Opportunity zones have received a lot of attention in the press and in the investment community recently.
But investors would be wise to approach these opportunities with considerable caution, and they may find private funds that invest in traditional institutional-grade real estate properties sometimes are a more suitable option for their dollars.
Those were two of the major points made during "Frequently Asked Questions on Private Real Estate vs. Qualified Opportunity Zones," an educational session at the American Institute of CPAs' (AICPA) ENGAGE 2019 conference in Las Vegas in June. Steve Meyer, JVM's Chief Investment Officer, and Maureen Reichert, a partner in Rubin Brown's Real Estate Services Group, were the speakers.
To spur long-term private investment in economically distressed communities, the federal Tax Cuts and Jobs Act of 2017 created the opportunity zone program. Nearly 9,000 areas – scattered across all 50 states, the District of Columbia and five U.S. territories – have now been designated as opportunity zones.
The program allows investors to reinvest capital gains into the creation or expansion of businesses and into the development or renovation of real estate located in opportunity zones. In return, the investors receive tax deferral and other tax benefits.
However, adhering to all of the rules and regulations to receive those benefits can be tricky, Reichert told the audience. "There is a lot of nuance to this new law – a lot of i's to dot, t's to cross that can trip people up," she said.
Additionally, if investors are looking for more than tax benefits, real estate investments in opportunity zones may be found wanting when compared to traditional private real estate funds, Meyer added.
He noted that new or renovated real estate developments in opportunity zones likely face substantial risk and may produce negative returns. Additionally, because of the lengthy zoning, entitlement, construction and lease-up processes, qualified opportunity funds that invest in these properties may not be able to offer investors cash flow for several years at least.
By contrast, established private real estate funds can offer immediate cash flows and have been known to provide internal rates of return in the low teens over the life of an investment, Meyer said.
At one point, Meyer walked the audience through a scenario in which two investors each has $100,000 in capital gains to invest. Because of the tax deferral component of opportunity zones, one investor is able to put all of her capital gain into a qualified opportunity fund while the other has to pay nearly $24,000 in taxes before investing $76,000 in a private real estate fund.
At the end of four years, though, because of the difference in cash flows, the opportunity zone investment is worth only $92,000, while the private real estate fund investment has risen in worth to nearly $95,000.
"If you're generating after-fee positive cash flows, by this four-year timeframe you're either even or you're actually ahead with direct private real estate, and you're not following all of these different rules," Meyer noted. "It's just something to think about."