The Land of OZ

9 min read

Many Conferences, Few Answers 

WHO? Anyone with significant capital gains.

WHAT? A way to protect those gains from taxation.

WHEN? Soon, if you want to take full advantage of the benefits.

WHERE? Opportunity Zones designated by state governors.

WHY? To bring jobs, commerce and development into blighted or economically disadvantaged communities.

HOW? Ah, that’s where it gets complicated.

The interest, curiosity and enthusiasm surrounding Opportunity Zones has been dramatic since the program was announced as part of the Tax Cuts and Jobs Act of 2017, and forums bringing potential players together have proliferated around the country. But as attendees at a high level conference in Washington, DC on March 20, entitled “Venturing Into the Land of OZ” learned, the Yellow Brick Road may be a long and winding one, and travelers along that road can easily stumble over the bricks that are not yet firmly set in place.

“This is still a waiting game,” said Wesley Hudson, by way of introduction. Hudson is a partner and the national leader of Opportunity Zone Services at Cherry Bekaert LLP, the national CPA firm. Cherry Bekaert cosponsored the event with the JLL real estate firm and the Miles & Stockbridge law firm.

“It’s like Wild West at this point,” Cherry Bekaert partner Ron Wainwright commented.

There are three tax incentives for OZone investors, Cherry Bekaert director Michael Elliott explained in the first panel: temporary deferral of capital gains taxes; permanent reduction after five and seven years; and no gain recognized for tax purposes after ten years and the ability to write the asset basis up to the current fair market value. “I don’t know any other incentive like it in tax law,” he observed.

“This program can be transformational,” said Jill Homan, president of DC-based Javelin 19 Investments, LLC, in the concluding panel.

And the program is already having a positive effect. There has been a 25 percent average increase in values in OZones in the past two years, compared to nine percent in comparable areas that haven’t been designated as OZones.

On the other hand, one response that kept cropping up throughout the panels essentially amounted to: At this point, we just don’t know. The reason this is such a challenge is that Opportunity Zone is a severely time-limited program, so if potential investors don’t get in soon, it may be too late to take advantage of the most important benefits, particularly the ten-year threshold. In fact, as Miles & Stockbridge principal Jerome Breed said, “Treasury will tell you this is a statute, not a program. If we’re going to turn this into a real program, governors must be allowed to redesignate tracts, there must be an ability to assess the program, and the 2026 [end] date would have to be rolled over. This would be a substantial rewrite that would require political action.”

There is also no current IRS guidance on how to treat interim gains, and no real certainty about whether an initial investment can be rolled over before the time necessary to protect the original capital gains.

A U.S. Tax Court judge Tax Credit Advisor consulted confirmed that it is not unusual for legislation to go into effect before the regulatory specifics are in place, leaving room for both professional interpretation and investor uncertainty in the meantime.

The Greatest Uncertainty
Perhaps the greatest uncertainty is the definition of a qualifying trade or business. It seems that the most significant determinant may be where the employees are physically located – a similar criterion to that used for New Markets Tax Credit investments. “There are things Congress could do to provide certainty,” commented Corenia Riley Burlingame, counsel at Miles & Stockbridge.

Homan worries, “Are only dry cleaners and cupcake stores going to qualify in the strictest interpretation of in-zone?”

As a result, more OZone investments are being made in real estate assets, as opposed to businesses. For one thing, it is easier to buy or invest in a hard asset, like a building, than it is to begin a new business. For another, there isn’t going to be nearly as much question about whether it is a qualifying asset. If more certainty could be provided, more capital would be brought into OZones,” said Richard “Rick” Schneider, another Cherry Bekaert partner.

“The real estate piece is the easy piece,” said Wainwright. “Six billion dollars in capital gains is sitting in family offices and with other [potential] investors. But everyone is working in silos right now.” And the “burning question in everyone’s mind,” according to Wainwright, is what the “exit strategy” for these investments should be. “We’re still looking for guidance, particularly for multi- asset funds. At the hearings, there were more questions than answers.”

Wainwright also warned that because of the fixed end date, OZone investment fund opportunities are likely to devalue over time.

