Opportunity-Zone Funds Are Off to a Slow Start, Lagging Behind Heady Expectations

Investors have been slow to embrace a new tax break meant to spur economic growth in distressed communities, leaving the amount of money raised for these programs well short of fund managers’ lofty expectations.

The program, part of the 2017 federal tax overhaul, allows investors to defer and reduce taxes if they reinvest capital gains in nearly 9,000 low-income communities designated by the federal government as opportunity zones. Funds qualify for the preferred tax treatment by making equity investments in companies or real-estate projects in these communities.

Some real-estate executives have said the program could be the biggest thing for the industry in decades. Treasury Secretary Steven Mnuchin predicted last fall that opportunity zones would attract more than $100 billion in private capital.

But opportunity-zone funds have so far, on average, raised less than 15% of their goals, according to a new analysis by Novogradac & Co., a San Francisco accounting firm that advises fund managers and investors on tax incentives.

The Novogradac data includes 103 funds set up to invest in opportunity zones. These funds, which include many of the industry’s largest, have raised a combined $3 billion of the roughly $22.7 billion they seek. Novogradac said it is aware of 285 of these types of funds, though not all have shared fundraising details.

“Every manager I talk to is saying gaining traction is slower than expected,” said John Lettieri, chief executive of the Economic Innovation Group, a nonpartisan think tank that helped develop and promote the opportunity-zone program.

Mr. Lettieri said it isn’t surprising that the program is taking time to pick up steam, especially given that regulations aren’t yet final and these are new markets for many investors. But the slow start is raising fresh questions about investor appetite for the program, and what impact it will have on distressed communities.

Opportunity-zone investments must be held for 10 years to capture maximum benefits. The value of deferring capital-gains taxes, a key advantage, could fall if tax rates rise.

“The No. 1 concern [investors] have is the length of time they are investing for and the uncertainty of what can happen over that period of time the money is invested,” said Chris Loeffler, chief executive of Caliber Cos., which has raised about $50 million of its $500 million target.

A spokeswoman for Cantor Fitzgerald, which is seeking $500 million for its joint venture with Silverstein Properties Inc., said the biggest headwind has been the need to educate the market. She declined to say how much the firm has raised, though she said it is “on target for where the business wanted to be by year-end.”

Uncertainty about the program’s fine points has hampered early fundraising, industry participants say. The Treasury issued its first guidance in October 2018 and a second set of guidelines this spring.

“The first six months was very slow. There were a lot of questions,” said Ben Miller, chief executive of Fundrise LLC, which has raised $50 million of its $500 million target.

Fundrise’s early investments include a mixed-use development in Washington, D.C., and an office and retail renovation in South Los Angeles. “People were very concerned about how the regulations would be promulgated,” Mr. Miller said.

A Treasury spokesman said the agency “has worked diligently to issue comprehensive guidance” for the program. “As investors continue to learn more about this policy, the amount of capital flowing to new and expanding businesses in those communities will only increase.”

Some funds have reached their goals. SoLa Impact, which invests in distressed neighborhoods in South Central Los Angeles, closed in August a $100 million opportunity-zone fund focused on affordable housing and a business campus. Much of the money came from investors with 2018 capital gains they needed to redeploy by midyear to capture the tax break, the firm said.

“We’ve been investing in areas that most people overlook for the last 10 years,” said Managing Partner Martin Muoto.

Other managers expect a pickup as year-end nears. “It’s not really until the fourth quarter that investment advisers start to engage in high-level tax planning for their clients,” said Kevin Shields, chief executive of Griffin Capital Co., which has raised $41.6 million of its $275 million target, according to Securities and Exchange Commission filing this month.

Return expectations could be a stumbling block for some funds after a first wave of projects already in the works soaked up early money. Gill Holland, a developer seeking $50 million for projects in a distressed Louisville neighborhood, said investors are reluctant to take on projects that may take a few years to produce double-digit returns.

Fundraising “should be going fantastically, but everyone in opportunity-zone funds wants a 15% return on investment,” he said, and isn’t thinking enough about social impact.

Other challenges are structural. Private-equity funds typically solicit commitments from investors, find deals and then call for money that has been pledged for two years. With opportunity zones, “the money that comes in has to be capital gains,” said Thomas West, a former Treasury official and now a principal at KPMG LLP. “It is very hard for investors to commit to having capital gains on hand over that time period.”

Some managers are already tweaking their strategies. Bridge Investment Group LLC initially aimed to raise a $1 billion blind pool opportunity-zone fund, in which property investments wouldn’t be identified until after fundraising. In June, Bridge switched to a series of smaller funds with investments that have already been identified.

Investors are also worrying about whether they are benefiting local residents as the program intended.

“A lot of people are saying, ‘Are there other ways for me to invest for impact?’ ” said Jennifer Kenning, chief executive of Align Impact, which advises social-impact investors. “It’s not such a slam-dunk thing as we thought it was.”
Source: Dow Jones