OZ Market Leaders Eye Extension of Incentive, Reporting Requirements

Published by Nick DeCicco on Monday, April 4, 2022
Journal Cover Thumb April 2022

As of the end of 2021, the 1,342 qualified opportunity funds (QOFs) tracked by Novogradac had raised $24.4 billion in equity, as reported in the Novogradac Opportunity Zones Investment Report released in February.

Novogradac’s report is based on a rolling collection of information from QOFs voluntarily providing information or through public sources such as Securities and Exchange Commission filings and press releases. Novogradac’s list does not include proprietary or private funds owned and managed by their principal investors

California, Arizona, Texas, New York and Florida were the top five states for equity investment.

Nearly $7 billion of that came in the final six months of the year. Some of that was a push to meet the Dec. 31, 2021, sunset of the 10% basis step up, which means that 10% of the originally deferred gain is permanently excluded.

Kevin Shields, chair and chief executive officer of Los Angeles-based Griffin Capital, one of the largest opportunity zones (OZ) investors in the multifamily sector with more than $1 billion raised in equity, said that, while there was increased activity to make the year-end deadline and secure the 10% basis increase, the increase in total return from that boost over a 10-year investment horizon is not material.

“Investors should not obsess about the 10% basis boost that is now no longer available,” Shields said. “The focus should center on the quality of the investment first and foremost, not the tax benefits.”

Shields was one of several OZ industry leaders who recently spoke to the Novogradac Journal of Tax Credits about the state of the OZ market, including the Novogradac report’s rise in hospitality investing as well as a recurring pursuit among those in the community: An extension of the OZ incentive.

Hospitality Takes the Elevator Up

OZ funds with any target of hospitality reported raising $3.5 billion in 2021, up from $2 billion in 2020, according to Novogradac’s report. More than $633 million of this was hospitality only, raised by 37 QOFs.

Greg Friedman, managing principal and chief executive officer of Atlanta-based Peachtree Hotel Group, which operates, develops and finances hotels with a focus on OZs, said the hospitality industry is seeing a resurgence after the pandemic wreaked havoc.

“The hospitality industry has gone through the wringer over the past two years, but today, there are tremendous opportunities in this space,” Friedman said. “While not every opportunity zone needs a hotel, these zones are in downtown markets, near airports, near industrial parks, near universities, places that hotels have historically done well, particularly in the chain scale we operate–select- and limited-service hotels. In addition to addressing travelers’ value and convenience preferences, these property types experience less volatility as they don’t rely on seasonal demand.”

Friedman said demand in the hospitality sector continues to improve.

“We will exceed pre-pandemic levels soon enough because the forces that propel the hospitality industry were interrupted, not impaired by COVID,” Friedman said. “Nothing has fundamentally changed to alter the trajectory of gross domestic product (GDP) growth or population growth or the course of household income growth. These are the tailwinds that underpin this industry’s growth.”

Friedman said that getting in before the Dec. 31, 2021, deadline to receive the 10% basis boost drew increased interest from investors, but also noted investors are always looking for vehicles to allocate their realized capital gains into tax-reduced vehicles.

Friedman spoke to Peachtree’s experience as an asset, saying their expertise affords the company competitive advantages in analyzing new hotel investments.

“Further, we focus on proven hotel brands, like Marriott, IHG, Hilton, Hyatt, with excellent distribution systems,” Friedman said. “This provides more certainty in the actual demand for hotel rooms. We also make sure they are institutional quality assets that are well maintained.”

A Bullish Outlook

Griffin Capital focuses on ground-up multi-family development, with Shields noting that the OZ incentive empowered the firm to accelerate its investment into that asset class more than it may have otherwise. He called the market “robust” for multifamily.

“We will invest over $2.2 billion in areas woefully underserved from a housing perspective,” Shields said. “We’re directing capital gains into housing and communities in desperate need. There’s a nationwide housing shortage … and we are developing multifamily communities to address that shortage.”

Shields said Griffin’s second qualified opportunity fund (QOF) closed in 2021 having raised $585 million in equity. Shields remains bullish about the future of the OZ tool, with Griffin launching a third QOF this year. He said education about what OZs are and do remain a crucial component.

