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Impact Medallion Project Spotlight: Urban Catalyst

31st Jan 2023

Urban Catalyst’s Erik Hayden discusses what he’s learned from five years of Opportunity Zones and what the future may hold for the program.

The JTC Impact Medallion Program recognizes impact fund managers and industry stakeholders who embrace best practices in security, transparency, and compliance. In this series, we’ll showcase Impact Medallion recipients and how they’re leading the way on Impact.

When Opportunity Zones were created as part of the Tax Cuts and Jobs Act of 2017, they got off to a slow start thanks to uncertainty about regulatory specifics and a lack of understanding among investors as to what the program was all about. As investors have become more educated about OZ, the program has flourished, and many in the industry agree that with a few tweaks, Opportunity Zones can continue providing incentives that help struggling communities.

Urban Catalyst is a leading real estate firm specializing in private equity placement into existing income-producing properties and ground-up development projects. The company’s first Opportunity Fund, focused on downtown San Jose, California, ranked among the top 5% of all 2021 tracked Opportunity Zone fund sponsors according to research firm Novogradac, and was named a top ten Opportunity Zone fund by Forbes. Fund II, launched in 2021, will include nearly 400 residential units and approximately 500,000 square feet of office space located a block away from San Jose State University.

We spoke with Founder and Managing Partner Erik Hayden about how the OZ market has changed since its inception, why education was a critical part of the early days of the program, and what effect potential legislation might have on the industry in the future.

What issues surrounding Opportunity Zones are most pertinent for you right now? Would the passage of potential legislation like the Opportunity Zones Transparency, Extension, and Improvement Act affect your business?

Hayden: I’ve been thinking a lot lately about the future of the Opportunity Zone program and what it would mean if my company, Urban Catalyst, could extend the deferral period for qualified capital gains by two years, one of several proposed changes to the program’s regulatory guidelines introduced in a bill last year. That legislation didn’t end up passing in the last Congressional session, and it’s hard to say whether that same bill would have a clear path to pass anytime soon.

Rather than focus on what we don’t know, now seems like a better time to look back on the program, which turned five years old in December. The federal government created Opportunity Zones through passing the Tax Cuts and Jobs Act in December 2017; I founded Urban Catalyst the following year. My first couple of years running a real estate equity fund manager and development company mirrored the early days of Opportunity Zones, so I saw first-hand that many people weren’t investing in the latter because it was too difficult to understand. So few people understood it that it took the federal government two years to clarify the program’s guidelines before issuing final regulations enacting the Opportunity Zones tax incentive in 2019.

What were those early days of OZ like? Do investors have a better understanding of the program today than they did five years ago?

Hayden: In the beginning, it was a lot of education. My company saw this through Google search results. People would find our website by looking up, “What is an Opportunity Zone Fund?” instead of coming across our page after searching “I had a capital gains event.” I like to use the word “intent” to describe whether someone is seriously considering investing money into something. What we at Urban Catalyst found is that the level of intent in Opportunity Zone Funds, ours included, significantly improved over time as more people who had a capital gains event not only understood what they were but wanted to invest in them.

Has there been a steady increase in investment as people learn more about the benefits of OZ?

Hayden: We raised $131 million for our first Opportunity Zone Fund before closing it at the end of 2020. Our second fund topped the $100-million mark 40 percent faster than our first one. We attribute our success to having a diverse project portfolio located in downtown San Jose, America’s 10th-largest city that ranked No. 5 in U.S. News and World Report’s latest “Best Places to Live” survey.

Yet we’re far from the only fund that’s been able to successfully raise equity: Novogradac, a public accounting firm, reported last year that over $75 billion is estimated to have been invested in Qualified Opportunity Zone Funds between 2018 and 2021. Former Treasury Secretary Steve Mnuchin predicted in 2018 that over $100 billion in private capital would be invested in Opportunity Zones, meaning we’re already three quarters of the way there. And we ought to have a better chance of achieving that number if the deferral period for capital gains is extended to 2028 from 2026 — and if the federal government revives the previously expired basis step-up incentive for investors.

Do you think if the step-up in basis is revived and the deferral period is extended, new investors will be more eager to invest in OZ?

Hayden: Those proposed changes to the program, outlined in that bill introduced last year, would apply to people who’ve already invested into our funds in addition to new investors. Not only would it be a boon to both groups, but it would also help funds like ours continue to raise money. However, tax incentives have never been the main thing that’s attracted prospective investors to Opportunity Zones in the first place. Rather, it’s the opportunity to invest in quality real estate. Those incentives, at least to us, have always been the icing on the cake. And even though we may see some significant updates to the program over the next couple of years, one thing will remain constant: it’s all about the real estate.

Learn more about JTC’s solutions for OZ funds and download the Opportunity Zones Fund Administration solution sheet!