Will an Opportunity Zone in the heart of Chapel Hill attract new startups?

Downtown Chapel Hill’s largest construction project promises to bring much-wanted lab space for biotech companies, which have flocked for years to nearby Durham and Research Triangle Park.

Could the fact that the future lab space sits within a federally designated Opportunity Zone lure more of those companies to Chapel Hill?

Grubb Properties, the developer of 137 E Franklin, hopes so — and it is actively advertising the potential tax benefits that could await any startup that sets up headquarters in its building.

“Opportunity Zones can have a significant financial impact, especially in high-growth sectors such as life sciences and biomedical engineering,” Will Partin, vice president of commercial development at Grubb Properties, said in a recent press release advertising the building.

BioLabs, a company that offers flexible space to biotech startups, is already leasing 23,000 square feet in the building, The News & Observer reported. The space, which is not yet completed, could hold 20 to 25 young startups, BioLabs previously told The N&O.

For startups, in particular, Grubb believes the Opportunity Zone designation will make it much easier for the companies to attract investors, Partin said in an interview last month. Grubb is using the designation to redevelop multiple properties along Franklin and Rosemary streets.

Introduced in 2017, under a Republican tax overhaul, Opportunity Zones allow investors to earn savings on capital gains if they put them in economically disadvantaged areas. The investors in Opportunity Zones get to defer the capital gains they roll over into the investment until 2026, and they can also earn savings on the gains from the investment, depending on how long they hold it.

Local municipalities were allowed to nominate census tracts to be selected as Opportunity Zones, and the town of Chapel Hill submitted one that stretches from East Franklin Street to Estes Drive.

The census tract, home to part of Chapel Hill’s downtown core and neighborhoods with million-dollar homes, earned the title because of its large student population, many of which are renters and make little income.

The median age in the census tract is 23 years, and the median household income is $41,000, according to the Opportunity Zones Database, a website that tracks Opportunity Zones across the country.

Importantly, from Grubb’s point of view, it abuts UNC-Chapel Hill — which has prolifically spun out new biotech companies in the past two decades.

How a business can take advantage

Conceivably one of those companies could take advantage of the Opportunity Zone law if it were to open shop in 137 E Franklin. The law notes that a business can benefit from the Opportunity Zone if it has at least half its employees working there or generates at least half its gross income from work done there.

“Investors (in an Opportunity Zone startup) have the potential for an added layer benefit on their returns,” Partin said. “And, for the entrepreneurs, who are starting the companies themselves and perhaps putting in their own money, they become investors as well, and they get that added benefit.”

If a venture capital fund that had been designated an Opportunity Zone fund invested in one of these startups, Partin added, they could significantly reduce the capital gains tax on the investment. Investors can get a full reduction on the sale of an investment into an Opportunity Zone if they hold it at least 10 years. Investors have until 2026 to invest in Opportunity Zones.

An example of how an investment might work, according to Wells Fargo, is if someone had invested $10 million in an Opportunity Zone fund in 2019, and then sold that investment for $15 million in 2030. The $5 million appreciation would not be taxable.

“That’s one of the biggest benefits for startup and early-growth stage companies,” Partin said, because an equity investment could jump significantly in value if, for instance, a biotech company started getting through a clinical trial years after the initial investment.

But it’s unlikely to change behavior

Brett Theodos, a senior fellow at the Urban Institute who has studied Opportunity Zones, said it’s possible that some startups could benefit from the Opportunity Zone designation, but he doubts it will play a big role in swaying companies to pick downtown Chapel Hill.

So far, just a small fraction of Opportunity Zone investments have flown into business — around 3.4% of the total investments, according to Novogradac, an accounting firm. The numbers are a bit fuzzy, Theodos said, because unlike many other federal programs there is no mandated reporting of every Opportunity Zone investment, making a comprehensive analysis extremely difficult.

But, clearly, most Opportunity Zone investments are going into real estate projects, like Grubb’s, rather than individual businesses that might choose to locate there. Theodos said that is because the rules make it much easier to invest in real estate than individual companies, because of the strict deadlines.

A startup in the Chapel Hill tract, “would likely be eligible,” Theodos said, “but they’d still need to find an equity investor that wants to make an investment, and the business would have to want that investment.”

“The big benefit (for investors) is on the back end: the permanent exclusion of gains,” he added. “But you have to hold that investment for 10 years.”

But that time frame creates a lot of uncertainty. “Real estate doesn’t move,” he said, “but operating businesses fail all the time and they can move.”

Additionally, Theodos said, the right time to sell a startup might come earlier than year 10, eliminating most of the benefit for the investor.

“No venture capitalist ... in year four or year seven is going to say, ‘No, I’ve got a tax advantage coming in year 10, I am going to sit and wait,’” Theodos said. “Because who knows what the right environment to sell is at the time.”

While in the perfect situation an Opportunity Zone could make an investment in a startup even more profitable, a company isn’t likely to choose to locate in Chapel Hill because of the designation, Theodos said. The fact that it is next to UNC is likely more important.

“It’s too much tail wagging the dog to think that this is going to unlock a whole new set of operating business equity investments,” he said. “It’s more likely the investments were going to happen anyway.

“On the margin, maybe a firm moves across the street to a qualifying tract because it wouldn’t have otherwise,” he said. “But it’s just not fundamentally a powerful enough, or certain enough, incentive to really drive investment.”

This story was produced with financial support from a coalition of partners led by Innovate Raleigh as part of an independent journalism fellowship program. The N&O maintains full editorial control of the work. Learn more; go to bit.ly/newsinnovate

This story was originally published December 27, 2021 at 11:30 AM.