Opportunity Zone Projects Hindered by Inflation, Higher Rates

Sean Lyons has enough equity for his multifamily and student housing projects, which are funded largely by opportunity zone investors. But the price of lumber he needs for construction has risen 16% in the past year, and the work has taken longer than expected.

His company has assumed the cost difference to keep the tax-advantage projects on track, said Lyons, of real estate developer Jackson Dearborn Partners. But for opportunity zone projects in general, he said, the economic and supply chain challenges mean developers could wait for stronger market signals before they launch new projects.

“Sponsors are more inclined to wait for the delays and higher costs to come down further before kicking off a new project,” said Lyons, who focuses on fundraising and investor relations. “Many sponsors are in ‘wait and see’ mode for the market to normalize before starting their next project, so this indirectly impacts the choices and options investors have in a higher cost environment.”

Opportunity zone projects, undertaken in designated low-income communities through a tax-incentive program created in the 2017 tax law, promise capital gains deferral and income exclusion tax benefits for investors. Investments reached a total of $28.37 billion as of March, according to Novogradac, which tracks 1,400 qualified opportunity funds.

But as inflation and interest rates rise and supply chains remain troubled, some sponsors have had to seek additional funding, alter plans, delay construction, or even cancel some projects.

The Opportunity Fund Association in an email said its members have been hit primarily by the rise in construction material costs, as well as a labor shortage in the construction industry. The Producer Price Index for construction sand, gravel, and crushed stone jumped 9.3% in June compared with last year, according to the US Bureau of Labor Statistics.

200-Plus Projects in Maryland

“Delays and increased cost of construction and increased interest rates have now made some projects less financially feasible,” said Frank Dickson of Maryland’s department of housing and community development. These delays and hikes, along with supply chain woes, “have stalled projects” or made some “infeasible to pursue at this time,” he said.

There are over 200 projects underway in Maryland opportunity zones, according to the agency.

The rise in interest rates can be a blow to the projects since most are financed with some commercial or private debt, and opportunity zone equity can represent in many cases between 10% and 20% of the total budget, said Brett Theodos, senior fellow and director of the Community Economic Development Hub at the Urban Institute.

Adam Smith, a principal at 3LB Equities, a real estate firm, is overseeing an opportunity zone fund for housing in San Antonio. Initially, the fund had enough to finance the project, but rising costs and interest rates meant more money needed to be secured.

While his project didn’t experience delays, Smith said, supply chain woes did create a revolving door of scarce items, including chips and concrete.

“It’s all kind of gone in little short cycles of ‘Which part of the supply chain is going to be difficult to get?’” Smith said. “We work with some really good contractors and smart folks that help us kind of navigate those waters.”

Although lumber and other materials have dropped in price from the peak months, Jason Watkins, a CPA and Novogradac officer specializing in opportunity zones incentives, said there are still backlogs to complete projects.

“I think it’s taking longer, and it’s more expensive. Additional sources of capital may have to be located in order to complete a project because the cost of construction materials in general really increased during the pandemic,” Watkins said.

More investment is coming into opportunity zones this year, added David Sillaman, founder and director of Eazy Do It, an opportunity zone agency. “Inflation rises, the cost to borrow goes up, and the cost of equity becomes a lot more attractive, which is what this program is about.”

“What I expect is that some things will slow down a little bit because of inflation,” said Jill Homan, president of Javelin 19 Investments, a real estate investment, development, and advisory firm on opportunity zones. “But what makes opportunities also unique are these longer-term holds. There’s a case also to be made to say, ‘Look, the returns might not be great, but that’s today, we’re holding this for 10 years’.”

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Looking for More States

Opportunity zone advocates are calling on more states to offer the same capital gains benefits that the federal program gives.

Currently, 33 states and Washington, D.C., provide the same tax treatment as the federal program. Some of them have gone a step further, offering another layer of tax credits.

Four states offer some of the benefits, four states have opted not to offer any, and other states have no capital gains tax. New York is one of the states that decided to implement only some benefits of the federal program. California distanced itself from it entirely.

Opportunity zone advocates said two of the big players in real estate taking a different approach than most states has been disappointing.

“State leaders in nonconforming or not fully conforming states like California need to move toward full conformity immediately,” said Shafron “Shay” Hawkins, a former staffer for Sen. Tim Scott, one of the sponsors of the 2017 law’s opportunity zone tax breaks, and founder of the Opportunity Fund Association.

Local investors in California have “one arm tied behind their back” when it comes to opportunity zones, he said.