opportunity zones - newmark · 2020. 10. 12. · opportunity funds are the required investment...

OPPORTUNITY ZONES:

DECEMBER 2018

NAVIGATING A PATH TO INVESTMENT

Introduction

Legislation Timeline

Opportunity Fund Requirements

Real Estate Requirements

Opportunity Fund Business & Equity Interest

Tax Benefits by Investment Term Length

5 to 10+ Years Simplified: Investment Example

Advantages, Challenges, Uncertainties

1031 Exchange and Opportunity Zone Comparison

Historical Investment in Opportunity Zones

Opportunity Zone Buyers & Opportunity Fund Targets

United States Opportunity Zones

Select United States Cities: Opportunity Zone Interactive Maps

New York City: Bronx Opportunity Zone Map

New York City: Queens Opportunity Zone Map

New York City: Brooklyn Opportunity Zone Map

New York City: Staten Island Opportunity Zone Map

Boston Opportunity Zone Map

District of Columbia Opportunity Zone Map

San Francisco Opportunity Zone Map

Los Angeles Opportunity Zone Map

OPPORTUNITY ZONES are likely to serve as a powerful vehicle to defer capital gains, receive tax breaks and ultimately increase after-tax IRR. While aspects of the program remain to be sorted out by the Treasury Department, investor appetite is gaining momentum.

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© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment

Current institutional investors and developers who have raised opportunistic and value-add funds will have a significant advantage—both their experience with ground-up developments, and possible experience in the neighborhoods that have now qualified as Opportunity Zones, make them natural first movers. Large owner-users and long-term holders of commercial real estate also stand to benefit from the tax plan, primarily because the maximum benefit occurs at the 10-year hold mark and their longer investment horizon lessens the impact of changes in Opportunity Zone law or even local events that might negatively impact short-term investment yield.

The advantages are not constrained to the real estate community—any individual or corporation, from a local businessperson to a high net worth individual, with a recent or upcoming capital gain also can benefit by rolling their gains into an Opportunity Fund or Opportunity Fund Business (via equity interest). By qualifying as an Opportunity Zone Business, local businesses such as retail shops or distribution facilities within Opportunity Zones can raise capital by receiving direct investment from Opportunity Funds or by issuing equity interest to various classes of investor.

INTRODUCTION

Prevailing market forces have redirected investments to many of the areas that now qualify as Opportunity Zones—some of the largest and most active foreign and domestic institutional groups are coincidentally the largest current investors in Opportunity Zones, such as Blackstone, Brookfield and Greystar. As the cycle has progressed, investors have grappled with lower returns across all asset classes, from equities in the S&P 500, which have averaged just above 12% annual return over the past three years, to commercial real estate yields, which have compressed in major markets to approximately 4.5% for office properties in markets like San Francisco and Manhattan.

Institutional groups have chased yield into developing submarkets in close proximity to major metros, and also into thriving non-gateway markets. Value-add and opportunistic fund strategies have grown in importance as the supply of core and core-plus product in these developing markets is inherently low. Therefore, for groups already developing product in Opportunity Zones, the legislation will reinforce their existing investment strategy and will almost certainly boost demand, without imposing costs related to strategy development and the identification of product. The lower return environment has also made debt and tax-deferral strategies more important to funds seeking to meet return benchmarks and deliver satisfactory performance to their investors, which could increase adoption of the Opportunity Zone program.

