In April 2018 the U.S. Treasury Department and IRS designated the first QOZs (“Qualified Opportunity Zones”), fueling a surge of curiosity and excitement from retail and institutional investors alike, looking to leverage the tax advantages associated with making long-term investments in these economically challenged areas.
Real estate developers, observing an opportunity to attract a new source of investment capital, quickly responded in mass, positioning themselves as the most attractive conduit to accessing such markets. Brokers touted properties being located in QOZs indiscriminately, and it seemed like every other week another firm was announcing fundraising for QOZ dedicated fund.
Now almost five years later, the dust has settled. Much of the excitement has died down. Countless funds and developers have quietly de-prioritized such investments, begging the question “was it all just a bunch of hype? Of equal importance, has this amendment to the tax code done anything to enable economic development in the communities that need it the most?
These questions and more were addressed at the IMN Winter Forum on Real Estate Opportunity & Private Fund Investing Conference. Louis Dubin, Managing Partner of Redbrick LMD, a development firm based in Washington DC, suggested that while the number of developers focused on QOZ investments may have declined since the program’s announcement, the recalibration was to be expected.
“There are a handful of national or regional developers that have been very successful in deploying the tax strategy on the real estate. Again, this is not a business. There are rules you need to follow for a tax benefit that drives 400-500 basis points of returns. It’s really that simple. The cowboys, people pretending like there was special business here, have evaporated or gone away. You are certainly not going to fund the B team today. The problem was originally 90% of players in these cities were B and C.”
Kimberly Brown, Managing Director at Cushman Wakefield, argued that demand for QOZ sites was still incredibly strong, not just affordable and workforce housing development sites, but other asset classes as well, including medical and grocery anchored retail, and novel uses like “techtainment.”
The panel members also shed light on the fact that since QOZ dollars funded represent tax-protected gains from other investments like the sale of an operating business, or gains from the appreciation of stocks, capital flows are less predictable than other vehicles, such as traditional close-ended funds. Alex Bhathal, Founder & Managing Director of Raj Capital, elaborated.
“The sources of the capital have evolved. It can be one-time events. That’s certainly common. There was a time when a lot of it was stock market gains, with people that were harvesting gains. That is less common now. But we have seen a pickup in real estate investors. People who are coming out of partnerships, broken exchanges, where they can’t find good properties to exchange into.” He did point out, however, that the industry has normalized around more widely accepted deal structures, which bodes well for long-term capital flows.
“There has been an evolution. When the space was new, people were creative and trying new formulations, whether it was promote crystallization, or different structuring techniques to optimize the tax benefit and the long term nature of the investments. All of those have been shaken out now it tends to be a standard JV protocols which are not that dissimilar than non-OZ JV deals.”
Ms. Brown made it a point to remind the audience that QOZs were created to economically jumpstart disadvantaged communities, not just a tax shelter for developers and the wealthy.
“ESG is more than the CBD. Communities are not commodities. When you are thinking about impact investing, you are either diminishing social inequities or you are adding to them. There is a reason why there is an opportunity but there is a history of why these communities are the way they are.”
She also emphasized that there are many BIPOC (black, indigenous, and peoples of color) developers active in these communities that are worthy of investment but have largely been overlooked relative to their larger competitors and need to be prioritized.
Panelists were in agreement that to maximize positive social and economic impact, local stakeholders must be included to help steer best practices and win community buy-in. Mr. Bhahal explained, “We partnered with the Urban Institute to develop a scoring tool for each of the projects and evaluate as a part of our due diligence process, the impact we are making as well set up a social impact council that is bipartisan, diverse and multi-disciplinary. They help us in our decision-making process on where we should be steering our capital.”
Mr. Dubin also spoke bluntly about the importance of rolling up sleeves when it comes to community engagement. “There is a business at the end of the day that is about making or activating place. It’s entirely different than just putting up a structure. There is community engagement at a very intense level. If you are not willing to do that, to march in the parade, and be all in at the food bank on turkey day, and you don’t have your compliment of faith-based leaders that can call on you when there is a need, that is felt. This is a business that requires a lot of approvals.”
The panel concluded with speculation around proposed legislation, which could make favorable modifications to QOZ rules that attract even more capital, including extending the deferral date for capital gains until at least year end 2028. Enthusiasm was somewhat muted, however, due to continued uncertainty and skepticism around Congress’ ability to function and act decisively.
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Written by Vernon Beckford at [email protected]