It’s time for a crash course in a new investment opportunity that could do some good while bringing returns. Billionaire Sean Parker, co-founder of Napster and former president of Facebook, worked alongside lawmakers to put forth a program that the real estate industry is buzzing about: Opportunity Zones. There are 8,700 Opportunity Zones nationwide, which are qualifying low-income census tracts designated by state governors as areas for investment with the potential to benefit communities and investors alike. Analysts and spectators are debating how to best use Opportunity Funds to take advantage of the new tax break and help low-income communities thrive at the same time.
Smart investors should turn this talk into action because the clock is ticking. Opportunity Zones are part of a 10-year program, and the best returns will go to those who invest in year one. The Opportunity Zone program, conceived by the federal government to drive private investment into low-income areas using major tax incentives, will tap nearly $6.1 trillion of unrealized capital gains.
In truth, this program lives at the intersection of need and opportunity. Designed to maximize community impact by promoting job creation, entrepreneurship and inclusive investment, the program introduces low-income census tracts as an entirely new source of equity investment. And though it’s a federal program, state-level administration allows those closest to the communities to dictate when and how investments are made.
The key for investors is to move prudently with a sense of urgency. The crescendo effect of the tax break means investors that plow 2018 capital gains into an opportunity fund receive three very attractive benefits: temporary deferral of tax on their 2018 gain until 2026; up to a 15 percent reduction on those gains when taxed in 2026; and 100 percent of the fund’s appreciation is tax-free if held for 10 years or longer. The accretive nature of these benefits to a developer’s return profile, especially on an equity multiple basis, is something that the industry has never seen before.
To do this the right way, investors should partner with experts who can execute a micro-level investment strategy on a macro level. Opportunity Funds offer local communities with investment-ready assets unprecedented access to large private banks, hedge funds and high-net-worth investors. The right partner can turn that powerful combination into high-impact investments with long-term growth potential for investors and equitable, transformative economic growth for distressed communities.
It can take time to develop a strategy, secure capital and make new investments happen, so the challenge to act on Opportunity Funds this year may seem daunting. However, the program is tailor-made for commercial real estate because Opportunity Zone deals are generally at a lower basis and can continue to bring returns as the neighborhood grows. This new growth will lead to job creation, entrepreneurship, economic development and affordable housing driving true communal change. Many developers are finding that they already have deals in their pipeline in areas now designated as Opportunity Zones, which will help to turbo-charge the development process.
I’ll bet Parker would like to see the next Napster or Facebook started within an Opportunity Zone, but for the commercial real estate junkie a well-executed Opportunity Fund investment could look something like the one surrounding Mount Sinai Hospital in Chicago. Ogden Commons is an ambitious community redevelopment program driven by a joint venture partnership between an experienced Chicago developer, The Habitat Company, and two prominent North Lawndale institutions, Cinespace and Mount Sinai Hospital (Sinai). The project, located on West Ogden Avenue, near the historic Douglas Park, combines needed retail services, 100,000 sq. ft. of new office space and over 300 high-quality affordable housing units. Over time, the inclusive development should help revitalize the surrounding areas, providing job creation as well as affordable and near-market housing for the entire community. Ogden Commons is expected to proceed in three development phases, which would include sub-phases for commercial and residential development. The project will be financed through one of the country’s very first Opportunity Funds and combined additional federal incentives such as New Markets Tax Credits.
As with any new investment opportunity with potential, it’s essential to beware of profiteers. Though investors should act now for the best results, they should not expect to see returns immediately. In fact, the program is designed to thwart people just looking to make a quick buck. Any property acquired as part of an Opportunity Fund investment is subject to a “substantial improvement” test, in which the costs associated with improving the property must exceed the original cost of the investment. The rule means that investors can’t simply acquire a building, make superficial improvements and call it a day. Instead, it ensures they hold up their end of the bargain, and any returns they see benefit the community as well.
The nation’s economy is currently experiencing the third largest growth period since 1857 and investors with sizable capital gains cannot be skittish about community investment. Opportunity Funds have the potential to bring an entirely new class of investors to the community development space—and their dollars are sorely needed. Now is the time to take advantage of one of the most exciting investment developments in recent history.
Bobby Werhane serves as assistant vice president with Bellwether Enterprise, a full-service commercial and multifamily mortgage banking firm.