United States

The power of relationships when investing in opportunity zones

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Last month, the IRS released a set of long-awaited regulations on opportunity zones. The document provided further clarification and insight into navigating the opportunity zone program, which allows investors, developers and business owners to invest in a historically distressed neighborhood, or designated opportunity zone, in exchange for a significant tax break.

However, the newest regulations fail to address the social and political challenges developers and investors could face throughout the process. One of the largest criticisms of opportunity zones is that they may be benefiting investors and developers more than the communities themselves. Many expect this sentiment will cause friction between local municipalities, zoning boards, city planners and developers. But if done correctly, opportunity zones could be mutually beneficial for both commercial real estate professionals and the communities they decide to invest in.

A Bipartisan Issue

While the opportunity zone legislation was introduced as a provision to the Tax Cuts and Jobs Act, introduced by GOP lawmakers, the concept of opportunity zones was born out of bipartisan public policy think-tank Economic Innovation Group. Joint party support for this legislation could increase the likelihood that it will see successful implementation. Politicians and government officials have begun working together in support of opportunity zones, regardless of party affiliation.

“The fact that there is bipartisan support for opportunity zones makes it more likely to outlive tax reform and administrative changes,” RSM partner Troy Merkel said. “There is a good opportunity for this to help drive investment and continue to be a tool for development in the future.”

Merkel, who has spent much of the past few months advising commercial real estate clients on the impact opportunity zones could have on future investment, said the legislation could eventually replace existing tax credits for developers and investors.

“This could dramatically impact the new market and historic tax credit, and potentially the low-income housing tax credits,” he said. “There is a good chance that this is the future of new markets tax credit. Many of my clients are saying this benefit of opportunity zones is so great, they are willing to even walk away from what the historic or new market tax credit equity would have been.”

The success of opportunity zones will not come overnight. Investors and developers hoping to get their money’s worth will also need to invest in building relationships.

Leveraging state and local government

One of the easiest ways for investors and developers to be successful is to start collaborating with state and local officials. Navigating these relationships will help them get their tax benefits, while also looking out for the community and the people who will be affected.

“We know that governors are on board with these opportunity zones because they are the ones who actually designated these communities, but we’re also seeing a lot of local communities that are absolutely on board with using this as a means for redevelopment,” RSM partner Craig Mason said. “In fact, some of these municipalities are also hiring people to help developers with opportunity zones and guide them through the process.”

There is also an opportunity for investors and developers to pair state and local incentives with the benefits they get from investing in designated opportunity zones. Those who do their research will find that many opportunity zones align with state-specific tax abatements or grant programs. For example, some tax abatements can impact tax flow, and developers can leverage capital gains from opportunity zones to help with grant funding or priority loans.

Once developers can successfully navigate these relationships and begin to develop in a given community, it will start to fuel increased investment activity.

“You’re going to see a domino effect, where some properties that were on the fringe of being redeveloped are now seeing more interest from investors,” Mason said. “There are places that may not have been redeveloped for, say, six or seven years, and now people are looking at them because of the potential returns.”

Forging community connection

In addition to working alongside community leaders and officials, developers need to consider the citizens themselves. There is a level of friction that can come with the decision to develop in opportunity zones, most of which are low-income areas. Many of the people in these communities have been there for years, if not their entire lives. It is important for investors and developers to work with members of these communities, not against them.

“I think there is the concern about gentrification of neighborhoods and what this investment will do to those neighborhoods,” Merkel said. “That is something that’s always a concern as neighborhoods are transitioning. Most of these developers are looking to be in communities for ten years, so if you’re looking to be in those communities for an entire decade, it's critical that you form strong relationships with the people there.”

This article was originally published November 15, 2018 in Bisnow.

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