Opportunity Zones: Aligning Public and Private Capital
At the end of 2017, a potential $6.1 trillion in unrealized capital gains was available for reinvestment.
Throughout the U.S., unrealized capital gains have significant tax implications with enormous potential. Unrealized capital gains occur when the value of an asset has gone up on paper, but has not yet been sold for a profit. Taxes are triggered once the asset has been sold.
Investors can offset or defer these taxes in a few ways, including one new strategy: investing in opportunity zones.
Today’s infographic from Bedford Funds explains what opportunity zone funds are, their core benefits, and their potential impact across the country.
What is an Opportunity Zone?
Opportunity zones are U.S. Census tracts whose citizens experience economic distress.
Originating in the 2017 Tax Cuts and Jobs Act, they offer the potential to connect long-term capital with low-income communities across the country to drive return and impact.
How are opportunity zones chosen? The initial base is low-income census tracts, which have:
- Poverty rates of at least 20%; or
- Median family incomes lower than 80% of the surrounding area
The state’s governor or chief executive then nominates up to 25% of these areas as opportunity zones. Nationwide, a total of 8,700 opportunity zones exist, and 7.9 million of the areas’ residents live in poverty.
Overall, 35 million people live in these opportunity zones. There are a number of disparities between opportunity zones and notional averages across key variables:
|Poverty Rate||Median Family Income||Education*|
*Adult with Bachelor’s degree or higher
It’s evident these cities could benefit from increased investment.
What is an Opportunity Zone Fund?
An opportunity zone fund (OZF) is an investment vehicle that provides tax benefits for private capital to help revitalize economically distressed communities. Both operating businesses and real estate are eligible for investment.
Many investor types may take advantage of opportunity zone funds:
- Corporations– Also includes partnerships
- Accredited investors– Defined as high net worth individuals, brokers, and trusts
- Nonresident foreign investors– Only on capital gains earned in the U.S.
- Retail investors– Through funds that have lower minimums, though options are more limited
In addition to their wide eligibility, OZFs have a number of potential benefits.
Tax breaks on capital gains can be organized into three tiers:
- Initial Tax Deferral– Once the previously-earned capital gains are channeled into a qualifying OZF, federal tax is deferred until December 31, 2026 or the date the investment is sold— whichever comes sooner
- Step-Up In Basis– 10% of the original capital gains will be excluded from federal taxes if an investment is held for five years
- Capital Gains Tax Exclusion– Federal tax on capital gains earned within the OZF is 100% eliminated if an investment is held for 10 years
All things being equal, OZFs realize after-tax outcomes that are over 40% higher than a standard portfolio investment. For example, the potential after-tax value of a $100 investment after a 10-year holding period would be as follows.
|Initial Investment||Net after-tax value|
|Standard portfolio investment||$76.20 ($100- 23.8% capital gains tax)||$132.36|
*Note: assumes long-term federal capital gains tax rate of 23.8%, no state income tax, and annual appreciation of 7% for both the OZF and alternative investment.
While it takes a few years to realize these tax benefits, OZFs have long-term horizons to encourage sustained investment with a lasting impact. The result is the potential for sustainable and equitable wealth creation.
Although real estate investments have captured significant attention, recent regulation has clarified that operating businesses are also eligible OZF investments.
By investing in businesses, OZFs can have a direct impact on economic growth and job creation.
Ultimately, OZFs have the potential to catalyze collective impact through their scalable operating company and real estate investments. Working directly with community leaders, OZFs can help drive long-term rejuvenation from within, versus gentrification from outside forces.
Opportunity zone funds are projected to raise $44 billion in capital designed specifically to invest in this future growth.
How to Avoid Common Mistakes With Mining Stocks (Part 3: Jurisdiction)
“Location, location, location…”
This famous real estate adage also matters in mining. After all, it’s an industry that is all about the geology—but beyond the physical aspects and the location of a mineral deposit, there are also social and environmental factors that create a mining jurisdiction.
Common Mistakes With Jurisdiction
We’ve partnered with Eclipse Gold Mining on an infographic series to show you how to avoid common mistakes when evaluating and investing in mining exploration stocks.
