"Doing well while doing good" has long been a mantra of the wealthy looking for ways to preserve their wealth while doing something worthwhile for the less fortunate. The newest investment opportunity giving them a chance to do so is the "Opportunity Zone" program, or "OZs."
OZs were created as part of the 2017 tax cut package with the intention of directing money to poor areas by offering potentially very large tax breaks to the rich. It has attracted hedge funds, investment banks and money managers who are in the process of raising billions of dollars to get in on the opportunity. Some of America’s richest families and biggest investors are setting up opportunity funds.
Since January 2018, more than 80 funds have been created. Managers of these funds are trying to raise huge amounts of money by selling investors on a combination of massive returns an altruism.
While optimism is high, so is skepticism. The Congressional supporters of the program, including its primary sponsor, Senator Tim Scott, Republican of South Carolina, believe the money will help distressed towns and neighborhoods that have been left out of the recent economic expansion. However, skeptics worry that the funds will mostly target real estate and other projects that would probably attract investment without the tax break, and that the returns being promised may not be realized.
The essence of the program is that it reduces capital gains taxes - potentially substantially - for investors who finance projects in about 8,200 OZs in the 50 states, DC and Puerto Rico.
Another concerning issue is that while the IRS has released some preliminary guidance, there are a lot of questions remaining. It is still not clear as to exactly what type of projects will qualify or what information fund managers must provide to investors and the government.
To date, most funds have focused on real estate development investments. Many of the Wall Street funds are investing in major metropolitan areas on the coasts, especially New York City. Critics of the program claim that these are areas that already receive substantial investment and would do so without OZs.
There is one category of investor that is targeting their activities in secondary markets such as the southeast and Midwest; these are the "impact investors." Several of these investors are working with social activists in establishing accountability standards for the funds since the federal government has not yet done so. These standards will address issues like the quality of jobs created in poor areas. The goal for impact investors is to steer opportunity funds to small businesses and other development that communities actually need, and not just to finance development that provide wealthy investors with high returns - like high-end hotels and condos. When it comes to housing in OZs, the impact investors will look to the Low-Income Housing Tax Credit (LIHTC) as a primary source rather than the more high-end gentrification housing developments. Efforts are now underway by this category of investor to develop a set of principles for the OZ program.
The first segment of the investor market to lay out some guiding principles will shape the market and determine its future direction - i.e., will OZ be just another vehicle for wealthy investors to expand their fortunes - or will it be a legitimate program for enhancing the futures of needy areas?
It is too early to know which way the program will go. Wall Street is intrigued by the OZ concept and it is being embraced by some big technology investors seeking ways to capitalize on stock market gains while avoiding large tax bills.
The law permits an investor to roll over capital gains - e.g., proceeds from the sale of stocks or real estate - into an OZ fund. The fund then invests in a qualified OZ with investments in projects such as condos or affordable housing. If the investor leaves the money in the fund for at least ten years, they may exclude 15 percent of the original capital gain from federal taxation. And - even more attractive - the investor will owe no tax on any gains that accrue as the result of an increase in value of the investment.
The largest opportunity fund so far is a $5 billion fund by CIM Group, a large real estate investment firm and property manager. According to the National Council for State Housing Finance Agencies (NCHFA), not including the CIM Fund, money managers and non-profits have raised or are seeking $18 billion for OZ funds.
In early February 2019, the real estate company Cushman & Wakefield began seeking investors for two apartment complexes planned for OZs in Puerto Rico. The company is projecting a Rate of Return of 29-37% over five years and reportedly has received interest from over 100 investors.
While coastal investments are getting the most interest, some investors are looking inland. McNally Capital, a Chicago investment firm, is considering financing housing developments in the south and Midwest.
The OZ program is also attracting non-philanthropic investors whose only goal is a substantial profit. Skybridge Capital an example of this type of investor. This is the investment firm of Anthony Scaramucci (famous as the shortest serving Presidential Communications Director in history). This firm is looking for $3 billion in investments and the initial marketing document advertises the prospect of "meaningful social benefits" from investment in Opportunity Zones, including job creation and reduced poverty. It also shows how a "hypothetical" investor could earn a ten-year return that is triple what could be expected from a non-OZ fund.
The Opportunity Zone program is in its infancy and the jury is still out on how successful it will be in terms of meeting its goal of assisting communities in need to share in the growing economy. Whether the program contributes to the long-term well-being of these communities or becomes another tax-payer funded program for the super-rich will depend to a great extent on how quickly the impact investors can take the lead in establishing the character and direction of the program.
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