Opportunity zones are creating an exciting new era of real estate development
By SEAN BURTON
First introduced in late 2017 as part of President Trump’s $1.5 billion Tax Cuts and Jobs Act, the opportunity zone program has become the new darling of commercial real estate (CRE). While there is a lot of buzz surrounding the incredible tax incentives offered by the program, CRE professionals need to consider a wide range of market fundamentals and the duration and complexity of an opportunity zone investment before diving head first into the opportunity zone pool.
The opportunity zone program is designed to combat poverty and geographic inequality by encouraging investment and development in the 8,700 areas of the country designated as opportunity zones. Investments in opportunity zones are made through an opportunity fund, which in the real estate sector requires that the opportunity fund substantially improve the asset through construction of new buildings or significant rehab of existing ones.
In many ways, opportunity zone investments are like 1031 exchanges with much more valuable tax incentives – allowing for the deferral and elimination of taxes (up to 15 percent on the contributed gain and up to 100 percent of the gain on the new investment) rather than simply the deferral of taxes until a sale. Unlike 1031 exchanges, any capital asset can be invested, and investors only have to contribute their capital gain; however, there are geographic and improvement requirements.
Finding the Right Partner
To maximize the benefits, opportunity zones require a minimum of a 10-year investment, so investors should be extremely diligent about who they partner with and trust. Highly knowledgeable managers who have experience on similar projects with a solid track record are going to be a much better choice than an inexperienced manager or operator who just announced a big fund in hopes of cashing in on the latest trend. The legislation is extremely complex, and many questions were left unanswered, even after last October’s proposed regulations from the IRS and U.S. Treasury Department. While subsequent regulations have been released that have started answering many of the open questions, these investments are quite complex, so it is critical for every investor to also find an attorney and accountant familiar with the intricacies of the program.
The biggest risk is that investors will pursue opportunity zone projects because of the tax incentives, rather than the fundamentals of the deal. It is very difficult to time the market, which is why you want to go back to the fundamentals and assess not only what you want to own in a good market, but in a down one as well. To us, that means focusing on urban locations near transit that have strong job and demographic growth and high barriers to entry. Such urban locations are great in an upmarket, but also very resilient when the market is down. This type of versatility is important for any real estate investment, but particularly with opportunity zones since the 10-year holding period means you are likely to experience a downturn at least once over the life of the asset. Property location, supply, and other fundamentals are much more important than the tax structure.
Our philosophy is to invest in markets that are attractive regardless of whether they were designated opportunity zones, and we continue to actively pursue deals in markets and locations that fit within our investment parameters. The only difference for us is this legislation opens up investment to a different class of capital from small retail and family office investors who can take advantage of a potentially highly advantageous tax structure.
The opportunity zone program brings us into an exciting new era of development that presents a multitude of opportunities for developers, communities, and investors. There will likely be billions invested in the program over the next year alone, with multifamily making up a sizable portion of this investment. New apartment developments will start breaking ground in areas some developers may have previously overlooked – an increased investment that will spur job creation and economic activity while helping to alleviate the housing shortage that is present in many opportunity zone locations.
At Cityview, we are excited to be part of a program that is creating valuable opportunities for investors while bringing much-needed housing to communities across the country.
Sean Burton is CEO of Cityview, a Los Angeles- based multifamily investment management and development firm dedicated to redefining urban living. Led by a team with unparalleled expertise in real estate, development, operations and finance, Cityview’s investments have generated more than $4 billion in urban investment across more than 90 projects to date. Learn more at cityview.com