This thought leadership piece is the first in a series to examine the potential impact of Opportunity Zones on communities and specialized real estate sectors.
Recognizing the need for growth expansion outside core markets, the federal government created new tax regulations to stimulate economic growth in areas that otherwise may have been overlooked. This stimulus was borne from the Tax Cuts and Jobs Act and has quickly become the most talked about investment thesis from coast to coast. Poised to re-shape once marginalized communities, the Opportunity Zone program will create an unprecedented opportunity for long-term capital appreciation and socioeconomic change. The OZ program as it is commonly known, will yield tax savings across the investment spectrum from real estate to small businesses.
By way of background, land parcels eligible for Opportunity Zones were nominated by State and Federal officials based on census data in their respective communities. In June, the Department of the Treasury finalized the 8,700 Opportunity Zones throughout the country. These designated areas provide tax benefits as any investment in real estate or businesses provide the potential to completely defer the payment of capital gains taxes, if the investment is held longer than 10 years. Stephen Shapiro, one of the senior leaders in the Colliers New York City office, has his finger on the pulse of domestic and foreign commercial real estate investments trends. Although the specific regulations have yet to be entirely defined, he has studied the proposed change in preparation of the regulatory release.
“This legislation will enable real estate investors to create transformative neighborhoods, by leading infrastructure development. The opportunity to grow a neighborhood organically with residential, commercial and business development creates capital preservation in a way that’s never been seen before,” says Shapiro “It’s allowing investors to put their money to work in the most efficient way while providing net positive long-term impact to communities that may have otherwise never been invested.”
The Opportunity Zone program has already attracted the highest quality, blue-chip investors from all real estate backgrounds. With several billion dollars raised thus far, it is clear that this is a high priority investment thesis.
While the popular 1031 program delays capital gains, Opportunity Zones will grant investors the potential for a complete exclusion of capital gains if the asset is held for a period of 10 years. Opportunity Zones, unlike 1031, provide for the shelter of capital gains for all types of investments, not just real property. Shapiro remarks, “The 1031 was just focused on real estate, but the Opportunity Zone program is serving as a catalyst to tap into the $6.1 trillion in total unrealized capital gains from both American households and corporations.”
With accelerating speed over the last several months, organizations from nonprofits to investment groups have proposed a wide variety of approaches to capitalizing on opportunity zones. But because of the vast benefits that stand to be collected, this program will attract more than just traditional commercial real estate investors.
The Opportunity Zone program says it all in the title: the opportunity is there for growth, financially and otherwise, for both investors and communities that lie in existing opportunity zones.
When asked how investors can take advantage of the Opportunity Zone program, Shapiro responded, “By expanding their investment geography and hold period, investors have the potential to realize exceptional returns while at the same time providing the capital needed for a community to thrive. Anyone that has ever made a successful investment says the same thing ‘I wish I had gotten in on the ground floor’. The OZ program allows investors to make the ground-floor investment in high-potential growth markets while making a lasting, meaningful change in that neighborhood.”
Waiting for Answers about Opportunity Zones
When announced as part of the Tax Cuts and Jobs Act, organizations from every sector began raising funds to dedicate to Opportunity Zones. However, a year later, there are still unanswered questions about how the regulations will affect these funds.
In a September 2018 Bloomberg report, EIG co-founder John Lettieri stated, “Not all regulatory questions are equally critical at this stage. Most investors aren’t willing to commit their capital until Treasury releases clear rules of the road.”
As of October 2018, the Office of Management and Budget sent proposed rules to the Treasury for review. Over the next month the Treasury Department and the Internal Revenue Service will be providing additional details including legal guidance on this new tax benefit. Eager investors are closer than ever to being able to participate in this exciting new program.
In a new development, Amazon announced its HQ2 location in Long Island City, which lies in an opportunity zone—a prime example of how the Opportunity Zone program may transform the geography of U.S. real estate investment. The trickle-down results of this program are already being seen, and it hasn’t even taken effect yet.
There are two aspects of the Opportunity Zone program Shapiro is tracking, one being Opportunity Zone investing because there is a finite limit to land parcels with this designation. “With the Opportunity Zone program is there a point, where you actually run out of potential Opportunity Zones to invest in? Given that there is a finite number of parcels how does that affect values and liquidity of the sites?”
The other point Shapiro considers is how real estate investments will shift because the program caters to long-term investments. For capital gains to be exempt from tax liability, investors must hold the property for over 10 years. This will impact businesses and their models, but also communities as developments in multifamily and commercial real estate spaces have a legacy effect.
Another benefit of this program is to reduce property flipping and create more stability in previously economically-distressed, high-turnover areas. Businesses are often the staple in strong communities. With the Opportunity Zone program, commercial real estate investors will drive this neighborhood grounding and building effort as a result of their longer-term investment in assets.
The OZ program will have a transformative effect for communities across the board. Shapiro concludes, “They will add value to any neighborhood.”
Stephen Shapiro is a senior managing director in Colliers International’s New York Capital Markets & Investment Services group. Over his 18-year commercial real estate career, Mr. Shapiro has participated in transactions valued at more than $30 billion throughout the Tri-State Region.
Next topic in the series: Opportunity Zones and Warehouse Distribution