Positive and negative assessments of investments in designated opportunity zones have been proliferating since those zones were created as part of the Tax Cut and Jobs Act of 2017. The main argument in favor of investment in low-income communities that have earned that designation, according to the act, is they protect investors from taxation. Another is that creating opportunity zones encourages investment in neighborhoods that have potential for growth, but would not ordinarily get consideration from investors.
Objections to these investments include the exceptional amount of patience required to take advantage of them. Unpacking and abiding by the various complex regulations associated with opportunity zones takes considerable legal expertise. Fully realizing the financial benefits means keeping your money in the investment for 10 years.
And, just recently, accusations of cronyism have arisen in association with opportunity zones. Specifically, some observers point to the designation of an opportunity zone in comparatively prosperous Storey County, Nev. They wonder whether the influence of developer and former junk-bond king Michael Milken resulted in preferential treatment for him in that geographical area — and whether similar deals are happening elsewhere. Other observers of the Storey County development insist that the area’s designation as an opportunity zone is entirely on the up-and-up, and point out that two mixed-use projects are in the works in downtown Reno as a result.
Opportunity zone funds are similar to a 401(k) in that investors may realize stronger gains by deferring taxation until the money is taken out of the fund, with zero capital gains tax payable if the money stays in the investment for 10 years. An investor playing the long game, who has complete confidence in the individual play, might find opportunity zone funds appealing; a more mercurial investor might not.
To qualify as an opportunity zone, a tract of land must have above-average unemployment rates and below-average household incomes. More than 8,700 areas in the United States (rural, urban and suburban, containing about 10 percent of the U.S. population and 12 percent of the land) have been designated by states and certified by the Treasury Department as opportunity zones. Different states employ different strategies in setting up opportunity zones, so investors will find considerable variation in the geographical locations involved.
Paul Fiorilla, director of research at Yardi Matrix, reports the overall growth of opportunity zone funds looks slow for the moment, since, after all, opportunity zone transactions are invariably more complicated than an ordinary deal. It is a matter, he says, of raising patient money, identifying the project, ensuring the project is suited to long-term performance, and ensuring the regulatory time limits are observed.
One complication is fund structure, he says. Most corporate real estate funds are commingled, with money going into multiple assets. But the intricate rules of opportunity zones with regard to the holding period and tax structures turn this into intricate work, for purposes of calculating capital gains and the taxes thereon, and calculating the holding time.
A recent study of the Yardi Matrix database found that properties in opportunity zones, in place or under construction, represent 13.1 percent of total multifamily units nationwide, 13.7 percent of total office space and 11.4 percent of total self-storage space. Much of the activity in opportunity zones will be ground-up development, since investors are required by the new law to increase the basis of the properties purchased. In some cases, the returns might be attractive to “value-add” investors. However, the risks of investing in low-income or depressed areas are well known.
“The political element has to be considered,” Fiorilla admits. “The appearance of stories like the Milken project might make some investors wonder whether they will see a newspaper story written about them. It is bad publicity for the program. Overall, we see good opportunities for the right projects, the right investors, in the right places, but complications have restrained the number of deals.”
However, several opportunity zone projects have gotten under way recently, to positive notices from the investment community. One of these is the historic Kern’s Bakery in South Knoxville, Tenn., where Mallory & Evans Partners is leading the building’s transformation into an innovative mixed-use community. The 16-acre development will preserve the building as a retail, restaurant, office and entertainment destination while adding 160 boutique-style one- and two-bedroom rental apartments nearby. A branded hotel is part of a later stage of development. Ozone Capital Management, which specializes in opportunity zone investments, is an equity partner for the multifamily component. One of the principals, Brantley Basinger, says opportunity zone developers should not expect an easy ride.
“There were not many of these deals when we started, so it felt like we were inventing the wheel,” he says. “But after you set up the entity correctly and understand the tax considerations so you can be compliant, it is like any other deal. There may also be tax considerations such as historic tax credits or new market tax credits. The new market tax credits on the Kern’s Bakery redevelopment allowed us to expand the scope of the project and offer more.”
