Certainly, the delay of capital gains to 2026 is an attractive element of an Opportunity Zone investment.
Opportunity Zones present an enormous opportunity to realize important public policy goals for stimulating investment in much-needed housing in underserved markets, particularly in reviving stalled projects that have already been entitled.
For the rental housing community, the advent of Opportunity Zones triggers three key considerations.
Most of the designated zones are located in areas where the achievable economic rents do not support today’s new construction costs. Therefore, it is likely that investments in these zones will also require other elements of public commitment, such as Low-Income Housing Tax Credits, middle-income (workforce) housing funds, Historic Tax Credits, etc.
It should be emphasized that the otherwise taxable gain needs to be invested within six months of realization. Therefore, more often than not, investors will need shovel-ready projects to invest in – not projects just beginning a potentially arduous design or permitting process.
Rental housing developers and property managers can become involved in Opportunity Zone investments in two practical ways. First, they can directly invest their own capital gains in their own projects and deals. Second, they can invest through a fund, such as an investment bank generated fund, in which they pool their gain with the gains of others in order to invest in a variety of projects in a variety of locations through various developers and sponsors.
Certainly, the delay of capital gains to 2026 is an attractive element of an Opportunity Zone investment. But, for the rental housing industry, the most important focus should be on investing such gains in developments that have the best potential for value growth, enabling the delayed gain to enjoy substantial tax-free returns. This is where the most attractive aspects of Opportunity Zone investment will occur – projects in under-served census tracts that have the best potential to realize long-term tax-free gains.
Ultimately, Opportunity Zones represent a welcome and exciting incentive from the federal government, but caution is needed.
An Opportunity Zone is not a magic wand that causes age-old real estate fundamentals to instantly disappear. Allowing the attractive nature of the new program to cloud a hard analysis of the underlying fundamentals will impact the long-term success of projects and growth of the investment.