What is an Opportunity Zone?  A census tract designated by each state or territory and certified by Treasury as eligible to receive private investments via Qualified Opportunity Funds.  Meets definition of a “low-income community” (LIC), or …  Contiguous to a LIC and with a median family income that doesn’t exceed 125% of the LIC.  10-year designation as an Opportunity Zone.  More than 8,700 Opportunity Zones have been designated in the 50 U.S. states, the District of Columbia and five U.S. territories. Source: Milken Institute Opportunity Zones Source: Economic Innovation Group. 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 1 What is a Qualified Opportunity Fund?  An investment vehicle set up as a partnership or corporation to invest in eligible property located in an Opportunity Zone.  Qualified Opportunity Funds are funded by realized capital gains and must deploy 90% of capital into Opportunity Zones.  Eligible investments include real estate and operating companies, although real estate investments are subject to improvement tests (100% of basis).  Qualified Opportunity Funds must self-certify they meet all rules; forms expected 1Q2019. IRS revenue guidance pending. How do the Tax benefits work?  Opportunity Funds may provide potential Federal tax incentives to investors (1,2,3)  A temporary capital gains tax deferral for all newly realized capital gains reinvested in an Opportunity Fund, lasting until the investment is sold or December 31, 2026, whichever is sooner.   Timeline of tax benefits (4) 2018 Realized capital gain A 10% basis adjustment on the original capital gains, which can result in tax reductions if the Opportunity Fund investment is held for 5+ years; plus an additional 5% adjustment if the investment is held for 7+ years. If an investor holds the Opportunity Fund investment for 10+ years, the investor may permanently avoid capital gains taxes on any proceeds from the Opportunity Fund investment itself. 2019 Investment Made into Opportunity Fund 2024 Basis increased by 5% on original gain 2025 2020 2021 Basis increased by 10% on original gain 2023 2022 Deferred Fed Tax on original gain due by 12/31/26 2026 2027 2028 Basis is adjusted to equal Fair Market Value. No tax on Opportunity Fund appreciation 1 Milken Institute does not provide investment advice and any information contained in this document is for informational purposes only and does not constitute financial, accounting, or legal advice. 2 IRS Revenue Guidelines are required for clarification and have yet to be released 3 For a more detailed explanation of Opportunity Zones and Qualified Opportunity Funds, please visit: irs.gov and cdfifund.gov. 4 Kosmont Companies proprietary graphic 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 2 Why Reno? Source: Economic Development Authority of Western Nevada Reno/Sparks Opportunity Zones Hub to the Western United States  1-day truck drive to more than 60,000 customers and five 5 U.S. ports serving the Pacific Rim.  2-day truck drive to 10 large metros. 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 3 Reno to Palo Alto Blackbird … is looking at launching a round-trip flight between Reno and Palo Alto, Calif., to better connect the Biggest Little City’s growing technology sector with the center of the tech industry. Source: Reno Gazette Journal, March 2018 Fallacy “Any loan to real estate is a good loan … ” 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 4 Federal Spending Priorities Annual, in $ billions Housing Subsidies $300 $200 (forgone tax revenue) $100 $0 Education NIH CDC FDA Sources: FDA, CDC, NIH, DOE, and Office of Management and Budget. Note: FY 2018. Education reflects total DOE budget. Housing subsidies reflect estimated forgone tax revenues from deductions for imputed rent, mortgage interest and property taxes. Fannie Mae and Freddie Mac Housing Loans Growth since 2007 Multifamily 120% 100% 80% 60% 40% 20% 0% -20% Single family -40% -60% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Federal Housing Finance Agency. 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 5 Housing Loan Payments 90% 80% 70% 60% 50% 40% Partial interest-only 30% 20% 10% 0% 2008 Interest-only 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Federal Housing Finance Agency. Change in U.S. Home Ownership 65.6% 64.3% 1980 Bottomed out in 2016 at 62.9%, the lowest since 1985. 2017 Note: Lowest value was 2Q 2016 at 62.9%. Source: U.S. Census Bureau 4Q 2017. 