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Outside Forces Slow OZ Investment, but Economy, Extension Could Spur Increase

Published by Brad Stanhope on Tuesday, June 4, 2024

Journal Cover June 2024   Download PDF

A looming expiration date and a decrease in capital gains events are combining to put a damper on opportunity zones (OZ) investing, but many advocates are confident that things could change quickly.

The combination of a Dec. 31, 2026, deadline for recognizing taxable gains for investments in OZs and a broader decrease in capital gains events in 2022 and 2023 slowed OZ investment over the past year–as indicated by Novogradac data on equity reported raised by qualified opportunity funds (QOFs).

As of March 31, the 1,890 QOFs tracked by Novogradac–1,471 of which reported a specific equity amount raised–reported raising $37.85 billion in equity since the start of OZ investment in 2018. QOFs reported $229 million raised in the first quarter of 2024, continuing a trend of lower quarterly investment totals. 

QOFs are the investment vehicle through which taxpayers invest capital gains to qualify for deferral and other tax benefits. Novogradac collects data from QOFs that voluntarily provide information as well as from public sources such as Security and Exchange Commission filings and press releases. Novogradac's QOF figures don't include proprietary or private funds owned and operated by their principal investors. Actual OZ investment is likely greater than the Novogradac total by a figure of three or four times.

"What we're hearing is that things are plateauing in terms of funds raised and deployed," said Catherine Lyons, director of policy and coalitions at the Economic Innovation Group (EIG), a bipartisan public policy organization and national leader in the OZ space. Lyons said stakeholders cite the 2026 deadline for recognizing taxable gains and expiration of the policy as reasons for the leveling off. She also said the broader economy plays a major factor.

"There are fewer or more-limited capital gains realization events than in 2020 and 2021," Lyons said. "It's reflected in the data for the last couple of quarters that show funds are still being raised, but at a slower clip."

Slowing Down?

Novogradac's QOF investment data appears to reflect broader economic trends.

"The flows of capital rise and fall with the markets, broadly speaking," said Jeff Feinstein, co-founder of Pinnacle Partners, a dedicated OZ investment firm that was founded when the incentive became law in 2017. "We had a lot of crypto [investors] in 2019 and they've returned. There are real estate sellers [in the OZ market] because of interest rates and recently we've seen an uptick in activities associated with tech stocks, some of which reached all-time highs."

Ashley Tison, the founder of OZPros, a full-service advisory firm that specializes in captive OZ fund creation and other tax mitigation strategies, agreed.

"We're seeing a lot of interest from folks whose stock portfolio went up and are getting out while the getting's good," Tison said. "It's similar with crypto markets. We've seen a spike since crypto rebounded and some people are harvesting it. Prior to that, it was dismal, which isn't surprising because the availability of capital depends on people having capital gains events. When the economy isn't doing so great and real estate is slowing because of the rise in interest rates, it's not surprising that less people have capital gains."

As capital gains rise, interest in OZ investment increases–although the looming expiration date dampens that enthusiasm somewhat.

"I don't know that investor demand has tailed off," said Alex Flaschbart, founder, president and CEO at Opportunity Alabama, an economic development organization focused on transforming Alabama communities. "I think there's less rah-rah activity in the industry because some people don't feel like the hold period justifies them locking up capital for 10 years. But at the end of the day, you're underwriting real estate."

Feinstein said the looming deadline has affected Pinnacle's sourcing strategy.

"I think it's reflected in the types of projects we're pursuing," Feinstein said. "In the early days, we pursued land acquisition, which is an early-stage investment. We no longer do that, so we only see permit-ready projects. There's greater risk if we don't get an extension [of the incentive], so we're cognizant of the timing. We need much greater precision, visibility and a high confidence of the ability to execute on a project."

Tison said that investors who are reluctant due to the looming expiration date often change their mind once they learn the facts. He expects an extension.

"If the legislation goes through, there will be all kinds of PR about it and that will give people the ability to go back to their investor networks," said Tison. 

