I am for Opportunity Zones (OZ). OZs are designated geographic communities where certain investments are eligible for preferential tax treatment. They were designed to encourage economic growth in distressed communities. I am in favor of tax-advantaged investments, and I am usually in favor of anything designed to free up additional investment – particularly for areas where investment has lagged.
I cannot open Linkedin or an email without somebody touting their new “$500 million Opportunity Zone Fund”. I’m not sure, but I think my mom is launching one next quarter. I feel compelled to express what I believe is actually going to happen.
New real estate developments will clearly benefit. Provided the underlying real estate deal is sound – meaning there is actual demand for what is being built – it should give investors a very attractive tax break at the end of their hold period.
Unfortunately, I believe Opportunity Zones largely will not lead to a boom of affordable housing for two reasons.
- OZs do nothing to drive down the cost of construction. So, if you are going to develop a new project today, you’re going to pay today’s market prices. A seasoned, reliable multifamily developer I know here in the Northeast cites the cost to construct at $250 per square foot, or more, depending on location and product type. This is not affordable and will likely lead to further gentrification of urban areas.
- There is a high investment requirement of Opportunity Zone Funds when rehabbing or repositioning existing properties. The requirement is that investors must invest an additional 100% of the basis of the improved property. For example, if a developer bought an existing multifamily property for $100,000/unit and the land was worth $25,000/unit, it would leave the improved property value to be $75,000/unit. OZ Funds require the investors to invest another $75,000/unit to qualify. So now the total basis in the property is $175,000/unit (assuming you can actually find a way to spend $75,000/unit in improvements). Is that affordable? For me, this is the biggest miss of the Opportunity Zone Fund investment requirements. Doubling the improvement investment is too high and unnecessary.
The undersold story of Opportunity Zones is what they can do for businesses located in those zones. OZ Funds could provide a new source of investment for enterprises. Pay particular attention to some of the nuances around the distinction between ‘tangible’ and ‘intangible’ property. Remember, the entire Opportunity Zone Fund idea is not from the Red or Blue team – but a group of tech moguls. Intellectual property is intangible property. And there are no requirements governing intangible property for Opportunity Zone Fund investments.