By: Katie Tang
The final panel of ULI New York’s Real Estate Outlook 2019 conference was titled How will Opportunity Zones Impact Land Use and Development? The panel was led by moderator Miriam Harris, Executive Vice President at Trinity Place Holdings, and included Eric Clement, Senior Vice President of the NYC Economic Development Corporation, Rachel Diller, Managing Partner at UrbanView Capital, Seth Pinsky, Executive Director at RXR Realty and Aaron Yowell, Partners & Chief Innovation Officer at Nixon Peabody, LLP.
Laying the foundation for the conversation – Seth Pinsky stated, “what the opportunity fund is today is different from what it will be in a year, two, or three years” as more people are continuing to better understand how to put in place a more efficient structure. Currently, the benefits of the Opportunity Zone program can be placed into three buckets: (1) tax deferral (2) partial forgiveness of capital gains tax and (3) permanent exclusion from taxable capital gains if an investment is held for at least 10 years in an Opportunity Fund. These incentives are attracting more family offices, ultra-high net-worth, in general, very wealthy tax-paying investors, bringing a whole new set of investors to the table due to taxability and tenure nature (longer term holders).
Time is of the essence for investors to take part in tax benefits. Anxious to get into the market to maximize benefits, there is increased competition to find a project that checks all the boxes when complying with Opportunity Funds as well as producing an attractive financial return. As Opportunity Funds have a relatively limited period to make improvements to comply with the rules, the traditional fund model where you identify assets with certain parameters over a period of time will not work. Specifically, these Opportunity Funds need to have identified and primed assets ready to go. Since a lot of qualified Opportunity Zone projects include ground-up development, these assets will need entitlement in place, construction drawings finalized, and financing (other than the equity) lined up. With these requirements, Opportunity Zones/Funds will most likely benefit long-time sophisticated players who have been active in markets that turned into Opportunity Zones unexpectedly.
Taking a step back, there are a couple of other challenges surrounding a typical economically crossed real estate fund. Beside deploying capital, the disposition of the asset is also an issue. The current real estate fund structures are tax heavy in terms of driving the disposition of the asset. Taxes are inevitably a key part in a real estate investment, but to have “tax wag the dog does not feel right.” Lastly, you also only get the Opportunity Fund benefits if you dispose of interests in the fund – which may turn the typical real estate fund on its head. There are a number of challenges the industry still needs to overcome before being able to truly realize the benefits of the program. The IRS is expected to provide much needed guidance on the program, though the government shutdown has delayed progress.