Opportunity zones are a hot topic in commercial real estate. Why? Investors receive big tax benefits when investing in these government-designated areas. However, no good thing comes without risk. Read further to learn about the big weakness in opportunity zones.
What is an opportunity zone?
You can read more about opportunity zones basics here. In short, opportunity zones are government designated census tracts where investment is encouraged through significant tax benefits.
Where are opportunity zones and how do I invest?
The US Department of the Treasury Community Development Financial Institutions Fund provides a list of designated opportunity zones. Opportunity zone investments must be made through an “opportunity fund” entity. An opportunity fund must have at least 90% of its assets in opportunity zones. Investments must be for new construction or “substantial” renovations (major redevelopment projects).
What’s the catch?
Opportunity zones tempt sponsors to over-look risky market fundamentals in return for favorable tax benefits. Opportunity zones typically coincide with low-income, under-served neighborhoods.
While you can (and should) expect a lower yield and IRR in an opportunity zone project, don’t compromise on the risk metrics. Debt coverage and leverage ratios still matter.
Does the classification spur riskier investments?
Yes – think modern day gold rush for wealthy Americans in high tax brackets.
Community criticism of opportunity zones ?
Opportunity zones were designated using the 2010 census. Since then, some areas have seen substantial growth. In some cases, development is being encouraged in already gentrified areas.
What is a CRE professional to do?
Proceed with caution. Opportunity zone benefits are icing on the cake. Don’t confuse it with the cake.
Learn more here: Fundrise: What are Opportunity Zones and How do They Work?