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 6 Home Ownership Rates 70% 65% 60% 55% 50% 45% Canada France U.S. U.K. Denmark Japan Germany Sources: EuroStat, Statistics Bureau of Japan, Statistics Canada, U.S. Census Bureau. Note: Latest data available as of 3/1/2018; based on latest census. Mortgages Guaranteed by the Government $7.3T 49% $13B 7% 1980 2018 Source: Federal Reserve. 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 7 Value of the Housing Market Recipe for a Future Housing Crisis? Delinquencies/Foreclosures Decline … but Debt-to-Income Ratios Rise Delinquencies/Foreclosures Agency/Government Loans Sources: Urban Institute Housing Finance Chartbook July 2018; AEI’s Center on Housing Markets and Finance. 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 8 Home Price Increases From 2011 to June 2017 Lowest-tier housing has the largest price increase Source: Case-Shiller HPI, June 2017 Standard & Poor’s Ratings New Issues: 1/1/2000 to 9/30/2008 Investment-Grade Securities AAA AA+ AA AAA ABBB+ BBB BBB- 16,907 240 2,098 3,414 2,602 2,027 903 1,371 1,359 Non-investment Grade Securities BB+ BB BBB+ B BCCC+ CCC CCCCC C 238 313 331 339 330 1,189 293 214 104 36 11 Source: Bloomberg 11/6/08 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 9 When is a AAA not a AAA? High-grade structured-finance CDO Senior AAA Mortgage loans Mortgage bonds AAA 80% AA 11% A 6% BB-Unrated 3% 5% AA 3% A 2% BBB 1% Unrated 1% Mezzanine structured-finance CDO 4% BBB 88% Junior AA CDO-Squared Senior AAA 62% Senior AAA 60% Junior AA 14% Junior AA 27% AA 8% AA 4% A 6% A 3% BBB 6% BBB 3% Unrated 4% Unrated 2% Source: International Monetary Fund. Home Prices Don’t Go Up Forever Change in home prices in 128 years 30% WWI 25% Great Depression WWII 70’s Boom 80’s Boom Last Boom 20% 15% 10% 5% 0% -5% -10% -15% -20% 1890 1906 1922 1938 1954 1970 1986 2002 2018 Sources: IHS Global Insight, Corelogic, Milken Institute, 3/1/2018. 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 10 Consumer Spending U.S. Asia 33% Housing 23% Food 18% Transportation 15% Supplemental Education 10% Housing 13% Food 11% Insurance/pensions 8% Clothing 6% Healthcare 8% Other 5% Entertainment 6% Transportation 4% Apparel and services 5% Healthcare 2% Supplemental Education 5% Communication Source: U.S. Bureau of Labor Statistics/CLSA When Lenders Make Non-Recourse Loans Heads they lose — Tails they lose     If prices rise, the borrower keeps the gain. If prices fall, the borrower can walk, sticking the lender with a long-term depreciating asset. If interest rates rise, the value of the loan depreciates as the “real” average life of the asset is extended. If interest rates fall, the borrower prepays. 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 11 “The no-recourse mortgage is virtually unique to the United States. That’s why falling house prices in Europe do not trigger defaults. The creditors’ ability to go beyond the house to other assets or even future salary is a deterrent.” - Martin Feldstein U.S. Economist Social Effects of Overly Large Houses        Degradation of environment Divorce Spousal abuse Drug abuse Alcoholism Hypertension Depression 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy 12 Neutron Legislation - Late 1980s “It was OK to lend money to build a building, but it wasn’t OK to lend money to any company that would hire a person to work in the building.” Examples of Regulation Following Volatility Period 1780s 1830s-1850s 1893 1907 1929-1933 1930-1933 1970s 1970-90s 1987 2002 2008 Volatility Weak state currencies Wildcat state banking Stock market panic Run on trust companies Market crash Bank failures Commodities speculation Employment insecurity S&L Crisis Dot.com/Enron/etc. Great Recession 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy Regulation Constitution/Commerce Clause National currency/Banking acts Bankruptcy Act Federal Reserve Act Securities & Exchange Act Glass-Steagall Act, FDIC, New Deal CFTC ERISA, COBRA, HIPAA FIRREA Sarbanes-Oxley Dodd-Frank 13 Pages in the Code of Federal Regulations 180,000 160,000 140,000 120,000 100,000 80,000 60,000 1975 1983 1991 1999 2007 2015 Source: Georg Washington University Regulatory Studies Center, 2015. Regulation Complexity 6 pages More than 2,000 pages… 2018 Milken Institute Hamptons Dialogues Opportunity Zones & US Housing Policy … longer than the Torah, Bible and Quran COMBINED! 14