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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   June 2019

Working in a New Frontier of Opportunity

Private lenders can help investors revitalize economically distressed neighborhoods

Definition

Opportunity Fund

An Opportunity Fund is an investment vehicle implemented by the Tax Cuts and Jobs Act of 2017 to spur investments in targeted communities known as Opportunity Zones, which are census tracts designated by state and federal governments as targets for economic development. Investors can defer federal taxes on any recent capital gains until Dec. 31, 2026, reduce their tax payment by up to 15 percent, and potentially pay no taxes on any profits from an Opportunity Fund if the investment is held for 10 years.

Source: Fundrise

The federal Tax Cuts and Jobs Act of 2017 introduced a new pathway to revitalize properties in struggling neighborhoods across the U.S. Aptly named “qualified opportunity zones,” investments made in these areas qualify for select tax incentives designed to help property owners retain more of the gains on their investment.

Opportunity zones were created to spur investors to buy and renovate properties in once-bustling areas that have fallen on hard times. Two things should be said about them from the outset. First, the potential tax benefits diminish over time and will eventually expire, so the clock is ticking to take advantage of the program. Second, it is clear that private lenders and their commercial mortgage broker partners are ideally suited for financing deals within opportunity zones.

More than 8,700 areas across the U.S. have been designated as opportunity zones since the program’s rollout in 2018. This should spell new opportunities for commercial mortgage brokers to connect investors with financing. The average opportunity zone has a housing stock with a median age of 50 years, about 10 years older than the U.S. median, the Economic Innovation Group reported.

Capital, including the flexible debt financing primarily provided by private nonbank lenders, is desperately needed to revitalize these neighborhoods. Many deals will be completed in these areas, particularly in 2019 when the tax incentive for investors is the greatest.

Tax advantages

The new tax code established a temporary investment vehicle, known as an Opportunity Fund, which is set up as either a partnership or a corporation for investing in properties located in designated opportunity zones. Basically, investors can place their capital gains from another property sale into the fund to gain tax benefits.

First, the investor is allowed to defer paying federal tax on the initial gains until the property located in the opportunity zone is sold or until Dec. 31, 2026, whichever comes first. Investors also can reduce the amount of capital gains taxes owed. Holding an eligible property located in an opportunity zone for at least five years earns the investor a 10 percent break. In other words, only 90 percent of the original capital gain is subject to tax. Holding the property for at least seven years earns a 15 percent break.

Furthermore, investors who hold the property for at least 10 years won’t have to pay capital-gains taxes on that investment once the property is sold or exchanged. The opportunity created by these tax advantages is enormous. U.S. Treasury Secretary Steven Mnuchin predicted last year that the zones would attract $100 billion in private-capital investments.

Investors have been scrambling to create funds that take advantage of these time-sensitive tax breaks. This past October, The Real Deal reported that a handful of companies had already launched efforts to raise funds, with a minimum target investment of $500 million for projects in opportunity zones throughout the country.

Hurdles to clear

For commercial mortgage brokers and investors looking to finance deals in opportunity zones, it is not as simple as identifying a building or a piece of land and getting to work. Investors can face several obstacles to secure the capital needed to purchase properties in opportunity zones.

For one, traditional investors are likely to shy away from these deals. Although many buildings or land located in opportunity zones are ripe for development or redevelopment, they are regarded as a risky investment. Many sites are in economically depressed areas, which aren’t attractive to traditional financing institutions with rigid lending criteria.

Opportunity zone projects also can be ambitious. A risk-averse lender simply may not see the deal on the table in the same light. Finding a new use for a long-defunct property can be enthralling yet challenging. A traditional lender may look at an old, dilapidated factory, for example, and may not share the investor’s vision to convert the building into a multipurpose venue.

Finally, time is of the essence. Investors have until the end of 2019 to secure the necessary capital and purchase property in an opportunity zone in order to take advantage of the maximum capital-gains tax benefit of 15 percent. Those looking for the right opportunity have limited time to identify a property, move on all the necessary paperwork and make the purchase.

Enter private lenders

All of these factors make it likely that private lenders will be key players in funding deals in opportunity zones. Lenders will need to be creative and willing to take risks to revitalize these struggling areas.

A private lender is typically flexible and is capable of seeing beyond the old building or empty lot in front of them. They can truly partner with an investor who has an ambitious dream to breathe new life into the area. Traditional lenders are more likely to shy away.

An opportunity zone located in a former industrial area, for example, may work for a mixed-use complex or an apartment building because of the available public transportation and its location near major employers. A traditional lender is likely unwilling to take that kind of risk.

Private lenders also have the added advantage of moving faster on an opportunity than a conventional lender. Banks and other traditional institutions can take months for approval and many investors simply do not have that kind of time. Given a clean title and a recent appraisal, private lenders can close a loan in weeks and, in some cases, days.

• • •

Time is of the essence for investors who want to capitalize on the tax benefits offered through opportunity zones. Although there is still time to take advantage of these tax breaks, that timeline gets shorter with each passing day. Working with a flexible private lender can shave precious weeks or months off an already strict timeline — a key component of a successful investment, especially when the clock is ticking. 


 


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