Breed added that one of the greatest challenges is for potential investors with significant capital gains, but who don’t know much about real estate or whom to rely on for expertise, to get into an OZone Fund in a timely manner.

What to invest in?
What all potential OZone participants want to know, of course, is where, and in what, to consider investing. As Emeka Moneme, senior vice president and managing director of MG Capital of DC’s Menkiti Group noted in the second panel, “Not all qualified Opportunity Zones are equal.” He went on to explain, “The program is about bringing commerce into these [designated] communities, so neighborhoods matter. We look to long-term, holistic commitment. Given the ten-year timeframe, that’s a great runway to make this happen.”

He cited the Martin Luther King Gateway project in Washington’s Anacostia neighborhood, for which the DC government selected Menkiti in December 2016. The public-private partnership encompasses 50,000 square feet of adaptive reuse, comprising offices and retail, and a cybersecurity company as the anchor tenant. Keller Williams Capital Properties will operate a real estate training academy at the site. It is anticipated that the street-level retail may feature a fresh foods market, a coffee concept, a full-service restaurant and a local bank. Moneme projects the creation of 250-plus jobs. Groundbreaking is scheduled for this summer. “We think this is very much a poster child for the kinds of programs we should be doing, with local job training and a workforce development component.”

Michael Tillman, CEO of PTM Partners, LLC of Miami, FL, is currently developing Soleste Grand Central, a 360-unit “ground-up, transit-oriented multifamily development” in the Overtown section of downtown Miami that will have 11 percent affordable housing. “We evaluate these deals as if they are not in OZones: Does the deal make sense on its own? Some zones are well-situated, some not. We look at the inherent characteristics of the area: Do the local stakeholders have pride [in the neighborhood]? Overtown had been a blighted area, but it is close to big time development, like Brightline train service and Miami Worldcenter. This is transformational, bridging the gap between Overtown and downtown Miami and will give residents the opportunity to step up in housing because of the small size of the units.”  Echoing Homan, “transformational” is a term one hears a lot at OZone conferences. Tillman added that the proximity of transportation was a crucial factor since many, if not most, residents don’t have cars.

Going into OZones near established institutions, like universities, hospitals, large retail centers and military bases, is a recurring theme. The logic is that these institutions draw in capital investment and are not going anywhere, so they anchor and assure the viability of the new project. This is also true if large commercial developments are already underway nearby.

Breed mentioned another factor in choosing areas to focus on, given the rapidly ticking OZone investment clock. “Local governments can help by speeding up zoning and permitting. This is important for the investor, and for the municipality, it is easier than starting up another subsidy mechanism.”

Billy Huger, managing director of Atlanta’s Monarch Private Capital Advisors, also scrutinizes each potential investment. “We use the same analysis as market-rate projects, and we’re trying to partner with groups we’ve partnered with before as the financing arm. We’re not trying to be pioneers in markets we haven’t been in or with partners we don’t know. We use experienced developers in ways that have worked for us before.”

He also finds it simpler and more efficient to establish single-asset funds rather than multi-asset funds. And Moneme points out that many projects, particularly large ones, will need distinct OZone funds and none-zone funds to be able to meet the specific needs of a range of investors.

There remains a large field of “weeds” for the experts to be in, including the 90 percent utilization test, original use vs. substantial improvement requirements, rules for existing businesses operating in OZones, ultimate exit strategies, capital rollover, allocation of future capital gains, challenges in layering OZone investments with New Market Tax Credits, treatment of interim gains, ground leases outside the funds and many others. And as Homan notes, there are significant constraints on all actors, from investors to fund managers, to land owners, to developers, to business operators. But as the interest generated by conferences like this one show, the opportunities for investors and designated neighborhoods seem to be well worth both the uncertainties and the risks.

Story Contacts:
Jerome Breed,
Corenia Riley Burlingame,
Michael Elliot,
Jill Homan,
Billy Huger,
Wes Hudson,
Emeka Moneme,
Richard Schneider,
Michael Tillman,
Ron Wainwright,