Interview with Albany Law School’s Edward De Barbieri
OZ Laws Need Reform, Says Author of Paper in Yale Law & Policy Review
Click here to read De Barbieri’s Paper in the Yale Law & Policy Review
TRANSCRIPT
TED: But one thing that is consistent is the government is giving away public money to private hands without in many cases knowing exactly what the public is getting back.
ILONA: Sounds like a recipe for graft.
TED: It’s certainly a challenge.
ILONA: Hello, and welcome to All Things Hudson Valley. My name is Ilona Ross. It’s a pleasure to hear from a law professor who focuses on Opportunity Zones and other tax giveaways that put money in private pockets but may not do much for the community. These questions are timely in the city of Kingston, where developers are asking for a $27 million dollar property tax break for their luxury housing project – on top of the millions in tax breaks available to Opportunity Zone investors. This professor recently authored an article called “Opportunism Zones” that appeared in the Yale Law and Policy Review. It is linked in the bottom of the transcript. This podcast was recorded on Monday, November 2, 2020.
1:24
TED: My name is Ted De Barbieri. I’m on the faculty at Albany Law School in the Capital District of New York State. I’m an associate professor of law, and I direct our Community Economic Development clinic, which is part of the Justice Center at Albany law school.
ILONA: You also have a degree in divinity. How did you come to go to law school and how did you come to be in Ireland? You’ve been all over the place.
01:47
TED: My career path led from an undergraduate in humanities. I focused in philosophy. I chose Yale Divinity School because I was able to do an interdisciplinary Master’s in religion, with a focus on Christian social ethics, which was a great foundation to understanding Community Economic Development. A Community Development clinic gave me the chance to understand the laws and regulations designed to bring capital to communities where capital had fled. So this was a formative experience at the time. We were working to charter a community development financial institution or community bank. So it’s really at that time around, 2004-2005, that I got a passion for the law related to Community Economic Development, which led me to pursue law school. During law school I was looking around at different models for Community Economic Development. Ireland has robust co-operative ownership, both with respect to financial institutions through credit unions where three quarters of the country has a savings account at a credit union. That’s in the Republic of Ireland. I did some research on the Irish cooperative economy, and was lucky when I graduated law school to start in legal services providing transactional, which is everything that doesn’t involve going to court, services to community groups and individuals, mainly in New York City. As the foreclosure crisis happened following the Great Recession I learned how to litigate too in defending homeowners against foreclosure. Around 2014, I started teaching full time, first at Brooklyn law school, actually initially at NYU School of Law as an adjunct. Around in 2014, I went full time teaching, first at Brooklyn law school, and then a position opened up at Albany, which is where I am today.
03:50
ILONA: Many economists oppose tax giveaways such as PILOTs and Opportunity Zones because they’re unfair to other businesses. That’s one viewpoint, and it’s wonderful to balance it out with a social ethics perspective. I told Ted that his article should be required reading, because from what I’ve seen, our local legislators either don’t realize what they’re up against, or they’re in the pocket of local kingpins. One thing I noticed when I read your article, you were saying something about CDBG grants, Community Development Block Grants. There has been silence from recipients of CDBG grants. I think they’re afraid to to put at risk their future grants if they speak out against this Kingstonian development, because the mayor is for it, and the mayor is the one who doles out the CDBG grants. This particular project this Kingstonian, really fits into, you know, every problem you’ve identified in the Opportunism Zones. This Kingstonian came into being sort of at the same time the 2017 tax bill was going into effect. I have to wonder if there wasn’t direct lobbying on the part of one of the developers or two of the developers or more of the developers. Your issue of silence, of lack transparency is a big one also. There have been reports that a local alderman is invested in this project.
