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The Growing Prominence of Opportunity Zone Funds in the US

by Joshua Rubin

  • 12 Mar 2019
  • RE

Opportunity Zone Funds (OZFs) are investment vehicles targeting properties, businesses and other assets within demarcated opportunity zones in the US, which were created alongside the Tax Cuts and Jobs Act of 2017 and allow for investment in distressed areas. There are around 8,700 opportunity zones across the country, and investors can receive significant deferrals on their capital gains taxes by investing in opportunity zones.

There is much interest surrounding the newly introduced OZF market. In January 2019, Preqin conducted a survey of investors to gauge their perception of these new investment vehicles, and understand how OZFs may impact their investment plans going forwards. Due to the uncertainty surrounding unfinished regulations, as well as the risks associated with investing in distressed regions, the survey found that LPs are wary of investing in opportunity zones, with 92% of surveyed investors not currently invested in OZFs. However, 51% of investors are considering investing in OZFs in the next 12 months, and a further 12% are interested in investing after this timeframe, highlighting the interest this nascent industry is attracting.

Investors Target Wide Range of Strategies
Investors recognize the risks of OZF investments, as well as the need for substantial improvement of properties in order to abide by regulations; a majority (78%) of surveyed investors are targeting opportunistic and value-added strategies respectively for their OZF investments . The final regulations are expected to be confirmed by June, and after this we expect a significant inflow of capital into the OZF market. The chart below shows that investors in OZFs are also targeting the more risk-averse core and core-plus property assets. Due to the significant risk involved, 87% of surveyed investors are looking to invest less than $50mn in OZFs; 66% are looking to invest in only one OZF over the next 12 months and 27% plan to invest in 2-3 funds to diversify their OZF investments.

The range of opportunity zones across the US is wide, and different investors are attracted to different real estate projects. Ninety-four percent of survey respondents look to make OZF investments in each of the West and Southwest, while 90% target the Northeast. Residential properties attract 60% of investors, while 56% target industrial properties and 54% are interested in office properties. Additionally, a substantial 81% of investors are targeting diversified OZF investments: by targeting multiple vehicles or a diversified fund, investors aim to hedge their risk by mixing investments in more rural and distressed opportunity zones with investments in opportunity zones adjacent to metropolitan markets.

The Opportunity in the Market
We expect new OZFs to launch throughout the year as legislation is completed and regulations are clarified. Preqin tracks more than 70 OZFs currently in market, and 73% of these are managed by emerging mangers, as specialized managers form to target region- and strategy-specific OZF investments. Almost half (48%) of funds have a target size of $100-349mn, which represents $5.2bn in aggregate capital. While target sizes of funds in market vary greatly, a sizeable funds are looking to raise $500mn or more, representing $9.0bn (56%) of the total $16bn being targeted by OZF funds. This exemplifies the huge opportunity for the sector should these managers successfully secure this capital.

Opportunity zones are designed to make significant improvements in low-income areas, and real estate OZFs targeting higher-risk value-added and opportunistic strategies represent 99% of all those currently raising capital. Among funds in market there is also much appetite for geographic diversity, as 38% of funds employ a national strategy, and may look to source deals across the 8,700 zones. Funds focused on individual regions are also evenly distributed: 19% are targeting the West, 16% the Southeast and 15% the Northeast. As greater clarification on rules and regulations emerges, it will be interesting to see if certain opportunity zones begin to attract greater investment.

2019 will be Pacemaker Year for OZFs
Investors are cautiously optimistic about investing in opportunity zones, in spite of the risk of investing in property in low-income areas, and the prevailing uncertainty as OZF regulations are finalized. The potential tax benefits of OZFs are highly attractive, but fund managers will have to ensure that these projects fit stringent underwriting requirements before exposing significant LP capital to risk.

The next year will be crucial for OZFs, as investors will have to allocate their capital gains before the end of 2019 to be eligible for the full tax deferments outlined in the law – additionally, investors will only receive full capital gains tax benefits if they remain invested for a 10-year holding period. Investors we spoke to in January recognize the importance of following the outlined regulations to receive the full benefits of the OZF program, with 86% expecting to remain invested in their OZF investment for 10 years. The OZF market is an exciting new private sector investment program that is fast taking shape, and we will continue to track fund managers and investors in their assessment of potential investments and report on the trends.

For more data and analysis on Opportunity Zone Funds in real estate, please take a look at our new factsheet or browse Preqin Insights for more of our recent research. 

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