As the federal opportunity zones (OZ) incentive reaches the midway point of its second year, attracting investors is still an issue for qualified opportunity funds (QOFs).

Unless it isn’t.

“I think most people don’t know about investUS and our fund,” said Deborah Burns of investUS Opportunity Fund, which had commitments of less than $5 million of a targeted $100 million as of mid-June. “For most people here [in New Mexico and other rural states], I’m the first person to tell them about [the OZ incentive] and it sounds too good to be true. Another reason we have been slow to raise capital is we think the best returns for investors will be a diversified pool of opportunity zones projects and businesses in a fund that seeks to redeploy capital within the 10-year holding period. But now, interest is really picking up because, unlike most funds, we have a $1.1 billion deal pipeline with 42 deals in need of more than $250 million in QOF equity.”

At the other end of the spectrum is Sean Lyons of Jackson Dearborn Partners (JDP) in Chicago. JDP formed its Campustown Opportunity Zone Fund in Champaign, Ill, at the University of Illinois. The fund reached its target of $10 million in six weeks and intends to replicate that.

“Honestly, I was completely blown away,” Lyons said. “I’ve been in real estate since ’03. [After launch of the fund], people started calling us out of nowhere. They didn’t know what we were, but we were getting calls from all over, from investment bankers, wealth advisors. I’d never had that level of incoming interest.”

Then there are those in the middle, such as Mark Elliott of the South Carolina Opportunity Fund, a state-specific fund based in Greenville, S.C.

“It’s been a mixed bag,” Elliott said. “There was the start and then the new regulations and then another set of regulations. Three times, we had to become the expert. It doesn’t seem stable when that happens, but we feel comfortable with the latest regulations, especially the business part.”

Those reactions are reflective of an informal survey of QOFs listed on the Novogradac Opportunity Fund listing. Those who responded to the survey showed that as of late May, the funds had raised 12.3 percent of their capacity, although just one–Lyons’ Campustown Opportunity Zone Fund–reached its capacity. The capacity of funds on the Novogradac QOF list ranges from less than $1 million to $3 billion.

Among those who responded to the survey, 53.7 percent indicated their top target for the QOF financing was market-rate multifamily housing. A vast majority of the survey participants (81 percent) said they intended to mix other tax incentive programs with the OZ funds.

For QOF managers, the response from investors has varied and is largely dictated by geography and project type.

An Attractive Incentive

Lyons’ group already planned to build student housing at the University of Illinois when the OZ legislation passed. The area for the housing was included in an OZ, so his group established their QOF.

“The big question [for investors] is whether it’s a good deal or not,” Lyons said. “Would you invest in it if it wasn’t in an opportunity zone? What made ours attractive was that the deals pencil out on their own merit.”

Lyons has been involved in student housing and market-rate multifamily housing in university cities for more than a decade, collaborating with management company Green Street Realty since 2014.

“Our story checks all the boxes–student housing at the University of Illinois, which has 50,000 students and the owner-operator is established,” Lyons said. “If someone looked at a (QOF) directory, this one stood out. I can’t take personal credit, because to a somewhat savvy investor, ours is a sexy investment.”

Lyons plans to repeat the strategy that succeeded in Illinois–and that he has about $400 million worth of similar projects in his pipeline.

“We have four or five other projects teed up,” Lyons said. “They’re all student or multifamily property in student-driven markets. Our plan is to do three or four in succession on individual opportunity funds with about a $10 million to $25 million raise for each. We’ll do three or four, have success and then go for a big one, maybe $200 million.”

‘Opportunity Zones Fit in Well’

Tony Barkan, whose Allagash Opportunity Zone Partners manages the Allagash Opportunity Zone CRE Fund I, also has a pipeline of properties ready to go. Barkan and his partners, each with 30 years of experience in commercial real estate and investment management, planned to form a commercial real estate investment firm focused on inexpensive properties in low and moderate income communities before the OZ legislation passed.

“We had an investment thesis and a process that we thought could provide outsized returns without increasing risk,” Barkan said. “Then the opportunity zone incentive was announced. It fit perfectly with our investment focus and the added tax benefits allowed us to form a really compelling offering.”

However, Barkan emphasizes that investor interest is being driven primarily by the quality of the commercial real estate returns, the abilities of the manager to realize those returns and the fund’s positive impact on low and moderate-income communities, rather than the program’s tax benefits.

While marketing began as early as January, Allagash didn’t finalize their fund details and offering documents until after the second tranche of guidelines was released in April.

“We believed we should wait,” Barkan said. “We wanted investors to feel comfortable that we had addressed all of their concerns.”