5:20
TED: Okay, so the Opportunity Zone as you point out came about as part of the Tax Cuts and Jobs Act of 2017. The TCJA was a Republican-passed tax cut which is important just to point out. The Investing in Opportunity Zone Act was initially proposed as a bipartisan piece of legislation. Senator Cory Booker, being a Democrat, New Jersey, Tim Scott, R-S.C., were among the initial sponsors of the bill. It ended up not being bipartisan in terms of getting passed with the tax cut and some changes had been made to it as it was adopted. So, essentially, the Opportunity Zone, put plainly, allows investors who have capital gains, so if you if you sell an asset like a piece of property or some stock, and the asset has appreciated, then the tax that’s owed is what’s called a capital gain. So, the Opportunity Zone allows individuals who have proceeds from the sale of an asset that’s appreciated to invest the proceeds of that sale into what’s called a Qualified Opportunity Zone. If this sounds complex it is. And if you think that only a small portion of the population actually has capital gains, you’re correct. A profound minority of the population actually have capital gains. You have to be wealthy to begin with to have capital gains for which you are looking to reduce the tax liability. The idea is that, at least as articulated by the sort of the theoretical founders of the Opportunity Zone, Sean Parker who was involved in Napster, who was one of those individuals, and the idea is that there’s funds sitting inactive in investments that aren’t actually doing something useful. But it’s individuals who have enough money to have significant enough tax liability to seek to reduce both federal tax liability as well as state tax liability. And there’s a whole cottage industry of attorneys and tax advisors who can tell investors what they need to do in order to ensure exemption, but that’s exactly the idea. So you pay less in taxes for investing in the project, you are able to get what’s called stepped up basis. Commercial real estate is so desirable as an investment because if it’s sold after the holding period, it’s possible to avoid capital gains on the initial sale, but then also avoid capital gains on the sale of the asset, especially if it’s appreciated. So that’s sort of the double whammy of the tax benefit to the investor. And on the flip side, it’s the subsidy both from federal government and from the states, in order to incentivize those investors to invest in projects like the one that you’re talking about in Kingston.
8:50
ILONA: Charts from the St. Louis Fed show that since the mid 90s multifamilies have been appreciating at a good clip. In fact, their prices double every ten years. This means that the Kingstonian could be worth 120 million in ten years or 240 million in 20 years. And any profit will be tax free.
ILONA: So the one in Kingston. Apparently the Opportunity Zone inducements, or the Opportunism Zone inducements, as you call them, they’re not enough for these developers. They’re also asking for a property tax break. They started out asking for a $30 million property tax break, and now they’re asking for a $27 million property tax break. And that means that they would pay $5 million in property taxes over 25 years, and they would be exempted from 27 million in property tax breaks. And this on top of the Opportunity Zone tax exemption. What’s wrong with this picture?
9:42
TED: I mean I think that’s a great question. So the the particular project that you’re describing, and the tax exemption stacked on top of the Opportunity Zone is not uncommon. So across the country, developers layer tax incentives. So, both local property tax, sales tax exemption for purchasing materials. So it’s certainly not uncommon for developers to take this approach of using all available tax incentives. It’s not for me to say what is fair or what is not fair. But what I can say is the public should know what you’re talking about. So we should have some sense of what taxpayers are giving up in exchange for what we’re getting. And I think part of the challenge with the Opportunity Zone incentive is that it’s difficult to quantify the public subsidies that are being extended and to square that with the economic benefits that are accruing to the public. We can make our best guesses and certainly the developers of the Kingstonian have their consultant materials talking about the economic benefits. I think it should just be simpler to know, and one of my primary critiques of the Opportunity Zone is lack of transparency in terms of the process, very little participation, no participation requirement in terms of being able to use the Opportunity Zone, and no restrictions on usage of the particular project. So, you know, I know in this case there’s a parking garage that is being included. Hopefully it gets used, right? Hopefully that’s something that is necessary.
11:19
ILONA: That’s actually very debatable. The developers say that the garage is going to have 420 spots with 277 available for the public. But there’s already a parking lot with 138. So take that away, and you have 139 new spots. But if you follow code, it actually turns out that there’s going to be a loss of spots. And the best guess is that there’s going to be at the most 24, maybe 30 new spots available. So when you talk about what the developers show in terms of the economic benefits, I recently interviewed a free market economist, and he pointed out that through alchemy, costs to the developers are transmogrified into benefits to the community. So, whatever they have to spend money on is transformed as if by magic into a benefit to the community. Yeah, they have some pie in the sky predictions that there are going to be hundreds of thousands of tax dollars flowing through the community and there are going to be jobs created. Apparently, these predictions do not always turn out to be true. As a matter of fact, they seldom turn out to be true. And another interview I did with a George Mason economist found that a lot of times these economic incentives lead to less well-being in the population.
12:45
TED: The challenge is to figure out what does a developer actually need in terms of a public subsidy, in order to go forward with the development. From my perspective, the calculus, or the equation shouldn’t just be, you know, how much can the developer seek in terms of public subsidies, but rather sort of the opposite, what’s the minimum dollar amount needed for the developer to go forward and do the development. My personal perspective is not anti-growth, but I think we need to know the public is receiving something fair or equitable for what it’s giving up in terms of tax revenue forwent, and it’s really difficult to make that determination, especially with a program like the Opportunity Zone where there’s no reporting requirements, um, we won’t know for the amount of the investment that is coming from Opportunity Zone, let alone the other local incentives, like the PILOT, like the, or you know, additional incentives offered through the IDA. So I think communities across the country are dealing with these issues. New York and the Hudson Valley are not unique. What’s experienced locally, I think, is a symptom of what is experienced nationally. The movement to get developers to agree to community economic benefits or the sharing of community economic benefits is one way that community has attempted to negotiate benefits from developers up front. The Opportunity Zone is perhaps the most extreme place-based economic development strategy where government has had a total hands-off approach. One caveat about the Opportunity Zone is, we can’t forget that there is a market out there and the market for a project six months ago or 18 months ago or two years ago is likely not the same as the market is today, especially in light of the pandemic and the catastrophic impact that it’s having on small businesses, including in hospitality. I can’t imagine that the sponsors of the project and the developers have the same perspective or at least the same modeling now as they did previously.
