Money is drying up for one of the signature US economic development programmes of the Trump administration, as investors balk at inflation, higher interest rates and the looming expiry of a lucrative tax benefit.
Then-president Donald Trump signed so-called Opportunity Zones into law in 2017 as part of broad tax legislation. The zones, which had bipartisan support, were designed to attract private investors to economically distressed areas by allowing them to defer taxes on capital gains.
Investors are now hesitating. Opportunity Zone funds received $229mn in equity investment inflows in the first quarter, down by two-thirds from $682mn the same quarter a year before, according to Novogradac, an accounting firm that tracks the industry. The funds raised $3.5bn in the full year 2023, compared with $9.7bn in 2022.
There are “an awful lot of projects under water right now”, said Robert Hutchins, founder of the New Jersey-based OZ fund Ellavoz Impact Capital. He said he was getting “no less than” 10 calls or emails a week from cash-strapped peers that were “stuck and need more money”, compared with almost zero a year ago.
More than 1,400 opportunity funds have attracted at least $38bn in equity investment, according to Novogradac. They invest in projects ranging from multi-family housing to shopping centres to hotels, and have built up to 700,000 homes since the programme began in 2018.
The programme came under scrutiny early in its life for investing in luxury condominiums and giving tax benefits to the rich without adequately helping low-income communities. Charitable foundations were among the first to back out.
“I don’t think it is a good public policy to craft our tax code around delivering personalised and niche investment vehicles for ultra-high net worth individuals,” said Aaron Seybert, managing director of the Social Investment Practice at the Kresge Foundation, which stopped making new commitments to the programme after providing a $15mn financial guarantee for an OZ fund in 2019.
Stubborn inflation and higher interest rates are to blame for the recent slowdown in funding, industry insiders said, because they burdened opportunity funds with a surge in construction and capital costs.
Robert Silverman, managing partner at LJJ Fund, a New York-based opportunity fund, said the low interest rate environment during the first few years of the programme “fuelled an enormous amount of people entering this space”, as they had access to the cheapest construction loans they had “ever been able to take in this country”.
“They didn’t realise that when interest rates rise and there is inflation in the system, that has an effect on your return on capital in a bad way,” he said. “A lot of these people who got into the OZ scheme are not able to complete their projects with the amount of capital that they raised in the beginning.”
The struggles of several US regional banks, once a major issuer of construction loans, in the past year have exacerbated the problem as their healthy peers became more cautious in entering the field.
“The market for bank financing remains challenging across the board,” said a spokesperson at Belpointe OZ, a New York-listed fund, “whether it’s ground-up development or substantial improvement, and even in the case of stabilised acquisitions.”
The programme enables investors in opportunity funds to defer capital gains tax until 2026, and pay no tax for cashing out if a fund lasts for 10 years or longer. The looming 2026 deadline has also put off some investors.
“The fundamental marketing pitch around the [OZ funds] was, why would you pay the tax to the government now if you can invest in a fund and pay tax in six years?” said Riaz Taplin, founder of California-based OZ fund Riaz Capital. “That big marketing line is no longer relevant.”
While several US lawmakers introduced last September a bill to extend the programme by another two years, investors did not expect legislation to pass ahead of the presidential election in November.
The challenges have prompted many investors to stand by. “Some investors who were very active three or four years ago are now taking a wait-and-see approach,” said Ross Baird, chief executive of Blueprint Local, a real estate private equity firm that invests in Opportunity Zone projects.
That has put many OZ funds under stress as they grapple with a funding shortfall to complete ongoing projects. Brandon Lacoff, chief executive of Belpointe, the listed OZ that is trading at 55 per cent of its net asset value, said in an investor call in November that his firm did not have “the capital needed to build out all of its projects” and was exploring other ways to raise funds.
The Belpointe spokesperson said the company had made “solid progress on many fronts”, such as taking a $56mn mezzanine loan.
The pressure is likely to intensify in the coming months. While most OZ projects are still up and running, Hutchins said he was getting requests where OZ funds agreed to take equity “at any amount”.
“Certainly we are not going to do that because when you are desperate, it doesn’t work,” he said.
Many opportunity funds, however, still see potential in the industry that has benefited from strong demand for affordable housing and policy support. LJJ Fund’s Silverman said there remained lucrative deals even when he “stress-tested” them with higher interest rates.
“They are not as attractive as what they were,” he said, “but they are still attractive enough to attract investment.”