Novogradac tracks public QOFs and Lyons said she has only anecdotal information on whether privately held QOFs are facing the same plateauing in funds raised.

Tison said there are fewer issues raising equity for those private funds for taxpayers who already had a capital gain event. "I don't think there has been as sharp of a drop-off [as with the bigger QOFs]," Tison said.
Potential investors in QOFs have a 180-day window to invest capital gains and Tison said that timing plays a role in investment.

"We should look at what was happening in the economy 180 days prior to that testing window," Tison said. "That's what drives investment."

Lyons said the lack of information on the private QOFs could be addressed by legislation.

"That's exactly why we need reporting requirements, so we can properly evaluate the full OZ market without differentiating privately vs. publicly held funds," Lyons said. "It would be really great to have that, especially as we enter a pivotal year in 2025."

That's the year when tax legislation passed in 2017 faces expiration, leading to a likely new tax bill.

Housing is Focus

QOF investment has always focused on housing, an emphasis that has increased over time. QOFs tracked by Novogradac have helped finance more than 175,000 homes across more than 200 American cities–with 164 of those cities seeing at least 100 housing units financed by those QOFs.

Novogradac can track specific types of investments made for $29.67 billion of the $37.85 billion that QOFs report having raised. Of that amount, $12.93 billion is for residential-only development and another $10.03 billion is for residential properties with another element (often commercial space).

Lyons said that OZ residential development should be trumpeted.

"In the midst of a significant housing crisis across all types of communities, this is an incredible contribution to the overall housing supply," Lyons said. "It's reflective of the fact that opportunity zones are a market-oriented and market-based incentive. When we were first discussing the idea of opportunity zones, there was not as much of a housing crisis as there is now. We've seen opportunity zones respond to that need and it's reflected in [RealPage] data that shows 20% of all multifamily housing units built last year were in opportunity zones, up from 8% before the opportunity zones designations. It's projected that will be even higher in 2024."

However, Tison said a hidden issue for OZs is the preponderance of multifamily housing transactions, which have become harder to get done. "I think that investor perception about difficulties in multifamily has trickled down into opportunity zones," Tison said.

Effect of Extension

While investment slowed, those interviewed about the OZ market were unanimous that an extension of the incentive would increase investment.

"The interest level is still there," Flaschbart said. "The knowledge base is there and the interest is there."
Feinstein said he suspects many private QOFs are struggling to execute their business plans because of difficulty in finding deals. He said the idea of a "fund of funds"–a provision of the Opportunity Zones Transparency, Extension and Improvement Act–would address those, allowing funds to merge.

"With an extension, we'll probably get a rush of capital into the program," Feinstein said. "It would be a real triggering event."

EIG is pushing for the Opportunity Zones Transparency, Extension and Improvement Act, which would also extend the deferral date until the end of 2028 and includes reporting requirements.

"National-level aggregate data would provide important information about who is raising funds, where they are raising and deploying capital and into what investments and projects that capital is going," Lyons said.

Lyons said there is much focus on a possible extension of the incentive.

"I would say that's probably the question we get most frequently," Lyons said. "Not just from investors, but from all types of stakeholders. Given that it took a couple of years to finalize OZ regulations, people often tell us, ‘I could do so much more if we had a couple more years.' They could start or complete more projects and raise more capital to deploy into communities, but they need the extra time."

Strategy Ahead of Expiration Date

As the deadline nears, participants are busy. Pinnacle has a fund that closes in June with all the projects identified and several under construction, with one completed.

"I would advise people to find a fund that has clearly identified projects, rather than blind pool funds, has permit-ready deals and projects under construction because 2026 is coming fast," Feinstein said.
Lyons said the benefits of OZ investment are clear.

"We have moved into the phase of the policy of project delivery and impact, which is very exciting," Lyons said. "We are seeing more and more projects finally come online and deliver real benefits and services to the surrounding communities and residents."

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