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As the Opportunity Zone Program Nears Its End, Real Estate Pros Eye an Extension

Any renewals of the Opportunity Zone program would have to be enacted by a divided Congress, but real estate industry experts are cautiously optimistic.

Since their adoption, Opportunity Zones (OZ) have proven popular with developers, investors and communities seeking revitalization of blighted areas. The bill, however, only authorized the use of the OZs for 10 years, although commercial real estate insiders are optimistic that Congress could approve the program’s extension sometime in the next two years.

Senator Tim Scott, R-S.C., and Senator Cory Booker, D-N.J., have co-sponsored the Opportunity Zones Transparency, Extension and Improvement Act that aims to build upon the OZ incentive enacted in 2017 as part of the Tax and Jobs Cuts Act (TCJA). The extension appears to have bipartisan support in Congress and real estate industry trade groups say it will help spur more investment in affordable and workforce housing and in commercial development that brings new businesses to impoverished neighborhoods and creates jobs.

Qualified Opportunity Funds (QOFs) tracked by national professional services firm Novogradac & Company LLP reported nearly $9.68 billion in equity investments in 2022, the highest amount since the OZ incentive was enacted. The cumulative volume of investment in qualified QOFs since the legislation was adapted in 2017 reached $34 billion last year. The average fund tracked by the firm raised $26.7 million in 2022. Eight funds raised $500 million or more. Novogradac tracked 1,661 QOFs, 1,274 of which reported exactly how much equity they raised.

The legislation proposed by Scott and Booker would extend the OZ incentives by two years, to Dec. 31, 2028, from the current expiration date of Dec. 31, 2026. That was previously the first year in which the earliest investments in OZs could be sold while qualifying for the 10-year capital gains tax exclusion. The extended period would make up for the two years it took the Treasury Department to issue final regulations for OZs, which discouraged many investors from participating in the program, according to the legislation’s authors.

The bill would also create an early sunset for OZs not located in impoverished neighborhoods (where median family income meets or exceeds 130% of the national MFI). It would add reporting requirements that were stripped out of the 2017 law, helping promote greater transparency and provide data on the effectiveness of OZs by tracking their long-term outcomes. In addition, the legislation would create pathways for smaller-dollar impact investments in OZs. By allowing QOFs to be organized as "fund of funds" that may invest in other QOFs, smaller projects will receive the financing they need, supporters said.

Finally, the legislation would provide operating support and technical assistance to high-poverty and underserved communities through a state and community dynamism fund. Flexible grants from the fund would help states drive private and public capital investment to their underserved businesses and communities.

While there appears to be bipartisan support for the plan created by Booker and Scott, Ryan McCormick, senior vice president and counsel with the Real Estate Roundtable, a non-profit public policy think tank, said it’s difficult to predict what a divided Congress will pass. The outcome will likely depend on the state of the economy and interest in tax legislation that would help fuel investment, he added.

OZs have provisions that support capital formation and help make investment and development possible in an environment where capital sources are cautious and credit is tight, especially when it comes to construction financing, McCormick noted.

OZs come with tax incentives such as the capital gains tax exclusion for holding an investment for 10 years. That tax benefit remains in place. But another tax benefit that has to do with initial investment in an QOF requires taking a capital gain from a prior investment and rolling it into the new fund.

“If you do that, you get to defer your gain for a period of time, but with the passage of time that deferral period is getting shorter and shorter to the end of 2026,” McCormick noted. “For the other tax incentive of the gain that you roll into an opportunity fund if you hold it and don’t take it out for five years, you get a partial exclusion of that gain. If you hold it for seven years, you get an additional exclusion, but just the way the dates work, that’s no longer available.”

If the extension bill is passed, that issue will be solved, he said.

But there are obstacles to getting a bill passed. For one, the presidential election cycle could delay a bill being approved. In addition, there are some in Congress that do not want to take up discussion of OZs without consideration of the entire TCJA, according to Anya Coverman, president and CEO of the Institute for Portfolio Alternatives (IPA), an advocacy group for the portfolio diversifying investments industry.

“There’s a reluctance to take up provisions of TCJA that are separate from the entire package of tax provisions that need to be renewed,” Coverman said. “There’s a partisan-only House Ways and Means package that would have expanded Opportunity Zones in rural areas and add reporting requirements, but the chance of that passing in the Senate is slim to none. That did not include the extension of the program beyond 2025, which I think is very likely.”

