Investment In Opportunity Zone Projects Has Plunged As Program Approaches Its End

Equity investment in opportunity zones has plummeted by nearly 70% this year as economic strain and uncertain tax breaks hold investors back despite the program’s approaching sunset in 2026.

A potential extension of the program under the next president has been pitched, but investors in the space say anyone who wants to take advantage of the program should do so as soon as possible.

“Anyone who wants to start a[n Opportunity Zone] project better start it,” StarPoint Properties CEO Paul Daneshrad told Bisnow. “I wouldn’t be investing into an OZ project in 2026 with the chance that it wouldn’t be grandfathered in.” 

Total equity raised by funds investing via the program topped $38B since it began in 2017, but just $446M was raised in the second quarter of this year, compared with $1.3B a year earlier, according to data from Novogradac. The slowdown began in Q4 2023 when investors placed just $414M in OZ projects.

This corresponds with the overall dropoff in investment and development activity in the last two years as elevated interest rates have choked capital markets activity.

A related factor could be a decline in investable capital gains in 2023, Novogradac partner Jason Watkins said. The OZ program allows for a deferral or, in some cases, a full exemption from capital gains taxes. So in years when capital gains are not generated in high amounts, it can contribute to a drop-off in OZ investment, Watkins said.

Although there have been some record spikes in the stock market in 2024, the major indexes have taken big hits in the last 12 months, cutting into the pool of possible OZ investment dollars.

But with inflation moderating and a rate cut likely coming soon, two factors causing the debt markets to loosen, Watkins thinks OZ investment could increase again through the rest of this year and into 2025. 

Watkins also expects investors will want to try and cash in on one of the primary advantages of the program before it is potentially gone. 

“I expect to see sort of further uptakes in investment over the next two years, particularly if there were not to be an extension or renewal of the incentive, because one of the most valuable, or probably the most valuable, portion of the incentive is the long-term hold benefit,” Watkins said. 

OZ investments that are held for 10 years can be sold without any capital gains tax on the investment.

“As more and more investors become aware of that, I think investment is likely to tick up,” Watkins said. 

It’s a phenomenon that Watkins has seen before when a fractional tax deferral that was part of the program expired in 2021. The years before the expiration led to an influx of capital raising as investors sought to cash in before the deferral disappeared, Watkins said. 

“The investors that truly understand the long-term benefits just keep pouring more money in and keep investing more and more gains,” Watkins said. 

Daneshrad is investing in OZs now, with three projects in various stages of construction and three more in the pipeline across the country. The fundamentals of the projects have to be strong enough to make financial sense even if the program, which allows for deferrals of capital gains taxes, ends in 2026, he said. 

By his count, developments have to be tracking to provide an 18% internal rate of return to tick that box. The projects he has underway are meeting that threshold, and one, an industrial project in Arizona, is tracking to provide a 26% internal rate of return. 

“You really need to have very strong, solid projects to get anything capitalized today and have it make sense,” Daneshrad said. 

Though the future of the program is indeed uncertain, both Watkins and Daneshrad expect to see the program extended and modified. The upcoming election is likely to play a role in the program’s future. Former President Donald Trump’s 2017 Tax Cuts and Jobs Act created opportunity zones, and he has lauded the program as a success. Vice President Kamala Harris has not spoken publicly or issued policy proposals about the program.

Critics of the program have long sought to ensure that investments made in these designated census tracts wouldn’t have happened without the program. They have campaigned for a revisiting of applicable tracts that would direct more money to rural areas and away from tracts that are already experiencing a fair amount of attention from investors. 

Despite criticism, OZs may have at least one thing going for them in terms of broader community benefits. From 2018 to 2022, the housing stock in OZs grew at a faster rate than peer census tracts, according to an analysis of census data by the Economic Innovation Group. And in one-third of states, OZs experienced faster growth in housing units than the state in which they were located. 

The impact on housing could be boosted even further with tweaks to encourage the construction of affordable housing, Watkins said. 

“We think a renewal makes a lot of sense, certainly with some additional reporting requirements, so the impact it’s having can truly be judged,” Watkins said. “Along with some relatively minor tweaks, we think it would open up a lot of different types of investments and bring in different types of investors.”