Inflation and the Decision of Investment Placement

The Opportunity Zone (OZ) market is still in its early phases of application. Since its inception in 2017 through the Tax Cuts and Jobs Act, multiple shocks to the broader economy have halted portions of the developmental cycle. As stated by Barrons, “The initial QOZ investors, real estate participants with traditional return-on-investment expectations, have met with limited success.” 

The IRS acknowledged this when it extended critical deadlines via Notice 2021-10. At the same time, according to Forbes, the “pandemic ignited a home-buying frenzy, as the decade-long housing shortage converged with historically-low mortgage rates, shifting workplace dynamics and new opportunities for young buyers to pursue their first homes.” Similar trends occurred in the commercial real estate sector according to the Wall Street Journal, which reported on January 25, 2022 that, “Investors set a record for U.S. commercial-property sales last year, betting that the pandemic is reordering how Americans live, work and play.” 

Real estate buyers loaded up on warehouses, apartment buildings and hotels. At the same time, interest rate hikes are taking effect, inflation is at an expected 7.9% for 2022 following the 6.8% increase in 2021, and the VIX index reaching 36.45 in March of 2022. The question that seems reasonable to follow is, “Are QOFs worth investing into?”. While this is not financial advice, it is important to view all the information available on the whole OZ industry rather than narrowly view one aspect that is available. In this week’s blogpost we will delve into the effects of inflation on the OZ market.

The Bureau of Labor Statistics stated on December 10, 2021 that the U.S. Inflation rate increased 6.8% over the previous year, the largest year-over-year increase since 1982. It isn’t difficult to see how this will directly affect the overall cost of products. According to Forbes, “many commodities (including fuel, food and housing) [are] seeing price hikes for the sixth consecutive month. Yet even with this inflation rate, according to Forbes, “the stock market turned in a solid performance in 2021. Except for a few brief sell-offs, the S&P 500 gained 26.9% for the year. The Dow Jones Industrial Average (DJIA) gained 18.7% in 2021, while the Nasdaq Composite gained 21.4%.” 

We believe that if one had simply left their capital gains invested during 2021, they would have functionally hedged against inflation. With an expected 5 to 7.9% inflation rate coming in 2022, it would also not be a stretch that retail investors will retroactively see this market response and continue to deploy into the overall U.S. market. Institutional investors, however, do not see it this way. Blackrock states, “Amid the uncertainty, one thing we feel relatively certain about is that we are exiting the investing regime that had reigned since the Global Financial Crisis (GFC) of 2008. That was marked by low to moderate economic growth, alongside low inflation and interest rates. The new environment is still taking shape but will undoubtedly entail higher inflation and rates than we knew from 2008 to 2020.” Subsequently they have decided that overall investment in the market is not sustainable and that “Stock selection matters more”.

So what does this mean for the OZ industry? It depends on what market you believe real estate represents. According to Forbes, real estate has always been considered a strong inflation hedge. For example, a 43-year review of the NCREIF Property Index demonstrated that private real estate total returns were robust during years of inflation. Knowing that OZ development is not a direct reflection of the overall real estate market, but specifically selected tracts of land, with additional tax benefits and typically cheaper pricing, they may be the equivalent in decision to the “selection matters more” category from Blackrock. With new options not only in development but in leveraging working capital prior to groundbreaking, we believe there are consistently more ways to beat inflationary tendencies and market bloat. 

In addition, OZ funds can be a good fit for investors interested in what is known as “sustainable investing” or “ESG funds” (for which environmental, social and governance factors have been integrated into the investment process). In next week’s blog post, we will go over how investors can explore the benefits of real estate exposure while also pursuing ESG initiatives.

The content provided in this article does not, and is not intended to, constitute legal, financial or investment advice; instead, all information and opinions provided herein are for educational and informational purposes only. To the extent you are interested in making an investment in QOZB Capital, LLC, please carefully consider the following risk factors and contact our office for further information.