Despite the buzz, some investment professionals remain cautious on opportunity zones, even as the first major deadline for investors to drop their capital gains into a fund looms.
“We have looked at a lot of opportunity zone funds, and we haven’t been compelled by most of them,” Kevin Philip, a managing director at Bel Air Investment Advisers, recently told Buyouts.
Philip said his firm has identified “a couple” OZ investments that seemed useful for their clients, but “it’s very selective.”
“They will from time-to-time have a role to play, but on the edges of an investment plan, not as the central thesis,” he said.
The concern comes down to whether an OZ investment would make sense on its own, even without the tax benefits that are part of the program.
“To do something that generates a subpar investment return, simply to have a delay in taxes—it’s a simple math calculation and it just doesn’t make a whole lot of sense,” Philip said.
Philip said he sought out more predictable real estate investments in established locations and added more risky investments in up and coming areas to enhance the overall return. Opportunity zones are by definition less developed, and therefore more risky.
“A lot of people believe we’re going to face a recession sometime in the next five years, so if you’re investing in a property in a location that you believe is gentrifying, that gentrification might get stalled and recessed if we have a recession three or four years from now,” he said.
Philip went on: “I have a feeling the real estate people specifically love opportunity zone funds because it’s helping them raise more money for projects they otherwise would have a problem raising funds for. The outcomes sometimes don’t matter as much to them as long as they’ve raised a fund they can charge fees on.”
Opportunity zones were created as part of the 2017 Tax Cuts and Jobs Act, and were spearheaded in congress by South Carolina Republican Senator Tim Scott. They provide a series of tax breaks to investors who roll their capital gains into a qualified opportunity zone fund for investment in one of 8,700 designated census tracts across the city.
Benefits include a 10 percent tax break for an investment carried for five years and an additional 5 percent if it is held for seven years. That part of the program sunsets in 2026, meaning investors have until June 29 to apply their 2018 capital gains to a QOZ to get the 7-year carry and the end of this year to apply that carry to their 2019 capital gains.
Profit or impact
Fund managers and real estate investors focusing on OZs for the most part seemed to agree with Phillip that OZ investments need to be able to stand on their own.
Avy Stein, chairman and co-founder of Cresset Capital, which is making a big OZ push, stressed that his firm does not expect clients to invest only in OZs.
“I would never tell anybody to put all their eggs in any one basket,” he told Buyouts. “I absolutely agree that this has a role in a portfolio, it is not a portfolio.”
Stein also said his firm is taking a possible recession into account.
“I don’t think anybody does a set of numbers on a real estate deal without pricing in a recession,” he said.
“If you buy and/or build quality real estate in quality locations, it stands the test of time,” Craig Bernstein of OPZ Bernstein, a QOZ fund that is part of Bernstein Cos, told Buyouts in an email.
“If you can find attractive investments, and they also happen to be located in opportunity zones, we view that as a win-win opportunity for us,” said Frank McGrew of McNally Capital.
Some investors do not even see OZ investments as being primarily about profit.
Kamil Homsi, founder and CEO of Global Realty Capital, the onshore arm of a Dubai-based family office, told Buyouts OZs are, for him, “all about impact.”
“You’re not going to make more money than you’re going to make in regular investments,” Homsi said, stressing that he felt investors needed to work closely with communities.
Kunal Merchant, president and co-founder of CalOZ, a nonprofit trade organization that seeks to facilitate OZ investments in California, told Buyouts that he hoped family offices would look beyond the “low-hanging fruit” of easy profits.
“I ask them to try to push a little bit out of their comfort zone for the benefit of the state and the country and all of the people in these opportunity zones that are counting on us to help them,” he said.
But most investment advisers and fund managers still stress deals must make sense on their own.
“Under no circumstances can you allow the tail to wag the dog, as it relates to making sound investment decisions,” Bernstein wrote Buyouts. “The program has the ability to make a good deal great but will not make a bad deal good.”