The clock is ticking to identify solid investments that will qualify for the new Opportunity Zones tax benefit, created in the 2017 Tax Cuts and Jobs Act.
The Opportunity Zones tax benefit allows investors to defer the capital gains from the sale of an earlier investment for up to nine years if they put the proceeds into a qualifying new investment in a designated Opportunity Zone. Opportunity Zones are a set of designated economically-distressed neighborhoods in all 50 states, the District of Columbia and five US territories that are eligible for the tax benefit.
“If investors' capital is not invested in 2019, they are not going to get the full set of benefits," says Ken Rogozinski, co-head of the Opportunity Zone initiative for Greystone.
Finding the Right Places to Invest
Investment fund managers have already announced a long list of equity funds with aggressive fundraising targets, promising to put investor dollars into qualifying projects in the Opportunity Zones. However, the Treasury Department has yet to issue the last set of rules governing the program, according to Rogozinski. That adds to the challenge of finding enough new projects that can absorb this capital and meet the tight timeframe of the new program, while still earning a solid return for investors.
“There is a distinction between finding any deal and finding a good, sound deal," says Allison Berman, co-head of the Opportunity Zone initiative for Greystone.
Government Shutdown Creates Delay in Guidelines
The longest shutdown of the federal government in U.S. history added to prolonged uncertainty surrounding the Opportunity Zone process. The Treasury Department shuttered operations before officials could release further regulations, including clarification on how much time investors have after they sell an old investment to reinvest their capital gains in a new Opportunity Zone investment.
Similar tax benefit programs, such as a 1031 exchange, give investors 180 days to close the new deal. But experts would prefer not to have to guess.
“We were hoping to see regulations before we go out to investors with our first projects," says Berman.
Apartments Hold Opportunity Zone Potential
Experts like Berman and Rogozinski are already identifying potential investments in the Opportunity Zones that will likely qualify for the new tax benefit. For several reasons, the most promising are developments or redevelopments of urban, rental apartment properties or hospitality projects.
“The highest certainty of execution is in a real estate type development in the Opportunity Zones," says Berman. “Everyone wants to be involved with multifamily, especially, given its strong fundamentals."
These types of investments are a good fit with the program because, unlike a new business that can move from place to place — or fail — an income-producing property will be firmly located in its Opportunity Zone long enough to receive the full tax benefit by the end of 2027, says Rogozinski.
Real estate redevelopment also qualifies as an Opportunity Zone investment, he says. A planned renovation of an existing property would have to at least double its initial cost basis (excluding land) to be substantial enough to qualify. Also, a project sponsor cannot hold more than a 20 percent stake in the property going forward if they have owned it for more than three years.
Low-Income, Urban Areas Are Key
The low-income neighborhoods where the Opportunity Zones are located can make the development of rental properties attractive. Opportunity Zones are an economic development tool which encourages economic development in distressed areas. Bringing multifamily development to these areas by providing tax benefits to investors will result in commercial space following where previously there was little demand, says Berman.
Dense, urban areas are also attractive. For example, a single Opportunity Zone in downtown Brooklyn, N.Y., changes block to block from areas with public housing to a cluster of new luxury rental towers.
“Investors want to be involved in cities," says Berman. “In rural areas, investors are less comfortable."
Projects to build affordable housing could offer an attractive way to invest in Opportunity Zones. The rules so far don't seem to prevent Opportunity Zone investments from being combined with other community development tax incentives, such as the federal low-income housing tax credit (LIHTC).
Experts like Greystone's Berman and Rogozinski are also looking for developments led by sponsors who are intimately familiar with their markets.
"We are focusing on the quality of the sponsors and projects," says Berman.