Real estate attorney Roman Petra had a feeling that President Trump’s affinity for property might translate into benefits for investors when his administration proposed sweeping tax reform legislation.
So when the Tax Cuts and Jobs Act of 2017 was signed into law, the Nelson Mullins Broad and Cassel attorney dug in.
Among the potential benefits to investors and real estate developers Petra found was a sometimes opaque opportunity in property tied to low-income U.S. Census tracts, which allowed investors to defer or even eliminate capital gains.
“Our practice is driven in part by helping clients seeking incentives and tax credits, including low-income housing tax credits, so we had some familiarity with the concept,” says Petra.
“And we had a feeling that the tax law of 2017 might provide new programs for real estate, because of the president’s real estate background,” he adds.
In the months since they were first created in April 2018, the administration’s Qualified Opportunity Zone designations have become the new darling of the commercial real estate industry, based on a theory that investors would be willing to put capital to work if they could defer or avoid writing a check for capital gains taxes.
Though many of the rules governing the zones remain murky, investors have flocked to capitalize on the potential for tax benefits that are similar to 1031 exchanges or previous iterations of low-income housing tax credits.
Today, it’s not uncommon for major investment groups to tout $500 million or even $1 billion Opportunity Zone funds to develop — despite some noteworthy catches — property in the more than 8,700 such zones nationwide.
By some estimates, roughly $6 trillion — yes, with a “T” — worth of capital is being bundled in anticipation of being deployed in a fund targeting Opportunity Zone properties.
Florida, by comparison, has 427 such Opportunity Zones, some of which appear oddly designated and out of step with the goal of improving low-income areas.
In Sarasota, for instance, one Opportunity Zone touches the city’s Bayfront. Another includes property on downtown’s Main Street.
Tampa has Opportunity Zone land downtown as well, and in Ybor City and near the David A. Straz Jr. Center for the Performing Arts.
Similar zones are found along the Interstate 4 corridor between Tampa and Orlando, which has been a hotbed for logistics firms and distributors in recent years, and in Gibsonton.
Petra’s client Thomas Ablum, founder of Chicago-based investment firm Ablum, Brown & Co. and a transplant to St. Petersburg, became intrigued after examining the tax implications with his accounting firm, Plante Moran, and seeing where many of the zones were located.
“Many of these zones are in deeply rural areas, areas that really are in need of redevelopment,” Ablum says. “But many already have significant population, and that immediately peaked our interest.”
So much so that Ablum and three partners last year formed the Capital Gains Opportunity Funds to invest $250 million in equity into Opportunity Zones before the end of 2020.
“A bad deal doesn’t become good because it’s in an Opportunity Zone. You still have to make good deals.” — Thomas Ablum, Capital Gains Opportunity Fund
To date, Ablum and partners have focused on multifamily rental properties in places like Sacramento, Calif., and Norwalk, Conn.
“The asset classes we like are multifamily rental, student and senior housing, hospitality and mixed use,” Ablum says. “We have good experience with each of those.”
He’s seeking local properties, as well.
“We’re looking at a few properties in and around Tampa, a couple that are off the I-4 corridor,” says Ablum, who previously co-headed corporate finance for New York securities and broker/dealer firm Rodman & Renshaw.
Unlike many Opportunity Zone funds, Capital Gains is matching investors’ capital — about $15 million to $20 million per deal — to specific deals, rather than pooling it all into a general fund, as many have done.
Capital Gains also is vetting all of its deals through Plante Moran, too, to consider the tax impacts underlying the real estate investments.
It hasn’t been an easy process, however.
Though new “guidance” in April from the U.S. Department of the Treasury clarified many misconceptions surrounding the zones, significant questions remain around what can be done, and when, and how property dispositions are to be handled.
Investors also are racing the clock. U.S. Internal Revenue Service rules say all Opportunity Zone investments must be placed by the end of this year to qualify for the ability to exclude 15% of the capital gain benefit when a property is sold at the end of 2026. (Investors can also place money in 2020, with lesser benefits.)
“The biggest issue I’m seeing is that many developers are waiting on the sidelines because all the requirements haven’t been firmed up or they don’t exist,” Petra says. “But we’re telling clients not to wait, just be mindful that you may have to be flexible going forward.”
At the same time, sellers of property this year must wait until Dec. 31 to redeploy funds to defer capital gains, but then have a scant 180 days to identify an Opportunity Zone investment.
Maximum benefits from owning and improving property — another iron-clad IRS rule — that include the waiving of capital gains altogether come only after 10 years.
“The problem is, most real estate investors don’t consider a 10-year investment window” says Ablum, who also worked for Prudential Bache Securities, Borg-Warner Acceptance Corp. and Walgreen Co.
“And that’s because the (internal rate of return) tends to drop off precipitously after year seven. So we’re spent a lot of time looking at scenarios in which the tax benefit pushes up the yield to make the deal more attractive overall.
“Ten years is a very long time — in real estate, it’s a lifetime to some people. Because in 10 years, your luxury apartment building might not be considered luxury any longer.”
Ablum also has faced hurdles regarding eventual dispositions.
“We spend about half our time pondering ‘how are we going to get out of this?’” Ablum says. “You have to consider whether the area, not just your property, is growing or has the potential to grow over the next decade.”
Additionally, he worries about macro-economic conditions.
“I’ve been through five recessions,” he says. “A lot of people in real estate today haven’t been through even one. I think there’s a 100% chance that the U.S. will have some sort of economic recession sometime in the next 10 years.”
Some properties just don’t meet the criteria, either.
“We look at probably four to five new transactions a week, and half just don’t fit,” Ablum says.
And despite all the supposed money chasing Opportunity Zone investments, raising capital has been another obstacle.
“We have two of our partners who are full time working to raise money, and it hasn’t been easy,” he says. “I think that’s because in the scheme of things, we’re a small player. Our first commitment is going to be for about $30 million. And $250 million sounds like a lot, but it’s not when considering these investments, and there’s a lot of competition out there.
“Fortunately, we’re ahead of the curve, we know the rules and we’re working our model,” Ablum says.
Meanwhile, Petra continues to grapple with the arcane differences between states as each has rolled out Opportunity Zone designations.
“There’s not a universal system to work from,” he says.
He thinks, too, that further rules could be forthcoming from the federal government.
But while the zones have altered the landscape for taxes, Ablum says some key real estate fundamentals still apply.
“A bad deal doesn’t become good because it’s in an Opportunity Zone,” he says. “You still have to make good deals.”