from Bisnow

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Funds Flood OZs As Program Faces Possible Rule Changes
by Dees Stribling

May 11, 2021

The tax policy adjustments proposed by President Joe Biden in April as part of the administration's $1.8 trillion spending package included plenty of potentially bad news for commercial real estate.

For now, the industry is most focused on changes like a hike in the effective tax rate for high earners, the end of tax breaks on carried interest, and curbing the benefits of 1031 exchanges.

But there was one remaining bright spot for CRE. The major tax break offered by opportunity zones still isn't slated for elimination or reduction. And while the administration is still mum on its plans for OZs, the program's exclusion from that list of tax adjustments has caught the attention of investors, according to OZ experts.

If the program is indeed the last windfall for CRE tax breaks, the OZ operation stands to heat up even more.

"As the capital gains tax rate increases, the attractiveness of deferring those taxes also increases, and so does the idea of tax-free future gains," said Pacific Oak Capital Advisors co-founder Peter McMillan, whose company has developed apartments in Arizona opportunity zones.

"That could make OZ funds more appealing to investors, and even more so if there are changes made to the 1031 exchange process," McMillan said.

Even before the proposed tax changes, investment in opportunity zones by qualified opportunity zone funds has been growing at a healthy clip, according to Novogradac, with an increase of more than $1B in reported investment between the end of 2020 and mid-April.

Funds tracked by Novogradac have raised $16.34B as of April 12, which is $1.18B more than the end of 2020. Two years ago, OZ funds had raised only about $790M altogether.

Novogradac further explains that total OZ investment is probably higher than $16.34B since its report is based on a collection of information from funds that voluntarily provide information or from other public sources such as Securities and Exchange Commission filings. Of the 1,002 funds tracked by Novogradac, 114 are fully subscribed and thus are no longer raising funds.

OZs might be even bigger by now, given their attractive tax advantages, but the program's inherent complexity has meant a long learning curve for investors, fund organizers say.

"We basically wasted a year while the Treasury Department was getting the regulations in place, and during that time only the major private equity players were able to take advantage of the program," HCVT Senior Tax Partner Blake Christian said. "Now more average investors are discovering the program, and even without any other tax charges, there will be a rush of interest."

Interest in the program has never been stronger, Capital Square CEO Louis Rogers agrees, though it has been a slow buildup since OZs were rolled out. His company is developing multifamily properties in OZs in Virginia.

"The program offers tax deferral and forgiveness, depending. So it's two different concepts in one, and during the early years, not much happened because it took that long to get to know the program," Rogers said.

Yet there is still lingering uncertainty associated with the program, Christian said. Complicating matters now is what the Biden administration and Congress might do to further adjust OZs. Original supporters of the plan have remained sanguine, for now, but have also not been forthcoming about what changes the program might see.

“Opportunity zones are an example of why we can be hopeful that good things are still happening in Washington, D.C.,” Sen. Tim Scott, a Republican from South Carolina, one of the original architects of the program, said during a virtual discussion held by [2] The Ripon Societyin March.

Scott, as well as Sen. Cory Booker, a Democrat from New Jersey and another architect of the original program in Congress, didn't respond to Bisnow's queries for further comment on the future of the program, nor did representatives of the Biden administration.

While industry observers, and supporters of the program in Congress, have tried to stay optimistic, there is still no guarantee that opportunity zones policy will still be in place further into this presidential administration.

OZs have long enjoyed significant bipartisan support, which might help the program survive the current political climate more or less intact, according to Shopoff Realty Investments President and CEO Bill Shopoff, whose company launched its first OZ fund late last year to provide the equity for construction of Dream, a hotel on the Las Vegas Strip.

"There may be changes, but I believe the core aspects of the program will be kept," Shopoff said. "I wouldn’t be surprised to see a job creation addition to the bill, similar in nature to the EB-5 program. That would make sense given the idea behind the program is to create economic growth in lower-income census tracks."

Another tweak to the program could be reporting requirements. Currently, data on the economic impact of OZs is sparse, because the Treasury Department isn't required to collect and publicly release any granular information.

As a candidate, Biden proposed a number of modifications to the OZ program, including incentivizing funds to partner with nonprofit or community-oriented organizations and more Treasury Department oversight of the program. He also said he would push for detailed reporting and public disclosure requirements, a feature that was reportedly in early drafts of the bill before 2017, but which didn't make it into the final version.

"I talk to people often about this, and I can't find anybody that really has a problem with more disclosure of the impact of OZs," USG Realty Capital CEO Greg Genovese said.

"They just don't want disclosure to mean jumping through a bunch of complicated hoops," he said. "But if we have to disclose how many people are working on a construction site or how many local residents are working on the project or will be employed in the final project, that's all useful information to evaluate the effectiveness of the program. I'm on board with that and most other OZ funds would be as well."

Also, FS Investments Managing Director-Real Estate Matthew Malone notes, the Biden administration may do more to require fund managers to demonstrate both their qualifications and intentions as investors and the program overall may become more regulated.

Additional guidance through regulation may drive further interest in opportunity zone investments, as some investors have remained on the sidelines due to a lack of clarity around certain aspects of the original legislation.

"It's possible that the program may be modified to give priority to improving infrastructure, supporting small businesses, enhancing community development and other similar initiatives," Malone said.

There is also an effort in Congress to extend the program, presumably to compensate for the slow rollout of its regulations. In February, Reps. Tim Burchett of Tennessee and Henry Cuellar of Texas, a Republican and Democrat, respectively, introduced a bill called the Opportunity Zone Extension Act of 2021 (H.R. 970). The bill focuses entirely on extending the program from the end of 2026 to the end of 2028.

A final uncertainty for OZs is in the form of the 2020 U.S. census. With the new census, the boundaries of many census tracts changed and others were merged or disappeared altogether. About 15% of the 2010 tracts designated opportunity zones in 2018 don't exist anymore.

What that will mean for the program isn't clear yet, since the Biden administration hasn't set a timeline for determining eligibility for new or modified census tracts for the OZ program.

“Extending this program would give investors additional time to provide meaningful financial support to businesses and create ... good paying jobs in Opportunity Zones,” Burchett said in a statement, while Cueller characterized the measure as a way to support underdeveloped communities and accelerate the U.S. economy’s recovery from the coronavirus pandemic.

As yet, Congress has taken no action on the extension, which has been referred to the Ways and Means Committee.

“Biden is likely going to look to mend, not end, opportunity zones and try to find a way to respond to the legitimate criticisms,” CalOZ President Kunal Merchant told Bisnow shortly after Biden took office. “I think that gives investors a sense of comfort and stability that the program is going to return to its bipartisan roots.”
SOURCE: [3] [link removed]

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The Ripon Society is a public policy organization that was founded in 1962 and takes its name from the town where the Republican Party was born in 1854 – Ripon, Wisconsin. One of the main goals of The Ripon Society is to promote the ideas and principles that have made America great and contributed to the GOP’s success. These ideas include keeping our nation secure, keeping taxes low and having a federal government that is smaller, smarter and more accountable to the people.
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