Ever since the opportunity zones program was launched in the US in the first quarter of 2018, it has generated widespread interest in the real estate investment community. The adoption, however, has been slow. Opportunity zone transactions accounted for 10.5 percent of overall US volume between Q1 2018 and Q2 2019, according to figures from CBRE – roughly the same percentage as 18 months prior to the program’s inception.

Opportunity zones provide a series of tax breaks for investors which roll their capital gains into one of the 8,700 designated zones, typically considered distressed, low-income neighborhoods. When set against the current backdrop of a global pandemic and a recession, such a tax-efficient investment strategy is being seen by some of its proponents as an even more financially appealing, long-term investment proposition going forward.

“This is a program designed to stimulate economic activity in areas in need of investment, and one could argue that all of America is in need of investment currently,” says Nick Parrish, managing director at Cresset Partners, the private investing arm of Chicago-headquartered manager Cresset Capital Management. “You have 30 percent unemployment. Communities across the country are in dire need of reinvestment and recovery capital. The government has spent as much as it possibly can and will need to rely on private capital.”

Within the opportunity zone investment spectrum, multifamily investments have typically generated more investor interest than other asset classes. A broker advising on opportunity zone transactions notes that when they would pitch office opportunity zone investments pre-covid 19, many investors would say they would have agreed to make an investment had it been multifamily. Indeed, multifamily site investment acquisitions accounted for 35 percent of all development site transactions between Q1 2018 and Q2 2019, according to CBRE. In these 18 months, dollar value of multifamily construction starts was $32.6 billion, over 53 percent of the total commercial real estate value invested in this program.

The appeal for multifamily investments is expected to continue growing in the months following the outbreak of covid-19, given the defensive, recession-proof characteristics of the asset class.

Cresset Partners, which raised $465 million for an opportunity zone fund, Cresset-Diversified QOZ in December 2018, is currently in the market with Fund II and is expecting to hold a first close in July. The fund, with a $400-$500 million total target raise, will be 70-80 percent invested in multifamily assets.

“In our mind, multifamily is a good, well-capitalized, well-leveraged long-term asset to own. People always need a place to live,” Parrish says.

Other firms ramping up opportunity zone investing include Utah-based manager Bridge Investment Group. According to a May SEC filing, the firm has launched a $1 billion opportunity zone fund. The target capital raise for Bridge Opportunity Zone Fund III, if achieved successfully, will make this fund bigger than its two predecessor vehicles combined.

Parrish says the short-term disruption caused by the coronavirus pandemic will be a temporary setback for opportunity zone fundraising, but the trajectory of its own capital raise will not be impacted, given the fund has until end July 2021 to finish raising its target equity.

“In some ways, opportunity zone fundraising may be quicker to return to normal because people have tax deadlines they have to meet. They may be reticent to invest in real estate, but their capital gains will end up wearing off so they might not have an option.”

On the other hand…

Critics of opportunity zones, however, point to multifold challenges that will continue to deter certain types of investors from committing to the program, even in a post-covid-19 world.

Underwriting is a key concern. To maximize the tax incentives attained by investing in an opportunity zone, the typical holding period is 10 years. But the question is the type of assumptions that can realistically be underwritten to fully leverage the benefits from such a long-dated investment.

This varies by investor type. David Krantz, senior managing director in the capital markets group at property services firm Savills, says institutional investors that are more IRR-driven will evaluate these investments differently than the non-institutional, more entrepreneurial investors that can be more aggressive in their assumptions.

“Most investors, regardless of perspective or origin of capital, are still generally going to underwrite the near term as anywhere between a five to 10-year hold, in which case the benefits of the opportunity zone are not seen or experienced. And in that case, you cannot underwrite those benefits,” he adds.

As Krantz points out, a lot of the opportunity zones are located further away from the “ground zero of the strongest dynamics” in more fringe and secondary locations. As a result, firms would need to factor in either low rents, slower absorption, higher vacancies, or other concessions in their underwriting to appeal to investors investing in such locations for the first time.

Pricing of opportunity zone transactions is another issue, especially at a time when the real estate industry is waiting to see how the disruption caused by the pandemic will be reflected in valuations, whenever trading resumes its normal pace.

“All investing inquiries we currently receive are from people seeking a discount and wanting to buy distress. Generally, the opportunity zone fund transactions were those that were hoping to sell at a premium because of tax incentives. We are less likely to see these trade at a discount,” says Woody Heller, vice-chairman and co-head of capital markets at Savills.
Parrish notes that in March and April, he too had anticipated more discounted multifamily investment opportunities to unfold during the lockdown, but that has not happened yet.

“Financial markets have all but recovered. Equity markets are up year-to-date. Land prices have come down a little bit, but land price is only a small fraction of the cost of these development projects. So, the pricing has not really experienced a level of distress that people expected,” he says.

Not all types of opportunity zone strategies will be equally appealing to investors, either. At a time when most investors are being cautious about taking on too much risk in their overall portfolios, Parrish believes a core-focused investment approach will be a better suited strategy. For Cresset’s opportunity zone funds, the firm targets 9-11 percent net IRRs. In addition, depending on the tax situation of its investors, Parrish says one can layer in an additional 300-500 basis points in potential benefits.

Pre-covid or presently, institutional investors have not fully recognized the advantage of investing in opportunity zone programs. The tide can turn only if the program is able to prove its standing as a better risk-adjusted, long-term investment than a conventional multifamily investment.