Opportunity zones are probably the buzziest potential solution for the affordability crisis and local economic stimulus out there at the moment.
But so far, they've been shrouded in confusion. But no more. Here’s the skinny on how they would work, some of the risks they present and what they are meant to accomplish.
According to a research bulletin from Yardi, there are more than 8,700 areas in the U.S. that were designated Opportunity Zones by the Treasury Department in the Tax Cut and Jobs Act of 2017.
There is a novelty to these areas and their potential boons that are making investors curious. Though activity in the program has been limited and there are still many unknowns surrounding it, investors have already begun to position themselves to pounce once given the green light.
Let’s start with how it works.
According to Yardi, the program is meant to encourage investors to reinvest their capital gains. Gains can come from any investment, whether that be stocks, bonds, real estate or partnership interests.
To qualify for the opportunity zone tax breaks, investors must invest their capital gains in an Opportunity Fund Zone within 180 days of receiving those gains. The money cannot be invested directly into a property, and funds must invest 90% of their capital into opportunity zone properties.
If they do this, shareholders will be rewarded with tax breaks based on how long they keep the interest in the funds. Shareholders who keep their investments for five years will pay no taxes on 10% of their gains; at seven years they will pay no taxes on 15% of gains; and if they hold their investments for 10 years, they pay no taxes on their gains at all.
Because the tax bill was passed in a hurry, there are a number of outstanding questions, but that hasn’t stopped funds from cropping up with ambitious goals.
According to the Yardi report, PNC Bank, Goldman Sachs, Fundrise, RXR Realty and a partnership composed of Beekman Advisors, Rivermont Capital and Enterprise Community partners have all already started cobbling together opportunity funds that have goals upwards of $2 billion to $3 billion combined.
Add these bigger funds in with the smaller funds that are probably forming under the radar and opportunity zone funds could draw as much as $30 billion in capital over the next few years, according to some estimates.
The hope is to revitalize struggling communities with the potential for growth with a little nudge from a broad swath of the investor community. According to the report, these opportunity funds are more likely to attract attention from high-net-worth individuals and family office investors, which is a largely untapped investor pool in commercial real estate.
There is some evidence, especially in the multifamily space, that smaller investors are taking a shine to commercial real estate investments, and these opportunity funds could accelerate that trend, bringing in significant crowdfunded capital to put toward the revitalization of the opportunity zones.
Though these zones are an exciting prospect and the program could do exactly what it set out to do, it is important for investors to keep their heads on straight and know that to make this work, they must be prepared to be in these funds long-term and come to the table with solid development practices.
But with that disclaimer, happy funding!