© NEWMARK KNIGHT FRANK | 2018 Opportunity Zones: Navigating a Path to Investment | 1

DECEMBER 2017 Program is released as part of the Tax Cuts and Jobs Act

MARCH 21, 2018 Governors’ deadline to nominate up to 25% of the qualified census tracts in their state as Opportunity Zones

OCTOBER 19, 2018 The Treasury Department released guidance on the initially proposed regulations, including clarification of the 70-30 rule and requirements for the improvement period

JANUARY 10, 2019 Public hearing will be held to discuss proposed regulations and provide further clarification and guidelines

DECEMBER 31, 2026 The date when Opportunity Zone investors must pay the deferred capital gains tax on their invested capital gains

DECEMBER 31, 2028 The Opportunity Zone designation for qualified census tracts expires on this date

LEGISLATION TIMELINE

2017

2018

2026

2028

2019

DECEMBER 31, 2019 Deadline to maximize the deferral benefit on invested capital gains, assuming the investment is held for 7 years (see page 6 for further information)


Must be organized as a corporation or partnership for the purpose of investing in Qualified Opportunity Zone property

LLCs can organize as a Qualified Opportunity Fund as long as they choose to be treated as a partnership or corporation

Individuals and corporations can self-certify through the IRS by filling out Form 8996 with their federal income tax return

Opportunity Funds are the required investment vehicle to invest in Opportunity Zones

Investors have 180 days to invest a capital gain into a Qualified Opportunity Fund that invests in Opportunity Zones

Opportunity Fund investing does not require the use of a qualified intermediary

Qualified Opportunity Zone Property is property that is:• Stock• Partnership Interests• Business Property

Hold at least 63% of their assets in Qualified Opportunity Zone property (applying the 70-30 rule to the original 90-10 requirement)

Lending activity on an Opportunity Zone project does not qualify as an OZ investment

Opportunity Fund investments in real estate are subject to a substantial improvement or original use requirement

There are carveouts for non-qualified businesses, i.e., casinos, golf courses, racetracks, etc., and for financial companies that invest and lend as their core business

OPPORTUNITY FUND REQUIREMENTS


For real estate property to qualify as Opportunity Zone property, the real estate property needs to have been acquired after December 31, 2017, and meet one of the two requirements below:

SUBSTANTIAL IMPROVEMENT A property is substantially improved when capital improvements in the 31-month period following the acquisition exceed the purchase price of the property, land value excluded

Qualifying Example: Property is purchased for $1.0 million with land value of $200,000. Within 31 months, the OZ investor must improve and invest at least $800,000 to qualify as substantially improving the property

ORIGINAL USE This requirement has not been fully clarified by the Treasury Department, and therefore caution is advised for developers attempting to meet it

The Opportunity Fund must prove that it is the first to use a property, during the property’s existence

If interpreted similarly to “empowerment zones,” this rule would also apply to real property that has been vacant for more than one year, that is put to a commercial use by an Opportunity Fund

In the case of unimproved or vacant land, it has been interpreted that the original use provision commences with the development/improvement of the land into a property type (industrial, retail, etc.).

REAL ESTATE REQUIREMENTS


OPPORTUNITY ZONE BUSINESS Substantially all (70%) of tangible assets of the Opportunity Zone Business must be owned or leased in an O Zone and at least 50% of the gross income earned by the business must be from the active conduct of the business in the Opportunity Zone

If the business is newly formed, it doesn’t need to hold Opportunity Zone investments at the time of purchase, as long as it is established and organized as an Opportunity Zone Business

With the exception of various leisure businesses (such as golf courses and gambling facilities), most businesses would qualify and can range from industrial distribution facilities to retail shops

It is unclear whether the Treasury Department will allow technology firms, or other businesses that can conduct business globally from a location in an Opportunity Zone, to qualify

Opportunity Funds may hold interest in an Opportunity Zone Business directly or through a subsidiary partnership or corporation

OPPORTUNITY ZONE EQUITY INTEREST Equity issued by any domestic corporation that is a Qualified Opportunity Zone Business

Capital gains reinvested in Opportunity Zone equity are subject to the same tax benefits as direct investments into Opportunity Zone Property

The issuing corporation (O Zone Business) may not redeem a “significant” amount of its own stock one year before or after it issues its Opportunity Zone equity

The issuing corporation (O Zone Business) may not redeem any equity from an Opportunity Fund, or related party, two years before or after it issues Opportunity Zone equity to that Opportunity Fund

OPPORTUNITY FUND BUSINESS& EQUITY INTEREST


<5 YEARS

7 YEARS

5 YEARS

10 YEARS

Deferred payment of invested capital gains

until the date the Opportunity Fund

investment is sold or exchanged.

