Market Expects Pipeline Growth, More Regulations in the Near Future for OZs

Published by Mark O’Meara on Monday, April 5, 2021
Journal Cover Thumb April 2021

The opportunity zones (OZ) incentive was created to drive capital into low-income communities across the United States. One year into the global COVID-19 pandemic, the OZ incentive is more vital than ever.

“Last year was such an important year for recognizing the value of impact investing in opportunity zones,” said Alexander Flachsbart, founder and CEO of Opportunity Alabama, a nonprofit organization dedicated to creating an impact-based OZ ecosystem to provide access to capital to Alabama’s low-income communities. “More and more investors are beginning to recognize that domestic problems like broadband access and workforce housing can be solved by this capital. … The silver lining of the pandemic was awareness.”

During the pandemic, Opportunity Alabama focused on laying better infrastructure to produce investable projects. “The focus at Opportunity Alabama is on pipeline generation in 2021,” said Flachsbart. “The first two years were more about education and marketing, and we were still able to get over $300 million in deals done. With more local investors at the table than ever before, we see the sky as the limit for this coming year.”

Griffin Capital Company found success during the pandemic, having closed out its first qualified opportunity fund (QOF) with nine properties and $1 billion in development expense and launching a second QOF.

“It’s hard to assess how the pandemic affected the properties in our funds,” said Kevin Shields, chairman and CEO of Griffin Capital Company, whose QOFs focus on multifamily community development. “We rebid material and labor contracts this past year and realized savings [with the exception of lumber] and experienced material declines in LIBOR, resulting in construction period interest savings, but we have also flattened out our rental rate growth assumptions, so it’s hard to quantify the net economic impact of the pandemic on future fund performance.”

“During the pandemic, we first saw a dip, then demand accelerated,” said Tom Shapiro, president of GTIS Partners, which is a global real estate manager that has OZ investments.

Shapiro said that, “The pandemic really accelerated trends on certain asset classes. People are moving to the Sun Belt, people want space since they are working from home, single-family rentals are doing well in the pandemic and there is a greater need for more senior housing.”

Flachsbart said in Alabama there has been a push for investors to look locally.

“The promise of those $1 billion national funds never materialized, but there were so many local gain events happening,” said Flachsbart. “High-net-worth investors never had a framework that motivated them to invest in their backyards. OZs give them the incentive they needed to invest locally.”

While Opportunity Alabama found success locally during the pandemic, Griffin Capital Company found success in diversified QOFs, or funds comprised of multiple developments.

“Early on there was a focus on single-asset funds and an investor could achieve diversification by investing across multiple qualified OZ funds, but that is a bit clunky,” said Shields. “We focus on larger funds with multiple identified assets, which the market prefers relative to a full or partial blind pool. We do not think it appropriate to have to find an asset after we have raised the money. We believe that approach inappropriately shifts the risk to the investor and could lead to poor investment decisions.”

Different Market Sectors of OZ Investment

Industry experts say real estate remains the largest sector of OZ investment.

“Eighty percent of our pipeline is real estate,” said Flachsbart. “There are not a lot of national funds interested in operating businesses–but we have seen more targeted local interest in everything from breweries to tech startups.”

“We focus exclusively on multifamily real estate development–it’s an asset class with which we have significant experience,” said Shields. “Multifamily housing is very scalable and we can achieve meaningful diversification with a billion-dollar portfolio. Time series data also suggests multifamily housing generates the highest relative return with the lowest standard deviation–or the highest risk-adjusted return. The cash flow from other asset classes, office and industrial, experience greater volatility depending upon tenant movement–exposure to capital expenses in a multifamily context are very programmatic and predictable.”

However, Flachsbart said the OZ incentive has had some unexpected positive consequences for operating businesses.

“For operating businesses, one of the unexpected results of OZs has been the ‘bug light’ effect–businesses that came to us as OZ deals may be an even better fit for another capital source in our network, and we can make those connections once we know about the opportunity,” said Flachsbart. Flachsbart said projects looking into OZs often come across other sources of funding, including crowdfunding, Community Development Financial Institutions funds and even qualified low-income community investment loans.

OZ experts mentioned two other sectors that are doing well.

“[We have seen] a trend toward e-commerce, which is bad for retail, but good for industrial,” said Shapiro. 

Flachsbart said access to broadband internet is also a growing sector of OZ investment.

“Broadband is the new electricity,” said Flachsbart. “The No. 1 need in most rural communities is getting internet. You can’t do remote learning or conduct business without broadband, and we have seen opportunity funds like Arctaris address this need head-on.”

OZs Under the Biden Administration

“Under the Biden administration, we expect to see more regulations, which we are all for,” said Shapiro. “We want to make sure that investments are not just following the letter of the law, but are being made in the spirit of the program as well.”

“Hopefully we can get reporting requirements done ASAP,” said Flachsbart. “That way, we will have the data we need to prove the program is working in the ways we believe it should.”

With the anticipation of more regulations coming, industry participants see a bright future for the incentive.

“There is a high degree of bipartisan support for the legislation,” said Shields. “I don’t see anything on the horizon that would cause a cutback–in fact, there is already a draft bill intended to extend the deferral period through 2028, which bodes well for general political sentiment.”