OZ program gives life to passion projects for real estate investors

Oct 31, 2019
Credits & incentives Opportunity zones Real estate Business tax

Investors are no longer just concerned with their investments doing well. They want their investments to be doing good, too. All too often, though, investments that would have a positive impact have to be left on the back burner because they are financially infeasible.

The opportunity zone program has opened the door for new impact investment projects by reconfiguring their capital stacks and giving investors tax benefits. But they also offer something else powerful and personal — the feeling of having made a difference.

“As they age, investors are increasingly focused on what their legacy is going to be,” RSM partner Troy Merkel said. “They’re looking for the social good, what is being done to improve the community and the wider world. To balance returns and impact, we’re working to funnel that energy and capital into opportunity zones.”

A survey from Bank of America found that 63% of Gen X investors — ages 39 to 54 — had reviewed their portfolios for investments that had "positive environmental, social and corporate governance impact." ESG was even more important to millennial investors, 78% of whom reviewed their holdings.

Merkel, one of RSM’s leaders in opportunity zone investing, said he has seen a growing interest in projects that have a positive social impact from his clients, which include high net worth individuals and family offices as well as closely held private equity funds. The nature of the impact itself varied, but affordable housing, job creation, economic redevelopment, environmental protection and social justice were among the main goals.

The advent of opportunity zones has only intensified calls for socially conscious investments, Merkel said, and the tax savings that OZs provide create more financial wiggle room for investors to pursue impactful projects that may not otherwise be financially feasible.

Workforce housing is one of the more common targets for investors looking to make a positive impact with OZ capital. While the real estate industry has established strategies for financing both high-end housing and affordable housing, the area in between has become a trouble spot for developers and housing advocates alike. Renters who earn from 80% to 120% of the annual median income are running out of places to live, Merkel said.

Developers who might not be able to get the financing they need for workforce housing may be able to turn to OZ capital, where tax savings provide an added incentive. For investors who want to make a difference in their communities, workforce housing is an easy sell. 

“The people who need this housing are our nurses, our cops, our firefighters, our teachers,” Merkel said. “It’s very easy to show potential investors how much of a shortfall there is in terms of this housing. They feel that pressing need.” 

Merkel has advised developers and investors on these workforce housing projects in OZs in cities like Miami, Detroit and Cleveland. But workforce housing is not the only socially conscious investment vehicle. Merkel regularly consults with investors to create impact funds and help them operate business that will bring the jobs to these zones that the program intended. 

He pointed to Local Grown Salads, a Qualified Opportunity Zone Business that has turned underused warehouses and shopping centers into urban farms that provide produce — and dozens of jobs — to communities in food deserts. 

The healthcare industry is also taking advantage of OZs to build facilities closer to patients that may have limited access to healthcare. The OZ program is changing fundraising strategies for healthcare providers, Merkel said. Rather than soliciting large donations from high net worth individuals, development offices have started asking for large investments of OZ capital. The strategy gives philanthropists a way to benefit financially from their goodwill. 

OZs are a new and powerful tool for investing, but they are also complex and they have ramifications not only for funds, but for individual investors. The complexity is deepened by the fact that OZ sponsors often look to other state and local incentives to make their projects financially viable.

“We have built a team of OZ professionals, with a variety of backgrounds,” Merkel said. “It is imperative that we not only can assist our client with the structure of the deal, but all aspects in particular the impact on the individual investor, which is a critical selling point for any OZ deal.”

Many of the first OZ funds were blind pools — sponsors raised large amounts of capital without having chosen any projects. But increasingly, sponsors are raising OZ funds on a project-by-project basis, Merkel said. Rather than touting potential returns or tax savings, sponsors are trying to make an emotional connection with potential investors, helping them believe in the mission of a single building or business. 

“They are positioning themselves to be investors’ passion projects,” Merkel said. 

The solidity of having a single project to back gives OZ sponsors a leg up on equity funds that may have trouble proving the social impact of their work. The market is rife with metrics that claim to gauge how much social and environmental good a fund creates, but investors are generally skeptical of these measures, Merkel said, and are much more willing to back a project with an impact they can see and feel.

Working on a single OZ project is also far less complex than trying to orchestrate a portfolio of OZ projects, especially since approvals processes vary so widely from state to state and county to county and because OZ rules about deploying capital are so strict.

“If it’s filed at the wrong time, the capital doesn’t get any of the tax benefits,” Merkel said. “So investors also have a financial and logistical incentive to handpick their projects.”

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