Opportunity Zones: The Do’s and Don’ts of Real Estate’s Most Exciting New Investment Vehicle

During Commercial Observer’s third annual Fall Financing Forum at The Metropolitan Club in New York, a break-out panel discussed the exciting, but often confusing, Opportunity Zone investments. The discussion was led by John Napoli and Steven Meier, co-chairs of Seyfarth’s Tax Practice, and addressed a number of questions from developers, investors and capital providers.

As explained by Meier, Opportunity Zone benefits include deferral of tax on gain that investors invest in a fund, and the elimination of gain in the new Opportunity Zone investment if it is held for more than 10 years. From a real estate perspective, Opportunity Zone projects need to be development projects, he said, “because the requirement is to create new property or substantially improve property — in other words you need to transform the property that is the subject of the fund.”

Allan Fried of GFH Development LLC asked if Opportunity Zones can be used for just one property, as opposed to for a fund.

Meier explained that the rules favor a project-by-project offering structure “because that’s how you get the benefit of the working capital on-ramp” provided for in the recently issued proposed regulations on Opportunity Zone funds. He said that, in order to take advantage of the working capital on-ramp, you must have “a written plan that provides for capital to be deployed in 31 months…from the date of the capital is received by the fund.”

Napoli expanded on this to say that the ideal projects for Opportunity Zone funds are those where everything’s in place, from plans and budgets to local zoning. “Having everything ready to put into the fund will make it a more valuable asset,” he said.

Jack Cortese of D2 Capital Advisors asked if you could divide a fund between projects – selling a project after seven years, for example, then re-investing that money in a different Opportunity Zone project.

Meier explained that “although the statute contemplates that a fund can sell its assets and reinvest in a reasonable time frame, the regulations have not been issued on that yet.”

Conlyn Chan of Hongkun USA asked if Opportunity Zones might be more beneficial for smaller developers.

Meier said they might be because the investment is designed for specific projects, noting that, “you can’t just raise a $1B fund and bring in that capital, because you have to have a plan for where to put that money.” The penalties for failing the opportunity zone tests, he notes, are a potential “death sentence” to a fund.

Fried asked if a developer wanting to participate can buy land, or if they have to buy a building?

Meier noted that you can buy land, but you must do something with that land. Noting that it’s not totally clear yet how vacant land will be evaluated for purposes of the “original use” or “substantial improvement” tests, he nevertheless notes that for pure vacant land, “I would just conservatively assume that whatever I pay for the land, I’ve got to invest at least what I paid for that land, plus $1 more, to satisfy the applicable tests.”

Fried then asked if you don’t have that gain and paid all your taxes, could you take fresh cash and buy into an Opportunity Zone?

Meier clarified that “you only get the benefit with respect to invested gains. You have to have the gains to get the tax benefits. It doesn’t make any sense for anybody who does not have gain to invest in opportunity zones.”

Meier and Napoli believe that the proposed tax regulations issued in late October are enough to allow for Opportunity Zone fund sponsors to launch funds. Meier predicts that, after an initial wave of Opportunity Zone fund offerings in late 2018 and early 2019, there may be a pause that coincides with the issuance of additional regualtions duing which market participants will evaluate fund and project structures. After that, barring the rise of general economic headwinds, it should be full steam ahead for Opportunity Zone funds in 2019 and beyond.