Regulatory uncertainty poses roadblock to wide acceptance
Manager interest in launching funds to invest in U.S. low-income communities designated as qualified opportunity zones is running high but the number of funds launched still is low as firms await greater regulatory clarity.
Money managers are avidly exploring the possibility of attracting significant assets from U.S.-based taxable investors seeking the relief from capital gains taxes available through investing in qualified opportunity funds.
Under the provisions of the Investing in Opportunity Act, part of the Tax Cuts and Jobs Act enacted in December 2017, investors can reduce, defer and exempt capital gains liabilities through Dec. 31, 2026, if they reinvest at least $100,000 within 180 days of a sale in a qualified opportunity fund for a minimum of five years.
At least 90% of the assets of a QOF must be invested in new real estate development or significant rehabilitation projects and in business development in the 8,761 communities designated as qualified opportunity zones in 50 states, the District of Columbia and five U.S. territories, according to the IRS.
"This is an interesting new pocket of opportunity for money managers to attract taxable wealth management investors, but so far, there's been more smoke than fire," said Tyler Cloherty, senior manager at consulting firm Casey Quirk, a practice of Deloitte Consulting LLP, New York.
"We're seeing interest among large managers but it's still too early for many to invest," Mr. Cloherty said, noting that money management firms are busy determining whether investment in disadvantaged communities is a "small, niche opportunity or if it can be scaled up for bigger funds."
Regulatory uncertainty is the primary reason many money managers are holding off on establishing QOFs, said Beth A. Mullen, a partner and affordable housing industry leader in the Sacramento, Calif., office of public accounting firm CohnReznick LLC.
The list of qualified opportunity zones was only finalized in June and "the industry only got real tax guidance from the agency in October," Ms. Mullen said.
She stressed that many more issues require regulatory clarification, particularly mechanisms for fund managers to measure and report the impact of their investments in real estate development and business support in the zones.
"Everyone will want to measure the impact of these investments on communities in the opportunity zones," Ms. Mullen said.
Mostly for wealthy so far
To date, most of the managers that have launched qualified opportunity funds are fairly small and oriented toward wealthy individual investors, including Bridge Multifamily Fund Manager LLC; Fundrise Advisors LLC; Somerset Partners LLC; and Cresset Capital Management LLC and Diversified Real Estate Capital LLC, which opened a jointly managed fund.
An exception is SkyBridge Capital LLC, New York, a manager well known in the institutional investment management business, which seeks to raise $3 billion for the Skybridge-EJF Opportunity Zone REIT. The fund launched Dec. 1 and is subadvised by alternative investment manager EJF Capital LLC, Arlington, Va.
The theme of "democratizing the opportunity zones" through broad-based investment from individual investors "plays well with the (registered investment adviser) distribution channel," said Brett S. Messing, SkyBridge's president.
About half of SkyBridge's $9.4 billion of assets under management is from retail distribution platforms, Mr. Messing said, adding that the firm has seen tremendous interest in the new fund.
"I've never seen anything that's been easier to get investors' attention," Mr. Messing said, not only because of the significant reduction of capital gains taxes but also because of the potential positive impact of the fund's investments on disadvantaged communities.
Mr. Messing said SkyBridge's roadshow presentations about the new fund have has been attracting audiences of 100 or more, but stressed that because opportunity zone investment is new "it's going to be a longer sell to convert interest to investment."
Sources said tax-exempt investors including pension funds, endowments and foundations are unlikely to invest in qualified opportunity funds designed for retail investors but likely will be keen to invest in a variety of projects in designated urban and rural communities.
"The initial catalyst for investment in opportunity zones will be from taxable investors to defer long-term capital gains, but there could be significant interest from institutional investors in investing in opportunity zones because of the potential for good returns," said Neal T. Wilson, EJF Capital's co-founder, partner and chief operating officer.
For example, Mr. Wilson said most development projects in qualified opportunity zones will have 30% to 40% of real estate equity with the balance financed by debt, in which institutional investors could invest.
Commingled funds likely
Attorney John S. Lore, managing partner at Capital Fund Law Group PC, New York, said asset owners likely will look to larger investment managers to create commingled or co-investment fund vehicles suitable for ERISA and other institutional investors to invest in qualified opportunity zones.
Mr. Lore said the legislation establishing QOFs does not mandate impact investing, but noted the potential is high for significant positive effects for low-income communities from investment, particularly in real estate development.
By way of spurring impact investing in U.S. qualified opportunity zones, the $3.8 billion Kresge Foundation, Troy, Mich., and the $4 billion Rockefeller Foundation, New York, joined forces to offer incentives to managers of QOFs, including administrative support, training and guarantees, if necessary, to cover potential investment losses.
In June, the foundations issued a request for information from managers intending to establish opportunity zone funds, said Kimberlee Cornett, managing director of the Kresge Foundation's social investment practice.
The foundations want to establish partnerships with potential managers of opportunity zone funds willing to provide in-depth data in order to gauge the success of the QOF program on affected communities.
Both foundations are concerned about the lack of a reporting requirement in the Investing in Opportunity Act, Ms. Cornett said.
"There are no guardrails on this legislation," Ms. Cornett said, adding that the Kresge and Rockefeller foundations are "trying to signal to the market the importance of measuring the success of the program. Developing the measurement system seemed an appropriate role for philanthropy."
Five fund managers from the 141 responses received were selected as partners, and in exchange for providing in-depth reporting on their QOF investments, also will receive unfunded guarantees of up to $25 million to cover a portion of losses if an investment fails.
The guarantee against investment loss likely will be an important confidence-builder for potential QOF investors, Ms. Cornett said.
Ms. Cornett said she could not identify the selected managers but noted the selection of two managers will be announced this month.
The Kresge Foundation and the Rockefeller Foundation both are active supporters of affordable housing and economic justice issues through grant-making.