14:55
ILONA: Believe it or not they’ve increased commercial real estate, in other words, stores, from 8,000 square feet to 9,000 square feet. They’re still including the 32-room hotel. Maybe they’re counting on the fact that Ulster County apparently has the fastest appreciating real estate prices around the country. I don’t know what they’re counting on, but we have empty stores throughout Kingston and throughout Ulster County, one one empty store after another. So I, you know, it beats me. One of the developers is in hospitality, and he may be suffering big time. The other developer owns the land and he owns a mall. He’s got a couple of vacancies in his mall. Another thing I wanted to ask about was your J-shaped hockey stick curve. Now I’m used to seeing J-shaped hockey stick curves in conjunction with coronavirus transmission in the pandemic. I’m not used to seeing it in a real estate context. Is it true that real estate could appreciate that fast? And why is so much money flowing into real estate? Is that because banks want it?
16:02
TED: You asked about the, the J shaped nature of the Opportunity Zone. So the Opportunity Zone incentive is maximized when the initial market value of the project is low, and then it appreciates rapidly. If you hold an asset for 10 years it remains low, and then it drastically appreciates in value, then the appreciation in value is captured by the investor. And then if there’s a sale, then the investor doesn’t have to pay tax on that appreciation, so that’s sort of why the J. You know if you start low, and then…. I’m talking to you on the telephone and I have my right hand is sort of making a J shape and increasing. If there’s an increase in the fair market value, the investor gets the value of that increase and then also gets tax benefits by not having to pay tax on the sale. That’s just a feature of the Opportunity Zone program.
17:00
ILONA: So that might fit here because the construction cost is about 60 million, the valuation for tax assessment purposes is 19, so they use the income valuation method, that’s 19 million. But let’s say after 10 years if they sell condos, with 143 apartments, let’s say the average price is, I don’t know, $300,000, that could net them a good $50 million. That’s definitely J-shaped.
17:34
TED: Right, most likely the developers of the Kingstonian are soliciting investment dollars from outside investors. So one question is, who are the investors? It’s hard to know.
ILONA: Well we don’t, we don’t know that because they, they’re not identifying them. A lot of the county legislators and the school board, and the city councilmen, they do not know the names of the individuals who are invested in the LLC, and there’s been a rumor flying around, you know, for years now, that one of the aldermen is invested in the LLC and that he actually ran simply to promote this project. There could be other local worthies who have an interest in it because, you know, there could be other local hotel owners who were given a piece of the pie just in case their boutique hotel suffered. We don’t know. We know that there’s supposed to be a $9 million cash investment. And there’s a $43 million dollar mortgage.
18:29
TED: At least with respect to the Opportunity Zone investment, there’s no requirement that the investors disclose names of investors in the Qualified Opportunity Fund. There’s no requirement that they disclose other information like the value of the investment, etc. which is getting to the piece about reform. Senator Scott, and others have… There are a number of proposals in Congress to reform the Opportunity Zone. There’s also some proposals to expand it to provide additional COVID relief to small businesses. We’re recording this the first week of November before the election. I think whoever wins we’ll likely see some changes to the program going forward but unlikely before the end of 2020 to see any changes.
19:20
ILONA: Let me ask you a little bit about disgorgement. So let’s say that a developer lobbies the governor to get a certain area where he wants to build something designated an Opportunity Zone. Is that by itself grounds for disgorgement?
19:37
TED: So disgorgement is a remedy. Legal remedies typically have to do with something in the statute, equitable remedies have to do with doctrines or equitable doctrines. Disgorgement is an equitable remedy. I talk about it in the paper as a possible theory upon which the public might recover benefits or subsidies extended. It’s a theoretical approach to a scenario where investors should not have received benefits. So it’s certainly not in the text of the bill, and it’s not something that I think is even proposed in any of the proposals currently in Congress, but I find it an interesting idea to explore. This is why I include it in the paper. The way you raise it was in the context of zone selection and the way that Opportunity Zones were designated was the US Treasury said to the governors, and the governors could either delegate the designation process to their economic development agencies or to other offices. And in some instances, individuals or companies lobbied for a designation of particular census tracts.