“The question we should ask ourselves is will that education take hold and will there continue to be a demand for good product and good sponsorship?” Shields said. “I believe the answer is yes, which compelled us to commence our third fund.”

Shields said the creation of a new market naturally draws participants who are apt to test its limitations, but made Griffin’s case for its long-time expertise in real estate investment and development. Additionally, Shields mentioned the Government Accountability Office’s investigation into OZs, saying the incentive is serving as a vehicle for community development, but allowed that there are areas where it can be refined.

“Things happen where people really take advantage of the situation,” Shields said. “You can clip their wings, but why cut the entire program? … There are things the government can improve along the way. They can improve the way in which the industry reports on the impact to those communities in which it invests to monitor whether the capital invested is directed to the right communities for the right purpose.”

A Dispatch from D.C.

Catherine Lyons, director of policy for Economic Innovation Group (EIG), a policy and advocacy organization that seeks to forge a more dynamic economy, described the policymaking landscape right now as “promising.”

She hopes for bipartisan, bicameral support for improvements to policy, backed by the more than 50 market stakeholders who signed their name to a policy letter EIG sent to President Joe Biden’s administration at the start of his term. The priorities include reporting requirements, early sunsetting for a small percentage of higher-income census tracts that don’t meet the spirit of the incentive, and extending the sunset date for the OZ incentive from the end of 2026 into the future.

“Market stakeholders are willing to participate in a robust reporting regime to track activities and investments. I think that’s notable,” Lyons said. “It speaks to the broad and deep support that establishing reporting requirements has.”

Lyons said she has not seen or heard of resistance to establishing reporting requirements, but said care should be taken with regard to how they’re structured.

“I think it’s important that reporting requirements are not overly burdensome,” Lyons said. “There needs to be a balance between collecting important information that’s properly aggregated and protected. … Policy proposals should ensure that confidential taxpayer information, competitive information is properly aggregated.”

Lyons said it’s a particularly exciting time for OZs as some of the first projects are beginning to open doors or move into service.

“We’re starting to see tangible results from the OZ incentive and the capital it is catalyzing,” Lyons said. “It’s exciting to see that. We can see real intentionality behind the investment thesis of many of our [OZ coalition] members.”

Lyons mentioned the impressive diversity in investments, from broadband internet to multifamily housing to a robotics business to the hospitality industry.

“It’s exciting to see how OZs have been able to support such a wide range of investments that are meeting unique community needs, to see investors and fund managers and engaging and aligning with communities, getting community input and investing in projects that support the community and its residents.”

Seeking an Extension

Lyons, Shields and Friedman all mentioned the market’s hunger for an extension of the OZ incentive, speaking to its popularity.

Lyons said that in a survey EIG conducted in May 2020, the top priority from respondents in the OZ marketplace was an extension.

“We asked what policy change would ensure opportunity zones are an effective tool for economic recovery and the highest number of respondents agreed with the proposal to extend the policy,” Lyons said. “Generally, they support an extension to help and support their impactful work and lengthen the timeline around it.”

Friedman called an extension “the most significant factor” to influence OZ investing, one that could have substantial positive effects, if achieved.

“Opportunity zone funds are an attractive option,” Friedman said. “And we are encouraged by discussions happening in Washington, D.C. We are members of the Opportunity Fund Association, an organization that participates in public policy, shares best practices, and communicates the industry’s contributions to distressed rural and urban communities across the country. They are working with both sides of the aisle on improving opportunity zone investments.”

Shields, too, hopes to see an extension, especially given that many aspects of the OZ incentive were not finalized until spring 2019, which meant the 15% basis boost went away quickly at that year’s end.

“An extension would be a boon,” Shields said. “It does set a line in the sand that causes people to transact.”

Without an extension, Shields speculated that the appetite for OZ investments may thin.

“The 15 and 10% basis step-ups are no longer available and, as we approach 2026, the less valuable the deferral becomes,” Shields said. “However, the 100% fair market value basis step up after 10 years is the real economic driver behind this legislation and that, I believe, will continue to drive demand for OZ investment.”