Opportunity Zones and Opportunity Funds create much excitement as powerful new economic development tools for many businesses and investors as well as communities looking to develop (or redevelop) areas that could become economic drivers. They were created specifically to spur economic development through the benefit of capital gain deferment to incentivize an injection of capital in communities previously red-lined for investment. However, it’s important to note the relative high risks to which investors can potentially be exposed when investing in these new vehicles.
First, investors need to consider unforeseen risks a Qualified Opportunity Fund (QOF) could face. From natural disasters to risk of fire or flooding during the development or redevelopment process, there is a full gamut of unpredictable pitfalls that could devastate the QOF’s investments.
Next, management, or rather mismanagement, of the fund could prove damaging to returns, or even the decertification of a fund. As a relatively new vehicle, poor execution of the fund strategy that falls into noncompliance is a very real threat.
Lastly, and one of the hardest to predict, is changing market conditions. As commercial development has become synonymous with Opportunity Zones, so too is the need to be ready for economic downturns and unexpected labor market responses that could drive up costs or otherwise disrupt projects.
To hedge risk, QOFs can utilize a specialized insurance program to protect against the tremendous liability with such projects. For instance, Lovitt & Touché’s Opportunity Zone Insurance Program (OZIP) — among the first programs of its kind nationwide — was developed in tandem with some of the most highly qualified attorneys in the space who understand these unique risks to help fill traditional voids and excluded insurability. Programs for QOFs can provide fund investors with insurance for tax liability in the event of recapture, which is typically excluded from E&O coverage, and can ultimately protect an investor in the event of a successful challenge by the IRS. Construction delays, political football, market instability, fund mismanagement and climate change all pose potential threats to a QOF’s ability to stay in compliance with the law. Investors need to consider the possibility that the capital gains being invested into the fund could be at risk.
Ryan Donahue is risk management advisor at Lovitt & Touché, A Marsh & McLennan Agency LLC Company, who oversees the Opportunity Zone Insurance Program.