FEBRUARY 05, 2019|MARK HESCHMEYER
Big Money Enters Race for Opportunity Zone Investments
Private Equity, Institutional Funds Are Likely to Drive Property Pricing, Market Selection
Markets with the most opportunity zones, such as Chicago, are areas that are likely to be on the receiving end of a substantial amount of new investment. Image: Lisa Blue
Large institutional and private equity funds are beginning to stream into the unseasoned strategy of investing in federally designated low-income zones where every new dollar spent on development or redevelopment could be eligible for tax breaks.
With the entrance of these funds, the nature of capital raising and the target markets where the funds will invest could change dramatically.
The Opportunity Zone program was created under a provision of the Tax Cuts and Jobs Act of 2017 to encourage private capital investments in underfunded communities. Under the law, anyone owing capital gains taxes can start a qualified opportunity fund by self-certifying with the Internal Revenue Service. Until this year, the bulk of the money being raised for opportunity zone investments was coming from smaller funds targeting one deal in one market.
CoStar Group is keeping a running list of qualified real estate opportunity funds. Of the more than 230 funds on the list, more than half average a target capital raising of less than $30 million. Most of these were launched early last year when the provision in the tax law first took effect.
This year, though, has seen new funds launched by major players such as CIM Group, Bridge Investment Group Partners, The Bernstein Cos. and Starwood Capital Group. The four firms are seeking to raise a combined $7 billion, the equivalent of 233 funds trying to raise $30 million each.
“We are seeing opportunity zones restructure the traditional capital stack being deployed in emerging neighborhoods, which has largely been serviced by local and regional investors,” said Jaime Sturgis, chief executive of Native Realty in Fort Lauderdale, Florida. “Institutional capital, which historically only chased ‘Main & Main’ credit deals has been enticed by the tax savings to venture into less developed emerging neighborhoods. This introduction of institutional capital into these under-capitalized neighborhoods is going to dramatically accelerate the gentrification of these neighborhoods as the opportunity zones require substantial capital investments to the real property to qualify for the tax exceptions.”
Starwood Capital Group, a global private investment firm focused on real estate and energy investments, this month launched Starwood Opportunity Zone Partners I to raise $500 million. Starwood Capital currently has 58 properties located in opportunity zones.
It hired Anthony Balestrieri as a senior vice president to lead the business. Balestrieri joins Starwood from MetLife Real Estate Investors, where he most recently served as director and head of acquisitions in Washington, D.C.
Starwood Capital will focus its opportunity zone strategy on markets in regions where the firm has developed a strong real estate presence, including the West Coast, Southeast and large metropolitan markets such as New York City and Washington, D.C.
Jack Gail, an associate with Younger Partners, a full-service boutique commercial real estate firm in Dallas, sees potential issues for some of the larger companies and private equity funds that are raising enormous amounts of capital.
“The potential problem with raising, say, a $500 million qualified opportunity fund is that based on the current guidelines, that money needs to be deployed,” Gail said. “For lack of a better term, there is a ‘shot clock’ on the fund, and its capital needs to be invested in a timely manner or the entire fund could face penalties and potentially lose the tax incentives all together.”
That means opportunity funds do not have the luxury of time to store up dry powder to spend at some future point. It has to be deployed and deployed fairly quickly.
“At the end of the day, yes, raising a few hundred million dollars is an enormous accomplishment but they will have to find quality deals that makes sense for their investors long term,” Gail said. “And that part is not as easy as you might think. The designated opportunity zones were selected for a reason — they are the more impoverished areas in our country.”
Bridge Investment Group in Salt Lake City this month launched a $1 billion qualified opportunity zone fund after announcing the beginning of the effort this past October. Bridge is targeting development and redevelopment projects to invest in alongside high-quality development partners.
“Our acquisition team has already identified over $500 million of attractive opportunities that are expected to provide meaningful impact on the districts in which capital is invested,” said Jonathan Slager, co-chief executive of Bridge Investment Group, in a statement announcing the initiative.
Over the past decade, Bridge has invested more than $12 billion of equity across its apartment, office and seniors living platforms. Given that not all opportunity zones are created equal, Bridge is leveraging its national footprint and local market knowledge to focus on zones at an inflection point or located inside of or within close proximity to high growth markets.
Michael Walker and Lane Beene are partners in a more typically sized opportunity fund, the $50 million Pilot And Legacy Opportunity Fund. The fund’s objective is to build workforce housing/apartments in opportunity zone locations in Texas.
It is choosing locations that project both job and population growth, and where a need exists for affordable, energy-efficient apartments.
“The reality is that while many taxpayers have heard about opportunity zones and opportunity funds, the majority do not yet know enough to take action,” Walker said. “So while there are many quality investors and private equity firms entering the fund arena every week, I believe this helps to bring legitimacy to socially responsible investing in distressed communities.”
Fund partner Beene added, that “the opportunity zone fundraising will niche down the investor profile and emancipate capital for new investment. We see the primary opportunity zone investor as a more seasoned investor with established funds interested in capital preservation.”
With more seasoned investors coming into the space, comes more competition for deals.
“One additional impact of opportunity zones is increased competition for sites with strong investment fundamentals,” Beene added. “Many opportunity zone locations are difficult investment scenarios with poor financial appeal and decades of negative momentum. The few opportunity zone sites with stronger investment fundamentals will be pursued in high demand. I anticipate a price premium for opportunity zone locations in attractive areas as more investors learn about the advantages.”
For Roland Pott, broker of record for New Jersey at Slatehouse Group Property Management, that means increased uncertainty for what happens in markets in which he works.
“I do a lot of work in Trenton, New Jersey, and we have a concentration of opportunity zones. Because it is not a major market city, I think that our zones here will be slower to receive the influx of capital, whereas opportunity zone neighborhoods in larger cities will be more primed to receive capital more quickly.”
Still the coming wave of big institutional money into opportunity zones could mean an extension of the already long-running recovery, according to Matthew Honnold, an economic analyst with Wells Fargo Securities.
The new opportunity zone initiative comes at a time when overall property prices have begun to ease, especially in major gateway markets. Outside of Puerto Rico, the markets with the most opportunity zones are located within New York, Los Angeles, Chicago and Houston, areas that will likely be on the receiving end of a substantial amount of new investment, Honnold’s group reported.
“The net effect of these provisions will likely be to draw significantly more capital into the industry in 2019, which will further support property valuations and restrain cap rates, even as interest rates increase,” the company reported.