By Meghan Hall
Opportunity Zones made a splash several years ago with the passing of the 2017 Tax Cuts and Jobs Act, with many investors and commercial real estate experts keen on investigating just how beneficial the program could be. The program, which provides tax breaks to investors that place capital gains into qualified funds, in an effort to lift and stimulate low-income areas around the country. As COVID-19’s economic impact has become clearer, questions have arisen as to new expectations for opportunity zones, and whether investors will still deploy their funds in the near future. According to two Bay Area experts, despite gray skies, it has been mostly business as usual for those in the OZ fund industry.
“Like anybody, [investors] are cautious on underwriting, because there have been a number of questions that have come up with everything else, but throughout this pandemic, I have had active dialogue with opportunity zone groups and opportunity zone deals that we are out trying to find equity for,” said Jordan Angel, managing director of JLL’s San Francisco office. “They are cautious, but they are still looking to invest. Many of them have committed capital raised, and while they might have a little more time to invest it, they are still actively looking to put that money out.”
The opportunity zone program allows U.S. investors to defer capital gains so long as they invest profits into a qualified opportunity zone, enabling them to defer paying taxes on such gains through December of 2026. Taxes owed on capital gains decrease by 10 percent if the investment is held at least five years; investors will be exempt from any tax if the investment is held for ten years. More than $10 billion in opportunity zone funds has been raised as of mid-March, according to the Novogradac Opportunity Zone Funds List, although that number may be much higher as the list does not reference proprietary or private funds.
Typically, investors looking to deploy capital have 180 days from the date of their sale to invest capital gains into a qualified OZ fund to get the desired tax benefits. For those who closed on sales in the fall of 2019, the deadline to invest was approaching as COVID-19 was reaching its peak and impacting how both investors and banks view investment. However, the IRS extended the deadline to invest if their deadline originally occurred between April 1 and July 15th of 2020, and has been welcomed
“It’s great to give investors some additional time to invest. It also mirrors the 1031 exchange extension,” explained Erik Hayden, founder of Urban Catalyst. “This is really important because investors that sold a property after October 4, 2019 and are having a problem with their 1031 exchange because banks are becoming so conservative, now have until July 15, 2020 to invest in an Opportunity Zone Fund.”
The federal government also declared California a Disaster Area, allowing opportunity zone funds an additional 24 months—on top of the 31-month standard—to deploy funds in an effort to continue infrastructure, development and redevelopment projects.
The extensions are important in that it provides those with capital more opportunity to make decisions regarding their investments and to weigh the market.
“The more deferred capital gains that are eligible to be invested in opportunity zone funds, the more supply of capital there is to be invested and the more deals should get done,” said Angel. “It is helpful. There may be some gains that were realized as people were selling as we were going into the stock market dip, and there may be some gains that are no longer gains because they have lost value.”
According to Hayden, Urban Catalyst is moving forward full steam ahead with its projects, which are focused in San Jose. The Silicon Valley opportunity zone fund is moving toward breaking ground on a multitude of projects, including the Fountain Alley Building, which will include 67,000 square feet of office and an additional 19,500 square feet of retail, and The Icon, a 348-unit multifamily apartment complex.
“Because Urban Catalyst is so well capitalized, we are in a position to take advantage of this distressed market,” said Hayden. “Historically, construction costs go down during a recession [because of] supply and demand. With roughly $600 million in hard construction costs as a part of our seven-project portfolio, even a 10 percent reduction is a $60 million savings to our investors. Since the beginning of the pandemic, the City of San Jose has remained open for business and working remotely. That has allowed us to hit all of our milestones as we get closer to breaking ground on all of our projects.”
Others are also making progress on opportunity zone funds. Riaz Capital has raised nearly $100 million for new housing developments in Oakland-area opportunity zones. This spring, Marwood Development Company pitched its plans for a 2.72-acre parcel near Diridon Station in San Jose. The pre-application indicates that the property could be redeveloped into either two residential or two office towers.
Looking ahead, said Angel, opportunity zone funds will still be a useful tool in investors’ arsenals. And, as more information comes to light as to how COVID-19 has impacted the commercial real estate industry, investors will make more concrete decisions on how to move ahead.
“I would say there will continue to be capital focused on the OZ space because it is a tax efficient vehicle,” said Angel. “Investors are going to make good investments with that capital, and there’s just an element of figuring out how to put the deal structures together.”