A new federal program implemented last year is starting to take shape, and it has win-win implications both for the country’s poorest residents as well as commercial real estate investors and developers.
One in six Americans lives in economically distressed communities, according to research from the Economic Innovation Group. Despite the recovery from the recession happening elsewhere, these places struggle to attract capital and sustain economic opportunity for their residents.
Looking to equalize this disparity, last year’s federal tax reform bill created a new investment vehicle intended to encourage spending in distressed communities. Qualified Opportunity Zones are pre-selected areas around the country where investors can receive preferential tax treatment while long-beleaguered residents can benefit from an influx of funding.
“I don’t think there is another program that has the possibility of bringing these large amounts of equity into low income communities where in the past they’ve been seen as a risk, in particular on dollar-for-dollar returns,” said Charlton Hamer, senior vice president, Habitat Affordable Group at The Habitat Company.
The money can be put toward a business venture or a real estate investment. But either way, the end result is that impoverished communities will soon see economic revitalization that should result in new and refurbished real estate developments.
“From what I know of the program, and my experience over the years in dealing with community development and affordable housing development, I think this is a seminal policy that will provide changes to economically distressed areas,” Hamer said.
Opportunity Zone investors can defer federal taxes on any recent capital gains until December 31, 2026 so long as the gain is reinvested in a Qualified Opportunity Fund, an investment vehicle organized to make investments in Qualified Opportunity Zones. There is no cap on the amount of money that can be invested in Qualified Opportunity Funds, but at least 90 percent of fund assets are required to be invested in Opportunity Zones.
Long-term participation in the program is incentivized. Those who hold on to their investment in an Opportunity Zone for five years can avoid a 10 percent of capital gains taxes; holding the investment for two more years get another 5 percent step up.
“But if you hold for 10 years, not only do you get that 15 percent, but any appreciation after you invested is also free from tax,” said Darryl Jacobs, member at Ginsberg Jacobs. “I think you need to make a judgement, but the numbers are hopefully enough to juice it that you’ll forego an early return.”
A quarter of a state’s qualifying low-income census tracts can be enrolled in the Opportunity Zone program and in April, the state of Illinois submitted 327 tracts to the federal government for inclusion. The methodology for selecting the final Opportunity Zones took into account need-based indexing (poverty and unemployment rates, violent crime and other factors) and equitable distribution across the state.
Local government and community groups were also given the chance to weigh in with specific recommendations. Illinois Governor Bruce Rauner’s office worked with groups and municipalities across the state to decide on which tracts would be submitted, and they had to do so quickly as the states only had 90 days to submit their information.
“If it would have gone on longer, if more people would have known about the program, there would have been a great deal of politicking,” Hamer said.
To qualify, at least 20 percent of the residents within a tract must fall below the poverty rate and the area median income cannot eclipse 80 percent. There is one loophole, as census tracts that don’t meet that criteria but are adjacent to one that does may be designated as an Opportunity Zone as well, though they can’t eclipse 125 percent area median income.
Though the finer points of the program are still hazy, savvy investors are already looking to take advantage. Last summer, the Chicago Housing Authority tapped a joint venture between The Habitat Company, Sinai Health System and Cinespace Film Studios to redevelop the former Ogden Courts East site in the city’s Douglas Park neighborhood. Plans are already underway for the mixed-use and mixed income project, but as the area is within an Opportunity Zone, the team will explore the new program.
“We’re already looking at new market tax credits for the commercial development and we are looking at utilizing funds from a Qualified Opportunity Fund, which we are looking to establish,” Hamer said.
Located at the 2700 block of W. Ogden Avenue, the first phase will include 384 residential units (affordable and market-rate), office, hotel and retail space within seven buildings as tall as five stories. Construction is slated to begin later this year.
Jacobs, too, has already been advising his clients to see if they can benefit from the program. This early on, that means looking at projects that are already underway in eligible areas.
“There may already be an Opportunity Zone where some of our clients are doing deals,” Jacobs said. “They’re out there raising money and this may be a way for them to raise money at a cheaper return or help them plug the financing gap to get their project started.”
All of the details of the program have yet to be disclosed, such as how to report gains of if there will be a special tax return. The U.S. Treasury Department and the IRS plan to issue additional information on Qualified Opportunity Funds sometime this year.