When Michael Tillman’s PTM Partners bought property in Overtown in February to build an 18-story apartment complex, it became one of the first Miami-based real estate firms to utilize the Opportunity Zone program.
The federal program is seen by many as the biggest economic boost to the real-estate industry since the 1031 Exchange. But given the murkiness of the Opportunity Zone guidelines, developers have been slow to get shovels in the ground.
Office developers were especially wary, given a rule that stipulated that at least 50 percent of a business’ income must come from within the Opportunity Zone in order to qualify for the tax breaks. That meant that these developers would have a harder time using the prospect of tax breaks to lure new tenants.
New proposals released by the Treasury and the IRS in April, however, make it easier for businesses to qualify for the Opportunity Zone tax benefits. And that, in turn, could stimulate new-office constructions as developers gear up to cater to the increased demand.
“This is going to make it easier for businesses to qualify and it’s going to be easier to lease (office) space,” said James Jago of Pebb Capital, who is working on projects in Opportunity Zones in New York and Florida.
What changed?
The April rules clarified a number of developers’ most pressing concerns about how a property could be refinanced, and how much time real estate funds had to buy and reinvest in Opportunity Zone properties.
But the biggest change could be a provision around how Opportunity Zones businesses can qualify for the tax benefits. According to the initial regulations, businesses could only qualify if they received at least 50 percent of their gross income from a trade or business coming from within the Zone.
This made sense for a real estate development, such as a multifamily project, where all of the income is coming from the project in the zone. It made less sense, however, for businesses like software companies or manufacturers, who may have operations spread throughout the country and may derive just a sliver of income from the actual zone.
Under the new proposed rules, a business can also qualify for the tax breaks if 50 percent of wages or hours worked come from within the zone.
“For the incubators, the start-ups (businesses), there is now going to be a lot of action,” Jago said.
The Opportunity Zones program was part of President Trump’s tax overhaul and was meant to provide investment in distressed areas that traditionally had little private investment. Real estate developers quickly became enamored with the program and large real estate investment funds such as EJF Capital and RXR Realty were seeking to raise substantial Opportunity Zone funds, hundreds of millions of dollars of capital and in some cases billions.
Developers or investors investing in an Opportunity Zone could defer and potentially forgo paying capital-gains taxes.
John Gahan, a partner at the law firm Sullivan & Worcester, said the new rules could also increase the types of businesses and projects investors can invest in.
“Uncertainty regarding how capital got deployed and re-deployed led many to structure their funds as one asset ( one location) per fund,” Gahan said. “Following this round of guidance, there will be more funds holding multiple assets.”
One of the largest projects in an Opportunity Zone, LeFrak and Turnberry Associates SoLe Mia in North Miami, is currently trying to figure out how best to use the program.
The development group could see $100 million in added revenues from using Opportunity Zones, Bloomberg reported, with their $4 billion megaproject slated to have more than 500,000 square feet of office and retail space.
Richard LeFrak previously told the publication last year that he thought that office could be the best use of the program.
Other office properties around the country are also seeing more redevelopment potential. In North Carolina, Grubb Properties bought a 120,000-square-foot building right across from the University of North Carolina-Chapel Hill, where the developer is hoping to redevelop the property and add more co-working space, according to the News & Observer.
Quinn Palomino, co-founder and CEO of Virtua Partners, a private equity firm, has four Opportunity Zone funds and is focusing on single-family rentals and hospitality projects, including a 130-room Springhill Suites by Marriott in Avondale, a suburb of Phoenix.
Palomino said she is looking to build single-family rentals in Opportunity Zones because there is a ton of demand for entry level housing around the country. She said developers are looking for projects that they can stabilize quickly and provide the highest rates of returns for investors.
“The main rules are still in place, you need to get that project completed in 30 months, it needs to be profitable,” said Palomino. “Opportunity Zones is an incentive that doesn’t change the basic rules of investing.”