Residential Investments Top Novogradac QOF Listings

Published by Michael Novogradac on Thursday, October 24, 2019 - 12:00am

Investment in opportunity zones (OZs) continues to grow, with qualified opportunity funds (QOFs) focused on residential development leading the way.

An updated survey reveals that investments in QOFs seeking capital from third-party investors is now at $3.17 billion, and counting, for funds for which we have fundraising information. Novogradac is tracking 287 QOFs, for which 112 funds have voluntarily reported funds raised or for which other public sources, including press releases, are available. The 287 QOFs are targeting investment in residential, commercial, operating businesses, hospitality and renewable energy.

A September report on the Novogradac Opportunity Funds Listing showed approximately $2.5 billion in equity raised.

The Novogradac survey includes funds seeking to raise money from third-party investors and doesn’t include proprietary or private funds owned and managed solely by their principal investors.

As investors, developers and others gather for the 2019 Novogradac Opportunity Zones Fall Conference in Chicago, a closer look at the numbers reveals what types of investment are drawing the most interest from investors and which types are trailing.

Good News for Residential

When the OZ incentive became part of the Internal Revenue Code in late 2017, the presumption was that an early beneficiary would be residential investment, due to the comparative ease and perceived risk profile of developing residential real estate in OZs. So far, that’s true.

QOFs with an exclusive focus on residential development or with residential development as part of a multiple-investment focus have raised $2.76 billion, or 87.2 percent of $3.17 billion in total equity raised. In addition to making up the lion’s share of the overall funds raised, those QOFs have raised 22.4 percent of their investment target, easily the highest percentage of any investment type.

Capital Raised by Fund Focus
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Capital Available by Investment Focus
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Before going further, a significant point to understand while evaluating this: With so many QOFs having multiple investment targets, the sum of percentages for different types of investment add up to well more than 100 percent. Of the 112 QOFs that report having raised funds, 60 (53.6 percent) have either multiple or unknown investment types.

Investment Focus of Tracked Funds
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Still, residential investment is sturdy. So is commercial investment: QOFs that target commercial investment, either as their sole focus or as part of a multiple-target strategy, have raised 72 percent of the overall total (again, remember slightly more than half of the QOFs listed have multiple targets, so the funding won’t necessarily just go to commercial development).

To round out the major investment areas, hospitality (25.5 percent of total funds raised by QOFs include a hospitality focus) and renewable energy (12.6 percent) follow.

Commercial and residential investments are the kingpins of OZ investment so far. At the bottom? QOFs focused on operating businesses have raised only 2.6 percent of the total investment ($81.2 million, almost half of which is by QOFs with a sole focus on operating businesses).

Operating Businesses Lagging

The fact that QOFs that include operating businesses as a focus have raised only 2.6 percent of the total is amplified by the fact that those funds make up 8.9 percent of the QOFs on the listing. They are clearly underperforming so far, but it is a mistake to think that operating businesses won’t benefit from the OZ incentive.

While it’s disappointing to see that low number for operating businesses, there are mitigating circumstances that soften the blow, most notably that several of the other investment categories will lead to more operating businesses in OZs. That means operating businesses should grow as the incentive matures.

Exhibit 1 in that area is commercial real estate. The investment numbers for commercial real estate–$2.25 billion raised by QOFs with at least some interest in the category, with more than $201 million by QOFs with a sole focus on commercial–will likely be a catalyst for many operating businesses.

Coming Up

Treasury is expected to issue the updated guidance for OZs soon, combining the first and second tranches of guidance. That guidance could go to the Office of Information and Regulatory Affairs for review any day and will likely remain there for 30 days or more before being released to the public, meaning the guidance could be available by early December.

With the looming Dec. 31 deadline for investments to be made to receive the maximum 15 percent reduction in capital gains (the original legislation requires that gains be recognized by Dec. 31, 2026) and the fact that some capital gains from this year can’t be invested in QOFs until Dec. 31, we expect a notable increase in investments as we near the end of the year.

The current numbers show that residential and commercial investment is popular. Just how popular they remain–and whether operating business investment picks up–is to be determined.

The information contained on this page is for informational purposes only and does not constitute an offer to sell or solicitation of an offer to buy securities. Novogradac does not provide investment advice and the information on this page is not to be construed as a recommendation to engage in any specific transaction. Readers are urged to consult with their own professional advisors if they are considering investing in a QOF.