Part 3 of the series focuses on six signals investors can use to gauge a company’s preparedness for the jurisdictions they operate in.
#1: Geological Potential: Methodical Prospecting or Wild Goose Chase?
It all starts with a great drill result, but even these can be “one-off” anomalies.
Mineral exploration is a methodical process of drawing a subsurface picture with the tip of a drill bit. A mineral discovery is the cumulative effort of years of research and drilling.
The key to reducing this geological risk is to find a setting that has shown previous potential and committing to it. Typically, a region is known to have hosted other great discoveries or shares a geology similar to other mining districts.
Signs of Methodical Prospecting:
- Lots of geological indicators
- Potential for further discovery
- Sound science
#2: Legal Environment: Well-Paved Path or Minotaur’s Maze?
Now that you have identified a region with the prospective geology you think could host a discovery, a company will have to secure the permits to explore and operate any further.
However, a management team that cannot navigate a country’s bureaucracy will face delays and obstacles, costing investors both time and money.
Without clear laws and competent management, a mining company’s best laid plans become lost in a maze with legal monsters around every legal corner.
Signs of a Well-Paved Highway:
- Existing laws encourage mining investment
- Relatively low bureaucracy
- Well-established permitting process
- Legacy of mining contributing to economy
#3: Politics: Professional Politics or Banana Republics?
A good legal framework is often the outcome of politics and stable governance—however so is a difficult legal framework.
The political stability of a nation can turn on one election and so can the prospects for developing a mine. An anti-mining leader can halt a mining project, or a pro-mining leader can usher forward one.
A positive national viewpoint on mining may be enough to lure investment dollars, but local politics may determine the success of a mining company.
Signs of Professional Politics:
- Positive history with mining companies
- Politically stable jurisdiction
- Rule of law respected
- Changes in government have little effect on the mining industry
#4: Infrastructure & Labor: Modern or Medieval
Sometimes it is the discovery of valuable minerals that spurs national development, but this can also happen the other way around, in which development can encourage mineral discovery.
A mining company looking to build a new mine in a country with a tradition of mining will have an easier time. Access or lack thereof to modern machinery and trained employees will determine how much money will be needed.
That said, if a company is looking to develop a mining project in a new mining region, they must be ready to help create the skills and infrastructure it needs to mine.
Signs of a Modern Jurisdiction:
- Developed roads to access and support operations
- Trained labor for staffing and development
- Well-established grid lines and back-up power systems
#5: Community: Fostering Friendship or Sowing Enemies
Mining operations have a significant impact on the local community. Good companies look to make mutually beneficial partnerships of equals with local communities.
Ignoring or failing to respect the local community will jeopardize a mining project at every stage of its mine life. A local community that does not want mining to occur will oppose even the best laid plans.
Signs of a Friendly Relations:
- Operations bring community together
- Local history shows support for mining
- Understanding of local concerns and regional variety
- Company contributes to economic growth and health of the community
#6: Environment: Clean Campsite or One Night Party
There is no way around it: mining impacts the environment and local ecosystems. But, mining operations are a blip on the radar when it comes to Earth’s timeline.
Mine sites can again become productive ecosystems, if a company has the capacity and plan to mitigate mining’s impacts at every stage of the life of a mine—even beyond the life of a mine.
Signs of a Clean Campsite:
- Development plan mitigates environmental damage
- Well-planned closure and remediation
- Understand how communities use their environment
Bringing it together: ESG Investing
These six points outlined above point towards a more complete picture of the impacts of a mining project. Currently, this falls under what is labeled as Environmental, Social and Governance “ESG” standards.
Mining companies are the forefront of a big push to adopt these types of considerations into their business, because they directly affect natural and human environments.
ESG is no longer green wash, especially for the mining industry. Companies that understand and apply these concepts in their business will have better outcomes in the jurisdictions they operate within, hopefully offering investors a more successful venture.
Geology does not change on the human time scale, but bad management can quickly lose a good project and investor’s money if they do not pay attention to the other attributes of a jurisdiction.
By the Numbers: Are Tech IPOs Worth the Hype?
