Understanding the nuances of opportunity zones

It’s more than just a tax break

Opportunity Zones have been called everything from a “ridiculous loophole” to “the hottest pitch in real estate.” Originally devised by the Economic Innovation Group (EIG), Opportunity Zones were established by Congress in the Tax Cuts and Jobs Act of 2017 to encourage long-term investments in low-income urban and rural communities nationwide.

A few months ago, the IRS released additional guidelines for Opportunity Zones. Specifically, they clarified what a “fund” meant in this context.

As most investors know, you can choose to invest in a single stock — Apple, Nike, IBM, Boeing — or you can invest in a fund that incorporates stock options from multiple companies. But until recently, most Qualified Opportunity Zone Funds contained just one property, so the term was a little misleading. The main benefits of what most investors think of when looking at a fund, including diversification and risk mitigation, were simply MIA.

Thanks to these new guidelines, Opportunity Zone Funds can now incorporate multiple properties into a single investment vehicle, provided they meet the designation criteria. This allows for a diversified portfolio with a single investment, meaning your overall investment benefits from spreading the risk across multiple properties. So, even if one property underperforms, the more successful deals can level things out.

What makes an opportunity zone different from other properties?

Tax benefits aside, there can be differences between an Opportunity Zone deal and a typical commercial real estate investment opportunity.

The first hurdle to cross is finding a property in a designated Opportunity Zone.

Second, the project either needs to be a totally new development or it needs to undergo such drastic renovations that it doubles the value of the property. Upgrading the appliances or changing the rental strategy, things typically considered “value-add,” are not enough. This means that most, if not all, of Opportunity Zone projects are going to be considered “Development” or “Opportunistic,” which puts them on the more aggressive side of commercial real estate deals.

But unlike other opportunistic investments, Opportunity Zone projects often project lower target returns. A typical commercial real estate deal may target a 5-7 year hold, but these deals target ten years minimum.

Why the longer hold period? Because the real tax benefits only kick in if your investment is held for ten years. It’s a longer hold term, yes, but coupled with the tax benefits the final net return to investors can be similar to projects targeting larger returns.

Don’t let the tax tail wag the investment dog

One thing investors need to remember is that the tax benefits of an Opportunity Zone should be the cherry on top of an already sound commercial real estate investment. You’re locking up your capital for ten years in order to reap the tax benefits, so make sure the deal fits into your overall investment strategy and not just your tax planning.

Most Opportunity Zone projects are going to be in secondary and tertiary real estate markets, so you’ll want to be on the lookout for sponsors in those markets with a strong track record of success in other commercial real estate deals.

Opportunity Zones are proving to be great gateways into commercial real estate, especially for those looking for a new way to invest their capital gains. As the IRS continues to clarify regulations, there are likely going to be more ways to easily invest without the overhead of sourcing and researching specific properties.

If you’re interested in hearing about the Opportunity Zone offerings at CrowdStreet, register for free at crowdstreet.com.