Only 25% of census tracts in a state … or deserving census tracts could be designated Opportunity Zones, so there was significant competition. In a number of cases, Detroit, Nevada or some, some areas of New York City were highlighted, because there were instances where there was significant lobbying by landowners. The easiest remedy for designation is to de-certify or de-designate the zone, if it should not have been included in the designation from the start, because it didn’t meet the definition. In some instances, zones were designated that arguably should not have been. So I think that the remedy there should be just de-designate the zone. Investors ought not get benefits for zones that didn’t qualify.
21:43
ILONA: Well in Kingston, we have basically a tale of two cities and we have a split population which is I guess happening everywhere across America. And now we’re being swamped with people coming up from New York City. And, you know, these are well-off, prosperous people. I mean I guess that’s always happened to an extent, but the divide is really really severe right now. Do projects such as these increase inequality?
22:09
TED: So, with the Opportunity Zone, it’s, it’s early. It’s a ripe area to explore the, what happens when the government subsidizes these particular projects. it can be difficult to identify one particular tool as having a particular impact because there’s so many at this point. There’s Job Creation Tax Credits, which garnered significant attention around the Amazon second headquarters, where states and cities spend public subsidy in order to attract headquarters or influence business location decisions. And there’s other incentives too, like, the Opportunity Zone or New Markets tax credits, there are state-based, place-based tax incentives too. So there’s a number of different types of incentives and isolating one is very difficult. But one thing that is that is consistent is the public or the government through the government is giving away public money to private hands without in many cases knowing exactly what the public is getting back.
23:16
ILONA: Sounds like a sounds like a recipe for graft.
23:20
TED: It’s certainly a challenge. I think, you know, by contrast, a program like the Low Income Housing Tax Credit, which is a federal program that was put in place in 1986, we can quantify what the results were. Even a program like that will have shortcomings to in terms of where housing is created, but there’s consensus among the development community, I think, that the Low Income Housing Tax Credit, which is a supply side incentive, has created over three million units of affordable housing, is the most successful development program or tool that exists today. But the uses are very defined. Invested funds need to be for affordable housing versus a tool like the Opportunity Zone where, as you can see with this project or others, there’s really no limit to what can be invested, but we don’t actually know that the public’s getting what it needs, for instance, which I think is what you’re articulating.
24:18
ILONA: This project … out of 143 apartments, 14 of them are designated workforce housing, and they are destined for residents with incomes anywhere between 60 and 110% of AMI and it certainly leaves out an awful lot of people in Kingston who could not afford to live there. And then on top of it, when I when I looked at who they’re planning on hiring, their contractors do not even pay prevailing wage. Their contractors will be paying what’s a so-called livable wage for one person, which is, you know, maybe 20 bucks an hour or something like that. And on Sept. 19, the developers told the Industrial Development Agency that the true number of jobs they themselves could promise was 14, of which all but one would pay $15 an hour. So, you know, is it what is it what people need? What would you, what would you like to see happen if you were king for a day, what would you do?
25:20
TED: Yeah, that’s a good question. I, I think we need to incentivize development where we need it and the sorts of types of development that we do need. Part of what I spend my time thinking about is current tools that are available at law, and their shortcomings, of which there are many. One question you asked earlier is, why the emphasis on commercial real estate over, you didn’t, you didn’t say it was sort of over small business investment, but the intent behind the Opportunity Zone was to invest in business. We’ve seen the flood of dollars to commercial real estate because of the benefits of assets that appreciate like commercial real estate. It’s also reflective, I think, of the desire among investors to have conservative investments. Investing in a building is seen by many as more sound and less, less risky than investing in a company, especially a small one. So if I could wave a magic wand, I would rewrite the bill to include more use restrictions on the funds, either for uses like affordable housing in the context of commercial real estate, community facilities, health care facilities, daycare facilities, projects that perhaps need government subsidy. The New Markets tax credit is one of those programs that certainly has a portion of commercial real estate in the mix of uses that are allowable. Interestingly, a conference at the last week of October 2020, the overwhelming majority of developers using the New Markets Tax Credit, which is a 1990s-era federal government tool, the majority of developers indicated that their greatest demand is for community facility use at this moment during the pandemic.
27:01
ILONA: With community facilities, don’t you have to go there? Doesn’t that mean a lot of people are going to one place?