Technology IPOs draw massive investor and media attention, sometimes raising billions of dollars. But do tech IPO returns match up with the hype?
Tech IPOs — Hype vs. Reality
Initial Public Offerings (IPOs) generate massive amounts of attention from investors and media alike, especially for new and fast-rising companies in the technology sector.
On the surface, the attention is warranted. Some of the most well-known tech companies have built their profile by going public, including Facebook by raising $16 billion in 2012.
But when you peel away the hype and examine investor returns from tech IPOs more closely, the reality can leave a lot to be desired.
The Hype in Numbers
When it comes to the IPOs of companies beginning to sell shares on public stock exchanges, tech offerings have become synonymous with billion-dollar launches.
Given the sheer magnitude of IPOs based in the technology sector, it’s easy to understand why. Globally, the technology sector has regularly generated the most IPOs and highest proceeds, as shown in a recent report by Ernst & Young.
In 2019 alone, the world’s public markets saw 263 IPOs in the tech sector with total proceeds of $62.8 billion. That’s far ahead of the second-place healthcare sector, which saw 174 IPOs generate proceeds of $22.5 billion.
The discrepancy is more apparent in the U.S., according to data from Renaissance Capital. In fact, over the last five years, the tech sector has accounted for 23% of total U.S. IPOs and 34% of proceeds generated by U.S. IPOs.
The prevalence of tech is even more apparent when examining history’s largest IPOs. Of the 25 largest IPOs in U.S. history, 60% come from the technology and communication services sectors.
That list includes last year’s well-publicized IPOs for Uber ($8.1 billion) and Lyft ($2.3 billion), as well as a direct public offering from Slack ($7.4 billion). Soon the list might include Airbnb, which plans to list within the communication services sector instead of tech.
The Reality in Returns
But the proof, as they say, is in the pudding.
Uber and Lyft were two of 2019’s largest U.S. IPOs, but they also saw some of the poorest returns. Uber fell 33.4% from its IPO price at year end, while Lyft was down 35.7%.
And they were far from isolated incidents. Tech IPOs averaged a return of -4.6% last year, far behind the top sectors of consumer staples (led by Beyond Meat) and healthcare.
|Sector||Avg. IPO Return (2019)|
While last year was the first time tech IPOs have averaged a negative return in four years, analysis of the last 10 years confirms that tech IPOs have underperformed over the last decade.
A decade-long analysis from investment firm Janus Henderson demonstrated that U.S. tech IPOs start underperforming compared to the broad tech sector about 5-6 months after launching.
This dip likely corresponds to the expiry of an IPO’s lock-up period—the time that a company’s pre-IPO investors are able to sell their stock. By cashing in on strong early performance, investors flood the market and bring share prices down.
Interestingly, most gains for these IPOs tend to happen within the first day of trading. The median first-day performance for tech IPOs was a 21% increase over the offer price. That’s why the median first-year return for a tech IPO, excluding the first day of trading, is -19% when compared with the broader tech sector.
How to Make Money from Tech IPOs
So does that mean that investors should avoid tech IPOs? Not necessarily.
Longer-term analysis from the University of Florida’s Warrington College of Business shows that U.S. tech IPOs offer better returns than other sectors as long as investors get in at the offer price.
U.S. Tech IPO Returns from Offer Price
|Sector||Avg. Three-Year Return||Market-adjusted Return|
Even when adjusting for the broader market performance, tech IPOs have been solid in comparison to the offer price.
The challenge is that if investors are buying stock after that first day market bump, they may have already missed out on meaningful gains:
U.S. Tech IPO Returns from First Closing Price
|Sector||Avg. Three-Year Return||Market-adjusted Return|
So should investors shy away from tech IPOs unless they’re able to get in early?
Generally speaking, the analysis holds that new tech companies perform relatively well, but not better than the broader market once they’ve started trading.
However, in a world of billion-dollar unicorns, there are always exceptions to the rule. The University of Florida study found that tech companies with a base of over $100 million in sales before going public saw a market-adjusted three-year return of 24.4% from the first closing price.
If you can sift through the hype and properly analyze the right tech IPO to support, the reality can be rewarding.
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