April 1, 2019
By Amy Sorter
When the Tax Cuts and Jobs Act of 2017 was passed, little attention was paid to a program that would funnel capital gains from the sale of assets into lower-income tracts designated by the federal government. A little more than a year later, however, the Opportunity Zone program has sparked a great deal of interest among commercial real estate developers and investors. But, even with the first set of regulations issued by the U.S. Department of the Treasury and IRS, questions remain.
At the recent Connect Los Angeles conference, speakers participating in “The Opportunity in Opportunity Zones” panel focused on making sense of what is still a somewhat confusing, though promising, program for economic development, developers and investors wanting to defer taxes.
Moderated by George Smith Partners’ Gary M. Tenzer, the 30-minute presentation included insights from tax attorney Erik C. Loomis (Cox Castle Nicholson); and two Opportunity Zone investors. These were CIM (represented by Garrett Bjorkman) and Cadre (represented by Dan Rosenbloom).
Loomis launched the discussion by sharing common knowledge about the Opportunity Zone program: Namely, that it’s a method for investors to defer taxes on their capital gains, by rolling it over into a Qualified Opportunity Fund. Furthermore, if those investors hold onto their interest in the fund for 10 years, then sell that interest, they aren’t taxed at all. “That,” Loomis said “is what everyone is in awe about.”
The basics of the program are the easy part. “If you read the statute, it’s only about three pages long,” Loomis observed. “But it’s a dense three pages. It’s convoluted and raises a lot of questions. We wouldn’t be here, talking about it, if it was easy.”
One of the questions arising from both the program and its guidance seems to be debt. Loomis commented that if a Qualified Opportunity Fund, set up as a partnership, takes out debt to improve property in an Opportunity Zone, the debt is treated like a capital contribution to the entity. There is, however, “a question as to whether that debt is treated as some kind of rollover of gain, and whether the benefits will be covered, to zone extent, under Opportunity Zone legislation or not,” Looms observed. “The proposed regulations don’t deal with debt, and the IRS has received a lot of questions about that.”
Even with clarification needed on some of the regulations, CIM and Cadre are working toward Opportunity Zone investments. CIM’s Bjorkman, for one, noted that, his company owns and operates many assets in Opportunity Zones, running the gamut from multifamily, to offices, and locations from Brooklyn, NY to the Los Angeles Arts District. He did caution, however, that if the investment didn’t make sense before the program was introduced, it probably isn’t worth it.
“Based on everything we’ve seen, the after-tax benefit is between 300-350 basis points of additional yield on an annual IRR,” he remarked. “That basis is meaningful, but not that meaningful. If you can’t deliver on the ‘before’ tax part, it’s probably not worth it.”
He also opined that, even with all the hype, there isn’t much capital being formed to take advantage of the program, primarily because of the 31-month time period in place to meet what is called the “substantial improvement” test. Namely, an Opportunity Zone property needs to be substantially improved within that period for investors to qualify for the tax deferment. “You can only do that if you have deals already tied up, or those that can qualify,” Bjorkman noted.
However, Cadre’s Rosenbloom disagreed, pointing out that 31 months can be plenty of time — especially if the funds are relying on a combination of debt and equity. “If you’re using a debt-equity arrangement, the money (equity) would go in first,” he added.
Two deals that Cadre is working on are a shovel-ready multifamily build in Atlanta, on which ground will be broken in April, and a deal, on 3.5 acres, in the Lincoln Heights neighborhood of Los Angeles. “We won’t break ground on that for another nine months,” Rosenbloom commented. “In that instance, the build is 20-24 months, and you bump up against the deadline. But, because of the way you are funding, the equity is going in before the debt, and you can qualify for that substantial improvement test within the 31-month time frame.”
Rosenbloom and Bjorkman did agree that, out of the 8,700 tracts designated as Qualified Opportunity Zones, not all are created equal. Investors need to examine Opportunity Zone locations and state governments before determining if an investment might be effective. Noted Bjorkman: “350 basis points over a 10-year horizon is a big boost. But it has to make sense. You still have to make money.”
Pictured (L-R): Erik Loomis (Cox Castle Nicholson); Garrett Bjorkman (CIM); Dan Rosenbloom (Cadre) and Gary Tenzer (George Smith Partners)
For comments, questions or concerns, please contact Amy Sorter
Tags: Opportunity Zones