Introduced as part of the $1.5 billion Tax Cuts and Jobs Act, the opportunity zone program is designed to encourage development in the 8,700 areas of the country designated as opportunity zones. There’s been an incredible amount of interest in the program from investors hungry for the tax incentives, but it’s important to consider a wide range of factors before diving headfirst into the opportunity zone pool.
In many ways, opportunity zone investments are like 1031 exchanges with additional tax incentives that allow for the deferral and elimination of taxes (up to 15% on the contributed gain and up to 100% of the gain on the new investment) rather than simply the deferral of taxes until a sale. Unlike 1031 exchanges, any capital asset can be invested, and investors only have to contribute their capital gain. However, there are geographic and improvement requirements.
The biggest risk of the opportunity zone legislation is that investors will abandon the fundamentals of real estate in pursuit of the tax incentives offered by the program. Supply, location and a strong understanding of the renter demographic are far more important than tax advantages when evaluating a deal.
The two opportunity zone deals Cityview currently controls are located in areas we would invest in regardless of whether they were in designated opportunity zones because they fit within our investment parameters. Robust demographic, job and income growth, a highly educated workforce and lack of supply all guided our decision to pursue these West Coast projects, with the tax incentives being an added bonus. This will continue to be our strategy, the only difference being that the opportunity zone legislation allows us to offer tax advantageous opportunities to a new class of capital: family office and retail investors.
Investors should seek out locations that are solid in an upmarket, but also resilient when the economy isn’t as strong. This is especially important given the minimum 10-year investment horizon for opportunity zone investments. For multifamily, we feel this means urban locations with strong job growth, access to transportation and vibrant culture.
The 10-year minimum investment also emphasizes how critical it is to partner with an experienced sponsor you are comfortable doing business with for the next decade or more. A deal can look promising on paper, but if you don’t have a strong partner with experience and integrity it’s not going to be a good long-term investment. With the level of complexity involved in opportunity zones, investors should also seek out an attorney and accountant who are intimately familiar with the intricacies of the program.
Solid real estate coupled with a trusted partner are the fundamentals of a good opportunity zone deal. The tax breaks are an added benefit that create additional incentives for taxpaying institutional, retail and family office investors, while helping to bring much-needing housing to communities nationwide.
Sean Burton is CEO of Cityview, a Los Angeles-based multifamily investment management and development firm dedicated to redefining urban living that has generated more than $4 billion in urban investment across more than 100 projects to date.