Will advantages of opportunity zones endure a slumping market? 

By ERIN CHAN DING 

One of the hottest investing trends for family offices in recent years may be cooling in the middle of a downturn in the housing market and uncertainty about its endurance.  

For the past four years around the country, billions of investment dollars have poured into qualified opportunity zones, often called QOZs, attracting family offices that want to see disadvantaged communities redeveloped and take advantage of generous tax incentives.  

But interest may have flattened in the past year, said Dennis Caulfield, vice president of research at FINTRX. “We saw a big uptick around 2019-2020 and somewhat of a fizzle-out over the past year,” Caulfield said.  

The real estate market has taken a hit in recent months, with rising interest rates and persistent inflation slowing construction starts. Homebuilder confidence fell for the 10th straight month in October to its lowest level since the start of the pandemic, according to the National Association of Home Builders.  

Those factors haven't deterred Alex Bhathal, whose RAJ Capital family office has invested heavily in QOZs since 2018 and was named Opportunity Zone Investor of the Year in GlobeSt.com's ADAPT Awards in 2019. "We have invested into 14 real estate projects across the country with over $1.3 billion in total project value," he says, adding that he's focused primarily on multifamily housing, as well as industrial and office space and a hotel project, and likes to target "underdog communities." 

"We have seen a steady and persistent increase in QOZ investment activity since" 2019, says Bhathal, "despite an uncertainty around the regulations initially, a global pandemic, economic disruption and now a slowing economy." 

Some real estate investors are still optimistic about the program. In late September, Atlas Real Estate Partners in New York and Miami launched its fourth Opportunity Zone Fund, targeting multifamily developments across the Southeast and Texas and seeking to raise $1oo million in equity. Despite the current market volatility, Atlas co-founder Arvind Chary said that “by taking a patient, long-term investment approach to development in high-growth geographies [like the Southeast], we are able to continue executing through market cycles.” 

Kent Insley, chief investment officer of Tiedemann Advisors, says his firm has put in more than $100 million in client equity in two opportunity zone funds, one created in 2019 and the other in 2021. With the help of a subadviser, Tiedemann chose 12 new development projects spread out in opportunity zones throughout the United States, including in Phoenix, New Jersey, Philadelphia, Ohio and Charleston, South Carolina. He adds that Tiedemann just opened a new QOZ fund this year that continues to draw the interest of family offices.  

“Multifamily has been a type of asset that single family offices have found appealing for many, many years—affordable housing, workforce housing, life sciences facilities, industrial facilities, many of these are in high demand now, based on our observation from single and multifamily offices,” he said. 

The program has had bipartisan appeal, said Nick Parrish, managing director of Cresset Partners, the private investing arm of Chicago-based Cresset Capital. “You’ve got a program that is, arguably on paper, one of the largest tax breaks to asset owners and investors ever conceived. The Republicans love that. And you have something that’s incentivizing people to redirect that capital into urban redevelopment and revitalization—Democrats love it.” 

A huge challenge, however, is finding investments in opportunity zones that will generate gains in the first place. 

“If you invest into an opportunity zone and lose money, this does you no good,” Parrish said. “What’s really interesting about the program is it has to walk a fine line between doing public good — so investing in areas that need revitalization and are doing a social good — but you have to have the potential to earn a rate of return, because this is not charitable dollars, these are people’s actual investable dollars.” 

First, a family office has six months to decide whether it would like to invest its capital gains in an opportunity zone or opportunity-zone fund. Second, the gains can come from selling anything — not just stock. So gains from real estate, artwork, a business or cryptocurrency are eligible for opportunity-zone investment. 

The first step is to understand why your family office wants to invest in qualified opportunity zones because, Parrish said, “the motivation that drives a family is going to be unique.” 

Some may approach the zones purely as a financial decision, viewing them as ways to maximize after-tax returns. Others might be deeply rooted in a specific cause, such as affordable housing. 

And while some family offices may choose to invest their gains in a specific opportunity-zone project, others may diversify their dollars by choosing a QOZ fund with investments in various efforts and regions. 

Bipartisan legislation introduced in April by Booker; Scott; Kind; and Rep. Mike Kelly, R-Pa.; along with several bipartisan co-sponsors, would extend opportunity-zone tax incentives for two more years. 

That bill would also expand reporting requirements for transparency and help track long-term community impact in the zones. It would eliminate opportunity-zone designations in areas where the median family income is at or more than 130 percent of the national median family income. States also could do a one-to-one replacement of those zones with other areas in need. 

Parrish said he views the legislation as “good signaling” that opportunity zones have shown their relevance. 

“This,” he said, “is a pretty unique program that really combines what we think is a once-in-a generation tax benefit with something that is going to do some good and create some economic progress in areas that need it.” 

While you may see questions about opportunity zones popping up on tax returns, what are they, and what are their primary advantages? And are they the right investment fit for your family office? Here’s how opportunity zones can benefit communities while also enhancing investment portfolios:  

A qualified opportunity zone consists of an economically distressed area meeting certain conditions eligible for preferential tax treatment. There currently are 8,764 opportunity zones in the United States, “many of which have experienced a lack of investment for decades,” according to the U.S. Department of Housing and Urban Development. 

QOZs can range from urban to rural to suburban. Nick Parrish of Cresset Capital, which has invested about $1.2 billion in QOZs, said that an area of Portland, Oregon, that includes a Ritz-Carlton hotel qualifies as an opportunity zone, as do 21 areas of now-booming Austin, Texas, because the zones are based on tracts pulled from the 2010 U.S. Census.  

Even so, the poverty rate across all opportunity zones sits at 26.4%, according to the Economic Innovation Group, with about 35 million people living in areas that qualify for the opportunity-zone designation. 

Qualified opportunity zones are relatively new creations — and they have bipartisan origins. 

Originally introduced as the Investing in Opportunity Act by U.S. Sens. Tim Scott, R-S.C., and Cory Booker, D-N.J., as well as U.S. Reps. Ron Kind, D-Wis., and Pat Tiberi, R-Ohio, opportunity zones were added to the tax code in December 2017 as part of the Tax Cuts and Jobs Act.  

The first set of opportunity-zone designations were approved in April 2018 and covered parts of 18 states, according to the Internal Revenue Service. They now cover areas of all 50 states, along with the District of Columbia and five U.S. territories. 

Among its tax benefits, the program allows people to defer taxes on capital gains until the end of 2026, so long as they’re willing to invest in an opportunity zone for at least 10 years. 

The first big benefit comes through the deferred tax on capital gains, giving families flexibility with their investments before needing to meet the tax obligation. 

However, Parrish said, the “real magic” happens with the potential gains that could come from investing in opportunity zones. If the opportunity-zone investment is held for at least 10 years, those gains would incur no tax. 

For example, if a family business invested $100 million gain into an opportunity-zone-based real estate project this year and held it until 2032, fulfilling the required minimum 10-year investment, and then sold the building for $300 million, no tax would be incurred on the $200 million gain made in the zone. 

“It’s a much more powerful thing to grow and compound those new assets on a tax-free basis,” Parrish said. “So if you think about it, for a family or a family office who has often a lot of investable capital; who is likely generating gains somewhere in their portfolio; who has often a long-term, multigenerational horizon where 10 years doesn't make a lot of difference; and likely who has a comfort in owning private assets, this is a eureka moment for them.