Opportunity Zone Investors Weighing Risk vs. Social Impact In Program's Early Days

As developers and investors look for the ways opportunity zone deals can work for their business, the question is now shifting to how these deals will work for communities.

Although some have been reluctant to move forward with the program until they have a full picture of the rules, major national markets like New York City have already seen a flood of activity. Many are pushing forward with investments and deals rather than risk missing out.

But as developers strategize on how to squeeze as many benefits out of the program as possible, the commercial real estate industry is grappling with the question of how to make sure the deals fit with the ultimate intention of the zones, which is to drive investment to underserved communities.

“In whatever investments you chose to make, I would just think long and hard about whether you think those investments are in the spirit of the program,” Margaret Anadu, the head of the Urban Investment Group at Goldman Sachs, said at Bisnow’s 2019 NYC Opportunity Zones Summit Tuesday morning.

Last year, Goldman invested $83M into a new affordable housing complex in Hunter’s Point South that sits in an opportunity zone.

“You want a sponsor who's experienced in real estate, experienced in capital raising and all that," Anadu said. "But you also want a sponsor who maybe has actually been to a low-income neighborhood before and understands the nuances of those neighborhoods.”

The opportunity zone program was established as part of the Tax Cuts and Jobs Act in 2017 and allows investors to defer paying taxes on capital gains if they invest them in underserved communities through a dedicated fund.

The idea is to lure development to low-income areas, but while many have rushed to deploy capital, establish funds and search for deals that fall within the zones, there is no clear evidence yet that the capital is going to the places that need it the most.

Supporters of the program say a lack of clear rules has caused the activity to gravitate to places like New York City, which is already a magnet for capital. But as the kinks are worked through and more funds are established, they expect money to eventually flow to tertiary and secondary markets that need it the most.

“I always encourage investors to look upstate, we've got some great resources up there,” Empire State Development Executive Vice President Pravina Raghavan said.

In New York state there are 514 zones, 60% of which fall in New York City.

Raghavan said the ideal developers and investors making use of opportunity zones funds are the ones who have worked in these types of communities for years. She is encouraging people to reach out to regional councils to get a sense of the kinds of projects that are worthwhile.

“If you don’t know what you are doing, even with the great tax incentives, this is not the place to be,” she said.

Nationally, the number of sales of development sites in opportunity zones jumped by 80% in the first nine months of 2018, compared to the same time in 2017, according to Real Capital Analytics data reported by The Wall Street Journal.

However, according to a separate RCA report released in December, people are investing as a result of the tax break — but not changing the areas in which they would normally deploy capital.  

“I spoke to someone who wants to allocate $100M, and they're a billion-dollar family, who said, ‘I want something that really has that true social impact,’” OPZ Bernstein principal Craig Bernstein told the audience.

His firm closed on its first opportunity zone purchase in Ohio in January.

“The majority of the large family offices I am talking to, they think it's great and an added feather in the cap," he said. "But they are really driven by the tax incentives.”

He said the program in its current form is “too good to be true” — and that he expects it could be shut down by progressive politicians in coming years.

“I think what we are seeing with [Alexandria Ocasio-Cortez] and some of the Democrats — Bernie Sanders, Elizabeth Warren — they are going to look at this in four years, and say, 'This is a Trump special. We got to get rid of this,’” he said. “That's how good the benefits are, it probably will be a once-in-a-lifetime opportunity.”

RXR Realty Executive Vice President Seth Pinsky agreed the program does present some challenges. In New York City in particular, many of the zones are in areas that were already seeing development.

But it has changed the way large-scale investors view investments in areas off the beaten track.

“Historically when we were investing in these areas, we went out to raise capital from our institutional investors, there was a sales job that we had to do to convince them,” Pinsky said. “What has changed with this program is we have people calling us on a daily basis saying, 'We want to invest in these communities, find us deals.’ That has the potential to be revolutionary for these areas.”

But, he said, opportunity zones are not just about improving already attractive deals.

“If we as taxpayers hope for this program to be successful, the goal should be not just making good projects better, but making marginal projects that wouldn’t have happened, workable," Pinsky said.

While that may be the spirit of the program, as Anadu described it, many investors targeting opportunity funds for their capital gains may not want to see their money placed in high-risk deals.

“We are not doing any deals that we wouldn’t do otherwise … We view opportunity zones not as something that makes a bad deal good but something that makes a good deal better,” Somera Road Managing Principal Ian Ross said. “We generally don’t like messing with the margins.”