Introduction to Opportunity Fund Investing

This learning series on Modern Commercial Real Estate Investing first appeared on the EquityMultiple blog. Please check in there for updates and additions to this series.

“Our bet [is] if you create a brand-new model, one that can scale as much capital as can be brought in, and there’s, by our calculation, about $6 trillion in unrealized capital gains. It could be rolled into this Opportunity Zone program, rolled over through private sector vehicles, whose Opportunity Fund function like just about any other type of fund out there. And there’s no government intermediary to have to pre-approve projects or that creates a bunch of red tape around how you do this — you can move capital at scale in these communities … What model would both be attractive enough for investors to use on the one hand, and then have enough parameters and safeguards so we knew the capital was, one, going to places that need it, two, going to investments that were economically productive, and three, ultimately creating more businesses and jobs. And we think this program has all that.”

-Steve Glickman, Co-Founder & CEO of the Economic Innovation Group

The Investing in Opportunity Act — a bipartisan component of the Tax Cuts and Jobs Act1 passed by Congress in late 2017 created the Opportunity Zone program: a system of substantial tax incentives for private investment in under-resourced census tracts across the United States.

What is an Opportunity Fund, and What Does It Mean for Real Estate Investors?

An Opportunity Fund is a U.S. partnership or corporation (typically an LLC or S-Corp) that invest at least 90% of its holdings in one or more qualified Opportunity Zones: census tracts determined by state governors and the Treasury Department. There are over 8700 across the United States and territories.

Opportunity Fund investors benefit from deferment and reduction of capital gains on prior investments if rolled into a qualifying Opportunity Fund and, most significantly, potentially paying $0 in taxes on gains realized through an Opportunity Fund held for 10+ years. For more on the program, and the specifics of tax advantages to real estate investors who participate, please consult our Resource Page on Opportunity Funds.

The program is not limited to real estate, and investments in equity funds and infrastructure in qualifying census tracts may have a significant impact on revitalizing Opportunity Zone communities. However, the program is a natural fit for real estate investments for the following reasons:

• Precedent: many real estate developers and investors are accustomed to tax-advantaged investments from the New Market Tax Credit program, or other incentives offered by HUD. The tax advantages of Opportunity Fund investing, though, are much more robust, much simpler, and less subject to red tape.
• Housing affordability: many of the qualifying census tracts are in dense, transit-rich urban areas where housing is in short supply, and demand is at an all-time high. Many of these areas are already natural targets for real estate investment, and this program should provide additional incentive.
• The real estate isn’t going anywhere: to qualify for complete removal of capital gains tax, the Opportunity Fund must be held for ten years, with 90% or more of the Fund held within Opportunity Zone(s). Because ground-up and value-add real estate investments are typically long-dated to begin with, and because the investment is immobile, the program aligns well with commercial real estate.

Opportunity Zones in the close-in Seattle neighborhoods of Pioneer Square, North Beacon Hill, and the International District

Where are Opportunity Zones?

Qualifying census tracts were nominated by state governors and approved by the Treasury Department. All told, there are 8,700 Opportunity Zones across the country, spanning the entire country. They are 75% urban and 25% rural by population, covering roughly 10% of the land mass of the United States and covering a huge diversity of urban, suburban, and rural areas, including:

• Sections of the Lower East Side, Harlem, and Inwood in Manhattan
• The entire island of Puerto Rico
• Central urban cores in Rust Belt cities like Cleveland and Detroit
• Close-in neighborhoods in cities already experiencing robust growth, such as Houston and Nashville
• Infill markets in some of the strongest real estate markets in the country, such as Seattle and Los Angeles
• Wide swaths of suburban and rural land, particularly in western states

With this wide set of disparate communities eligible for tax-advantaged investment, there is likewise a diverse set of new opportunities for tax-advantaged investing across the country. Large rural areas in the Pacific Northwest and Southwest may be natural targets for clean energy infrastructure or industrial investment, whereas densely-populated urban census tracts may be natural targets for workforce housing and mixed-use space.

The Benefits of Opportunity Fund investing

Though a rollover into an Opportunity Fund provides a step-up in basis after 5 and 7 years, the most compelling incentive comes after a 10 year hold: investors who hang onto an Opportunity Fund investment for 10 years or more can not only defer capital gains paid on the initial rollover amount until Tax Day 2027, they will also pay $0 in capital gains on the appreciation of the Opportunity Fund.

For a complete breakdown of the incentives, and some illustrative examples, please refer to our Opportunity Funds Resource Center, which features a comprehensive post-tax return calculator. In short, rolling over a prior investment and holding an Opportunity Fund for 10 years can potentially increase earnings by 70% or more as compared to a continued hold of the prior investment.

How EquityMultiple is Well-Positioned to Provide Opportunity Fund Investments

EquityMultiple has access to a vast pipeline of sponsors and lenders across the country, and has raised capital for projects totaling nearly one trillion dollars in overall capitalization across dozens of markets. This national reach and network of partner real estate firms positions EquityMultiple to target real estate investments in the most promising qualifying census tracts. In order to qualify for tax benefits under the new program, real estate development must be either ground-up, or constitute “substantial improvement” (value-add upgrades within 30 months of acquisition that amount to at least the going-in basis). In other words, real estate investors may not reap tax incentives by simply “flipping” an existing property, an essential qualification for the program to have the intended effect on under-invested communities. EquityMultiple’s network of sponsors and developers includes many experienced, well-capitalized firms who are adept at executing these longer-dated projects.

Because EquityMultiple has already built a platform around efficient investment at low minimums, EquityMultiple is well-positioned to offer a diverse mix of Opportunity Fund investments across census tracts and markets and, potentially, to create multi-property Opportunity Funds within and across census tracts.

The Intent & Spirit of the Investing in Opportunity Act

EquityMultiple remains focused on providing investments with compelling investment theses, and attractive target returns. That said, we strongly support the underlying mission of the Investing in Opportunity Act and believe that, with proper guidance, Opportunity Funds can bring high-impact investment to neighborhoods and markets that will benefit tremendously.

Communities throughout the United States possess assets that can propel them to economic vibrancy with the help of targeted investment. We are looking forward to offering compelling Opportunity Funds in promising Opportunity Zones across the country, and opportunities for our investors to truly “do well by doing good”.

If you are interested in learning more, and receiving future updates, please visit our Opportunity Funds Resource Page.