Qualified Opportunity Zone funds present investors with an innovative and potentially attractive new way to participate in the powerful growth occurring in the renewable energy sector—but you’d never know it from reading many mainstream news outlets.
The New York Times, the Wall Street Journal and other publications around the country have published high-profile stories over the past 12 months, questioning the efficacy of the Opportunity Zone program—which was introduced as part of the Tax Cuts and Jobs Act in 2017—in guiding impactful investment toward housing and other development in economically challenged communities where it is desperately needed. In particular, a great deal of media attention has been focused on luxury property developments that would have been constructed even without the Opportunity Zone legislation.
The idea that Opportunity Zones are being used improperly by rich real estate developers has become so prominent that casual investors might be forgiven for thinking that Opportunity Zones, and the funds built on investments within them, are exclusively vehicles for real estate investing.
The legislation does point to Opportunity Zone “properties” as one eligible type of investment. However, the law also provides the same benefits for Opportunity Zone “businesses”—and that’s where new options for investors seeking attractive entry points to the renewable energy market enter the picture.
Opportunity Zone funds that focus on solar and wind energy businesses have the potential to yield comparable returns to real estate-focused funds. When constructed properly, they also carry potentially lower risk than real estate development investments in low-income areas.
Beyond the potentially attractive returns, renewable energy businesses developed within Opportunity Zones can drive powerful positive differences for the communities the legislation was intended to help. Low-income communities tend to be hardest hit by environmental degradation such as air and water pollution, and they often struggle economically due to the lack of well-paying jobs. Renewable energy businesses have the potential to make a positive impact on both fronts, by creating jobs in the construction and ongoing operation of facilities, and by addressing the environmental problems that plague low-income communities.
As the renewable energy sector continues to grow, advisors and investors owe it to themselves to re-examine the benefits of “green” Opportunity Zone funds, which give ecologically-minded investors a chance to align their investments with their green values—while helping struggling communities at the same time.
Renewable Energy: An Under-Appreciated Secular Growth Trend
Worldwide demand for renewable energy is increasing, presenting long-term growth opportunities for investors, even without the tax advantages of the Opportunity Zone legislation.
Overall demand for power will increase by 62% by 2050, according to Bloomberg New Energy Outlook 2019, resulting in a near tripling of generating capacity. Bloomberg New Energy also expects output from solar to make up 22% of global electricity generation by 2050, up from 2% today, with wind sources accounting for 26%, versus just 5% today.
On the supply side, the total costs of both solar and wind generation have fallen precipitously over the last few decades, putting the economics of those sources at parity with natural gas. The trend stands to continue as manufacturing technologies improve and global competition heats up between equipment makers.
Opportunity Zones: A Compelling Way To Access The Renewable Energy Sector
The Tax Cuts and Jobs Act allows investors in Opportunity Zones—businesses or real estate—to defer taxes on realized capital gains until December 31, 2026 if those gains are rolled into an Opportunity Zone investment within 180 days of realization.
If investors maintain their Opportunity Zone investment for five years, their basis in the investment will be bumped up by 10%, and if they hold it seven years, the basis will increase by an additional 5%. What this means is that if an investor keeps their investment in an Opportunity Zone fund for 5 or 7 years they will be paying capital gains tax on only 90% or 85% of the original gain, respectively. If they hold the investment in the Opportunity Zone fund for a decade or more, they won’t incur any additional capital gains taxes on their gains in the Opportunity Zone investment.
If they’re well-constructed and implemented, Opportunity Zone funds focused on renewable energy enterprises are potentially less risky than real estate funds, and may offer similar annual returns.
One way such funds mitigate risk is by investing in renewable energy projects after they have gotten past their development phase—that is, after they have cleared hurdles such as site selection, land acquisition and permitting and other administrative or legal challenges.
Such renewable energy projects tend to be constructed in weeks or months, so there is generally less delay between groundbreaking and the start of cash flows. And to ensure long-term, low-risk revenue, developers typically ink 12 to 25-year contracts to supply power to investment-grade utilities and municipalities, ensuring that the solar or wind farm has a long-term customer in place from the outset.
Real estate investments in Opportunity Zones, in contrast, are typically developed from scratch—a process that can take years—and frequently won’t attract tenants until they are nearing completion. When tenants do sign on, their contracts are generally shorter than 12 years.
Renewables-Focused Funds: A Better Way To Capture The Potential Of Opportunity Zones
While most Opportunity Zone funds are currently focused on real estate, renewable energy-focused funds may offer a better way for investors to capitalize on this legislation. Not only do such funds potentially offer solid returns with a lower risk profile—they may also provide a better way to help the communities that Opportunity Zones were initially intended to strengthen, while also allowing investors to utilize their savings to reduce carbon emissions and drive positive impacts for our environment.
David Sher is co-CEO and director of business development for Greenbacker Capital, an investment firm focused on the sustainable infrastructure sector.
