The Internal Revenue Service and the Treasury Department are starting to clarify qualified opportunity zone regulations, with the IRS releasing its first proposed rules in October 2018. Based on the rules proposed to date, these zones have the potential not only to dramatically boost real estate investment in regions that are struggling economically, but also to be a boon for the real estate industry.
“The recently issued opportunity zone regulations were generally favorable to the commercial real estate industry and provided much needed clarity in several key areas,” says Randy Barrus, a partner at Baker Tilly’s Washington DC office. “We expect many real estate companies to quickly begin strategizing on how they will participate in opportunity zones while we await additional regulations that will focus on operational issues such as the sale of an opportunity zoned asset.”
Jordan Angel, a Senior Director with HFF in San Francisco, adds, “I have spent a lot of time geeking out on opportunity zones as it is the topic du jour in commercial real estate. We are already working on a number of opportunity zone sites across the country from both the sales and equity-raising perspective. We have seen a huge demand for opportunity zone deals and overall knowledge on the subject.”
According to the regulations, those who invest in properties or businesses within qualified opportunity zones can defer most capital gains taxes until December 31, 2026. There are nearly 9,000 census tracks in all 50 states, plus the District of Columbia and five U.S. territories where there are named qualified opportunity zones – a designation that will last for 10 years. Qualified opportunity zones are defined by the IRS as economically distressed areas where tax benefits will be used to increase investment and job creation across a wide range of businesses, not just commercial real estate.
Businesses should be able to find qualified opportunity fund investors who will accept a less-than-normal return because of the favorable tax treatment they will receive later, according to Gerald Mildner, Director of the Center for Real Estate at Portland State University.
It appears that properties and businesses within qualified opportunity zones will likely see an immediate rise in asset values, given that tax relief should drive greater demand for those sites. Mildner notes that it is analogous to how crop prices rise after the government announces a new agricultural program.
Mark Stapp of the Arizona State University at Tempe, states, “So many opportunity zones are in underserved areas of communities, and a lot of times those areas have substantial political capital that they like to bring to the table. The idea of are you going to cause gentrification, are you going to displace me, is going to change the dialogue in the approvals process.”
There is, however, a potential downside. After 10 years, funds will be withdrawn from these zones unless the statute stays on the books. In reality, though, there could be a 10-year bubble in these areas, assuming that opportunity zone investing is the dominant investment form in those particular distressed areas.
So, is the promise of opportunity zones fact or fiction? While it remains to be seen, it is safe to say that based on what we have seen so far, it is indeed a fact and there undoubtedly will be a tremendous number of investors looking to take advantage of this program.