February 2, 2019
If there was an equivalent to the Oxford Dictionary’s word of the year in the commercial real estate arena, “Opportunity Zone” undoubtedly would have won the title in 2018. Introduced in late 2017 as part of Trump’s $1.5 trillion Tax Cuts and Jobs Act, the Opportunity Zone program, which flew under the radar in the first half of 2018, has since become the new darling of commercial real estate.
An Advantageous Tax Incentive Program
The tax incentive program is intended to combat poverty and geographic inequality by bolstering economic activity in certain distressed communities designated as Opportunity Zones by governors and the Treasury Department. The program offers tax incentives to attract funding for real estate developments, start-ups and other economic activity in the 8,700 qualified Opportunity Zones nationwide.
Investments in Opportunity Zones are made through Opportunity Funds, which are either a U.S. partnership or a corporation that invests a substantial percent of its holdings in these areas. Eligible Opportunity Fund investments in the commercial real estate sector are limited to the construction of new buildings, therefore multifamily is one of the sectors that stands to benefit considerably from this program.
There are short- and long-term benefits to investing in an Opportunity Fund. Immediate benefits stems from the deferral of tax on eligible capital gains reinvested in the fund until the investment is sold or exchanged, or December 31, 2016 (whichever comes first). Long-term benefits start materializing after five years when investors become eligible to exclude 10 percent of the deferred capital gain invested in the Opportunity Fund. After seven years, this percentage increases to 15 percent. After 10 years, investors also become eligible for a permanent exclusion from taxable income of capital gains from the sale or exchange of the investment.
Considerations for Investors
As intended by legislators, investors are lining up to take advantage of this tax incentive program. Perhaps most important to the multifamily sector, the new legislation has opened the door to a different group of capital: retail investors. Smaller investors and family offices are now given a chance to invest in the same type of quality multifamily deals as traditional equity and large institutional investors.
While many investors already have jumped on the bandwagon, others are still cautious, and rightly so. Unquestionably Opportunity Zones represent an exciting investment opportunity, but there are several factors to consider before investing in an Opportunity Fund project with a development partner.
First, investors should apply the same rationale to Opportunity Zones investments as they would to any other type of real estate deal. The tax incentive is not enough to guarantee the investment’s success. It should be treated as the icing on the cake to a sound and promising project that meets market fundamentals, which for Cityview include strong job and demographic growth, proximity to transportation options and potential rental rates. In addition, the developer’s past experiences both with the construction type and market are crucial for success.
At Cityview, we treat Opportunity Zone investments as an expansion of our existing business strategy of developing in urban markets with high barriers to entry where we have deep experience developing and stabilizing projects. We find that many Opportunity Zone sites meet our rigorous investment criteria. As a matter of fact, several of our past projects were developed in areas that today qualify as Opportunity Zones, long before legislation was enacted.
Second, the current legislation governing Opportunity Zones lacks clarity. The Investing in Opportunity Act, which only runs a dozen lines, leaves many gray areas. In October, the Internal Revenue Service and the U.S. Treasury Department issued proposed regulations, but several propositions still need to be clarified. Any investor looking to get its slice of the Opportunity Zone pie should consider engaging the services of reputable accounting and law firms that have vast experience handling sophisticated real estate and tax matters.
A Bright Future for Opportunity Zones
In December, the oval office signed an executive order to create a White House Opportunity and Revitalization Council. The entity will pursue a variety of federal efforts supporting Opportunity Zones, including infrastructure development, crime prevention, loan guarantees and grant funding. The push of federal funds toward Opportunity Zones will continue to be a hot topic in commercial real estate for developers and investors. At Cityview, we look forward to helping bring high-quality housing to communities in need and working on the forefront of this exciting opportunity for investors.
Author: Sean Burton
Originally published in the Mann Report