27:08
TED: So, community facility use, I think things like health clinics, I think things like daycare facilities for either essential workers or for people who need to work from home. Yes, it’s physical space, but it’s not brick and mortar retail. It’s some type of use or activity that is probably not going to see significant appreciation of the, of the asset, but will be something essential that is needed, either related to education, health, or some other project that’s essential.
27:35
ILONA: that fits in with a Bloomberg article that Tim Scott and Cory Booker expected a three to 7% rate of yield rate of return on their investments and instead, everybody’s getting between 12 and 16% with market rate housing. Do you subscribe to the notion that housing is a human right?
27:53
TED: Is housing a human right? I think it’s a great question. It’s certainly a human need, right? It’s 32 degrees and windy outside my window where I’m recording this right now. I have two children, they’re four and two, I have a wife and we need to live somewhere, and my kids needs to go to school. They go to preschool right now. So, is it a right? In the United States, we don’t frame housing as a human right, right now. Will it always be that way, or is that right? I don’t really know. I think it’s a bigger conversation. But is it a human need? Absolutely. When families, or individuals or families don’t have access to housing that’s affordable, then everything in their life falls apart. You can’t send your kids to school, and schools only get reimbursed when students attend. So if you get evicted, that has ramifications both for your children, it has ramifications for your school and for your city and for society if we don’t have students who are able to get educated. There’s healthcare issues, especially these days. I did research with four other professors, mainly tax law professors, about the limits of the CARES Act and making suggestions for immediate interventions to address and mitigate housing instability during the pandemic. So from my perspective, housing is absolutely a human need and we should treat the deprivation of housing as an essential need being taken away. I believe in a right to counsel for individuals that are either being foreclosed on or evicted, because I think the loss of housing is that significant in terms of its disruption and cost to society. And there’s economic data to support. For instance, investing public dollars in a right to counsel for individuals who are being and families who are being evicted or foreclosed upon.
32:54
ILONA: What would you advise our government officials to do, our local officials, our county legislators, our city councilmen, and the school board with respect to looking at the Opportunity Zone component of the Kingstonian?
33:08
TED: I think if the government is interested in an economic development strategy that takes advantage of the available tax incentives, then they’re foolish not to consider Opportunity Zones. Here’s a problem, though. We’re competing with every other jurisdiction where there are designated Opportunity Zones. Put yourself in the mindset of an investor for a minute. You’re going to chase the highest return possible. So, from the perspective of government, Kingston is not only competing with Kingston. Kingston is competing with Albany, Troy, New York City, Los Angeles, Denver, Portland, Oregon and sort of every other major metro region of the country. So, to some extent the Opportunity Zone tool pits state and local government against each other and in doing so, government is in a position where it arguably has to deliver the greatest subsidy possible to attract developers. That’s certainly the government argument.
31:02
ILONA: That’s a race to the bottom
31:04
TED: I agree. I think that’s right. In fact, we’ve seen that in the case of Job Creation Tax Credit programs. That’s why a company like Amazon can put out a request for proposals and get 239 proposals from cities and towns across the country, just, you know, waiting to throw dollars at them. I know you’re not asking about Amazon, but Amazon was gonna move to New York City anyways, and they are you know they’re there, Google’s there. So what I’d say to folks in Ulster County, and in Kingston is, you ought to be invested in, not just the appearance of legitimacy, but in a legitimate process. Here’s what developers are going to say. Developers are going to say that well, there’s already significant process, both with respect to the IDA and in terms of, I have to believe that they’re that they need some type of zoning. And developers will bemoan, you know that the not in my backyard or the NIMBY opposition. Frequently there’s vocal opposition from neighbors. In terms of this project I don’t know enough about who’s against it but the important question is well what we’ve been talking about for the last hour is, well, what’s the fair exchange? Is the extension of subsidy legitimate in this instance? What do constituents need to know and to feel good about the investment that the government is making? And I think all local government elected officials, as well as those who are who are hired by them, should be invested in that process.
32:32
Thank you very much, Ted. This was this was simply wonderful, this was great. I’m going to send your article to every single legislator around here it’s really really beautifully done.
ILONA: An article in the Hudson Valley Vindicator entitled “Opportunism Zones: Developers Could Shoot the Moon” shows the chart from the St. Louis Fed and also references a recent comparable multifamily sale. These numbers support the likelihood that the Kingstonian’s sale price could top $120 million in a decade and $240 million by the time the PILOT ends. If you support the project but reject the pittance that the developers are offering, one solution could be to tie future tax payments to the Kingstonian’s sale, because by law it must be sold before Dec. 31, 2047.
I hope you have enjoyed this podcast, and thank you for listening. In the meanwhile, stay safe.