Why Chicago's opportunity zone program is lagging other cities

CRAIN’S//Danny Ecker

After spending 18 months evaluating some 750 potential real estate developments in low-income neighborhoods around the country, Craig Bernstein is finding viable projects to bet on. Just not in Chicago.

His Washington, D.C.-based private-equity fund is backing a new $45 million mixed-use complex near an upscale shopping center in Charlottesville, Va., its first foray into opportunity zones—areas designated by a two-year-old federal program meant to revive poor communities. It's eyeing others in cities like Nashville, Tenn.; Columbus, Ohio; Portland; and Austin, Texas.

Bernstein has kicked the tires on deals in Chicago's opportunity zones, too. "But at this point we've been hesitant" to fund them, he says. "Our goal is to find what we believe are the best of the best."

His approach highlights a major critique of the opportunity zone program and an obstacle Chicago's most depressed neighborhoods need to overcome to take advantage of it. The incentive allows investors to defer or avoid taxes on capital gains if they redirect those profits into any of the roughly 8,700 designated zones nationwide.

Investment firms have formed more than 300 funds that have collectively raised over $7.5 billion to date to deploy into those blighted areas, according to surveys by San Francisco-based tax advisory and consulting firm Novogradac. That doesn't include money privately invested by high-net-worth individuals and corporations that could double or triple that total, the firm estimates.

But convincing those investors to funnel that money to Chicago's zones—which are mostly in areas of extreme need on the city's South and West sides—has proven to be difficult. Many funds are gravitating to other markets whose zones are in areas that don't need a tax incentive to fuel development.

"I think many investors recognize Chicago is probably at a slight disadvantage compared to some other communities across the nation," says Bob Tucker, chief operating officer of the Chicago Community Loan Fund, which provides low-cost financing to community-focused developers for affordable housing and other economic development efforts.

Many economic development advocates predicted the vast disparity among opportunity zones, which states designated based on different criteria using 2010 census data. Those figures might have shown a neighborhood that was blighted back then and qualified for the program, even if it had been gentrified since. A luxury residential tower in downtown Houston qualifies, for example, as do new offices and luxury condos in trendy downtown Portland.

Most of Chicago's 135 zones, meanwhile, are in neighborhoods with lingering high unemployment and poverty rates like Englewood and Auburn Gresham. It's especially difficult to lure tenants to real estate developments in neighborhoods like those, making them more expensive to finance and not as attractive to some opportunity zone fund operators who can find less complicated deals elsewhere.

To attack the problem, Tucker recently organized the Chicagoland Opportunity Zone Consortium, a coalition of community-focused developers, nonprofits and financial institutions as well as city, county and state officials. The group won funding and other support from organizations including the MacArthur Foundation and the Chicago Community Trust to launch an online platform to help local developers connect with opportunity zone investors. The idea is to paint a more detailed picture for fund operators about neighborhood development prospects, other available public subsidies and helpful initiatives such as Mayor Lori Lightfoot's new INVEST South/West program that prioritizes investment in blighted corridors in 10 Chicago neighborhoods.

"You can go invest $2 million in a 57-story office building in downtown Houston, but how do we attract you and others to invest that in a longer-term project in Englewood?" Tucker says. "It's all about facilitating connections."

Some local projects have recently been announced: One Chicago-based opportunity zone fund is partnering with local apartment developer Cedar Street on a $65 million residential building in Pilsen; another fund is teaming with Chicago-based DL3 Realty to redevelop the dilapidated Washington Park National Bank Building in Woodlawn; and in Jackson Park, Chicago-developer North Wells Capital has paired with Byline Bank to renovate a functionally obsolete apartment building.

Still, those projects are far smaller than what developers have announced elsewhere. Data is scarce about how much money investors have put into opportunity zone projects, and where. But property sales within the zones suggest Chicago isn't gaining as much traction with funds as other major markets.

CHALLENGES

Sales in Chicago-area opportunity zones in 2018 and 2019 totaled $952 million, according to research firm Real Capital Analytics. While the 2019 figure was 39 percent higher than 2018 sales—indicating a boost in local opportunity zone investment—the two-year total still ranks 29th out of the top 50 largest metropolitan areas by opportunity zone sales volume. That figure is on par with cities where property values are generally lower such as Raleigh-Durham, N.C.; San Antonio; Nashville, Tenn.; Norfolk, Va.; and Cincinnati. Markets including Houston, Miami and Portland, Ore., have seen three or four times Chicago's transaction volume during that period, Real Capital data shows.

Other Chicago factors make it tricky for some funds to justify projects, such as dwindling population and city and state fiscal uncertainty. Plus, fund operators point out it's a challenge to put together any real estate deal that makes financial sense so deep into an economic growth cycle, let alone ones in unproven locations.

"There's an inherent tension in wanting to get market returns in neighborhoods that are historically disinvested because the fundamentals aren't strong enough to generate the kind of returns that you want to see," says Rob Rose, a longtime advocate of community development in Chicago and executive director of the Cook County Land Bank Authority, which helps revive tax-delinquent houses. "The hope was that (opportunity zones) would help break that cycle, but I think it's fair to say these investors are proving that's not the case."

One route that may prove more effective for Chicago's South and West sides is working with local banks and corporations that also want to take advantage of the program. Looking for a way to spend capital gains close to its hometown, Northbrook-based Allstate is financing a new warehouse in an opportunity zone in Pullman. And Fifth Third Bank last month announced a $20 million commitment to Chicago's opportunity zones.

Banks can target projects in especially downtrodden opportunity zones to help meet their obligations under the federal Community Reinvestment Act, which requires a certain level of investment in low- and moderate-income neighborhoods where they operate.

"That avenue is there, and I think Chicago will be benefited by it," says Dan Cullen, chairman of the tax practice in the Chicago office of law firm Baker McKenzie, who works with several opportunity zone funds. He says his clients are considering Chicago projects just as much as those in other markets, but that local banks are already familiar with the dynamics of the area.

"There are opportunities they're already looking at," he says. "This just makes it even more compelling."