With (Some) Rules In Hand, Funds Prep For Opportunity Zone Investments

Real Estate

A woman pushes a cart as she walks along side of the facade of a former bank held up by steel beams during reconstruction in an opportunity zone in Newark, N.J. The Trump administration on Friday, Oct. 19, proposed rules for investors in a new program that it says could have a big impact on economically depressed areas around the country. About 8,700 of the “opportunity zones” have been set up in all 50 states and to lure investors and developers with tax breaks. (AP Photo/Julio Cortez)

The U.S. Treasury Department’s recent release of long-awaited guidelines for opportunity zones is expected to unleash real estate investment in low-income neighborhoods in the country – that is, as long as stock market volatility, the onset of a recession or other gloomy events don’t doom optimism and risk-taking.

As part of the Tax Cuts and Jobs Act passed last year, the opportunity zone program is providing federal capital gains tax deferral to investors who pour money into some 8,700 depressed communities across the country. To be eligible for the benefit, investors must roll profits from the sale of stocks, bonds, real estate or other assets into into a qualified opportunity fund. Investors will receive a 10% or 15% reduction in the capital gains tax through a step-up in basis if the original investment is held within the fund for at least five or seven years, respectively. If the investment is held for 10 years, the basis is stepped up to fair market value at the time of sale, and no capital gains taxes would be due.

While Treasury’s issuance of proposed rules left some questions unanswered – the department said it would release additional regulations soon – they address early concerns about the program. Initial provisions appeared to require opportunity funds to deploy capital within a narrow timeframe of six months after raising it, for example, but Treasury has proposed a “working capital safe harbor” period of 31 months as long as funds adopt and comply with a business plan. Additionally, Treasury cleared up uncertainty over the “substantial improvement” test related to the increased value of an opportunity zone investment by basing the calculation on the physical improvements and excluding the land. (More information can be found here and here.)

According to estimates by the Economic Innovation Group, an organization that advocates for policies that promote entrepreneurialism and investment, U.S. taxpayers held more than $6 trillion in unrealized capital gains in stocks and funds at the end of 2017. Real estate developers like Stellar Management, a New York-based owner and operator of apartments and office buildings, already owns assets in and around opportunity zones, and the tax benefits serve as a further incentive for the firm to continue to build in the communities and help spur growth, said Stellar principals Matthew Lembo and Adam Roman.

While Lembo and Roman plan on using the firm’s balance sheet to fund investments and are unsure whether the firm will launch a broader fund-raising effort, other sponsors began marketing funds in earnest nearly five months ago and continue to do so today. Most recently, Cresset Capital Management and Diversified Real Estate Capital, two Chicago investment managers, announced that they had partnered to launch an opportunity zone fund that will pursue new development and redevelopment as well as investments in data center, distribution and energy companies.

Other fund-raising and investment activity includes the following:

  • Global real estate private equity firm Virtua Partners launched a $200 million fund in June that’s investing in apartments and single-family rentals, hospitality properties, and office buildings in high growth sunbelt markets. In August, the firm rezoned 3.6 acres in Tempe, Ariz., to accommodate a 90-unit apartment project in an opportunity zone.
  • Shorewood Real Estate Group in August paid $20 million for an opportunity zone site in the New York borough of Queens, where it plans to build a 215,000-square-foot mixed-use project featuring some 300 apartments. Shorewood’s opportunity fund is focused on mixed-use, affordable housing and value-add projects in high-growth submarkets.
  • Saxum Real Estate is raising a $100 million opportunity fund that’s focused on value-add projects and new development in transit-oriented and urban markets in the Northeast and Mid-Atlantic.  
  • Crowdfunding platform Fundrise has kicked off a $500 million opportunity fund-raising effort. It plans on investing in “high quality real estate projects” in the San Francisco Bay Area, Los Angeles, Seattle, Atlanta, and Washington. In July the fund made its first acquisition, an old dilapidated residential and retail building in Wasington’s LeDroit Park. Fundrise plans to restore and expand the property.

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