Scottsdale Arts District

The Arts District may seem at least a little above the poverty level, but not according to the federal government and, apparently, the governor's office, as the area has been designated an opportunity zone.

Walking through downtown Scottsdale past high-end restaurants and galleries selling thousand-dollar paintings, visitors may have no idea they are in a low-income community.

But they are — at least according to a designation afforded the area by an economic development incentive tucked into the federal tax law passed in December 2017.

The law included a provision allowing states across the country to designate certain areas as opportunity zones designed to spur development in needy areas by allowing developers and investors the chance to defer a percentage of taxes on capital gains as long as they hold onto the property for a required number of years.

“Attracting needed private investment into these low-income communities will lead to their economic revitalization, and ensure economic growth is experienced throughout the nation,” said Treasury Secretary Steven Mnuchin when the first zones were announced.

That first batch of zones included downtown Scottsdale, or Census Tract 2107.2, specifically, which drew pause from some who do not associate the term “low-income community” with downtown Scottsdale.

State governors had the ultimate say in which tracts received the designation, but Arizona Governor Doug Ducey delegated much of that authority to the Arizona Commerce Authority, which, in turn, relied heavily on input from local governments.

In Scottsdale, city staff made the recommendation to nominate the downtown tract — not the mayor or City Council.

Mayor Jim Lane said he saw “no apparent need” for the opportunity zone designation in downtown Scottsdale, an area not hurting for investment.

That tract is roughly bracketed to north by Camelback Road and northwest by the Arizona Canal and to the south by Indian School Road and east by Miller Road.

It does not include Scottsdale Fashion Square Mall but does include much of Old Town, the Arts District, 5th Avenue and some properties along the canal.

Due to the designation, investors and developers in the area can reap some significant rewards for parking their money in the area.

If a qualified investment is held for five years, there is a 10 percent exclusion of deferred gain. That goes up to 15 percent if the investment is held for seven years, according to the IRS.

Funds investing in the zones must invest 90 percent of assets in real estate or business equity in qualified areas, and they must stay invested for 10 years to receive the maximum potential benefit, which includes capital-gains tax on 85 percent of the initial investment and no tax on any appreciation, according to financial news magazine Barron’s.

Shawn Novak, an associate professor at ASU’s School of Public Policy, criticized the program more broadly, calling it an inefficient way to invest in low-income communities that disproportionately benefits wealthy investors over the communities it is supposed to help, especially in areas like downtown Scottsdale that are not hurting for investment in the first place.

“You’re basically dumping a subsidy on people for doing something they were going to do anyway,” Novak said. “That is about as inefficient use as you could get.”

Data gamesmanship

The designation has left some local residents and businesses owners questioning how an area with a median home value $100,000 greater than the statewide median and commercial retail vacancy rate hovering around five percent could qualify as low income and in need of investment.

The area qualifies under rules set by the IRS that looks for tracts with indicators of poverty and income levels below the area median.

This tract qualifies under rules allowing for urban tracts with a median family income that is less than 80 percent of the area median family income or statewide median income, whichever is higher. 

Josh Utterbeck, an economic development specialist with City of Scottsdale, reiterated that the city could only choose tracts that qualified under the objective measures laid out by the IRS based on census income data.

Still, Novak, the ASU professor, said those guidelines left room open for political gamesmanship.

For instance, in Arizona tract designations relied on outdated census information to gauge area incomes.

According to a map of qualified tracts from the federal government’s Community Development Financial Institutions Fund, the tract in downtown Scottsdale had 72.22 percent of the area median family income, based on data from the U.S. Census Bureau’s 2011-2015 American Community Survey data.

That makes the area low income under IRS rules.

The perception of the tract’s financial situation can change, depending on which data you look at, though.

According to the most recent Census Bureau data, the census tract’s median family income jumped from $45,994 in 2015 to $91,071 in 2017.

Census tract 2172.01 in downtown Scottsdale now has a family median income that is 132 percent of the area family median income, according to the 2017 ACS data, meaning it would no longer qualify if the IRS used the most recent data to select opportunity zones.

Choosing the tracts

Despite this, Gov. Doug Ducey was still well within his power to nominate the tract to the IRS, because it did qualify using those 2015 numbers.

Still, an argument can be made that the Scottsdale tract, at the very least, violates the spirit of the program that, according to the Treasury Secretary’s own words, was designed to infuse investment into impoverished communities by using cherry-picked figures to justify the designation.

The Scottsdale tract appears to be an outlier when compared to the bulk of tracts in Arizona and across the country, which typically fall in communities with lower incomes and higher poverty rates.

It is unclear exactly how much Ducey himself had to do with the Scottsdale tract’s nomination.

When the tracts were announced, the official line was that it was nominated by Ducey in line with federal guidelines that delegated designation authority to each state’s chief executive office.

However, tracking down who really made the decision took a little more digging. 

When asked why this tract was chosen, a spokesperson for the governor’s office deferred to the Arizona Commerce Authority, which “took the lead on this.”

The ACA, in turn, referred the Progress to the City of Scottsdale.

 “For incorporated communities with 10,000 or more residents in Maricopa and Pima counties, the Arizona Commerce Authority solicited recommendations for eligible tract nominations from those communities, so the City of Scottsdale would be the resource for that information,“ it explained.

So, who at the city made the call?

It was not Lane or the City Council — and the mayor had a hard time finding out exactly who did make that decision.

“Overall, I don’t see (the need) in the areas that we have selected by whoever did it,” Lane said. “I almost hate to tell you the answer I got; nobody is fessing up on it is the answer I got,” Lane said.

