The Good, The Bad And The Unknown When It Comes To Opportunity Zones
Want to get a jump-start on upcoming deals? Meet the major Dallas-Fort Worth players at one of our upcoming events!
Unlike unicorns, opportunity zones have no magical powers, so planting commercial real estate in one of them is worthless unless the underwriting and numbers make sense from the beginning.
And asset price appreciation spawned by all the hype surrounding these neighborhoods could make these numbers harder to justify, experts said at Bisnow’s Texas Opportunity Zones Summit Tuesday.
Hoque Global CEO Mike Hoque already has developments underway in Dallas' opportunity zones of Cedars and South Dallas. With his projects bringing momentum to these communities, neighboring property owners are now expecting higher sales prices.
“We are dealing with an emotional seller,” Hoque said. “They have been sitting with distressed property for 20 years. Some of the people in Cedars … they see all of a sudden a farmers market is going in there, so they think their property is worth more than it is. They know they will get some premium if the development goes around it.”
While this is a benefit to sellers in opportunity zones, for investors, price appreciation is a land mine that could very well defeat the purpose of investing in a zone.
“I am warning my clients to price in some of the appreciation in land that they may be looking at,” Hunton Andrews Kurth partner JR England said. “They were seeing advantages of 2.4% to 2.5% in return on investment, but if there is appreciation, then the return on investment gets smaller and smaller. If you raise it too high, you get rid of the entire incentive for doing it.”
RSM Tax Services partner Kristi Gibson agreed with this assessment.
“We did financial modeling,” she said. “The benefit [of investing in a zone] was in the 2.54% range. It has to be a good deal to begin with.”
Noble goals and tax benefits alone are not enough to make opportunity zones worth the investment, panelists said.
"This will not make a bad deal a good deal,” Stonehenge Capital President Thomas Adamek said. “It does provide a marginal tax benefit.”
And there is no incentive to invest in a particular zone on capital gain deferments without the same expectation of success that governs other deals, Adamek noted.
And as land prices rise in zones, good deals may fade.
Wait, And Do It Right
South Dallas and nearby communities are attracting developers and investors, but panelists at Bisnow’s event urged caution until the Internal Revenue Service releases its final rules, which could come this month.
One question to be answered is what happens to clients with land already positioned in opportunity zones.
“We have a lot of real estate clients that have land that has been held for generations in these opportunity zones,” Gibson said. “They have explored the idea of developing that property now.”
However, she added, “if you have land that is existing, it won’t meet the original-use test.”
Smith agrees pre-owned land is an issue. He is hopeful the government will give some positive guidance on pre-owned land.
"A lot of people own land and want to develop it,” Smith said.
The Real Estate Council President and CEO Linda McMahon said Dallas’ Oak Cliff is an obvious opportunity zone choice for investors, but not necessarily a novel one.
“North Oak Cliff, that is a slam dunk,” she said. “People are already there. But if you look at I-35 around the bottom, around the Dallas Zoo with a deck park being built there, it’s an opportunity to create businesses. And if we are successful, it will create jobs there and bring the middle class back to the city.”
But not every deal is a fit from the city's perspective.
“It has to be shovel-ready and the financing needs to be right,” said Robin Bentley, the city of Dallas' assistant director.
When developers look at the financing side of the equation, it often makes financial sense for them to choose traditional financing over opportunity funds. At other times, she finds family investors unwilling to give up their equity stake in a business to take advantage of the funds.
The takeaway, she said, is “the rules and the financing structure have to make sense for the deal.”
And what makes a deal work is having the city involved to ensure projects conform to the area's overall mission and neighborhood.
“You need to have your city involved, your local government,” Folsom Institute for Real Estate Director Joseph Cahoon said. “There is no such thing as two opportunity zones that are exactly like. There is a lot of political risk.”
Cahoon said a big concern is neighborhood gentrification and fear that fund dollars will go outside their intended purpose.
The city of Dallas shares his concerns.
“The city has a huge interest in the redevelopment of low-income census tracts and putting living-wage jobs in those areas,” Bentley said. “An important role [of the city] is to make sure there is not a rush of investment that will negatively impact the people living there now.”
Bentley said the city is going to be vigilant in choosing opportunity zone partners who bring jobs and livable wages to parts of Dallas.
The right investors for opportunity zones are those who intend to build up the community — providing both real estate and day-to-day activity in the region, McMahon said.