January 3, 2019
By Dave Sorter
Meridian Capital Group is getting into the matchmaking business for Opportunity Zone investments.
The firm recently launched its Opportunity Zone Marketplace in an effort to provide full capital stack solutions for owners and investors in Opportunity Zone transactions. The firm will not only bring together potential investors and developers, but also help clients put together a team of advisors such as accountants and attorneys that specialize in the space. According to Steven Adler, managing director at Meridian and head of Meridian’s Opportunity Zone efforts, this network will help owners or purchasers quickly understand whether their project complies with Opportunity Zone requirements and what they can and cannot do.
“As part of Meridian’s investment sales and financing platforms, we have a natural flow of Opportunity Zone transactions from owners and developers. With respect to Opportunity Zones, we plan on broadening our focus to the investors,” Adler said. “People who have capital gains can reach out to us. We can understand what they’re looking for and can help match deals with investors.”
While Meridian’s website serves all owners, investors, and funds, it especially targets investors who prefer to use their gains to acquire or control a single-asset Opportunity Zone deal on their own, rather than to place their money with a large fund for a minimum 10-year hold period.”
Adler sat down with Connect CRE for a Q&A about Opportunity Zone investments.
Q: What should investors be looking for and trying to avoid when looking at Opportunity Zone potential?
A: One thing people have to remember is that these Opportunity Zone projects require construction or heavy redevelopment, which makes them substantially more complex than a typical “cash-flow” based real estate transaction. Investors who invest in a single-asset Opportunity Zone fund need to ensure the prospective project(s) are properly capitalized, make economic sense based on current market conditions, and that the developer can really execute the business plan. As many investors in the Opportunity Zone space will not have traditional real estate backgrounds, as their gains may have come from the sale of stocks, businesses, or other similar sources, they will need to understand who will be running their project day-to-day.
Q: Are there any types of development or specific types of distressed that you’re recommending?
A: We’re not recommending any specific property type to our clients, as every investor is unique. With respect to the larger funds that are looking at Opportunity Zone projects, they may be focused on the IRR and backend multiple, which may be driving them to certain asset types or markets where they can achieve this yield. On the other hand, we’re currently working with a private family who will have a substantial Q1 2019 capital gain, and they want to take a conservative approach. They are focused on residential and industrial assets in more specific markets where the risk is not as significant. In each case, we tailor solutions to our particular investors’ long-term goals.
Q: Have you seen a big push in deals since the Treasury issued its guidance on Oct. 19?
A: The deal flow has not necessarily been tied to the Oct. 19 guidance. There was some activity earlier in the year with investors who had capital gains that were within the 180-day period to invest those funds. With the new guidance, investors have become more comfortable that Treasury will be practical in making sure the program is broad enough to accomplish its intent to incentivize capital to flow into the Opportunity Zones. The Oct. 19 guidance provided enough information for deals that are straightforward and that clearly fit within the guidelines to begin moving forward. However, many investors are expecting further guidance, hopefully in early 2019, which should help clarify many of the outstanding questions.
Q: Some critics are saying that some of the Census tracts designated as Opportunity Zones are in areas already being gentrified. Do you think this is an issue, and do you think the current state of development in an Opportunity Zone should be a factor in deciding where to invest?
A: There has been a fair amount of criticism that much of the investment will flow into areas that have already seen substantial development. However, part of the reason that the initial dollars may flow into these areas relates to the timing challenges posed by the current state of regulations. The rules mandate a 30-month period to substantially improve a property, making it almost a necessity to invest in shovel-ready projects in order to meet this deadline. The projects that are shovel-ready today have likely been in the works for a year or more as developers went through the zoning and planning process. These projects tend to be in areas that have already begun to see some improvement. As time passes and more capital begins to flow into Opportunity Zones, more shovel-ready projects may begin to appear in areas that were previously overlooked.
In addition, the government is focusing on encouraging capital to flow into some of the more distressed areas that the program was intended to benefit. President Trump recently set up a council of 13 federal agencies, led by Housing and Urban Development Secretary Ben Carson, to ensure that federal efforts are focused on providing assistance and infrastructure for areas that are in most need of help. As these programs develop over time, we will hopefully see more capital flow into these more challenged areas.
Q: Of course, Opportunity Zones are designed to provide capital-gains-tax breaks and to reinvest those gains into distressed areas. Other than those tax breaks, what are some of the “hidden” benefits of Opportunity Zone investments, as opposed to other types of CRE investments?
There is a social aspect to Opportunity Zone investing. It’s a unique program that incentivizes people to do well by giving back. People who have had success in life or business may be more motivated to go back to communities where they grew up, and their reinvestment into these areas can give others similar opportunities.
In addition to the real estate aspect of Opportunity Zones, another important part of the regulations relates to investing in businesses within Opportunity Zones. Currently, the regulations around this area are vague, but as the rules get clarified, we may start seeing more investing into local businesses, which should help bring employment into these distressed areas.
Q: To get the maximum benefit from Opportunity Zone investments, they likely should be made by the end of 2019 (because the capital-gains taxes must be paid at the end of 2026). Are you pushing this deadline to your clients?
A: We’re explaining to people that to achieve the maximum benefit under the program, and in particular the full 15% step-up in basis, the investors must put their money into a qualified Opportunity Zone Fund prior to the end of 2019. Accordingly, we may see a flurry of deals happening prior to year-end to meet that deadline. However, I don’t think that investors should rush into a deal merely based on this consideration. The largest benefit of the program will be at exit after 10 years, when the profits will be tax-free, and it’s important to choose an investment that has the appropriate upside. The difference between the full 15% step-up in basis (for investments made prior to the end of 2019) and 10% (for investments made between 2019 and 2021) is not as significant. The more important deadline may be at the end of 2021 (the five-year period before 2026). For investments after that point, investors would lose the full 15% step-up in basis, and the timing of the deferral in gains until the end of 2026 starts to get a lot smaller.