Opportunity zone investors will want more than tax benefits

A speaker at the annual PERE America conference last week observed how few managers pursuing opportunity zone funds in the country have been thinking about the “end user,” which he defined as the underserved communities in these government regeneration areas.

Firms are quick to talk about the tax benefits and potential returns from real estate investments in the zones, he said. But how many are considering what the people living in them actually need?

The allure of capital gains tax benefits and projected return figures will not be enough for the majority of opportunity zone investors. To capture their interest, managers raising money for an opportunity zone fund will need to show a commitment to positive social impact and a solid strategy that can withstand the test of time – all while meeting return expectations, of course.

Family offices and high-net-worth individuals will be the target investor base for opportunity zones as they are best structured to take advantage of the capital gains tax deferrals. They are also increasingly interested in combining philanthropy with wealth management. Family offices, the conference heard, still care about getting their return on investments. But when comparing two firms with similar returns, they are likely to choose a strategy that also furthers their interest in doing ‘social good’.

That much is backed by data: one-third of family offices are now involved in impact investing, representing a 4.2 percent increase from the previous year, according to UBS’s Global Family Office Report 2018. More critical, 39 percent of the family offices surveyed reported that, as the next generation takes control, they will likely increase their allocation to impact investing.

Firms that seek to raise capital from family offices may want to start thinking about not only how they will meet return expectations, but how they will be measuring their social impact on the communities. These are metrics investors will be keen to see.

It is important investment firms recognize legislation behind opportunity zone investments is designed to encourage long-term investments. The tax benefits for these high-net-worth and family office investors increase with the number of years that the investment is held. Those that hold for five years can defer capital gains taxes until the end of 2026 and get a 10 percent step-up in basis on the original gain deferred. Extend the hold to seven years and that 10 percent step-up in original basis becomes 15 percent. Those that hold the investment for 10 years or more pay no capital gains tax on the appreciation of the asset. In other words, only by getting the investment thesis spot on will the tax benefits be relevant.

Family office capital is characteristically patient in nature. Many of these investors are prepared to invest for the long-term. Given that, managers will need to point to progressive strategies that not just weather usage changes, but embrace them. As PERE’s conference audience heard ad nauseum, the days of building empty spaces and waiting for tenants to show are fading away. Tenants are now customers needing and expecting services, amenities and personalization. This has to apply to investments in opportunity zones too.

Noise around tax benefits afforded by these areas must not distract from the bigger picture for the asset class. Giving tenants operating in them the same obligation to those operating outside is key to making the social impact their predominant investors are looking for.

To contact the author, email lisa.f@peimedia.com

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