Once things were settled, Allagash launched. Barkan said he expected $20 million to $50 million to be committed by the end of June and he expects to be fully funded at $500 million by the end of the year.

Non-Metro Struggles

Burns, meanwhile, has two decades of experience as an institutional investor and is finding it difficult to get investors in her fund, which has the $100 million goal and targets investments in metropolitan statistical areas with populations of 1 million and less.

“Ours is a story of non-major-city zones,” Burns said. “Because of my former role in private placement, I know the best value is in less-efficient, less-competitive cities and not in major markets.”

She was approached by state officials when the OZ incentive became law.

“When the opportunity zones were created, the economic development people from the state said we needed to start a fund,” Burns said. “They said ‘we’ve created great zones, but nobody can figure out how to do a QOF.’ ” So she did.

“It appears that all of the capital is being invested in major markets,” Burns said. “There are structural barriers that keep it that way.”

Her location also works against her, from a capital-raising perspective. Burns shared a story of being told investors will “collide” with her because her QOF is an attractive option–but that hasn’t happened.

“I’d be colliding with investors if I wasn’t in Albuquerque,” she said. “We have projects in California, New Hampshire, Florida, Oregon. These are all deals that have good market demand characteristics and in some cases phenomenal returns, but they’re off the radar of family offices and others.”

Burns has a pipeline worth more than $1 billion in projects. She said she gets 10 to 12 proposals a day and adds one or two projects to her pipeline each week.

As an example, she cited a development in Portales, N.M., where a $1 million investment in a senior care facility would have a catalytic effect of helping seniors age in place, keep local businesses open, the local hospital staffed and provide jobs for students at nearby Eastern New Mexico University.

“If we can invest $1 million alongside a proven developer of assisted living or rehabilitation facilities, we can stabilize the population,” she said. “It’s a little drip that has ripples.”

South Carolina Pipeline

Elliott said his South Carolina-based QOF has been patient–focused on state-specific transactions and raising $3 million of the targeted $50 million.

“We haven’t actively been seeking funding yet,” Elliott said. “We’ve been actively getting a pipeline built.”

Elliott said the fact that his QOF is state-specific brings some restrictions. “We’re trying to get people to invest in some rural counties and cities that they’ve maybe never heard of in their lives,” he said.

Elliott would like to do OZ deals in all 46 counties in the state. He acknowledges that all aren’t high-return developments, especially some government-backed municipality projects, but still are worthwhile.

“You’re not going to be able to knock it out of the park every time, but it’s a safe investment,” Elliott said.

Keys: Education, ‘Gravy’

The QOF managers said that one of the most significant issues is educating potential investors and the people who handle their money.

Burns went to a major investor event with 4,000 attendees and said that 98 percent of the people she met had not heard of the benefits of OZs.

“I wonder how many family offices have even heard of it,” Burns said. “I am concerned. I know nobody in New Mexico knows about it until I talk to them. Probably less than 1 percent of the market understand it.”

Some managers insist the best OZ deal is already a good deal.

“Basically, the opportunity zone benefits are gravy on what should be a good deal anyway,” Lyons said, acknowledging that student housing in college cities wasn’t the ultimate target of the original legislation. “My opinion is that it will be this way for the first couple of years of the cycle before we see if it does what it was intended for.”

Elliott said people are often looking for developments that have a significant community benefit.

“I think the tax benefit brings them to the table, but the project gets them over the edge,” Elliott said. “People are interested in projects that have a positive effect on their community. People want to make money, but want to make it while making their community better.”

Elliott said the looming deadline to get the entire 10-year benefit of the incentive–which currently means investments must be made by the end of 2019–is not an area of huge concern.

“We’ve been hearing that they’re going to extend it and give us a two-year time frame,” he said.

That theory was backed by reports in mid-June that Sens. Tim Scott, R-S.C., and Cory Booker, D-N.J., planned to introduce legislation extending the investment period.

Barkan is bullish on the OZ incentive.

“The first thing we tell people is that no one who can afford to lock up money for an extended period should pay capital gains taxes in the year those gains were generated,” he said. “There is still a lot to be wary of, but there are now enough good offerings that investors should be able to find a fund that enables them to generate significant after-tax wealth while also providing a positive impact on [low- and moderate-income] communities.”

Ultimately, Elliott said QOFs are learning lessons that will make a difference in the future.

“I was talking to another manager the other day,” Elliott said. “I told him that we would pay a lot of money if we could talk to a version of ourselves from two years in the future and get advice on what to do now.”