opportunity Zone, including its convention center and sports stadiums. So is most of downtown Portland, Oregon, including its tony Pearl district, replete with clothing boutiques, vintage furniture stores and a Whole Foods. Large swaths of south Seattle and west Oakland adjacent to booming tech hubs, big chunks of long-gentrified Brooklyn and Harlem and even bits of lower Manhattan, about half of inner-city Philadelphia and Baltimore — all now confer generous tax benefits upon those who invest in businesses or real estate projects.

In the hot real estate market of the last several years, those urban cores have been flooded with high-end condos and glassy office buildings. That creates a windfall for investors funding projects that they might have funded anyway.

“It’s not going to make something feasible if it was infeasible to begin with,” said Paul Silvern, partner in charge of the Los Angeles office of the real estate consulting firm HR&A Advisors. For some projects, he said, “this is just icing on the cake.”

There’s no official count of how many Opportunity Funds exist, nor how much money they’ve raised; the Treasury Department has so far declined to do any such tracking and a bill introduced by Booker and Scott to require it hasn’t yet passed. A running tally by the real estate consulting firm Novogradac puts the number at 134, and it captures only those that have been publicly announced — most of which are raising enormous sums to deploy in a basket of projects. The largest known fund, run by LA-based CIM Group, is looking for $5 billion.

On their websites, the fund managers advertise potentially lucrative investment opportunities like industrial warehouse spaces, data centers and vacation rentals. Defenders of the program often say that investment is inherently good for communities, regardless of what it’s for, because of the jobs they create and ancillary businesses they might foster.

Alex Bhathal’s family co-owns the Sacramento Kings basketball franchise, for which they developed a stadium and sports district in downtown Sacramento. He’s now running a fund called RevOZ Capital, and said he is vetting a pipeline of more than 100 possible deals all over the country.

“If you believe that markets work, then deploying capital in such a way that makes a successful project by definition means that you are improving the community,” said Bhathal. “The increase in economic activity, the increase in tax base, does have a multiplier effect.”

Effie Turnbull Sanders runs the South Los Angeles Transit Empowerment Zone, which is hoping to attract funding for affordable housing, pharmacies, grocery stores, childcare centers and sit-down restaurants that serve locals.

Plenty of people are skeptical of that assessment, though. At the moment, high-end housing is already displacing long-term, mostly African-American residents in neighborhoods like Crenshaw. In the census tract that covers its commercial strip, the median household income is less than $22,000 and 1-in-4 households receive food stamps, but in the wider neighborhood the average home value has risen from $366,000 in 2012 to $852,000 last month, according to the real estate website Zillow. The late rapper Nipsey Hussle had been planning his own Opportunity Fund that would source capital locally and do projects of interest to the community, according to the Los Angeles Times. Hussle was gunned down in late March.

Effie Turnbull Sanders is the executive director of the South L.A. Transit Empowerment Zone, a consortium of local nonprofits that won an Obama-era contest for extra help with economic development priorities like job training, small business investment and crime prevention. About half the geographic area her group covers now falls into Opportunity Zones, and they’re organizing to pull capital into affordable housing, pharmacies, grocery stores, childcare centers, and sit-down restaurants that serve locals. Without community involvement, she worries that outside investors will flood the neighborhood looking for only the most lucrative deals.

“We’re hopeful that with our efforts this could support our goals and residents’ interests,” Sanders said. “But without guardrails, it could be potentially devastating.”

‘We can’t afford to be cynical’

States and localities can’t create much in the way of guardrails for Opportunity Zones. The 2017 federal law on which the zones are based provided for only minimal local oversight of projects, and neither party in Washington seems interested in amending it. But they’re still trying to make the best of it.

One strategy: Sweetening the pot for particular types of projects by pouring additional tax breaks on top of the federal incentive.

Maryland, for example, extended a large slate of tax breaks to Opportunity Zones and allowed localities to slash property taxes for projects on vacant lots. Alabama passed legislation that would deepen tax benefits for tech companies and grant tax breaks for projects that underperform expectations in order to “de-risk” investment in marginal areas. Many states also subsidize Opportunity Zones indirectly, since their laws conform to federal tax rates, either automatically or by act of the legislature.

Still, no amount of tax forgiveness will get a deal done if investors don’t know the specific opportunity exists, and many investors are not used to working in distressed communities. That’s why local governments and nonprofits are also trying to surface investable projects, and speed their progress forward through thickets of zoning approvals.

Michael Banner, of the Los Angeles Local Development Corporation, has watched economic development programs come and go for decades.

Dozens of cities, for example, have created investor prospectuses with all the available properties in Opportunity Zones, and ready-to-go projects that just need capital to get moving. Los Angeles is in the process of creating one, and Deputy Mayor for Economic Development Billy Chun pledges to work with developers to ease the cumbersome entitlement process for projects on the list.

“We have no way to dictate what they do,” Chun said. “We just have to put it out there, to try to make it easier for investors to do affordable projects, rather than market rate. If we set the narrative with the private market, and really showcase, ‘This is the right way to do things,’ meaning talk to us, work with us, there’s a value add that we can help with.”

Investors may turn their attention to such projects after making it through their first round of low-hanging fruit. But Michael Banner, who has watched economic development programs come and go in Los Angeles for decades and now runs the nonprofit Los Angeles Local Development Corporation, doubts that the Opportunity Zone designation will overcome pervasive caution about truly marginalized neighborhoods.

“Is the amount of incentive that I’m going to get enough to make me adjust my investment criteria, to say I’m covered for the additional risk?” said Banner, who is seeking Opportunity Fund investment for a small office project in Lincoln Heights. “I’m not so sure, from an institutional standpoint, that that’s enough.”

What really tends to spur private investment, Banner thinks, is public investment — like renovating parks, building out light-rail systems, and planning large university and hospital campuses that tend to depend heavily on federal and state funding. “It’s hard to get private investors to show up without someone priming the ground,” he said.

By reducing both federal and local government tax revenue, the California Budget and Policy Center worries that Opportunity Zones will only make those public amenities harder to pay for. Meanwhile, the Trump administration has advertised Opportunity Zones as a holistic replacement for government subsidies. For example, Secretary of Housing and Urban Development Ben Carson told a congressional committee in April that maintenance funds weren’t necessary for hundreds of thousands of public housing units because they were located in the favored Census tracts, which would draw in private investment.

Houses line the street in the Crenshaw neighborhood of Los Angeles.

There may still be a role for government in steering investment towards projects that wouldn’t otherwise get it: Creating publicly-run Opportunity Funds. California Senate Majority Leader Robert Hertzberg, who represents the San Fernando Valley, would like the state itself to raise private capital and deploy it to desirable projects, especially those that are a priority to a local or state agency, that will still generate a reasonable return.

Barring that, Opportunity Zone advocates point out examples of the tax break prompting local banks, companies and high-net-worth individuals to invest not in far-off metropolises, but rather in their own backyards. They know that not every project will be a paragon of community impact, and that plenty of investors will get richer by claiming the tax break on projects they would have funded even without it.

But the tax break is not going away, they point out, and the outcome will depend on people working diligently to channel private capital into places it might not go of its own accord.

“We can’t afford to be cynical,” said Kunal Merchant, president of an advocacy group for California Opportunity Zones called CalOZ. “The need is too great for people to cross their arms, raise their eyebrow, and say ‘this isn’t working.’ This is a new way to get oceans of capital into places that really need it.”