According to a city spokesman, a group comprising representatives from the city’s Economic Development and Planning departments and the City Manager’s office submitted the recommendations.

ACA President/CEO Sandra Watson solicited recommendations from jurisdictions throughout the state, allowing them to recommend tracts for the programs. Scottsdale, a city with seven qualified tracts, was able to recommend two.

When asked how much weight the city’s recommendations carried, the ACA responded with the following statement:

 “The ACA reviewed all submitted recommendations for regular and contiguous tracts and prepared a final list. That list was then presented to Gov. Ducey for review and final approval. He approved the list in total.”

The governor’s office and ACA did not provide any specifics as to why they recommended the zone in downtown Scottsdale instead of another qualified tract.

Ducey was limited to giving the designation to just 168 of the state’s 1,526 census tracts, according to Howard Fischer with Capitol Media Services. 

The city was a little more forthcoming.

According to staff involved in the recommendation, five of the seven qualified tracts in Scottsdale contained mostly residential properties. 

The city chose the two remaining areas, the downtown tract and another further south, because they contained significant amounts of commercial property.

“Residential qualifies for this, but in terms of the macroeconomics and wanting to see what could be the most realized benefits from this, we thought it would make more sense to include as many businesses in that as possible,” said Rob Millar, Scottsdale’s acting economic development director.

The other zone is bracketed north to south by Thomas and McDowell Roads and east to west by Scottsdale Road and 64th Street.

“The McDowell corridor is a City Council top priority, so we thought that made a lot of sense because it’s got a lot of commercial property,” Millar said. 

City staff did not consider using opportunity zones in residential areas to incentivize investment to address the city’s affordable housing shortage.

Randy Grant, Scottsdale’s planning and development director, said there are already federal programs in place to incentivize affordable housing development through HUD and that there’s no guarantee developers would invest in housing just because an opportunity zone was put in a residential area.

“This really does not make a distinction about what type of development is being lended, other than it has to be in ownership for a certain period of time,” Grant said.

Still, other cities are looking at opportunity zones as a possible vehicle to spur affordable housing development.

In her recent State of the City Address, Phoenix Mayor Kate Gallego talked about her administration’s plans to reduce homelessness.

“We are researching innovative areas such as opportunity zones and looking at the lands owned by various city departments…to determine if they are ripe for housing development,” Gallego said.

Millar said seeing “reinvestment and revitalization” in downtown Scottsdale was important to the City of Scottsdale.

But Grant acknowledged that the downtown tract was not really in need of incentives to spark that development.

“I think there may be interest in opportunities zone benefits, but I don’t think that necessarily is what is stimulating interest in Scottsdale,” Grant said.

“I think the opportunities zones may provide some sense of urgency, just in terms of the tax benefits that can be accrued from it,” he added, “but we haven’t seen in the absence of opportunities zones, the downtown area lagging behind. There’s a lot of interest.”

Lane questioned the benefits of giving incentives to investors when there was no shortage of interest in downtown Scottsdale in the first place.

“Why would you need to pour accelerant on the most valuable land in Scottsdale?” Lane wondered, noting that much of the plans for development he has seen were in place prior to the new tax act’s approval.

For instance, Millar said there was a 27-acre parcel already assembled for redevelopment in the McDowell Road tract prior to the opportunity zone designation.

Also, Museum Square — the multi-use housing and hotel project slated for land next to Museum of the West — sits within the opportunity zone and was technically announced in mid-2018, months after the tax bill was approved by Congress.

However, Maricopa County Assessor records show that the developer MacDonald Development Corporation has been acquiring the land in the area for the project since at least 2015.

Novak said that not only will the program provide tax deferrals to investors who were likely going to invest in the area anyway, it could also pull investment away from other communities.

“Really what they’re doing is they’re shifting investment from one location to another,” Novak said. “Some of the investment that’s made in that particular census tract is probably investment that is now not going to be made in an adjacent tract.”

City staff said simply not designating opportunity zones to fill its two slots was not an option.

“I think it was our responsibility to submit sites that we thought might benefit the most,” Utterbeck said. “I’ve heard (some people ask) ‘what about not submitting at all and just letting others?’ but I think that would be a disservice to our community to not submit it at all.”

The lack of new available space for development has led to local business owner concerns that the city would like to see existing properties redeveloped.

Grant said that is not the case, noting that he believes some people are confusing opportunity zones with redevelopment areas.

He also said the opportunity zone will not affect the quality of projects that come to the area.

“An opportunity zone really only deals with the financing part of it, so an opportunity zone is not going to in any way affect what is developed on a piece of property…what gets developed is still a local control issue,” Grant said.

Grant said he thought local businesses would see the opportunity as a boon.

“We kind of struggle with the thought that property owners would reasonably be expected to be very favorable for being in an opportunities zones, rather than feeling like it’s a designation that is going to lead to deterioration,” Grant said. “We just don’t think that’s the case.”

Regardless of the type of development the project results in, Novak said there are fundamental issues with opportunity zones, noting that it puts money primarily in the hands of already wealthy investors in hopes that it will trickle down to needy communities.

“There’s really nothing about the way that this is designed that puts the value of the subsidy into the hands of the residents of these areas that are presumably the ones that you want to subsidize,” Novak said.

He said the government could make more lasting impacts by investing in education in low-income communities and could be more efficient by making direct expenditures to agencies like Housing and Urban Development.

“In hindsight when people are looking back at this 10 years from now and asking whether this with a good idea, I think it’s going to be held up as a model for how not to do things,” Novak said.