Recent IRS guidance regarding Opportunity Zones may unleash hundreds of billions, if not trillions, of unrealized gains into qualified, new real estate investment and Opportunity Zone Businesses, but the clock is ticking to maximize the program’s advantages, according to Opportunity Zones: Location, Timing, Capital, a new report released by Cushman & Wakefield.
Opportunity Zones are designed to spur economic development by providing tax benefits to investors in economically distressed communities. Eligible real estate investments comprise new (re)developments, capital-intensive renovations and, under the new guidelines, a wide range of operating businesses including those involved in managing and developing real estate.
Investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) or business until the investment is sold or exchanged or December 31, 2026. If the QOF investment is held for longer than five years, there is a 10% exclusion of the deferred gain, and a 15% exclusion if held for seven years. If held for at least 10 years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.
There are over $6 trillion in unrealized gains that could potentially be invested through the program, although Cushman & Wakefield research suggests the scale to be closer to $100 billion deployed over the next several years. Cushman & Wakefield currently is tracking 138 large CRE funds targeting more than $44 billion in equity. Most funds have national mandates and intend to invest in multiple product types: 82% of capital for multifamily investments (including senior, student and workforce housing), 60% for office and 49% for retail.
Locally, for Opportunity Zones located in and around Dallas, the implications for substantial development of office, retail and multifamily – and especially affordable and workforce housing – are significant.
Beth Lambert, Executive Managing Director at Cushman & Wakefield, said Dallas is ripe for Opportunity Zone investing, for the same reasons it is attractive for traditional real estate investments.
“With an Opportunity Zone, you’re still underwriting your real estate to the same fundamentals,” she said. “Dallas has extremely strong fundamentals, including a pro-business climate, strong job growth, a low cost of living, a diversity of industries and companies, and good quality of life. It’s still primed for traditional investing, which translates to promising Opportunity Zone development.”
The Dallas-Fort Worth metro has 52 designated Opportunity Zones, 18 of which are within Dallas city limits. Lambert says those Opportunity Zones that are located close to existing infrastructure promise to develop quickly.
“The zones that already have a bit of a foothold in terms of infrastructure are tending to move quicker,” she said. “It’s more difficult in more remote areas, where the infrastructure isn’t quite there. Those projects are going to take a little longer to get into play.”
Lambert says multifamily housing will most likely be the first stage of development for many local Opportunity Zones – particularly in the more remote areas.
“You’re not going to see these remote areas with hotels; there’s just not demand for that,” she said. “What usually comes first is the rooftops, and then all the things that support the rooftops – needs-based retail such as grocery stores.”
In preparing the Opportunity Zone report, Cushman & Wakefield evaluated 45 office and multifamily markets containing 2,700 of the approximately 8,700 Opportunity Zones across a range of factors indicative of economic momentum. These factors were divided into three categories: tax and regulatory, including State Tax Confirmation Status (Wharton Land-Use Regulation Index); economic drivers (five-year forecasts for population growth, employment growth and household income); and CRE fundamentals (2019 office and multifamily inventory, vacancy and growth).
Sunbelt markets, including Dallas and Austin, lead the group, as growing populations support economic and CRE fundamentals, and the tax regulatory environments are generally favorable for development. Fast-growing markets in California and the Mountain West also appear, including the San Francisco Bay Area; Los Angeles; Portland, Oregon; Seattle; and Manhattan.
Timing is key, though. The clock starts ticking once capital gains are realized, and funds should be invested 180 days afterward. The December 31, 2019, deadline for investors to maximize tax benefits is fast approaching and the value of the tax break declines after that. Investors can still contribute new capital to the program until the end of 2026 and avoid capital gains on the Opportunity Zone Fund investment itself, which can grow tax-free until 2047.
Working capital can be held in cash and short-term debt securities for up to 31 months. Funds also have six months to identify projects for newly raised capital and 12 months to reinvest proceeds from asset sales. In addition, the 31-month and 12-month windows can be extended when a project is delayed while awaiting a government action.
“Projects in highly regulated markets or ones that are not shovel-ready will be easier to do than previously thought,” said David Bitner, Cushman & Wakefield Head of Americas Capital Markets Research. “Overall, it’s rare that a policy program aimed at low-income areas across the country garners a high level of attention and capital, but Opportunity Zones do just that. The program potentially makes it significantly less expensive for taxable investors to back real estate projects as it can boost after-tax IRRs by up to 150-300 basis points in the first 10 years.”
The key to success, Lambert says, is to look at an Opportunity Zone investment as if it is a traditional commercial real estate deal.
“I tell people to underwrite to normal fundamentals,” she said. “Be disciplined. You need to know how to structure the deal, or you could easily undercut the benefits. Above all, understand that Opportunity Zones are intended to be longer-hold assets. Ensure your equity is available for a longer investment horizon.”
About Cushman & Wakefield
Cushman & Wakefield (NYSE: CWK) is a leading global real estate services firm that delivers exceptional value for real estate occupiers and owners. Cushman & Wakefield is among the largest real estate services firms with approximately 51,000 employees in 400 offices and 70 countries. In 2018, the firm had revenue of $8.2 billion across core services of property, facilities and project management, leasing, capital markets, valuation and other services. To learn more, visit www.cushmanwakefield.com or follow @CushWake on Twitter.