After interviews, conferences, and countless talks with investors, lawyers, CPAs, government officials, community advocates, and my poor family (who must listen to me rant), I’ve come to the conclusion that we are still missing the point of the Country’s relatively new Opportunity Zone Investment law.
- Dormant capital is useless, and it doesn’t have to be.
A family owns a real estate asset they’ve held for 30 years that they bought for $1,000,000 and is now worth $10,000,000. Today, the economy is effectively being stimulated by the $1,000,000 of capital invested in the asset and the $9,000,000 in additional value lies dormant.
If given no other choice, the head of the family will pass on and receive a “step-up” in their tax basis and their kids will continue to own the asset or may eventually sell it without re-investing, as they may use the funds to enhance their lifestyle (vs their parent, a builder, who may re-invest).
The Opportunity Zone law provides a tax incentive to sell the asset now, capture the full $10,000,000, and re-invest today. Not only that, the re-investment occurs in areas of the Country that need economic development. Activating dormant capital is a clear win that many experts in Opportunity Zone investing have overlooked.
I’d prefer to have $10,000,000 in capital enhancing our communities than $1,000,000 in capital enhancing a single family’s lifestyle — better yet, I’d like to have both!
2. Opportunity zones are often industrial and commercial areas.
There is significant fear, and sometimes well-founded fear, that investing in opportunity zones is going to hurt disadvantaged populations by reducing their access to housing — think bulldozing historic neighborhoods in favor of hipster apartment communities.
While this can occur, and local governments and community advocates do need to defend against it, there are simple solutions in the form of zoning and permitting that can block against unwanted development.
In reality, there are large census tracts in industrial, commercial, rural, and similar areas that pose very little risk to these disadvantaged populations. The conversation in our Country has quickly turned to a fear of gentrification while millions of square feet of empty commercial and industrial buildings are waiting for capital to transform them.
Focus on what actually exists in each census tract and get specific on the needs of the community. You will often find that Opportunity Zone investing is revitalizing areas that desperately want the capital, not hurting communities who do not.
3. There are little to no tax benefits if the real estate doesn’t gain value over 10 years.
Many of the early participants in opportunity zone investing have come from the real estate tax credit industry. This industry runs on the strategy of finding projects that are typically not profitable without tax credits and are then made profitable because of the tax incentive.
The opportunity zone tax law offers three distinct tax benefits, with the third benefit expected to comprise two-thirds, or more, of the tax savings. That benefit is an elimination of future tax liability on the gain in value of an opportunity zone investment, after a 10 year holding period.
Because of this benefit, fund managers and investors in the opportunity zone investment world need to look for projects that can gain in value over 10 years and the more value, the better.
4. Diversification is your defense.
The allure of control and simplicity has caused many early investors to choose to create and manage their own opportunity zone funds or invest in a single asset or single business investment.
When you make a 1 year bet — you can go on offense. When you make a 10 year bet — you need to build a great defense. Very few people, if any, could have predicted in 2009 that 2019 would bring a Trump white house, a stock market reaching all time highs, and 3.7% unemployment.
Similarly, very few of us will know if, in 2029, an investment in an office building, a hospital, or a hotel will or will not be successful.
The key is to make many small bets, in growing markets, to spread the risk of asset types, local market changes, and other business drivers.
5. It’s the people, not the program.
It’s not the program, the regulations, zones themselves, the hype, or the tax law that will make opportunity zone investing successful for the stakeholders who are cheering it on — it’s the people.
It’s the investors who choose to make 10+ year bets on transforming our communities that need economic development.
It’s the fund managers who take the risk of building new funds and investing in educating the country on why this form of investing is superior to others.
It’s the developers who take significant personal and financial risk to envision what could be, instead of what is, and pay for the plans and the start-up costs to make it so.
It’s the community advocates who care about what happens in each zone and take the time to make their voices heard and teach the opportunity zone parties.
It’s the local, state and federal governments who are clearing the way for economic development and helping developers find what opportunity zone projects are needed in each area.
And it’s the American people, who will find that the incentive we created to activate dormant capital and put it into the hands of our Nation’s innovators will transform our communities for the better.