Other industry insiders, however, remain optimistic that an extension will be completed in 2024 and some suggest that the process will get rolling this fall. For example, John Harrison, executive director of the Alternative & Direct Investment Securities Association (ADISA), said he believes a two-year extension bill on OZs will be put forth in September and work its way through the legislative process by the end of the year.

“Lobbying efforts are beginning this summer and will continue through the fall,” Harrison said. “I might note that this legislation is anticipated to have strong bipartisan support. ADISA will help in any way possible, and we are beginning our efforts now to help.”

Because so many provisions in the current OZ legislation will be close to the edge of expiration by the end of 2024, if the extension doesn’t go through before the presidential election, it will become a moot issue and “lose viability,” noted Bill Shopoff, president and CEO of Shopoff Realty Investments, a national real estate investment firm. “If they are going to get something done, I see it sooner rather than later,” he said.

Support for the changes

In the meantime, the commercial real estate industry recognizes that the program doesn’t just need an extension, but more data on the performance of OZ funds and supports the reporting requirements included in the proposed legislation, according to Coverman.

Because of the lack of adequate reporting, it’s too early to measure the program’s overall impact on jobs and poverty, she said. But there’s evidence of “significant real estate investment and positive impacts on communities” with job growth and economic development.

The other legislative change receiving backing is the one that would allow more rural and industrial areas to be qualified as OZs. The original designations were created by state governments who skewed more toward urban areas. “That’s an issue policymakers and those operating in the OZ space feel is important,” Coverman said.

With updated Census data that came out since the OZs were created, some would no longer qualify as low-income, while more rural and industrial zones could be added to the program, according to Doyle Bartlett, managing shareholder with the law firm GrayRobinson and a lobbyist for the IPA. When the initial program was launched, there were 42,000 Census tracts that were identified as low-income, and the Treasury Department allowed states to designate only 25% of their low-income tracts as qualified OZs. But in certain cases, the legislation also allowed for the designation of tracts that were contiguous to the low-income areas. That brough in 230 tracts that were not in low-income areas and triggered some controversy, Bartlett noted.

“Early on you saw politics that went on in the state, but that died down and you hear complaints now that you can’t change those designations,” Bartlett said. “There’s no way in the law to take into account a change in the underlying economic structure to make it qualify for OZ or add an OZ. You made those designations, and you are stuck with them, so there’s a lot of interest in adding new zones or reconfiguring those zones to address more local problems.”

Shopoff said he welcomes the proposed changes because older census tract data allowed for OZs in areas that should not have been included. On the other hand, he has owned several assets that are just outside an OZ that should qualify because they need incentives for redevelopment. That included one project in Carson, Calif.—a mixed-use sports entertainment complex—that’s moving forward with more creative financing.

Shopoff also supports the calls for more reporting requirements because “those who are doing good business don’t fear them, but those who are on the edge may feel a little more uncomfortable about it. I think it will further improve the quality of the participants in this space.”

Louis Rogers, founder and co-CEO of Capital Square, an investment manager for 1031 exchange programs and a sponsor and manager of OZ funds, said his firm has eight OZ funds that have undertaken mixed-use multifamily projects in older industrial neighborhoods where they buy a vacant lot or decrepit warehouse and redevelop it. These $600 million in projects are located in Virginia, North Carolina, South Carolina and Tennessee.

According to Rogers, management consulting firm FTI Consulting prepared a report on five of those mixed-use projects located in Scott’s Addition Historic District in Richmond, Va. The report found that the projects created 1,483 jobs during construction, 63 full-time jobs, $9.7 million in construction taxes and $7.7 million a year in operating taxes for the local governments.

“We are getting these neighborhoods cleaned up and renovated and jobs created and taxes generated and we have a housing shortage and we are creating housing,” Rogers said. “The program has proven to be successful.”

Because the support for the OZ extension legislation appears to be bipartisan and bicameral, Rogers said he believes it’s going to go through next year. “There’s no opposition,” he noted. “It’s just the mechanics of when to get this statue in.”

According to ADISA’s Harrison, the OZ program has surpassed the industry’s expectation for success and extending it would generate even more investment in impoverished communities. “The current legislation isn’t perfect. No legislation is. But it has certainly helped many areas come back and prosper,” he said. “One thing that is clear is that many investors would much rather see capital gains money go toward a worthy investment rather than simply be an outflow. In this way, the Opportunity Zone becomes an offset to opportunity costs.”

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