Opportunity zone investments are so hot that 150 people were turned away from an IRS hearing on OZ regulations on Valentine’s Day; more than $18 billion worth of investment plans in these zones have been announced, according to the National Council of State Housing Agencies; and even the mayor of Erie, Pennsylvania, plans to discuss the topic with Chinese officials when he visits Erie’s sister city Zibo, China, to attract Chinese investment.
“This is what everyone wants to talk about; should I invest in opportunity zones?” said Josh Brown, CEO of Ritholtz Wealth Management, in a recent video tweet. “Is it a good investment? Well maybe.”
ThinkAdvisor spoke with a number of investment professionals who are considering investing in opportunity zone funds to develop a checklist that can help advisors answer that question, beyond the consideration of their tax benefits, which are attractive.
Investors who roll over capital gains into an opportunity zone fund within 180 days can defer those gains until their investment in the fund is sold or until Dec. 31, 2026, and they can receive a tax advantage of a stepped-up basis in the investment if it’s held for at least five years. At 10 years, the basis is stepped up to the market prices.
What Your Peers Are Reading
Keep in mind that the IRS has not finalized regulations governing opportunity zone funds, and some of the current proposed regulations have been disputed by potential investors and others.
One key example: the requirement that 50% of revenues of a business in an opportunity zone come from local sales, which would deter businesses such as a local manufacturer who sells products outside that neighborhood. Another example: Can a fund that sells individual assets in one opportunity fund deploy those proceeds in another without losing the tax benefit?
“Everyone is lining up to put funds together, but they can’t invest until final regs are out,” says Andy Hart, managing director of Delegate Advisors, a multifamily office, who reports receiving no less than 10 emails a day about opportunity zone funds investments.
Know the Fund Manager
“Manager selection, along with due diligence, is most important,” says Nicholas Millikan, director of research at CAIS Group, an alternative investments platform.
Does the manager have experience working in the local community and have a local partner? “Part of risk mitigation is working with local partners and local governments to identify deals,” says Rachel Reilly, director of impact strategy at EIG, which is credited with developing the concept of opportunity zones.
A local partner can also help if and when complications arise, notes Reilly.
Is there an alignment of interests between the fund manager and investors? This is more likely if the fund manager is also an investor in the fund, has skin in the game, says Hart.
Is the manager as interested in the social impact of a fund as in the potential investment returns, if that is a priority for your client?
Can the manager deploy capital in time to satisfy IRS regulations and manage the investment long term without a cash injection? A highly leveraged investment won’t have the ability to reduce leverage afterward, Millikan said.
Existing regulations give funds six months to deploy funds, but many would like more time and are hoping the IRS provides some wiggle room and require that fund “substantially improve” the property within 30 months of purchase.