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Investors Need Final Guidance To Move Forward On Opportunity Zones, But Some See More Risk In The Wait

Opportunity zones, with their offer of tax breaks and diversification for investors, have been drawing attention even as investors await final guidance on exactly how those tax breaks and investments in opportunity funds are going to work.

Buchalter's Michael Williamson, ODG and Arkhouse Partners' Gavriel Kahane, Farella Braun & Martel's Julie Treppa, Cresset Partners' Mark Stern, KBS and Pacific Oak Cos.' Keith Hall and KPMG's Orla O'Connor

The uncertainty means that some firms are forging ahead with single- and multi-asset opportunity funds, taking what they know from the guidance as it currently exists and employing an army of accountants, attorneys and consultants to read the tea leaves and determine the best steps to take and the most likely tweaks that will happen in the final regulations.

Others are willing to forgo any first-mover advantage and await the security of knowing exactly what the rules are before making the leap and launching a fund.

That is the case for KBS Capital Advisors, which has been planning a fund since January 2018 under its Pacific Oak Cos., which was created to focus on opportunity funds. As an investment adviser registered with the Securities and Exchange Commission, any misstep before the regulations are finalized would be too great a risk for KBS, KBS and Pacific Oak Cos. co-founder Keith Hall said.

"A lot of questions still need to be addressed," he said. "We're not willing to take those risks. We've sat on an 80% completed fund document for a year."

Hall was among the panelists discussing the ins and outs of opportunity zone investing at Bisnow's Opportunity Zones 101 event Wednesday at Hotel Nikko in San Francisco.

Paul Hasting's Jeffrey Diener, Urban Catalyst's Erik Hayden and JMA Ventures' Todd Chapman

Hall is keeping a careful eye on what happens Feb. 14, when the IRS will hold a public hearing to discuss the proposed guidelines from October and move closer to setting those final regulations. The meeting was previously delayed due to the government shutdown and there is some concern that another shutdown could mean an even longer wait for that final decision.

And that could be a problem for those interested in opportunity zones, because there is a tight timeline associated with when someone invests and what kinds of benefits they receive. Hold an investment for five or seven years, and there is a tax break. Roll over capital gains from the sale of another property or asset such as stock and hold the investment for 10 years, and the capital gains could be forgiven.

Some firms are launching opportunity funds to take advantage now of the more relative certainty of what will happen with investments this year or next.

"We're only raising money for our fund in 2019 to maximize the benefit to our investors," said Erik Hayden, president of Urban Catalyst, which has a multi-asset fund that is starting with a project in downtown San Jose.

JMA Ventures, which started with a single-asset fund for a project in Arizona, recently launched a multi-asset fund. Such a fund requires different planning since any capital gains money that comes into the fund from investors has to be put into a project within 180 days of them realizing those capital gains to qualify for tax deferral or forgiveness.

"The concern we have is making sure we have the ability to deploy those funds when raised," JMA Ventures President and CEO Todd Chapman said.

The firm is doing a rolling fund raise over two years while planning out an adequate pipeline of projects to put that money into within the time dictated by the program.

Chapman said he has found that more experienced real estate investors tend to be more interested in single-asset funds, which have more transparency and let them choose investments based on the projects they like.

City of San Francisco's Ted Conrad, Blueprint Local's Daniel Palmer, Sixty West's Mike Ballard, Housing Trust Silicon Valley's Craig Mizushima, Upton + Partners' Jake Upton and George Smith Partners' Bryan Shaffer

Even at the event, there were questions raised that remain to be answered.

If a property within a fund goes through a refinance, there is a question of how that money is handled. There is a similar question about capital gains if one property owned by an opportunity fund is sold and those proceeds are then invested into another property in the fund.

Based on the current guidance, investors could take refinancing distributions and assets couldn't be sold within a fund and rolled over, but those looking at other documents and proposed regulations can see where the ultimate regulations may be very different, KPMG principal Orla O'Connor said.

A key caveat that comes up often in opportunity zone discussions is that being able to take advantage of an opportunity zone is a bonus — a benefit that can make a good project attractive for investment but won't make a bad project a good one.

"If we fund a project and we lose our money, it doesn't matter if we get a tax break," said Mark Stern of Cresset Partners, which just announced its first opportunity zone investment in Downtown Houston.

Many of those behind opportunity funds said they are looking at projects based on their merits alone. If it is a good project, then being in an opportunity zone means it may be possible to change leverage or attract more equity, ODG managing partner and Arkhouse Partners CEO Gavriel Kahane said.

"This is the most compelling tax incentive program introduced in a really long time," he said.

Kahane said many of the deals ODG is moving forward on are for projects the firm was looking at even before opportunity zones were part of the equation. The tax incentive just creates ways to get a better rate of return for investors.

It was also important to many investors that opportunity fund properties create operating income, since investors are being asked to hold the investment for a longer time than they normally would for a real estate investment. A 10-year hold period is more attractive if the property is generating revenue during that time, Hayden said.