The Tax Cuts and Jobs Act passed in December of last year brought plenty of changes to the nation’s tax code. But it also provided a significant opportunity for investors and low-income communities. That’s because the act also established opportunity zones.
These zones are low-income communities selected by a state’s governor. Governors can choose up to a quarter of the low-income census tracts in their states to become opportunity zones.
The opportunity zone program offers investors financial incentives — deferred and reduced taxes on capital gains — to bring private capital to those low-income areas designated as opportunity zone. The hope is that this new program will bring much-needed capital to communities that have long struggled to attract investors.
So far, governors have identified more than 8,700 opportunity zones across the United States. In response, funds dedicated to helping investors sink their dollars into these opportunity zones have already sprung up across the country. Virtua Partners, for example, launched its Opportunity Zone Fund I in June of this year. Fundrise in August debuted its Fundrise Opportunity Fund LP.
And that’s just two. Interest in these funds has been strong, with many financial pros pointing to opportunity zones as a chance for investors to provide a boost to low-income communities while also making a solid profit.
Midwest Real Estate News recently spoke with Bobby Werhane, assistant vice president with Bellwether Enterprise Real Estate Capital, about Opportunity Zones and what they could mean for commercial real estate investors.
How much interest are you seeing in this program?
Werhane: It’s just like with any federal incentive program. There is a lot of interest. We look at this as the single biggest incentive program since the release of the New Markets Tax Credits program. We were able to forecast and handicap the demand for this program well in advance. We’re not surprised, then, with how well this is being received by investors. This is a completely bipartisan program. We are overwhelmingly happy that multiple different capital partners are taking notice of this program.
We are seeing interest from so many different type of investors. This could bring Main Street investors into communities that have never had access to these funds. So, the demand we’re seeing so far is not surprising to us. But it is a very positive outcome. That is something we are happy to see.
What kind of impact will this have on low-income communities?
Werhane: We believe this will have generational transformative impact for these communities. Only 25 percent of the nation’s low-income census tracts were designated for this program. The exciting thing is that we can extend the program. There is too much money out there to be satisfied with just the 25 percent of communities now designated. We are hopeful that Congress extends this program. We hope that it will eventually designate another round of low-income census tracts. We’d like to see a constant pool of capital flowing into low-income census tracts for years. That is the excitement and promise behind this program.
There does seem to be a lot of excitement surrounding this program.
Werhane: There is a ton of promise. We all know that commercial real estate is one of the building blocks to growing communities. This truly is a field-of-dreams type of project: If you build it, they will come. If we build great commercial real estate structure in these low-income census tracts, new businesses will come. This can help elevate low-income census tracts throughout America, in communities that have never seen this type of action before.
We are talking about workforce housing, communal-based programming and job creation. Communities have always had to cobble these benefits together. With a program like this, you can have the private sector providing the infrastructure that communities need to thrive. That is very exciting.
Is there any concern that areas designated as opportunity zones will see too much gentrification, pushing out long-time residents?
Werhane: That could happen, maybe, in some of the sexier cities, places like Chicago, New York City and Los Angeles. Those communities, though, only make up 6 percent of all the designated low-income census tracts. The overwhelming number, the other 94 percent of these tracts, have never had access to capital. No one ever lends to them. No one invests in their communities. No one moves businesses there. You might see some splashy stories in which there is some profiteering going on in big, sexy cities. But it’s important to note that gentrification is only a problem in a very small percentage of areas. The resounding fact is that this program will allow capital access to communities that have never had the access to this type of capital, long-term, patient capital. The transformative impact that this investing is going to bring will be exciting.
It seems that the 70/30 rule is an important one for opportunity zones. Can you explain this a bit?
Werhane: This means that only 70 percent of the opportunity zone cash that a business receives has to be invested in tangible property in an opportunity zone. This allows fund managers to raise capital, invest that capital into an opportunity zone business, either in equity or in tangible property, and that opportunity zone business is only required to invest 70 percent into a qualified opportunity zone. This means that only 63 cents on every dollar must be invested in a qualified opportunity zone, leaving the balance to be invested elsewhere.
Let’s walk through a case study. Say an opportunity fund has $10 million in cash to deploy. Based on what is known as the substantially all test, that fund is required to invest 90 percent of those funds in a qualified opportunity zone. Of that $10 million, then, the fund is required to invest $9 million into a qualified opportunity zone business. That business is then able to invest only 70 percent of the cash it receives from the fund into tangible property within a qualified opportunity zone business. Only $6.3 million of the initial $10 million needs to be invested in an opportunity zone. The remaining $2.7 million can be invested elsewhere.
Why is the 70/30 rule so important?
Werhane: The opportunity zone program is already focusing on long-term, patient capital, folks who are more worried about long-term wealth generation than in the shorter-term private equity funds that have five- to seven-year cycles. Now the requirements are more flexible. This opens it up to more capital fund managers. This further solidifies the idea that there is going to be more capital available to this program than there are good deals.
Now we are seeing across the industry different ripple effects. Fund managers are starting to take a deeper look and announce that they are going to raise their own capital. There’s another effect: All of the folks who own property or were bequeathed property, inherited property, their ears are starting to perk up a bit.