Basinger also urges investors to consider, before committing to an opportunity zone fund, how long they are going to keep their money in it. After a five-year hold, 10 percent of capital gains will not be taxed; after seven years, that figure rises to 15 percent. An investor can withdraw the money with a discount to the capital gains tax, and re-invest it, or hold it for 10 years to escape the tax altogether.
Basinger is also principal of Mallory & Evans Development, which builds student housing. Through that company, he has two more opportunity zone deals: Bellamy Western near Western Carolina University in Cullowhee, N.C., and Bellamy Carrollton near the University of West Georgia in Carrollton, Ga.
Meanwhile, S2A Modular, of #GreenLuxHome fame, has created the S2A Opportunity Zone Fund to revitalize urban areas nationally. The fund promises “full visibility” for the use of investor contributions. S2A and its affiliates act as the builder, developer, fund manager and broker. According to S2A co-founder and president John Rowland, the fund will invest in projects that involve the creation of “safer, greener, stylish and smart-connected buildings that elevate quality of life” while lowering the costs of living through electrical self-sustainability and the latest environmentally friendly technologies.
The #GreenLuxHome, according to the company, are electrically self-sustaining, custom luxury homes that can stand alone as individual properties or be incorporated into full communities, along with commercial buildings and hotels.
Multifamily appears to be the property category with the most potential for development in opportunity zones, although some attractive office plays have been discovered. Self-storage is another popular category. An intuitive assumption might be that apartment rents in opportunity zones might fall in the below-average range, but no identifiable pattern has yet been discerned.
Some observers advise potential investors to keep an eye on demographic and economic trends. In some cases, outdated statistics have been used to select opportunity zones, and it is important to identify zones where improving trends can be observed — and the metrics best suited to spotting the zones that hold the most investor potential.
“PTM launched in 2018 and focuses exclusively on real estate development in opportunity zones,” says Scott Meyer, chief investment officer at PTM Partners. “While there has been a tremendous amount of chatter about the program in the real estate community and beyond, the legislation does not make a bad or even mediocre deal good. Rather, the legislation incentivizes capital to have a long-term horizon and develop value over time.”
Jen Collins, fellow in residence and opportunity zone lead at the nonprofit Beeck Center for Social Impact + Innovation at Georgetown University, explains that her career in the institutional investor arena has prepared her for the current mission of helping investors make maximum positive impact by creating favorable social as well as financial outcomes within opportunity zones.
“Opportunity zone legislation has brought a myriad of interested parties to the world of impact that had never been there before, to drive more positive social outcomes,” she says. “Opportunity zone legislation is a bipartisan lodestar in the world of investment, a real ignitor of collaborative behavior.”
Collins describes Beeck Center’s work as “setting tables” where interested parties can get to know each other. Among other initiatives, Beeck Center runs an OZ Investor Council, a group of about 15 developers, institutional investors and fund managers that gets together to cross-pollinate best practices and find opportunities for collaboration.
Other institutes of higher learning, including Columbia and Tulane, are working with Georgetown to create symposia to discuss how to identify, track and report the impact of specific real estate and business projects in opportunity zones and elsewhere. This initiative is likely to lead to harder data on how (or whether) opportunity zones have had a measurable positive impact.
When the opportunity zone incentives were voted into law, some legislators bemoaned the absence of impact tracking requirements. A co-sponsor, Sen. Cory Booker (D-N.J.), voiced concerns that the program could, lacking proper oversight, become a tax shelter that benefited only the investors and not the communities involved. This has led to considerable public discussion in several communities, and perhaps to more transparency. In response, the Trump administration has established the White House Opportunity and Revitalization Council to determine ways and means of measuring the effectiveness of opportunity zones and other initiatives.
Finally, the Atlanta-based law firm of Morris, Manning & Martin notes that the Office of Healthcare Programs is offering several incentives to encourage greater development of nursing homes, assisted living facilities, board and care facilities, and hospitals located in qualified opportunity zones, leading to job creation in those zones. Effective immediately, the Federal Housing Administration is giving priority to Section 232 applications for facilities located in those zones, with expedited underwriting for applications and application/exam fees for facilities in opportunity zones.
Joseph Dobrian (jdobrian@aol.com) is a freelance writer based in Iowa City.