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The Opportunity Zone Regulation Delays Could Be Good News For Philadelphia

For all the intrigue that opportunity zones have generated, they have also come with their fair share of concern. But as the delay in final regulations drags on, it may also solve one of the program's problems by accident.

KPMY senior lead tax partner Joe Scalio, Saul Ewing partner David Shapiro, Philadelphia City Councilwoman Maria Quiñones-Sánchez and Shift Capital Director of Development Nancy Gephart

The most talked-about facet of opportunity zone investing so far has been the 15% discount on capital gains invested in the zones if held for seven years, but that only applies for investments made by the end of this year. Some movement is already happening, like Plymouth Group’s purchase of the former Budd Co. factory where Bisnow held its Philadelphia Opportunity Zones and Capital Markets event last week.

As private equity firms try to put together huge qualified opportunity funds to take advantage of the new laws, time is running out before they can deploy the bulk of that capital for maximum tax savings. But with the second round of guidance still delayed and the entire process months behind schedule, City Councilwoman Maria Quiñones-Sanchez said she was confident that the deadlines will be pushed back.

Regardless of the timing, another provision related to the capital gains tax could wind up having the bigger impact, which is good news for commercial real estate.

Alliance Partners HSP Managing Director Jay Dunn, Goldman Sachs Urban Investment Group Vice President Dan Alger and Plymouth Group principal Michael Davis

If an investor makes an opportunity zone acquisition and invests the necessary capital in improving the property, then holds that property for at least 10 years, all capital gains from that investment are untaxed. Whereas the seven-year gains tax discount is only applicable to investments made by the end of this year, the 10-year hold condition applies to any investment made through June 2027, KPMG Senior Lead Tax Partner Joe Scalio said.

Philly’s underdeveloped areas could stand to benefit more from the 10-year provision, even though it requires a level of patience many private equity investors simply don’t have, according to Lubert-Adler Partners co-founder and CEO Dean Adler.

“When push comes to shove, most investors are not going to sign up for that [sort of wait],” Adler said. “Period, end of story.”

Duane Morris partner Brad Molotsky and Lubert-Adler Partners co-founder and CEO Dean Adler at a Bisnow opportunity zone event in April 2019

For now, Plymouth Capital has set out to be an exception. The company purchased the 26-acre, 1.8M SF Budd Co. complex for $10/SF, meaning that for $10/SF worth of improvements across a 10-year time frame, any returns from equity investments on that project would be tax-free, according to Plymouth principal Michael Davis.

“For what the program is designed for, projects of tremendous scale and larger timeline fit the timeline and yield for what you’re looking to do,” Davis said. “If you’re looking for something with asymmetrical return like so many developments are, then the benefits are even more valuable.”

Sites like the Budd plant and the Frankford Arsenal, for which owner Alliance Partners HSP is seeking opportunity fund equity, aren’t central enough to attract the number of people or businesses required to fill their impressive footprints.

Argosy Real Estate Partners principal Sara Doelger, Rubenstein Partners Head of Finance Scott Whittle and Walker & Dunlop Vice President Harvey Pava

Alliance Managing Director Jay Dunn said that most of the potential tenant interest in redevelopment sites like that is from startups, which don’t have the credit base to make financing deals easy.

That issue is one that all panelists agreed must wait until further regulation comes out, as investments in operating businesses — another element of the opportunity zone program — seem like a key to solving revitalization puzzles but have the least detail of any element in the regulation. 

“If you’re starting a business right now and you’re not in an opportunity zone, you’re out of your mind,” Davis said. “Because if you want to grow something over the long term, you can grow in an OZ without paying taxes [if you own a share for at least 10 years], which is a remarkable opportunity.”

Although dealmaking is well underway, the vast majority of capital sources planning to invest with opportunity funds are still sniffing for such opportunities.

Across Philly, there are smaller companies already at work to revitalize struggling areas, and if Kensington-based Shift Capital is any indication, they are getting more attention than ever before from such deal hunters.

Walker & Dunlop Vice President Harvey Pava, CBRE Research Director Ian Anderson and Pender Capital Vice President of Originations Kristin Rick

“I would say we’re getting a huge amount of interest from investors from all over the country trying to get into these deals,” Shift Capital Director of Development Nancy Gephart said. “That’s because we already have a pipeline and local relationships.”

Gephart clarified that Shift hasn’t been offered terms meaningfully better than what she was getting before, but increased attention in an area like Kensington is virtually a benefit in itself. The growing group of national investors raising hundreds of millions to invest in opportunity zones must feel like a prize catch for community stakeholders like Quiñones-Sanchez, but Adler cast doubt on whether such capital sources would be the ones to get in bed with.

“All these Wall Street fund managers building huge funds, they have no idea what they’re investing in,” Adler said. “They’re just looking to collect fees.”

CoStar Philadelphia CRE Market Economist Adrian Ponsen

When investors cast nets to find investments outside of their stomping grounds, building a good sense for what makes an area tick is crucial — more so when investing outside the city center. Quiñones-Sanchez, whose district includes much of Kensington, claimed that plenty of neighborhood organizations have plans ready to go, more open to outsiders than ever before.

“Because of the time sensitivity we’re dealing with, we’re open for business,” Quiñones-Sanchez said. “We want investors to come to communities with plans, and I think we can avoid typical NIMBY situations if investors come in, look at projects where people already have designs and fund them.”

The surrounding neighborhood of Nicetown might be far removed from the heyday that gave it its name, but it is positioned near burgeoning neighborhoods in East Falls and Brewerytown. In 10 years, who knows what kind of growth will happen around the factory.

Attendees of Bisnow's Philadelphia Opportunity Zones and Capital Markets event in the massive former Budd Co. factory in Nicetown

That New York-based Plymouth Group made the site one of its first purchases outside of its home base, and first in Philadelphia, shows how Philly can be an easy target for impact-minded investors.

“We have advantages relative to New York and elsewhere that can make us a workshop for the region,” Quiñones-Sanchez said. “If people are wondering how to create jobs and skilled jobs, then they don’t need to look any further.”