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Early Participants in OZ Incentive Express Optimism, Await Guidance

Published by Brad Stanhope on Tuesday, April 2, 2019

Journal cover April 2019   Download PDF

Whether it’s considered another device in the toolbox or a game-changing incentive, there is major interest in the federal opportunity zones (OZ) incentive.

“I’ve probably talked to 30 different clients about it,” said Tad Adams, an attorney with Adams Law Group in Louisville, Ky. “It hit the marketplace in a big way. Everybody’s interested.”

An informal online survey by Novogradac reflects that. More than 76 percent of respondents said they either were already a participant in the OZ incentive (28.2 percent) or were likely to be (48.1 percent).

“It’s really an interesting environment,” said Brad Ketch, chairman and president of Oregon Community Capital, a for-profit wholly owned subsidiary of the nonprofit Community Development Corporation of Oregon. “Folks are sitting on capital gains and are certainly eager  [to invest]. Every seminar we do sells out and 50 percent [of attendees] want a follow-up.”

Less than 18 months after the provision became part of the tax code, incentivizing the investment of capital gains in low-income communities, OZ participants are eager, optimistic and looking for guidance from the Treasury Department as they act as pioneers, staking out new ground.

“Everybody hears a lot about [the OZ incentive] and is really interested in it,” Adams said. “I’d say we have three or four individual projects in the pipeline. Typically, the people involved in it now are aggressive.”

Survey: QOF Investment, Geographic Range

In addition to the high level of participation in the OZ incentive, participants in the survey who plan to participate in qualified opportunity funds (QOFs) expect them to be significant. Half said the equity in their fund will be more than $10 million and the remaining answers were split among lesser amounts, with only 13 percent of respondents saying their QOF would raise $1 million or less.

The geographic regions for investment were spread. The South was narrowly most popular as a targeted region (45.2 percent), but the Midwest, West and Northeast were all cited by between 41 percent and 44 percent of those who responded to the survey (who were allowed to pick more than one region). Puerto Rico and the U.S. territories were cited as targets by 17.5 percent of respondents.

The OZ incentive benefits max out at the 10-year mark and that appears to be crucial to those who took the survey, with 76.2 percent of respondents saying they would hold their investments in a QOF for at least 10 years. The next most popular response was between seven and 10 years, while a combined less than 6 percent of those who responded said they would keep the investment for five to seven years or less than five years.

Where will the OZ incentive make the biggest difference? Housing was the leading area among those who responded to the poll, with 49.2 percent choosing that. Second was operating businesses at 25 percent, while 20.3 percent said others. The “others” included a range of areas, but the most popular were commercial real estate and infrastructure.

Variety of Applications

Survey participants revealed a diversity of uses for the incentive.

“I see it more of a toolbox to use to get in there,” Adams said. “It makes a lot of sense in the [low-income housing tax credit arena], since you hold the OZ investment for 10 years and maximize the tax benefit.”

Ketch, whose organization is using the OZ incentive to fund workforce housing, shared that approach–with a twist.

“Our initial objective was to create affordable housing,” Ketch said. “But it’s going to work out more as workforce housing [people earning 60 percent to 80 percent of the area median income, in this case]. There’s a massive need for workforce housing and we target rent-burdened people–many of our people are spending 60 to 65 percent of their income on housing.”

Operating businesses are the target for Vijar Kohli, co-founder and portfolio manager for Golden Door Asset Management.

“We are one of the few in this space,” Kohli said. “We’re one of the few who focus on acquiring operating businesses.”
 
Golden Door Asset Management has been investing in urban communities for five years, mostly on the real estate side.

“The real opportunity is to create jobs and to design and build businesses,” Kohli said. “No one was looking at that. My partner and I looked at a ton of businesses. We look at family-owned businesses that are already in the zones. There’s a variety–laundromats, car washes, distribution logistic companies. They’re not leaving and we view this as a tool to help them.”

Boost to Existing Properties

Some participants in the OZ industry say the OZ benefit is a bonus.

“Given our focus on affordable housing, properties that we already had in the development pipeline were located in opportunity zones,” said Freddie Fletcher, a project manager with the Lawson Companies, an affordable housing developer, construction and property management company. “The opportunity zones legislation came out and we saw a few projects were in the zones, so we knew we had to get smart quickly on how this could impact the projects. 

Fletcher said that his company will likely also benefit from the incentive when it builds a new office.

“We’re looking at potential office sites for Lawson and targeting opportunity zones for a few reasons,” Fletcher said. “Maybe the only benefit is the capital gain investment in the new building, which we expect to pair with historic tax credits in an adaptive reuse. Beyond that, our hope is that being located in an opportunity zone and doing most of our work within the zone would satisfy the requirements to qualify as an opportunity zones business. That would be a huge cherry on top and is something we’re exploring now.”

LIHTC Investments Already Using OZs

Fletcher said Lawson has two LIHTC investments involving the OZ. “We are looking at other sites that would also target workforce housing,” he said. “With the thought being that we can layer in opportunity zones capital with more attractive returns than we typically see.”

Fletcher said the Lawson Companies first looked at its own capital gains to benefit the housing, creating a QOF.

“We have some internal capital gains that we’re using,” Fletcher said. “We’re not going out and finding funds for these projects. The capital stack in a LIHTC development typically doesn’t require huge investment, so we’re able to create gains that meet the project needs. Going forward, we would consider bringing in OZ capital partners if the project needs it.”

Guidance Helpful, Needed

One view that was unanimous among those contacted: More guidance will help. Interviews for this story were conducted before a second tranche of guidance was issued by Treasury.

“We were expecting the fall [2018] guidance to be more detailed,” Fletcher said. “But now we’re getting to the point that the ambiguity in the incentive is something we feel comfortable enough with to go ahead and structure deals.”

Kohli said the lack of guidance is slowing others.

“We’re definitely able to do the legwork, but it needs [more] guidance to go bigger,” Kohli said. “A lot of investors are on the sidelines and don’t want to make a move before it’s clear. It’s very obvious that there are a lot of investors sitting there.”

However, early investors are comfortable in some areas.

“I’d say 98 or 99 percent are on the real estate side,” Kohli said. “It’s easier. It’s low-hanging fruit and there’s more guidance. There is more gray area for operating businesses and it takes more effort.”

Ultimately, the expectation is that the OZ incentive will have a tremendous impact.

“I think it will create the transfer of capital from high-GDP per-capita regions to low-GDP per-capita regions,” Kohli said. “People will move their businesses and it will help the businesses that are already there.” 

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