Deferred payment of invested capital gains and liability is reduced

by 15%.

Deferred payment of invested capital gains and liability is reduced by 10%.

In addition to deferred payment and 15% reduction in liability of invested capital gains, accrued capital gains generated from the Opportunity fund investment are 100% tax exempt.

TAX BENEFITS BY INVESTMENT TERM LENGTH


5 to10+ YEARS SIMPLIFIED INVESTMENT EXAMPLE

SCENARIO: A CAPITAL GAIN OF $100 REALIZED AND REINVESTED IN 2018

NON-OPPORTUNITY ZONE PROPERTY OPPORTUNITY ZONE PROPERTY

HOLDING PERIOD

TAX LIABILITY

FUNDS AVAILABLE POST-TAX

POST-TAX ANNUAL RATE OF RETURN

TAX LIABILITY

FUNDS AVAILABLE POST-TAX

POST-TAX ANNUAL RATE

OF RETURN

POST-TAX ANNUAL RATE

OF RETURN DIFFERENCE

5 Years $30 $96 -1.12% $29 $104 0.86% 1.97%

7 Years $33 $106 0.99% $32 $118 2.41% 1.42%

10 Years $38 $122 2.58% $20 $159 4.74% 2.16%

*Assumes long-term federal capital gains tax rate of 23.8%, no state income tax, and annual appreciation of 6% for both the O Fund and alternative investment.

$200

$160

$120

$80

$40

$0

Standard Portfolio Investment Excess Returns Offered by an O Fund Investment

5 YEARS 7 YEARS 10 YEARS

SCENARIO: A CAPITAL GAIN OF $100 REALIZED AND REINVESTED IN 2018

$8$12

$37

$96 $106 $122

AFTER-TAX VALUE OF INVESTMENT

Source: NKF Research


Unlike 1031 exchanges, capital gains from any investment (whether it be the sale of a business, or of stock) can be rolled into Opportunity Zones, within 180 days of sale. This opens up real estate investment to individuals and groups far beyond traditional real estate investors.

The inherent difficulty and risk involved with investing in impoverished and low-income neighborhoods; some areas might not be able to recover or appreciate as predictably as more established areas.

If the tax plan is not extended past December 31, 2026, investors could begin paying taxes on the accrued capital gains from the O Zone investment after this date, regardless of hold time. This is referred to as the “phantom” income date and is an inherent tax risk.

Opportunity Zones favor unrenovated class B/C product and raw land/development sites in emerging areas, which might already be targets by opportunistic funds, and even certain value-add focused funds.

Local regulations and permitting varies on a neighborhood basis.Some neighborhoods might be more accommodating to development than others.

Whether the “improvement” period can be extended past the 31-month requirement, due to delays caused by permitting, natural disasters, financing, labor shortages, and all other delays outside of the fund’s control.

The stated goal of Opportunity Zones is to improve and encourage development of qualified communities; if successful, value can be created throughout the community and have a compounding effect on the original investment.

Securing financing, especially for construction loans, could potentially prove difficult, and will be highly dependent on the experience of the Opportunity Fund and their development plan.

Construction and rehabilitation may take much longer than 31 months and may occur in several build phases; Opportunity Funds might need a longer runway to fully develop their O Zone site. However, it is unclear whether the IRS will be accommodating of this reality.

A business currently can lower its tax basis by using depreciation, and still receive benefits of Opportunity Zones.

Finding investors, particularly less sophisticated retail investors, could be a challenge; most of the industry has not caught up with the legislation, and the legislation continues to evolve.

Whether the IRS will continue to allow the depreciation of assets within an Opportunity Zone, which lowers your overall tax basis, in combination with complete accrued capital gains deferral after a 10-year hold period.

