Which Properties Investors Expect To Benefit Most From Opportunity Zone Investments
Investment firms have begun to set up funds to deploy money into opportunity zones, a host of areas designated by local governments that offer tax breaks under a new federal program, but not all properties within a qualified zone will experience the same benefit.
Opportunity zone investors have a number of factors to consider before putting money into a property, such as the likelihood of getting a solid return on investment, the ability to quickly navigate the project approval process and the other programs that can be utilized alongside the opportunity zone benefit.
The Opportunity Zone program, signed into law by President Donald Trump in December as part of the Tax Cuts and Jobs Act, allows investors to defer taxes on capital gains by putting them into funds that will invest into the areas designated by local governments. The industry is still awaiting specific regulations from the Treasury Department, but experts believe it will allow investors to see significant increases in returns while also benefiting communities that otherwise might not attract as much investment.
Develop founder Steve Glickman, who helped write the Opportunity Zone program while at the Economic Innovation Group, said the vision was to foster investment in low-income communities. But it was also important for local governments to select areas that could support private investment and create returns, and he said they did a good job of that. The census tracts selected cover 10% of the U.S. population, roughly 35 million people, and have an average poverty rate of about 30%.
"These are relatively distressed areas but were selected by governors because they were places they thought were in the path of development and growth," said Glickman, speaking Tuesday morning at Bisnow's D.C. Opportunity Zones event, held at The Watergate Hotel.
Investors receive a larger benefit from the program when the asset they put money into increases in value, and the risk of losing money on a bad investment still exists as it does without the program. CohnReznick Managing Principal Ira Weinstein said this means it won't lead to a surge of investment in otherwise unprofitable projects.
"It's not likely that an asset that isn't likely to perform very well is now going to perform," Weinstein said. "There has to be some underlying economics inherent in the asset."
Asheel Shah, who recently joined EJF Capital from Kettler and is now helping lead a $500M Opportunity Zone fund, said the program is best for projects that were already close to the finish line but needed a final push.
"It does all start with the real estate," Shah said. "I don't think that deals that would have never gotten done before and didn't make economic sense, this isn't going to make those deals all of the sudden make sense. This is a fantastic public policy measure, this is a transformative event to reinvest capital across America, and in time it will push deals over the hump that might have been marginal otherwise."
While investment firms like EJF, OPZ Capital, Fundrise and others are setting up large funds to aggregate investor money in opportunity zones, developers with opportunity zone projects in the pipeline are also able to deploy their own capital gains and receive the financial benefits.
One developer that plans to take that approach is Redbrick LMD, which has a major project in an opportunity zone in Anacostia: the 2.3M SF Columbian Quarter development. Redbrick founder Tom Skinner said the company is structuring an opportunity fund for each of its D.C. projects east of the Anacostia River, starting with Columbian Quarter. Given the short time period allowed between putting the money into a fund and spending it, he said Redbrick is waiting for an office lease to kick the project off before creating the fund.
"We have a couple of built-to-suit offices we're negotiating with at a 15-year lease, and once we have that lease in hand, we can commence the fund formation," Skinner said.
He sees Anacostia as the perfect neighborhood to utilize the Opportunity Zone program because it has historically been underserved but is directly across the river from one of D.C.'s fastest-growing neighborhoods, Capitol Riverfront. Since the program's structure gives greater benefits for investors who keep money in assets for longer periods of time, this will allow Redbrick to be patient in waiting for the neighborhood to grow and produce a larger return on investment.
"We're one stop away from the Navy Yard Metro, but [apartment] rents are lower because we're on the other side of the river. But that differential is going to narrow over time," Skinner said. "If we're at a 15% discount today, maybe we're at a 5% discount in 10 years' time. But the current source of development capital is looking at building it and selling it in three years and we're penalized for that. So that's another attractive feature of the program."
But a problem that Redbrick's development and many other D.C. projects face could make opportunity zone investment more challenging. Columbian Quarter is one of more than a dozen D.C. developments currently stuck in court following appeals from opponent groups. And because opportunity zone investments require short time periods to deploy capital into projects, the uncertainty created by appeals presents a roadblock.
"The planned-unit development process in D.C. is now broken, which is a big problem for opportunity zones," Fundrise CEO Ben Miller said. "If you get a PUD approved, it will get litigated by a few rogue attorneys, and that's a multiyear delay of the process ... This is a big problem for the city and I think it's going to become critical for opportunity zone capital deployment to resolve."
Given the roadblocks in the approval process, Miller said opportunity zone investment will be best placed in shovel-ready developments that already have the necessary entitlements. The challenges also make smaller developments more attractive because they don't have as many hurdles to go through before breaking ground, Bean, Kinney & Korman's Vikram Agarwal said.
"The $5M to $50M range deals, although they're smaller, the beauty of the program is there's still a tremendous amount of interest because the benefits are so substantial," Agarwal said. "I really like that space for developers that are putting up multifamily in the $20M range or hotels in the $20M to $30M range. Baltimore has been a really big area for that, and around the Arlington and Dulles area."
The law allows opportunity zone benefits to be utilized alongside existing programs, so properties in areas where other tax incentives apply could see a larger benefit. The Office of the Deputy Mayor for Planning and Economic Development's Jonathan Kayne said investors in D.C. opportunity zones can also take advantage of the Neighborhood Prosperity Fund, Supermarket Tax Incentives and the Great Streets program.
Additionally, opportunity zone investment is not limited to real estate properties. The money can also be used to fund companies or invest in clean energy solutions.
"We really want people to take a more holistic look when they're developing properties to say 'I have a unique opportunity not just to finance the property but also a means of financing that I can invest in my tenant base as well,'" Kayne said. "We want people to take advantage of trying to create new businesses, help incubate new retail and new amenities for neighborhoods as well."