Fund Managers Stand To Reap Benefits Of New Opportunity Zone Regulations

Nearly two weeks after the second round of opportunity zone regulations were released, many investors are still working to understand every nuance, while some may never bother.

Both groups are likely to trust third-party investment managers with millions, if not billions, of dollars in capital via qualified opportunity funds. Until the recent update, only single-asset real estate deals were laid out in enough detail to seem like a safe bet, but now that the Treasury Department has clarified that sales of assets within a QOF would not trigger capital gains taxes, big money can really start moving.

“[Fund managers] expect capital to flow more, and they’re ramping up their activity to be ready,” Altus Group Senior Executive Vice President Rick Kalvoda said. “It’s almost like the shroud of uncertainty has been removed.”

Because the tax benefits of opportunity zone investing can only be fully realized if capital remains in a QOF for seven years or more, funds formed around one property have to hold that property. Larger funds with the ability to sell and buy individual assets over their life span more closely resemble the types of deals that investors are used to, Kalvoda said.

Some familiar names in real estate have launched major QOFs in the past year, such as Silverstein Properties and Cantor Fitzgerald's $1.8B fund, CIM Group's $5B fund or Starwood Capital Group's $500M fund. One surprising-if-recognizable name that has entered the space is Anthony Scaramucci, whose hedge fund, Skybridge Capital, has launched a $3B fund, partnering with Westport Capital Partners for its real estate expertise.

In today's marketplace, there are dozens of fund managers looking to raise capital for their QOFs just as there are investors sitting on recent capital gains, seeking a QOF  to harbor them. How aggressive a capital source might search for a QOF, or how available they would be for recruitment, likely depends on its structure or the source of its gains.

Up to this point, those most likely to wade into opportunity zone investing have been high net worth individuals or family offices, multiple sources told Bisnow. Those capital sources often lack restrictions on how they allocate capital and likely have capital gains from other sectors newly eligible for tax breaks. Institutional sources of capital such as sovereign wealth funds and pension funds already avoid gains taxes, so the benefits of qualified opportunity funds are moot.

Investors already well-versed in real estate may not bother straying from 1031 exchanges, seeing the difference in tax benefits as not worth either learning a new part of the tax code or hiring advisers that do. Those rooting for the opportunity zone program's success can hold out hope that such investors have relationships or belief in a fund manager with a QOF.

“Some real estate [investors'] acumen kind of precludes them from considering OZ deals as tax-driven investments," CBRE Capital Markets Vice President Mike Caprio said. "They look at them as real estate deals first with the tax benefit as an extra boost.”

A rising group of potential opportunity zone investors is massing from Silicon Valley, according to Morrison & Foerster partners Mark Edelstein and Jay Blaivas. Entrepreneurs looking to cash in a windfall of capital gains due to an idea or company taking off would likely anticipate a tax bill they would rather put off or avoid entirely.

"In terms of moving money quickly, if you’re sitting on a couple billion dollars worth of stock on a low basis, you can move an awful lot of capital into OZs if you find the right project," said Edelstein, who is also chair of Morrison & Foerster's real estate group. "That’s more efficient [for fund managers] than rounding up the sort of retail investors who are realizing thousands of dollars in gains [at a time].”

Fund managers may not want to rely too much on that sort of investment, Blaivas said, since they tend to come in all at once and therefore not be renewable for deals that require additional financing down the road. 

Fund managers will likely experience serious competition in hunting for the larger sources of capital that will begin to enter the fray now that the second round of regulations is out. That competition will likely shake out in much the same way so many do in the real estate and finance industries.

“Investors are only going to invest in companies that they’re confident will maintain their qualifications and do what they need to do," Blaivas said. "I’m not sure companies are going into deals wondering about how to make sure they do qualify, but if it has the right resources and the right advisers, those will be the funds that investors gravitate toward and that avoid penalties.”

As multi-asset funds proliferate and begin making deals, developers that got in on the program early by attaching their projects to single-asset funds may feel a squeeze if they don't have their capital stacks already in order, Edelstein said.

"[Investors] are wondering, 'Who’s managing the fund to comply with all the rules?'" he said. "That’s such an important part, and if it’s my money that will either go towards one developer trying to get something built in Jersey City or a massive fund manager with history and expertise, I’m going to gravitate towards that fund, no matter how trustworthy I find that one developer.”