ADVANTAGES CHALLENGES UNCERTAINTIES


Like-Kind Property Required Not Required

Property Type Real, tangible property only Can be real or personal property as well as unimproved land, so long as a plan exists to improve the property in an O Zone

Finding the Replacement Property

Replacement property must be identified in 45 days, with limits on numbers of properties

180 days; deferred capital gains do not need to be managed by a qualified intermediary before they are deployed

Amount Invested Both principal and capital gains from the sale

The capital gains from any qualified investment or business sale

Partnership Interests, Stock, or Personal Property

Not allowed Allowed

Recognition of Deferred Gain Upon sale of replacement property unless further deferred in another like-kind exchange

December 31, 2026, or sale of property, whichever occurs first

Income Tax Basis Step Up for Holding Property Five or Seven Years

None 10% if five years before December 31, 2026, 15% if seven years before December 31, 2026

Sale to Related Parties Two-year holding period required Retention of less than 20% interest stake required. If over 20% is retained after sale, owner is considered a related party and the deal does not qualify

Improvement or Use Requirement

None Substantial improvement of the property; if property is owned by an O Zone Business, use is limited to the O Zone where the property is located

Future of Program Program nearly limited to $1 million per taxpayer per year in an early 2016 tax bill that did not pass

Program is guaranteed until December 31, 2026. The Opportunity Zone designation for census tracts is valid until December 31, 2028

1031 EXCHANGE OPPORTUNITY ZONE BUSINESS PROPERTY


• Demand for product has steadily risen in Opportunity Zones, even before the legislation was enacted; the past three years have attracted nearly $150 billion dollars in investment volume nationwide.

HISTORICAL INVESTMENT IN OPPORTUNITY ZONES(Inclusive of activity in areas prior to designation)

Source: NKF Research, Real Capital Analytics

• As yields have compressed in coastal gateway markets, particularly as the current cycle progresses, investors have chased yield into smaller non-gateway markets. This trend has benefitted Opportunity Zones, which are predominantly located in non-gateway metros.

• While the largest markets; such as NYC and Los Angeles, continue to attract the most investment volume, the majority of investment occurs in other non-gateway cities, which have accounted for $34.7 billion dollars, or 67%, of investment volume in the past 12 months.

$47$51$49$49

$38$31$29

$22

$60

$50

$40

$30

$20

$10

$0

$18

2008

$8

2009

$13

2010 2011 2012 2013 2014 2015 2016 2017 2018 YTD

Billi

ons

157.8%2008 vs. 2018

UNITED STATES TOTAL SALES VOLUME | ANNUAL TOTALS


TOP BUYERS

24 Months Opportunity Zones

$3.8 billion $771 million




$930 million $504 million

Blackstone Greystar

Wind Creek Hospitality TH Real Estate

Brookfield Morgan Properties

Fireside Investments DivcoWest

Gaming & Leisure Properties GIC

1 6

3 8

2 7

4 9

5 10

$75 millionViceroy Equities

<$100M

$468 million

PNC Financial Services Group Inc

$250 million

Enterprise Community Partners

$250 millionNormandy

$200 millionRubenstein

$200 millionVirtua Partners

$100M –$499M

$500 millionRXR Realty

$500 millionFundrise

$500 millionEJF Capital

$500 million

Youngwoo & Associates and EquitMultiple

$500 million Caliber

$500 millionBridge Investment Group

$500M–$999M

$3 billion

Skybridge Capital(EJF Capital will act as subadvisor)

$1,000M+

Source: Real Capital Analytics

Source: NKF Research, Bloomberg, WSJ

$100 millionHeritage Equity Partners

SELECT OPPORTUNITY ZONE FUND TARGETS


UNITED STATESOPPORTUNITY ZONE MAPDespite the low-income community requirements for Opportunity Zones, many well-known emerging markets have made the list, from census tracts in Bushwick and Bed-Stuy, Brooklyn to the South End in Boston. As these neighborhoods have already begun to attract the attention of institutional funds and are transitioning into vibrant live-work-play neighborhoods, the location risk for prospective investors is substantially less compared with investments in less well-known areas, further away from urban cores.

