Investors Boost OZ Equity By Nearly $10B This Year As Clock Ticks Down

Midway through the life cycle of the federal opportunity zone program, investors are pouring money into projects in the zones at a faster clip than at any point so far in the program's short life, trying to capitalize on the benefits while they can and mitigate some of the financial impact of macroeconomic downdrafts.

Nearly five years after the opportunity zone program was created by the 185-page Tax Cuts and Jobs Act of 2017, and three years after its regulations were finalized, opportunity zones have attracted perhaps as much as $100B in investment capital, much of it for real estate development. Qualified opportunity funds, or QOFs, tracked by consultant Novogradac, are on pace to end 2022 with a $10B increase in equity, the largest single-year increase on record.

More is to come. Investors continue to be interested in the program, despite stalled reform efforts, economic headwinds and its expiration, which is still scheduled for the end of 2026.

"I anticipate an uptick in OZ activity in 2024 and 2025, as liquidity starts to free up and investors look to take advantage of program benefits while they still can," Banyan Residential partner Max Friedman said.

But in the short term, he expects the turbulent economic climate will have an impact, reducing the number of OZ starts in 2023, much like the rest of the real estate market.

"The limitations for future OZ development are the short-term availability of debt and equity financing in the current recessionary environment, along with the dwindling supply of well-located sites that can support intelligent investment," Friedman said.

Investing in OZs became slightly less advantageous after the end of 2021, when investors stopped receiving the 10% reduction on deferred capital gains taxes, Duval & Stachenfeld real estate attorney Terri Adler said. Even so, the program still offers two important benefits remaining from a tax perspective.

Namely, investors can still defer their capital gains tax liability until the end of 2026, as well as eliminate taxes on any capital gains realized from an OZ investment after 10 years.

"The 10-year hold benefit is still the bigger piece of the puzzle, and investors are definitely still taking advantage of the program," Adler said.

Qualified opportunity funds tracked by Novogradac reported a jump of $2.2B in equity raised during Q3 2022.

Among the QOFs tracked by Novogradac, residential and commercial real estate investment continued to be far and away the most popular types of investment, with each reporting more than $20B since the beginning of the program. 

The $32.69B total raised as of the end of the third quarter of 2022 compares to $30.49B at the end of June and $24.4B at the end of 2021. The $8.29B increase over the first nine months is thus on the verge of breaking 2021’s record of a $9.24B increase.

That is only a part of the picture, however. Total investment in OZ funds is likely three to four times greater than the $32.69B reported by Novogradac because not all funds report how much equity they have raised. 

"Where we're seeing activity these days is in the private markets where investors have gains from partnerships, sales of a business or sale of private real estate," said Peter Ciganik, GTIS Partners head of capital markets.

As investors review their tax obligations at the end of the year, there will be a meaningful pickup again in December, which has been by far the strongest month for OZ fundraising over the last three years, though this year may be more muted as there are fewer gains in the market now, Ciganik said.

"There are still some people holding, say, Apple or Amazon or Facebook stock from ten or 15 years ago, and their financial advisors suggest that they liquidate some of their investments and diversify," Capital Square co-CEO Louis Rogers said. "So there's still plenty of those people, just not as many as when the market was roaring."

This year's high inflation has also helped spur interest in the program.

"OZ tax benefits can provide a very meaningful enhancement to investor returns, and in the current inflationary environment real estate is one of the best portfolio diversifiers," Ciganik said.

"Interest was very strong in the summer, when we launched our latest fund, through early September," Ciganik said. "The amount of gains that investors had generated in 2021 at the peak of the market were very substantial, and real estate proved to be an attractive diversifier."

Investors might still be interested in OZs, but reforming the program, especially to add reporting requirements, remains a longstanding bit of unfinished business, and it isn't clear whether the coming lame-duck session of Congress, or the new Congress in January, will take up the matter.

Sens. Cory Booker, a Democrat from New Jersey, and Tim Scott, a Republican from South Carolina, who introduced the original version of the OZ program in 2016, introduced a reform package earlier this year. The Opportunity Zones Improvement, Transparency, and Extension Act (H.R. 7467) also has a concurrent measure in the House. So far, the measure hasn't moved forward.

"Critical reporting and transparency requirements were removed from the final measure that became law in 2017, and I’ve worked with people in both parties to restore these requirements," Booker said in a statement emailed to Bisnow, but he didn't offer a timetable for pushing the reform forward.

Without reporting requirements, it is still hard to know the impact of the program on the places it is supposed to help. The 8,000-plus zones nationwide selected were chosen mostly because of their slow economic growth and lack of jobs.

There are some indications that OZs have had some positive impact on local economies, but they are indirect.

For example, median single-family home and condo prices rose from Q2 2022 to Q3 2022 in 51% of opportunity zones around the country and went up at least 3% in almost half of the zones, according to a report released in November by property data specialist ATTOM.

For the report, the company looked at 4,732 OZs with sufficient data to analyze: at least five home sales in the third quarter of 2022.

The gains were lower than earlier in the year, but they still stood out compared with a national market that saw a 3% decrease in the median single-family home prices in Q3 2022, after a decade of almost uninterrupted gains.

If the lame duck Congress takes up the reform package, or if something similar emerges from the next Congress, it would extend the program’s duration from 2026 to 2028, which would bring back a tax reduction benefit that expired last year. 

"In addition to the tax-free treatment of gains after a 10-year hold, the program had an upfront bonus of reducing the current tax liability by 15%," Ciganik said. "The proposal currently in Congress would reinstitute this tax reduction bonus, and likely bring a lot of investor interest if it passes."

An extension appears to be headed towards noncontroversial approval, Rogers said, depending on whether it can be slipped into a bill to keep the federal government running.

"Or next year if there's anything noncontroversial [Congress] can pack it onto," he said. 

But not everyone is sure there will be any changes to the program in the near future, or at least not by the lame-duck Congress. 

"Anything that involves Congress in the years leading up to the presidential election are going to be a hard push," Adler said. 

"There's always been talk about making the OZ program more permanent or extending the timeline or reupping some of the reduction benefits," she said. "But I've not seen anything that has gained momentum."

"I don't think there's any way [the reform] will pass this year," HCVT partner Blake Christian said. "But if it passes next year, that will be another shot in the arm for the program."