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Replicating Success: How Opportunity Zones Are Reshaping the Investment Landscape

March 21, 2019

KSM Real Estate Services Group

The economic divide in large cities continues to expand. Despite a financial resurgence following the recession that occurred between 2007 and 2009, the system wasn’t fixing itself. Enter the Qualified Opportunity Zone (QOZ) program, a creation of policy think tank Economic Innovation Group (EIG) designed to boost development in economically distressed communities.

On March 13, Katz, Sapper & Miller and Ice Miller LLP hosted a seminar that took a closer look at the program, “Seizing the Opportunity: The Vision and Forecast for Opportunity Zones.” The two-hour event included a fireside chat between Steve Glickman, co-founder of EIG and CEO of Develop LLC, and Jay Augustyn, partner at Ice Miller, followed by a panel discussion with:

Defining Opportunity Zones

Glickman co-founded the EIG in 2013 following his time as a senior economic advisor for President Barack Obama. Part of his efforts with the EIG was the creation of the QOZ program, provisions for which were included in the Tax Cuts and Jobs Act (TCJA) of 2017. According to the TCJA, a QOZ is an economically distressed community where new investments may be eligible for tax benefits.

“Opportunity Zones are not a traditional community development tool, rather, they’re a way to tap into investment capital within a community,” said Glickman. Glickman said in the past community development relied on massive government programs. The only way to solve the perpetual crumbling of distressed areas was to tap into investors who were willing to rebuild their connective tissue within the cities they had left behind.

With QOZs, the incentive to invest will limit the taxable impact of capital gains. Investors can take part by placing existing capital gains into vehicles called “opportunity funds,” which push investment dollars into the distressed areas. By investing in QOZs, developers can realize several benefits, including:

  • Deferral of gain recognition until the earlier of Dec. 31, 2026, or sale of investment
  • Exclusion of 10 percent or 15 percent of the gain if the investment is held for five or seven years, respectively
  • One hundred percent gain exclusion for investments held at least 10 years

Finding the Opportunities

Glickman says fund managers are currently the primary movers of the initiative. QOZ fund managers must raise capital from high-net-worth investors, execute real estate and development and investment – and do so in second-tier markets, some of which are economically distressed – manage the investments like a private equity fund, and adhere to the strict rules of the program. Investors and developers are also very active in the market.

The implementation of QOZs is leading to the formation of a new industry asset class that focuses on a place-based value of investing. Investors are able to make long-term bets on locations most people aren’t recognizing as growth opportunities. Yet, when growth occurs, the gains can be tax free.

Glickman closed by noting the big advantage of being an early mover in the market: Incentives become reduced the longer you wait. “Now there’s an opportunity to buy assets at good value and a way to build a track record and brand in a new space,” he said.

A Deeper Dive

During the panel discussion, experts offered insight into how they were seeing the QOZ program being applied. KSM’s Chad Halstead kicked off the chat by reiterating the advantages for investing in QOZs but noting that to qualify for participation, investors and corporations must already have capital gain. “The benefit is deferral. You won’t pay tax until 2026 unless you dispose of the asset early,” he said. “If you hold the investment for 10 years, appreciation in the asset is tax-free.”

The panelists agreed on the importance of place-based value investing as one of the key goals of the program. “State and local communities can make opportunities more attractive to investors,” said Halstead. “But if you want to market an Opportunity Zone, you need differentiators.”

Ice Miller’s Matt Ehinger echoed this point. “If we can identify industries that would benefit from the program, we can reduce the difficulties of getting investment.”

Halstead added that the approval process needs to speed up on the state and local level to maximize the program. Eric Gershman of Gershman Partners agreed. “As time goes along, the benefits of the program become less enticing.”

Panelist Parting Thoughts

The collective panel agreed that one of the key challenges to the program is identifying viable projects to undertake within an Opportunity Zone. The identification process needs to be very intentional and focused on the right partnerships; it needs to ensure investors get what they want out of the program while also benefiting the targeted communities.

Ehinger still sees some work to be done in getting the marketplace comfortable with investments in Opportunity Zones. “The projects must meet fund requirements but also satisfy individual investors.”

Halstead stressed the QOZ program is still developing, and investors must be willing to accept a certain level of risk. “Initial IRS regulations weren’t clear, so we need to build deals based on where we expect statutes to go.” But for high-net-worth investors with capital gains looking to capitalize on the new legislation while simultaneously improving communities, the program has substantial upside.

For more information on QOZs, or for help determining relevancy for your situation, please reach out to your KSM Advisor.

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