This map was produced using reliable private and government sources. This information is provided without representation or warranty.

Source: ESRI

Estimated unrealized capital gains from both American households

and corporations

$6 Trillion 1 Million 18.2% of Total Land Area

in the U.S. that is represented by Opportunity Zones; comprises 5.4% of

major metro land area

Properties across all property types nationwide are thought to be located within Opportunity Zones

Average household income in

Opportunity Zones

$52,694


SELECT UNITED STATES CITIESOPPORTUNITY ZONE MAPS

CLICK ON CITIES FOR EXPANDED VIEW

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Manassas

Lake RidgeWoodbridge

Dale City

St Charles

Centreville

Chantilly

Reston

Leesburg

Frederick

Springfield

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Annandale

McLean

RockvilleAspen Hill

Arlington

AlexandriaBurke

NorthBethesda

Chillum

Wheaton-Glenmont

BethesdaBowie

MontgomeryVillageGermantown

SevernGaithersburg

Columbia

Catonsville

Olney

Woodlawn

Randallstown

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Towson

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Arlington

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Wheaton-Glenmont

BethesdaBowie

MontgomeryVillageGermantown

SevernGaithersburg

Columbia

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Towson

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NEW YORK CITY: BRONXOPPORTUNITY ZONE MAP

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Soundview

Mott Haven

EastConcourse-Concourse

Village

ConcourseMelrose

South-MottHaven North

CastleHill

Hunts Point

UnionportMorrisania-Melrose

Longwood

Highbridge

UniversityHeights-Morris

Heights

FordhamSouth

Middletown-PelhamBay

Belmont

Claremont-Bathgate

VanCortlandt

Park

Baychester

Eastchester

0.75 mi

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Bergen

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LittleNeckBay

LongIslandSound

East River

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New YorkNew York

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West Farms

Tremont

CharlotteGardens

Brother Island

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NEW YORK CITY: QUEENSOPPORTUNITY ZONE MAP

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Maspeth

Elmhurst

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SpringfieldGardens

Corona

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DowntownFlushing

Flushing

College Point

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NEW YORK CITY: BROOKLYNOPPORTUNITY ZONE MAP

Brooklyn Heights

DowntownBrooklyn

SunsetPark

Vinegar Hill

Bay Ridge& Fort

Hamilton

Red Hook

Boerum Hill

Greenwood

Borough ParkSunset Park

Gowanus

ClintonHill

CrownHeights

Prospect Heights

Bedford-Stuyvesant

Gravesend

Bedford-Stuyvesant

Gravesend

ConeyIsland

Coney Island

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Bushwick

Bushwick

EastWilliamsburgFort Greene

Williamsburg

Greenpoint

BrightonBeach

Midwood

Flatbush

ProspectLefferts Gardens

Flatbush

EastFlatbush

BrownsvilleSpringCreek

East New York

Cypress Hills

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Kings

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NEW YORK CITY: STATEN ISLANDOPPORTUNITY ZONE MAP

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Stapleton

PortRichmond

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BOSTONOPPORTUNITY ZONE MAP

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Charlestown

South Boston

South End

JamaicaPlain

ColumbiaPoint

HarborIslands-Long

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Randolph

Quincy Point

DeerIsland

RevereEverert

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Quincy BayHingham Bay

Broad Sound

NahantBay

Boston Harbor

DorchesterBay

AtlanticOcean

Norfolk

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Middlesex

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MaldenMedford

NorthComoridge Somerville

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DISTRICT OF COLUMBIAOPPORTUNITY ZONE MAP

Arlington

Alexandria(City)

Fairfax

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BrightwoodPark

PleasantPlains

SouthwestWaterfront

HillEast

Hillsdale

Barry Farm

Historic Anacostia

Fairlawn

LowerFairfaxVillage

Hillcrest

Greenway

Central NE LincolnHeights

Deanwood

GrantPark

Carver /Langston

Brentwood

Edgewood

Kenilworth

Mayfair

Benning

Takoma Park

CongressHeights

ShepherdParkway

Arl ington

Alexandria(City)

Fairfax

Montgomery

PrinceGeorge's

Potom

acR

iver

§

§

§§

§

§

§

¨

¨

¨¨

¨

¨

¨

¦

¦

¦¦

¦

¦

¦

395

495

295695

95

66

295

Distr ic t ofColumbiaDistr ic t ofColumbia

Maryla

nd

Maryla

nd

Maryla

nd

Maryla

nd

Distr ic t of Columbia

Distr ic t of Columbia

Virg in ia

Virg in ia

1 mi

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SAN FRANCISCOOPPORTUNITY ZONE MAP

SanFrancisco

Bay

Golden Gate

PacificOcean

San MateoSan Mateo

MarinMarin

TreasureIsland

Hunters Point

BayviewExcelsior

MissionTerrace

CrockerAmazon Visitacion

Valley

Bayview

Hunters Point

0.95 mi

San FranciscoSan Francisco

§̈¦80

UV80

§̈¦280

UV280£¤101

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LOS ANGELES OPPORTUNITY ZONE MAP

Pacific Ocean

Pacoima

Sylmar

Canoga Park

Chatsworth Northridge

PanoramaCity Sun

ValleyNorth

Hollywood

NorthHills West

Van NuysResedaCanoga Park

Mount Washington

Elysian ValleyRiverside

HollywoodStudio District Lincoln

HeightsEl Sereno

UniversityHills

Boyle Heights

Boyle Heights

Chinatown

Downtown LosAngeles

RampartVillage

Pico UnionMid City

West AdamsBaldwin Hills University

ParkSoutheast Los

AngelesHydePark

Crenshaw

SouthLos

Angeles

Watts

HarborGateway

South

Wilmington

3.5 mi San Pedro

Long Beach

Norwalk

North Long Beach

Bell Gardens

Bell

NorthwestTorrance

Hawthorne

Central Alameda

Vernon Commerce

Garvey

Compton

InglewoodWestmont

UV118

UV14

UV170

UV134

UV134UV2

UV110

UV710

UV60

UV91

£¤101

§̈¦210

§̈¦10

§̈¦5

§̈¦710

§̈¦110

§̈¦105

§̈¦405

§̈¦10

§̈¦605

£¤101

OrangeOrange

VenturaVentura

Los AngelesLos Angeles

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Newmark Knight Frank has implemented a proprietary database and our tracking methodology has been revised. With this expansion and refinement in our data, there may be adjustments in historical statistics including availability, asking rents, absorption and effective rents.

Newmark Knight Frank Research Reports are also available at www.ngkf.com/research

All information contained in this publication is derived from sources that are deemed to be reliable. However, Newmark Knight Frank (NKF) has not verified any such information, and the same constitutes the statements and representations only of the source thereof, and not of NKF. Any recipient of this publication should independently verify such information and all other information that may be material to any decision that recipient may make in response to this publication, and should consult with professionals of the recipient’s choice with regard to all aspects of that decision, including its legal, financial, and tax aspects and implications.

Any recipient of this publication may not, without the prior written approval of NKF, distribute, disseminate, publish, transmit, copy, broadcast, upload, download, or in any other way reproduce this publication or any of the information it contains.

NEW YORK CITY HEADQUARTERS 125 Park Avenue New York, NY 10017 212.372.2000

Jonathan MazurSenior Managing Director, National Research [email protected]

Alexander (Sandy) PaulSenior Managing Director, National Research [email protected]

Mike WolfsonAssociate Director, Capital Markets Research [email protected]

Daniel LittmanCapital Markets Research Analyst [email protected]

Rich LachowskyResearch [email protected]

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